Expert Investor: Nick Cregan – 3 Small Cap Stocks You’ve Never Heard Of

HOSTS Alec Renehan & Bryce Leske|13 August, 2020

Meet your hosts

  • Alec Renehan

    Alec developed an interest in investing after realising he was spending all that he was earning. Investing became his form of 'forced saving'. While his first investment, Slater and Gordon (SGH), was a resounding failure, he learnt a lot from that experience. He hopes to share those lessons amongst others through the podcast and help people realise that if he can make money investing, anyone can.
  • Bryce Leske

    Bryce has had an interest in the stock market since his parents encouraged him to save 50c a fortnight from the age of 5. Once he had saved $500 he bought his first stock - BKI - a Listed Investment Company (LIC), and since then hasn't stopped. He hopes that Equity Mates can help make investing understandable and accessible. He loves the Essendon Football Club, and lives in Sydney.

In this interview we sit down with global small cap expert Nick Cregan. Nick is a portfolio manager at Fairlight Asset Management, a fund manager specialising in global small and mid caps.

In this interview we asked Nick to take us through three specific small caps he’s been looking at. Ideally, three we’ve never heard of. He obliged and took us through the research process and investing thesis for three companies from around the world.

In this interview you will learn:

  • Nick’s personal investing philosophy
  • Why Nick prefers global small and mid cap stocks
  • The key features of the Aussie small cap market compared to other parts of the world
  • How COVID has impacted the global small cap market
  • Nick’s three specific small cap stocks:
  • Ritchie Bros Auctioneers (NYSE: RBA)
  • Verisk Analytics (NASDAQ: VRSK)
  • Nemetschek Group (ETR: NEM)


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Bryce: [00:01:28] Welcome to another episode of Equity Mates, a podcast where we help you learn to invest in 45 minutes or less. We break down the world of investing from beginning to dividend so that you can hopefully make some returns. My name is Bryce and as always, I'm joined by my equity buddy Ren. How's it going? [00:01:42][14.3]

Alec: [00:01:42] I'm very good. Bryce very excited for this interview. We are getting stuck into the smaller end of the market and that's a big focus or big interest for me, the small and mid-cap space. And we've got a true expert here to help us understand it and unpack it. [00:01:58][15.5]

Bryce: [00:01:58] We do. We are fortunate enough to be joined on the show this evening by Nick Cregan. Nick, welcome to the show. [00:02:04][5.9]

Nick: [00:02:05] Thanks very much, guys. Appreciate your time and your interest. [00:02:07][2.2]

Bryce: [00:02:08] So Nicholas has 17 years investment experience in both domestic US and international markets. He's currently the partner and portfolio manager at Fairlight Asset Management and is an expert in global, small and mid-cap stocks, which Ren mentioned is a particular interest of ours. And Nick focuses in on technology, health care, light, industrials and consumer staples. So, look, we're going to pick his brains when it comes to the process of finding small caps and how we should be thinking about small caps, small and mid-cap stocks in our portfolio. So let's [00:02:43][35.6]

Alec: [00:02:44] do it. Yeah, and we've even got a few specific stocks that we're going to unpack. But before we do all that, we like to start with a game. The game is overrated or underrated, and so we'll get stuck into that now. So, Nick, first up, we'll start domestically at home, overrated or underrated, the ASX 200 index. [00:03:02][18.6]

Nick: [00:03:03] Very good question. And I think it depends on when you're looking at from a historical perspective basis. And I don't want to put the boot in too hot here because Credit Suisse did a study and I would show that Australia has been the best performing index from nineteen hundred all the way through to 2009. Yet it has in 1930 both the US and the European indices. So it's hardly been what you'd call a slouch. But that performance has come from a reasonably narrow contingency of stocks. So just under 50 per cent of the ASX 200 is comprised of financials. A big portion of that, of course, is the banks and resource stocks. So any sort of reversal of any of those trends driving the Australian economy over the last 30 years would leave investors pretty exposed. It's also quite expensive technology and interest rates are quite low, but the index itself is quite expensive. So from my point of view, overrated. [00:03:49][46.3]

Bryce: [00:03:51] Fascinating. That's such an interesting stat. Definitely going to pull that one out. [00:03:55][4.0]

Speaker 3: [00:03:55] Yeah. Yeah. [00:03:56][0.5]

Nick: [00:03:56] So it's it's been a wonderful place to be historically. But some of the some of the potential headwinds coming up could be a bit of an issue for Australia as we dive into some of the details through the talk. [00:04:08][11.7]

Bryce: [00:04:08] I think so, Nick. Overrated or underrated, the Nasdaq 100? [00:04:13][4.7]

Nick: [00:04:14] Well, once again, if we include Facebook, Amazon, Netflix and Google as part of the S&P, five hundred, the tech sector now makes up a record. Thirty seven per cent of the S&P. Five hundred, which is pretty interesting because you think that that actually peaked at less than thirty five per cent during the tech bubble of 2000, sorry, ninety nine, 2000. Of course, the major difference this time around is there's actually some real businesses with wonderful cash flow and growth opportunities. So there's no doubting that the amount of junk that was in that index going back to ninety nine was pretty horrific. But once again, from a valuation standpoint, they're incredibly expensive and probably due to a higher proportion of Robinhood investors and. [00:04:52][38.4]

Speaker 3: [00:04:53] Right. [00:04:53][0.0]

Nick: [00:04:54] And probably greater representation as well. So from my point of view, once again, overrated. [00:05:00][5.6]

Alec: [00:05:01] Hmm. So if we move back home, Australians obviously love property, but we want to get your thoughts on it. So overrated or underrated Australian residential property. [00:05:11][10.1]

Nick: [00:05:12] Great question. I think you can look at this topic through a couple of different lenses and the first one being financial. The question really is, do we think it's reasonable to expect the Australian property market to deliver some kind of reasonable return over the next couple of decades? I'm not sure I've got a great answer for this one and hardly wins you any friends raising the topic at a barbecue? Because a lot of Australians, I think and I believe the statistic is we're number two in terms of household debt to GDP after the Swiss prices have definitely benefited from benefited from a one way trend in interest rates over the past 20 years. So not really a lot of juice to go there either. I think Turnbull, as you guys said on the call on the programme a few weeks back, made a pretty good point on migration levels. So there's reason to believe we've got some stagnation going there. Lending standards are going to come in and it's probably not hard to see why the Australian housing lending is now contracting at the fastest levels we've seen over the past 30 years. So from a pricing perspective, I think it's reasonable to say it's probably overrated. But the other way of looking at it, of course, is through the lens of personal freedom, which I'm sure you guys are probably a little bit more outside with. And leveraging an asset 10 to one doesn't give you a lot of wriggle room and probably. Stifle your ability to take risk, so if you want to get involved in a new business venture, like launching a podcast, for instance, and having sort of a high percentage of disposable income going to mortgage servicing, it really does put a damper on your entrepreneurial perspective. So from that point of view, I think it's a little bit overrated also. [00:06:45][92.8]

Bryce: [00:06:45] And podcasting is a highly risky business. [00:06:48][2.4]

Nick: [00:06:50] I've just heard over the last few weeks you guys sort of pitching your ways and trying to sort of raise a bit of equity on the side. I thought from that. [00:06:56][6.0]

Bryce: [00:06:57] Are you. Should we take the short [00:06:58][1.3]

Speaker 3: [00:06:58] line we [00:07:00][2.2]

Alec: [00:07:01] would classify as a small cap? [00:07:02][1.3]

Speaker 3: [00:07:03] Yes. [00:07:03][0.0]

Nick: [00:07:05] So from that point of view, I think that I think you had, Ed from today on the line a couple of weeks ago as well, that saying that he doesn't own residential property. I put myself firmly in that camp as well. So putting our money where our mouth is and into into equities. [00:07:18][13.4]

Bryce: [00:07:19] Well, that was actually going to be my follow up question, because we had a couple of listeners reach out quite recently, actually, and and have suggested that the follow up should always be, you know, do you actually own property? Because we have a lot of these investors come on. And sort of, you know, give us a lot of reasons why property isn't good, but then they have this big property portfolio sitting behind them. So it's it's kind of like, you know, are you actually putting your money where your mouth is? So it's actually interesting that you're in that boat. [00:07:44][25.6]

Nick: [00:07:45] Yeah, I think they also you probably should get the follow up question. A few of the people who are listening in on, does the fund manager put his money into the fund is managing as well, which is it? Usually a pretty good indicator of what they sort of think of their own strategy and and whether they're willing to back themselves alongside their clients into that in debriding? Our team is heavily invested in the fund. So plenty of alignment through Fairlight. [00:08:05][20.8]

Bryce: [00:08:07] Add that one in. And if if the fund manager says no, then we've just sunk their funds. So so continuing on a couple more overrated or underrated, the Australian WACs stocks. So why is tech apen Afterpay zero? You know the big darlings at the moment? [00:08:27][19.8]

Nick: [00:08:27] Absolutely. And as you guys know, we at Fairlight invest 100 per cent offshore. So the limited amount of research I've done on the Australian tech businesses, I can offer some thoughts, but it may not be particularly wise counsel. So they take it with a grain of salt. But from the limited rating, Abdullah was picked specifically. It does seem to be quite the collection of prominent warts across its governance and accounting function. So plenty of red flags from across the board, highly acquisitive. It's capitalising its cost maybe should be expenses. It uses sort of quirky accounting gimmicks to shoulder some of some of its subsidiaries against what would think would be pretty appropriate scrutiny. And last but not least, insiders have been dumping stock at quite a rates on 20 times sales. I suspect that one's highly overrated. Afterpay is an interesting one and perhaps a little bit misunderstood when the business model first came out. Obviously, the newer generation tend to have less of an affinity with credit cards. So the company has found a genuine fit. But the big question is one of what the steady state look like and competition really rapidly coming into that part of the market. Do we need one do an eight five? It's pretty unclear to how that market develops. Once again, very, very expensive. Altium, I don't know that much about it other than it's got a pretty large addressable market, but a little bit more defined in the other WACs cohorts up. And from what I understand, use sort of humans to help I train neural net. So it's certainly a pretty sexy part of the market. But an impressive customer base, 70 per cent of their revenue is made up of just three customers. So from a concentration point of view or risk point of view on a big multiple, I'd say it's pretty overrated. And then zero, which is a genuine success story, born out of a pretty unique time when Michael was in private equity and private equity in their infinite wisdom, taking a knife to R&D and levering up the balance sheet maybe allowed zero to get a little bit of a leg ahead. Very, very impressive business being run by for growth as a cohort, however huge multiples. So all of that sort of good news is really priced into the outlook for the tech sector. And I think overrated probably talks a little bit of the narrowness of the Australian market and inability to find great businesses on decent multiples. [00:10:38][130.2]

Alec: [00:10:38] Mhm. Yeah, it's a serious scarcity play. [00:10:40][1.9]

Nick: [00:10:41] Yeah, I think so. [00:10:42][0.7]

Alec: [00:10:42] So next one, US China trade war is a very on again. Off again. Will they, won't they. Topic between Trump and Beijing. Jinping but overrated or underrated if the trade war does happen and does really blow up overrated or underrated, the effect it will have on the Australian economy. [00:10:59][16.5]

Nick: [00:11:00] Good question. And looking a little bit of history here is useful. So the last time we had a major downturn, we had a pretty good relationship with China and they unleashed a huge fiscal credit stimulus in 2009, which is about 10 per cent of GDP to pay for the construction of roads, bridges, railways, all that sort of stuff. And most of that or a great deal of that was a big misallocation of resources led to lower productivity. And so this time around, it really does look like the Chinese are a little bit more circumspect in the way that they're spending money. So some of the less commodity intensive projects such as 5G and charging stations for electric vehicles seem to be what they are focussing on. But with the backdrop of the rising tensions between the US and Australia this time around. So it's not just the US, but I did notice that we granted to 10000 new visas to existing Australian residents in response to the national security laws imposed by the CCP. We could expect a pretty dramatic impact to the Australian economy. However, it's not yet coming through in the numbers, which is quite interesting. So for the last six months to June, the exports to China in terms of iron ore is grew by 10 per cent and Coles 13 per cent in LNG was three per cent. So it's not really coming through the numbers yet. And of course, offsetting that is the bans on on beach, Bali, education, et cetera. So it's very, very difficult to see the situation improving either for the US or for Australia. But it does look like the West is coalescing around the idea of a united front against the perceived aggression of an increasingly assertive Chinese Communist Party. It doesn't seem like it's going to get any better, and it does really look like the huge stimulus package that we saw last time around isn't going to happen. So to mine, it's underrated in terms of the impact we're going to see over the next few years. [00:12:43][103.4]

Bryce: [00:12:44] Well, speaking of impact, and to close this out, overrated or underrated, the impact of covid-19 on the Australian economy, or if perhaps if you've got focus over in the US at the moment on the US economy? [00:12:56][12.2]

Nick: [00:12:57] Yeah, it's interesting. I mean, the big question mark is what happens once the stimulus or the support mechanisms roll off? Is there an appetite for further leverage and support of the consumer? I think that's really going to come down to a policy response. So hard to say that it's going to be positive when we see these responses roll off, just the sort of violent rebound we've had in equity markets tomorrow. It looks like it's a little bit underrated in terms of the impact. [00:13:23][26.6]

Bryce: [00:15:18] Moving on from the game. We always like to start these questions with the story of someone's first investment. There's generally a good story or a good lesson that comes out of it. So to kick us off tonight, can you tell us the story of your first investment? [00:15:32][14.5]

Nick: [00:15:33] Yeah, sure. I thought maybe when my first investment, it might be a little bit more constructive in terms of the lessons I learnt from one of my first larger investments. And that came about when I was a sell side analyst with the job of analysing. And I was a young analyst. So my very early 20s analysing and providing research on a terrible business called hasty air conditioning. And I was probably a few people in the cold if they're old enough to remember this business. But by all accounts, it really was a terrible business that razor thin margins, the working capital profile was horrific, that it never got paid on time. They were very acquisitive and they used equity as currency to to close deals. So issuing issuing equity at pretty low valuations. And it really was the cognitive bias is at work on my very undeveloped investing mind at that time that brought me unstuck. So we sort of run. So the three the major bosses there, always good to go back and really have a good look at where you thought you were suffering from these, but the first one was overconfidence, bias. So I was young and I didn't know what I didn't know, which is we're all in that spot when we start out. So no problems there. But I had a line into management, so I thought I had a great handle the operations in the financials of the business. But in reality, I was just close enough to the business that they could feed me sort of all sorts of interesting information that may or may not have relevance. There's all sorts of recency bias. So the stock was pretty new and had a very short track record, but quite a successful one, but it certainly hadn't been tested by a cycle. And so it really was a Johnny-Come-Lately sort of business and relying on pretty short track record to figure out whether it was a good business or not. And the last one was confirmation bias. So the nature of the deals that were doing in the short term, the earnings accretion look really terrific, but ultimately became quite over the leverage. Many of the founders of the business, they both left. I managed to sell the stock before I lost all my money, but eventually went to zero. But it was a fantastic list. And in some of the very easy to fall into when we get to too close to a business and start to look at look at it through rose coloured glasses, if you like. [00:17:41][127.4]

Bryce: [00:17:41] Yeah, I love that. You know, we speak about cognitive bias every now and then on the show. And it's something that I think as investors that the early stage of their journey or our journey, it's something we need to consistently remind ourselves of. Are there any sort of biases at the moment that you still need to be very aware of when you're in your day to day? [00:17:59][18.0]

Nick: [00:18:00] Absolutely. And in fact, we've actually built a number of sort of overrides into our process to overcome some of those. And a lot of what we do is backed by research. So there is a group up in the UK called Analytics that put a study together that showed that active managers are professional managers, give up about one hundred basis points per annum in essentially selling the best ideas to Italy and adding to that loses too readily. So what's called the disposition effect? So we overcome that by dividing our portfolio into three major buckets. So high quality growth, stable compounders and low risk turnarounds. And it's really in the high quality growth names that we suffer from that disposition affects more readily. So we're much more patient in the speed in which we sell those businesses. So, yes, we Trimingham we do. Have we looked through the portfolio always through the prism of risk, but it is those businesses that can compound out for long periods of time at high rates of return that can surprise you on the upside. So we built that into our process and tend to hold those businesses a little bit longer than we otherwise be comfortable with. [00:19:03][63.1]

Bryce: [00:19:03] Yeah, that's fascinating. So before we move into some specifics on Smolan midcaps, I guess you can answer this from the from a fellow asset management point of view. But what is the investing philosophy that you now sort of, I guess, live during your day to day? [00:19:17][13.9]

Nick: [00:19:18] Yeah. So the philosophy is and I guess the easiest way to really talk about it is sort of how it's come about, where it's where it's come from, how we arrive there. And ultimately the results have been. But I've been incredibly fortunate that I've been out to steal my personal investing philosophy down into a process that's form the backbone of the business. And during that journey, I've been lucky enough to work with some wonderful mentors like I would want to want to sustain. Now, the founder of Ren wife, Jenny Jones in New York, who is one of the best long term track records investing in US small caps in history. And Stephen Onal is now the founder of Iris, hardworking and a knowledgeable guy. And I've now been fortunate enough to part with some very, very talented people whose philosophy, thankfully, aligns with mine. And we've taken what's empirically, empirically worked for us over the years and cross-check that with the academic literature to design a process that sets out to build as many market tailwinds as possible into our process before we start looking at specific stocks. So in doing that, what we do is we we invest in the smaller cohort of the market as there's evidence over the last hundred years. And this is put together by academic literature over time that US smaller caps outperform the general market over about a hundred year period. It doesn't happen every year, but over that same time period, there is this tailwind of small caps consistently outperforming large caps. By the way, that's not persistent here in Australia. So Australia is one of the unique markets where actually large caps outperform small, but it is persistent across the other developed markets in Europe. So around 90 per cent of the developed market small cap for March. So that's a starting point. And then everything that we do, we look through the prism of risk, as I mentioned earlier. So we don't like sectors that need a lot of debt to drive their returns and we don't like highly cyclical sectors. So we screen those out as well. We invest only in developed markets where we can rely on the currencies and the reporting standards. So we like to be able to rate an annual report, trust the accounting sort of very important. You don't always get that in emerging markets. And sometimes that selective disclosure in emerging markets can be quite interesting as well. We love businesses that generate lots of cash, and so we loosely defined those businesses as quality companies, you can define quality in lots of different ways, but for us, it's really businesses that generate a lot of cash through the cycle. So typically, they've been around for a little while. And then we employ, as I mentioned, three slightly different styles of investing within quality. So we've got growth. We've got what we call stable compounders and special situations. The growth names to use a couple of Australian examples would be sort of typical ccls of the world where you could deploy Keppel's at very, very high rates of return for long periods of time. The same compound as the more you, Woollies and Coles, great businesses. And they can they can sort of a on GDP type returns, drive some margin, maybe buybacks and still can you get to reliable 10 to 12 per cent earnings per share outcomes and then around 10 to 15 percent or portfolios in what we call special situations. And these are turnaround stocks. They're not highly leveraged Ugandan oil explorers, but they're more sort of businesses that are at their core a quality. But they need maybe a management team to be moved along. And we get involved in activities within the activists in the US to try and help this process along or spin off. So statistically, spin offs have generated really good returns over time. So in the last few years or certainly over the last couple of decades, also been a great place to generate returns. And then at the individual level, we don't like leverage. I think that the Russell two thousand, the most leveraged about four and a half times cash flow, which is a pretty interesting place to be, whereas the Fairlight portfolio is more like one times cash flow, which is very low levels of leverage across the business. We remain really disciplined on valuation. Valuation really has added over the last five or six years. So it's kind of just rocketed up to bottom left to top right of the page and valuation as a matter of it. But it will eventually valuation does matter. And so we've been very, very disciplined there and continue to be. And then we remain diversified from both an underlying economic exposure and a market returns perspective. So the correlations. But we also look at the underlying economic exposures of our business. I think, most importantly, when this comes down to a bit more of a softer factor. But we foster a culture that openly communicates errors and swiftly terminates our investment mistakes. And I think that that one is one of the most important parts of our process, that it really is the communication between our team and how that works that allows us to eliminate errors very, very quickly and protect client capital. [00:23:49][271.1]

Alec: [00:23:50] I love that it's a complete philosophy. There's a lot of elements that we can unpack there. But I think it's a it's a pretty robust one in it. It definitely ties together a lot of elements that we hear from a lot of the experts we spoke to. So I think if people want to apply a personal investing philosophy for their personal portfolios, maybe they should just clip that and just set it up, set it as their alarm every morning or something like that. So if we move to the small and mid-cap space specifically, which is where you're focussed and where you're focussed on applying that investment philosophy, if we start General, can we start with what your definition is at Fairlight for your investable universe, what small and mid-cap stocks mean to you guys? [00:24:35][45.4]

Nick: [00:24:36] Yeah, sure. We keep it pretty simple so we decide from five hundred million up to 20 billion in market cap. So believe it or not, a 20 Dollars billion business in the US is still considered. It is crazy. And if you put that into perspective, so if you look at the ASX 200, the median stock is the average or maybe it's the medium that gives SNODDY is eight billion in terms of the average market cap. So the average weighted market cap across our portfolio is ten billion. So that should put it into perspective in terms of the range of businesses that are available offshore. And just want to know, at the end of the day, the Australian markets, I think we account for about four per cent of global market cap. [00:25:14][38.3]

Alec: [00:25:15] To put it truly in perspective, 20 billion is what Coles is valued at currently and from memory, Coles sits in the ASX 20. [00:25:23][8.3]

Speaker 3: [00:25:24] So there you go. [00:25:24][0.4]

Nick: [00:25:26] That's a pretty good start. But we consistently find businesses that are capped at five to 10 billion that don't have a single analyst covering them. So the of wouldn't call them undiscovered businesses, but I guess under broked or under Analise businesses is is quite a stock as compared to the Australian market. [00:25:42][16.2]

Bryce: [00:25:43] That's fascinating. Such a huge pool of opportunity out there. That I guess is Australian investors. It's quite hard to get access to information. How should we as investors early in our journey, think about small caps as part of our sort of portfolio? [00:25:59][16.0]

Nick: [00:26:00] Yeah, it's a good question. And it gets to the heart of whether you should be investing directly or if you should be spending your time analysing managers, quite frankly, because I think where it comes down to is this five thousand three hundred stocks in our index. And so I think in a lot of ways it's it's become less of an idea of management access where in the Australian market perhaps you can sort of. There are a lot of shoe leather and visit a lot of businesses and a lot of annual reports, and you can get a pretty good picture of what's going on. It's really a matter of distilling the market down to something more manageable when you start with five thousand three hundred stocks and you want to eventually for us anyway, get to a portfolio 30 to 40. How do you go about doing that? And so we apply, as you said, as we sort of indicated through our process, some pretty heavy Chilterns across the market in terms of what we're looking for. And then we apply to the cyclicals as geographic fields, as financial filters, et cetera, to get down to about two hundred businesses between the team of four of us. That's of some interest. And then we put together a portfolio of 30 to 40 names that does take some IP and it does take some time and it also takes some trouble. So we get out on the road and we visit management teams. We try and build relationships with active managers in terms of activists that can help us get to outcomes in some of the businesses we're investing from a sort of personal investing point of view that can be quite difficult to replicate. So I think it's almost like you take a barbell approach. I'm a big fan of people holding stocks directly, just one hell of a lot, but also keeping an open mind to the idea that there are reasonable managers out there scrubbing the world for ideas. Maybe it isn't such a bad idea to to try this at work and see if that that philosophy aligns with yours. And then, of course, the other way of going about it is if you want to if you're quite happy with market returns, is always an ability to index. So you can index the MSCI World Index without any troubles. And if you're happy with that market return, then that's a genuine way of gaining access as well. [00:27:58][117.5]

Alec: [00:27:59] Yeah, one thing that I've learnt through doing this podcast and just, you know, reading and speaking to experts is in the large cap space. It seems like it's very difficult to generate Alpha. But in emerging markets and in small caps, that professional edge still seems to play a major role. [00:28:14][15.0]

Nick: [00:28:14] It's very insightful. And you've actually managed to reverse one of the slide in our deck. So thanks. [00:28:19][4.2]

Alec: [00:28:19] Think that's just credit me when you update the slide. [00:28:22][3.3]

Speaker 3: [00:28:23] Will the data [00:28:24][1.0]

Nick: [00:28:25] shows exactly that. So obviously us large caps, incredibly odd index to outperform large caps, generally difficult. But then as you go out into the quadrants of of emerging markets and small caps, the meeting manager actually from active management perspective, actually does add value. I think the number from the last stats I saw was about two percent over the last decade. So your approach there is well informed. [00:28:44][19.5]

Bryce: [00:28:45] So for for an investor who is unable to get on the plane and go and talk to managers and go through the rigorous filtering process that you guys have at Fairlight, what would you recommend as sort of a key destination or piece of information that, you know, you should always start with when it comes to trying to identify a potential smallcap? [00:29:06][20.9]

Nick: [00:29:07] I guess you can take the approach of investing what you know, that's not a bad, bad spot to begin. So the idea of is there a business or a product or service that I know quite well that I might be able to sort of generate some sort of engine. And that's really the Peter Lynch Street sort of approach to investing. If you're an individual investor, that's not a bad spot to start. But I would encourage people to go to the effort of reading the literature that's put out by management. So the annual reports, you can get your hands on the conference notes and the proxy statements, et cetera, that can be a wonderful source of information. That's not for everyone to know that that sounds incredibly boring. But if you do genuinely want to back yourself to try to find some businesses that will outperform over the long term, there's really no substitute for the work you need to do to get to an informed decision. So there are some wonderful businesses out there that you can to read about on blogs and investment letters and the third and according to can you just Google 13, if there's all sorts of websites that put up managers, letters that you can read through the pages of those and find some interesting ideas, but you really do need to go to first principles and make sure you understand these businesses before you put your hard earned capital. Hmm. [00:30:18][71.6]

Alec: [00:30:19] So, Nick, obviously you're not investing in the Australian small cap universe. And as we just discovered, in terms of from a market perspective, international small caps in US, small caps are a lot larger in some cases than back in Australia. Are there any other key differences that, you know, beginner investors or everyday investors should be really cognisant of when they're thinking about investing in smaller midcaps in Australia compared to investing in that market overseas? [00:30:46][26.8]

Nick: [00:30:47] Yeah, well, from a starting point of view, the indexes are quite different. So the ASX mid-cap index, the largest Weitman index, makes up about six per cent of the index. So it's pretty concentrated at around twenty three per cent of the index itself is material. So it's not particularly well diversified. But our index is it's a large stock is around 30 basis points. So it's very well diversified and it has much better exposure to technology, health care, some of the parts of the Australian market where there is less representation. So that's a key input. The second thing is that it's important to note across the board whether it's in Australia or across the world, that. Unfortunately, the small and mid-cap index does have a big term as a junk problem, so a very large portion, I think it's around twenty five percent of our index doesn't have earnings. So you want to be very, very selective and careful in which portions of the index you want to invest and where you go fishing. So the first port of call for loss and I would suggest it's a pretty good starting point for anyone else. It's doing some work in this part of the market is to try and screen for those businesses that have been profitable for some time. By all means, you've got to maybe miss the 20 bagger. That's the new concept stock that that that might go up on news or because it's penetrated some sort of new market. But statistically, you're really putting yourself at a disadvantage if you stick to the businesses that have had a couple of cycles worth of history and have been profitable through that period, we do eliminate quite a portion of the market that and that does protect you in terms of from your starting point, at least fishing from the bottom. So I would look over the longer periods and try and screen for those businesses that have been around a bit longer in the small and mixed market, whether it's in Australia or across the world. [00:32:31][104.3]

Bryce: [00:32:32] So, Nick, before we move to some stock specific chart, just wanted to touch on Covid and this part of the market. Are there any major sort of lessons that you've picked up from investing in this part of the market, given what has happened over the last three or four months? [00:32:48][16.0]

Nick: [00:32:49] Yeah, that's a good question. The first thing is that the market's in much worse shape coming into this downturn than we were last time. So I think I mentioned it before. But the Russell two thousand is live in four and a half times. So huge amounts of debt through the small cap market, which is a pretty interesting place to be. [00:33:05][15.7]

Bryce: [00:33:06] Do you just want to briefly explain what that actually means? [00:33:08][2.7]

Nick: [00:33:09] Yeah. So there's a metric and it's a very poor metric, but it's a proxy for cash flow. So as the acronyms a bit so earnings before interest, tax, depreciation and amortisation and it's input that's used to measure up against the debt load in the business. And here the debt load is aggregated up into an index. So essentially showing the debt as compared to a dollar, which is a proxy for cash flow. So sort of four and a half years of cash flow to pay down the debt, the index. Is that to make sense? Yeah, of course. It's much worse than that because I think you guys are students of of of and Monga, but they've always sort of very astutely realised that a dollar is a completely made up number and subject to all sorts of accounting gimmicks. But it's the best sort of proxy that we have. And as always, it's applied consistently over time. And it does provide a bit of a indication of where we are from it, from a debt load point of view. So the lesson for us is that coming into covid and also during Covid, it was the more leveraged parts of the market that performed very, very poorly and probably would have gone on to really face some interesting times if it wasn't for the very aggressive actions of the Federal Reserve in buying or at least threatening to buy triple-A rated securities and really helping the overall average part of the market. So you really are at the whims of regulators and sort of macro support, if you like, if you're going to be buying the businesses. From our point of view, it really just re-emphasise that gets you into all sorts of issues, making a small issue, a big one by applying leverage. So stay away from that which is a good place to be. The second one is is proven business model. So we like businesses that have been in the market for a while and have proven themselves out. But at the same time, we recognise that disruption is real. So we try and keep an open mind to that. And in a similar sort of age, we came into the markets and our portfolio manager, we came into the markets in the sort of in the ashes of the tech wreck. So we're old enough to know what a cycle looks like, but young enough to know that that technology really is software really is eating the world. So we're mindful that our own existing business models, how they fit into this period, have they employ technology in the correct way to sort of help through and are they participating in that acceleration of Wynans that we've seen through the covid-19 period? That's been a pretty interesting journey. And also management teams are important. So the underlying management teams of these businesses that are going through this crisis, there really is a bar education and how these businesses are being managed, some businesses taking actions very, very early to shore up balance sheets and to really drive home the competitive advantage. The downturn has been quite stock. And so it really is those three lessons of steering clear debt, making sure that we understand our business models and making sure that managed by very capable and align management teams. [00:36:09][180.2]

Alec: [00:36:10] I think there are lessons that shone through during Covid, but they're probably good lessons for people to keep in mind whether or not there's a global pandemic raging around the world. [00:36:20][9.5]

Nick: [00:36:21] Yeah, I think you're absolutely right. I mean, it's really been an acceleration of a lot of the. We've seen over the last 10 to 15 years, and it's become a bit of a cliche lately, but I think it's absolutely right that the winners just sort of accelerating out of the gates and the losers find themselves in a much faster structural decline. So it doesn't take a genius to see what's happening with bricks and mortar retail in the fashion space, for instance, where a lot of that's moving online. If you don't have a hybrid offering these days, you really find yourself in all sorts of difficulty. And then where services can move online, they have been doing it at accelerating rate. So certainly some lessons to be found there. The second lesson, of course, is just the importance of the structure in which you're operating under. And this is just complete lock in some ways in terms of, I think, Australia and New Zealand, because they've done a wonderful job on managing the crisis. But other parts of the world, which have been less responsive from sort of government point of view, really have struggled. So really the responses of of governments and it's sort of a bit of a wake up call across the board as well and making sure that you understand the regime in which you're investing in. It's been quite a quite important lesson also. [00:37:26][65.4]

Alec: [00:37:27] So, Nick, at this point, you've talked us through your investing philosophy and the market that you're looking at at Fairlight now. We're really excited to get into some specific stocks that you're looking at. And we're particularly excited because it's three stocks that we've never heard of and probably a lot of our listeners have never heard of. So forget the Microsoft and Amazon conversation. This is going to be a conversation where we learn a lot and we're excited to unpack your process, how you found the stocks, how you analyse them and why you thought they were interesting ones to buy. So we'll start with the first one. The first one is called Ritchie Brothers, and they are auctioneer's in industrial asset disposition and management company explanation's. And I think there might be a typo there, but what they do is they help facilitate the selling of heavy industrial equipment and trucks through live and online auctions. So can you talk us through a little bit about this company and then perhaps how you first discovered it? [00:38:30][63.0]

Bryce: [00:38:30] What's the market cap on this one? Nineteen B [00:38:32][1.7]

Speaker 3: [00:38:34] as [00:38:34][0.0]

Nick: [00:38:34] as I think it's around eight billion bit off the doublecheck, but [00:38:37][2.4]

Speaker 3: [00:38:37] yeah. [00:38:37][0.0]

Nick: [00:38:39] Well taken a step back at Chaillot. We really quite like the niche network businesses because if I scale correctly, they tend to deliver incredible value over time. In fact, I was reading a study pretty recently that suggests around 70 per cent of the value created in the tech sector since the 1970s has been driven by pretty successful iterations of network based business models. So we hold quite a few of these that have to be particularly intuitive. So the network businesses that operate across insurance, vehicle scrappage, credit reporting services, financial benchmarking and in fact our portfolio is made up of about 30 per cent of these kind of really interesting niche networking businesses that don't really appear in the media all that often. So to your point, the stocks are pretty well known, but as a cohort, the FANG stocks are about twenty two years old, whereas the businesses that we hold have an average age of around forty four years, which to my point earlier about understanding longevity and and dependancy of these businesses really corroborates with that story. So if Ritchie brothers starting off with what they do, so you can think of them as really auctioneer's, if you like, of everything that's yellow. So think that Caterpillar trucks, more mining equipment, sort of all this heavy equipment that you see as you sort of driving through construction sites or roadworks or mining operations. They're the largest globally. So they've got a market share, which is a great place to be and where you need to be, really, if you're going to be building a network business. But they command only two per cent of the global market share. So they've got a huge runway for growth. And it's that classic network marketplace. So the more equipment they set, they sell, it gets more buyers. And then on and on that flywheel spins because more product attracts more customers over time. The investment case actually became pretty interesting back in 2015 as a gentleman by the name of Robbie Telegrammed joined the business after recently negotiating the merger between two businesses in the US called OfficeMax and Office Depot. And he did a terrific job of extracting some value for shareholders. But he had what we thought was an incredibly coherent strategy for driving sales growth margins and ultimately the cash this business was going to generate over around about a five year journey. And so we went about doing that in a number of different ways. But one of the most important things that he did was he recognised that the number two competitor of business called On Planet had a wonderful digital footprint but didn't have much in the way of sales. So he was able to pick up what was a fantastic digital asset for a pretty reasonable multiple because on planet hadn't bridged the gap between the old model and the new. So they didn't have enough salespeople to drive that philosophy that you need to get that flywheel spinning. But that's been a hell of a lot of money on the digital footprint, so. We had a situation where Rovi came into the business, he started to digitise the business, which meant that margins actually start to expand, but you don't need as many physical locks either. So the land banks that they required to store their equipment and have people on site to sort of bring the hammer down and drive these sales as much lower as well. So returns on capital started to rise and that money went into paying down the debt that he'd accrued on the balance sheet from doing this deal. So we accelerate to Covid. We now find ourselves in a situation where the competitive set that Ritchie Brothers is now competing against sort the local auctioneers and maybe state based auction is owned by very sophisticated families or private equity, but don't have that digital footprint that's required to service the market in a Covid like environment. And that sort of comes down to my point earlier about understanding your business model during covid-19 and understanding whether it's going to be part of the winner or the loser cohort. And we think that Ritchie Brothers is certainly going to be part of that, that when a cohort take nice swaths of market share away from their competitors during this top down period. So it's a really interesting business. It's driven nice returns for the portfolio and it's got a very, very nice runway for growth over the next couple of decades. [00:42:42][243.1]

Bryce: [00:42:43] Yeah, fascinating. And it's certainly become evident that covid is, you know, those businesses that have set themselves up with a digital capacity or, as you say, digital footprint are certainly able to take advantage of what's going on at the moment. Are you able to just take a step back and sort of define for those that have just joined the show what the key sort of aspects or characteristics of a network business are? [00:43:04][21.2]

Nick: [00:43:05] Yeah, sure. So the main sort of characteristic of the network is really having a set of buyers on one side, a set of sellers on the other. So you can take the eBay's of the world, the Amazons, where you're really building a focal point for buyers and sellers to come together to transact in a highly efficient way. And the way that these businesses build out over time is it becomes a sort of self reinforcing competitive advantage, where essentially, as long as you are the go to provider of a service, you end up with a disproportionate amount of the product inventory. It doesn't really matter what that product or inventory is. As long as you've got the most of it, you just become the natural go to spot for that that product or service. And so in this case, for Ritchie brothers, it's something as nations, essentially yellow equipment that needs to be sold on, sold and moved through the process of of the businesses that have got too much inventory. Or they might have found themselves in a downturn like we have at the moment where they've got excess equipment and they need to move that on pretty quickly. The best place for them to realise value for that equipment in the most efficient way is through which you bought this because you got the largest amount of sellers. So it's really that intersection between buyers and sellers and how you act as an agent between those to drive that network effect. [00:44:20][75.3]

Alec: [00:44:21] So, Nick, it sounds like a big catalyst for growth for this company was management and was the incoming CEO who, you know, as you explained, acquired the largest competitor and all their digital assets and shifted the focus of the business. That CEO has now moved on and there's a new CEO in his place. How do you think about that where, you know, such an important part of the growth story was the management and that management changes? What's your process to then sort of reassess your position and understand if you want to continue holding with new management in place? [00:44:59][37.4]

Nick: [00:44:59] That's a very good question. But one of the key elements that that gave us some confidence there was that Ravi communicated very, very early on that this was going to be his last hurrah. So his strategy they put in place was over a five year period. And he said at the end of this, I'm going to retire. We're going to hand this business on to someone that's going to sort of guide the business through a different stage of its journey. Sometimes the person, the guy or the girl that's in charge of the turnaround or setting the strategy isn't always the best person to drive the business in a steady state. And that's certainly the case with Robbie, who's a little bit more of a visionary in some ways. And I think that once he's the strategy is in place, is certainly showing the fruits of his labour, handing that over to a manager that was happy to do sort of the hard yards and extracting longer term value made a lot of sense to us. There's also a lot of continuity amongst the members of the management team. So I would say if the CEO remains in place, the strategy remains identical and the board members are executing against that. So from our point of view, that was fine, but it does definitely, in many instances, raise some red flags, especially where that's combined with other elements such as insider selling or to turnover amongst employees at the more junior ranks as well. So we try and sort of balance those views against what else is going on in the business. [00:46:21][81.5]

Bryce: [00:46:22] So for those interested in Richie. Brothers, the ticker is Arber, easy to remember. You can go and check that out. So let's move on to the [00:46:30][8.1]

Alec: [00:46:30] SEC traded in Canada. Is that is that right, Nick? [00:46:33][2.7]

Nick: [00:46:33] It's actually listed on both the US and the Canadian bourses. So you can even get exposure through the one. [00:46:39][6.3]

Bryce: [00:46:40] So if we move to the next stock, Nick, which is Verisk Analytics, if you want to give us a bit of a rundown on what they do. And again, what is the thesis behind this one? [00:46:50][9.7]

Nick: [00:46:51] Yeah, we love the intersection between incredibly boring and incredibly complex and so very definitely fits the bill here. So I don't think we're going to win any awards for the sexy stuff in the world, but [00:47:03][12.4]

Speaker 3: [00:47:04] can [00:47:04][0.0]

Bryce: [00:47:05] be less sexy than auctioneer trading heavy machinery. Yeah. [00:47:09][3.6]

Nick: [00:47:09] So it gets even more nation. And I guess this is where great investing for great returns don't necessarily have to correlate with the most interesting of stories. But that varies for what they do is you actually have to go back quite some time to understand the business. And it was actually born out of a McLaren Ferguson act of nineteen forty five, which actually pulled this business together. And essentially what barista's its at its core it's a contributory database for the property and casualty insurance market. And so one of the best examples of easiest ways to explain it would be every time there is a policy or there's a claim made against an insurance policy, that information is contributed to fair risk across all the different insurance companies in the US into a contributory database. And that information is used to price the policies and understand whether it is fraud. So maybe Frosted Terroris car in in California. He couldn't also make that claim in Arizona, for instance, so that you don't get the sense of fraud across state borders. Now, the reason why it could be that history is that it was a state based business back in nineteen forty five and it was actually exempt from the anti-trust laws in that time because legislators realised that it was very, very important for insurers to have this centralised database that allowed them to understand if they were being defrauded or not. So if we accelerate through to 2008, 2009, that business was listed and then managing sort of four and a half billion statistical records a year and they cleansing that data and they're extracting a little bit of financial Ren and selling it back to the insurance companies. But it's essentially a monopoly. I mean, there's just no way that you can replace that data set because they've got the historical data going back all of that time and they've got all these insurance companies that have no incentive to create a competitor, mainly because it's such a small cost to their overall operation. So you have this NASCH contributory database, which generates phenomenal margins, you know, margins in the sort of 40 per cent range, very, very consistent organic growth because they have a little bit of pricing power and they pick up new customers and use the data in interesting ways. And it gets to a business that generates a really nice consistent 10 to 12 per cent earnings per share outcomes every year. And that compounds out over a long period of time and drives great returns for shareholders. So, no, it's not Apple. It's not it's not Google. It's not sexy, but it's an incredibly profitable business that has delivered great returns for iPhone. [00:49:38][148.4]

Bryce: [00:49:38] So would lemonade be a customer of Verisk? [00:49:41][2.9]

Nick: [00:49:42] A very good question. Going to have to tell me who it is. [00:49:44][1.9]

Bryce: [00:49:45] And there a company that recently iPod in the States that used artificial intelligence to what sounds like analyse this sort of data that Verisk would be housing and then create much more specific premiums for insurance companies based on the customer rather than, I guess, like a more of a blanket premium approach, you know, your traditional insurers currently offer. So maybe it's a competitor for Verisk. I'm not sure, but it [00:50:15][30.7]

Nick: [00:50:16] could well be. But it sounds pretty likely they'll be a customer because that would be probably define that. I would say so. I mean, I'll have I'll have a look and come back to you guys, make sure I cross that off. [00:50:25][9.3]

Bryce: [00:50:25] But first thing tomorrow morning, going [00:50:27][2.2]

Speaker 3: [00:50:27] to the office, I do my homework and shoot that. [00:50:30][3.0]

Alec: [00:50:32] So, Nick, I'm looking at the history of Verisk since it was listed and it looks like there's been a number of acquisitions over time. It looks it seems to pretty consistently acquire a business every well in some in sometimes every year, but maybe every couple of years. How do you think about a company that is sort of constantly acquiring? Do you think that's value destructive or is it do you look at that as a positive and think of it as, you know, adding value? [00:50:59][26.6]

Nick: [00:51:00] It really depends on the company. So it's very hard to deny statistically. And there's been a lot of studies done over time on this topic that that acquisitions in aggregate provide value. So in aggregate, we think that acquisitions destroy value. And I think those are paper put together by McKinsey that really went into detail on this. But there is a cohort of businesses that do it well and there are some that are set up to do it, specifically this. We actually have a small list of stocks, about five or six that operate in pretty interesting geographies up in Sweden, in the Nordics and the U.K. and a couple in the US that do absolutely amazing job of what is really set up to be capital allocation businesses. They buy companies on very nice earnings, yields of sort of 12 and 15 percent, and they don't consolidate those operations. Let those businesses run as almost entrepreneurial units, reinvest the cash flows into new businesses. And they've been really successful over 20, 30 years. So it's hard to sort of paint the picture of those being the traditional, highly leveraged and risky roll up story. They are actually successful businesses now, as that refers to various, Verisk is a little different from that. So they've got a core operations and they use those cash flows to either launch or buy other businesses where they think they can add some value. And one of the opportunities we had to buy into these areas was when they made an acquisition. It wasn't particularly well liked by the wider market. And that was one would back which services, of all things, the oil and gas market where arguably there is doesn't have a competitive advantage. You don't have a lot of history and understand that market. And quite rightly, I think at the time equity markets decided to knock down the value of various based on the fact that it could be perceived to be quite risky. As it turned out, however, various get done an amazing job with that business. And the reason for that is it wasn't so much where the business was situated, but the kind of IP and knowledge that you need to build within that operation to drive returns. So the kind of statistical analysis and machine learning I that that employed on the insurance side wasn't being employed particularly well within wood back, which was aggregating data that was used by oil and gas companies to figure out whether they should be purchasing a new well or starting new operations based on the rates of existing assets, etc.. The damage just wasn't used particularly well. They had a great client base that had a great product, but the learnings that they could bring from their core business into wood back was actually pretty impressive so that they've actually gone on to drive margins up. I think a few hundred basis points, organic growth rates have been as of sort of four Covid pretty good. And now with this sort of kink in the road at the moment where so oil and gas is under some pretty terrific pressure, but the characteristics of that business is pretty strong because they have long term contracts, sort of access base contracts within their customer base. Their customer base literally has to go broke before they stop using some of those WABAC assets. So I think they do a pretty good job and it has come through on the returns on capital numbers and it has come through on the earnings per share. So we give them a bit of a passing grade on on the capital allocation side. [00:54:08][187.9]

Alec: [00:54:08] Now I'm reading here that when Verisk IPO in 2009, Berkshire Hathaway, Warren Buffett's company, was large shareholder and chose not to sell one of the few large shareholders not to sell any stock at the IPO. I guess that lends itself to a larger question, which is when you're analysing companies like this, how much are you looking at? Other experts, other asset managers, companies like Berkshire Hathaway and sort of reading into what they're doing and and potentially taking cues from their buying and selling actions? [00:54:42][33.5]

Nick: [00:54:43] Yeah, we don't mind standing on the shoulders of giants. Right. We were humble enough to to say that there's some guys out there doing an amazing job in screening stocks and investing. And so if a portion of the hard work's been done for us by looking at the share registry and seeing if there's a bunch of guys that we respect that are already there, then it will at least raise our eyebrows. So, for instance, if there's going through a screening process that we get the stocks down to sort of a listed two hundred and we're running, we'd run some pretty automated processes across those to screen them down further. If it's part of our first investment committee discussion, we look at the register and say that the likes of Warren Buffett or Choose Your Poison is on the register, then absolutely we will become a little bit more interested in that business. But it certainly doesn't determine our investment decisions. In fact, we found ourselves bidding against some of the most respected investors in the market and doing quite out of that. And a lot of that comes down to, you don't know the reasons why that investors are selling either. They might be repositioning their portfolio that might be buying for similar reasons. So whilst it is a good indicator, it's not the all. And so we do definitely take that element with a grain of salt. [00:55:51][68.6]

Alec: [00:55:52] Now, you've thrown the bait out there for me and I have to buy it. You said you went against a big investor and you were successful. Would you like to call out the investor that you were against and tell us the trade? [00:56:03][10.9]

Nick: [00:56:05] Well, there's been quite a few of gone the other way as well as I don't want to give you the impression that we're always right there. But I think even in this one, I'm not too sure that the FBI is still in various. [00:56:15][9.8]

Alec: [00:56:15] No, it looks like they sold twenty. Eighteen. Right. [00:56:18][2.6]

Nick: [00:56:18] OK, so the stock's done very, very well since then. So that would be sort of the first starting point that. The game, the Bryce, certainly has been running a bit demonstrably from 2013 to 2020, that stock is materially outperformed. The other one, which is terrifying in some ways to be betting against the Oracle. But we think there's good reason to be doing so is in the airline industry and we don't invest directly in airlines and we try to share. I think it's been a little bit schizophrenic on this topic in terms of buying and selling out of airlines and trying to get paper, reminding never to do it again. But he's found himself recently. He was a seller of airlines. And we were actually adding to one of our positions, which is a company called Excel, operates in a really cosy duopoly in the manufacture of carbon fibre for all of the shells or wings and body parts that go into the newest models of the aircraft. And it's just a huge structural tailwind there. That part of the market where carbon fibre is five times lighter than aluminium, it's it's far stronger. It's going to every new aircraft we can see in the market. So whilst we believe that, yes, that's going to be the short term headwind here of even up to a couple of years old, very well placed. It's got plenty of equity on the balance sheet. It's so a very large backlog of potential planes coming off the production units over the next few years. So whilst it wasn't a direct bet against Buffett, we were certainly heading in the opposite direction in terms of sector exposure. So I guess there are a couple of examples. One longer term and the second one a little bit shorter. Well, if you [00:57:49][90.4]

Bryce: [00:57:49] see Equity Mates Asset Management as a major shareholder in your next doing your filters for this, then you know you're onto a winner. So look, Nick, we'll move on to the last stock and forgive me if I butcher this name, but Nimet check group is [00:58:05][15.8]

Alec: [00:58:05] very glad that I didn't have to introduce [00:58:07][1.5]

Speaker 3: [00:58:07] this one. [00:58:07][0.2]

Nick: [00:58:10] I'm glad you're not the only one who struggled through that. Now that I'm not the only one that struggles with that. And so it's yeah, it's a very interesting business. It's based up in Germany and hence the name. And they are the pioneer in the digital transformation of the architecture, engineering, construction industry. In fact, the number one in Europe. And they're a strong contender to a business. You might be more familiar with Autodesk in the US. So the original CAD Cam guys, in all things design, they cover the entire life cycle of the construction and infrastructure projects. So if you think about a architect designing the plans, it used to be done on paper and pen and those plans I give them to the builder and the builder goes to the site and tries to put a building together. And then eventually that building is handed off to the maintenance stuff that's all put together by name, checking it in a digital footprint now, which is pretty interesting. It's he's got a really interesting background where the founder was one of the first to use programmes. And this is prepays for calculating the elements. I'm heavily loaded, a regular supported slabs in the building industry. So he goes back a long time to nineteen sixty three. When you started doing this sort of work, he's he still owns fifty three percent of the business and the culture of the businesses is founded in what's called the Mittelstand Principles in Germany, which is the small and midsize businesses in Germany that typically aren't listed. So it's usually quite hard to get exposure to these kinds of companies. But the typically family ownership they built for the long term is highly dependent, very small head offices and quite nimble in the way they go about things. It's quite interesting because they're building clients typically operate on three five per cent margins and thirty percent of the construction work is really work and forty per cent of their projects are typically over budget so it can help their clients overcome these problems in a slightly better economics. And the nice thing also is that the growth is mandated. So the most recent example was the UK government is forcing the building companies to use what's called this erm technology as part of the push to reduce build times and greenhouse gases by around 50 per cent. So that's nice tailwind. And it's also terrific up sell opportunities across the board where their existing clients don't usually use the full suite of offerings. So they might have one. But it's a nice touch, right opportunity where you can go from one product to two, introducing three to five products over time. So very established in the developed world that you've also got this tailwind as the emerging market start to develop building codes tight and people will get a little bit more sophisticated in the way they use this technology, which is a nice runway for growth in the emerging markets as well, which is an interesting place to be. The economics of phenomenal. They got to the ninety five per cent customer retention rates. There's no one customer. That's the one per cent of their revenues. And it seems to me that a lot of the stimulus that's going into the fiscal at the moment is really aimed towards the infrastructure and building part of our economy. So we a terrifically well placed and we're able to pick up some some stock during the year of markets in March and April. [01:01:08][178.9]

Alec: [01:01:10] Now, Nick, I'm going to make an assumption about you. And please forgive me if I'm wrong and please correct me, but I'm going to guess that you're not an architect by trade or you haven't worked in the construction industry. [01:01:18][8.9]

Speaker 3: [01:01:19] So if he did, [01:01:20][0.5]

Alec: [01:01:22] then we'd just edit this out. But I am interested you are throwing some terms around there, some construction industry terms I wasn't familiar with, and it got me thinking around the concept of a circle of competence. And when you're talking about a business like this, which is not a nation industry, but quite a specialised industry, how did you go about educating yourself about this industry and trying to understand if their products were actually good and if there was actually a product market fit there? [01:01:50][27.8]

Nick: [01:01:50] Well, the nice thing is that even not being specialists, you can get pretty close to the answer by looking at the outcomes of business. So we are all set up as generalists here at Fairlight. We do have some specialities running through and he's the portfolio manager. The product has a prior history in the health care space. So that certainly helps once you start to get the more technical in terms of health care, that can be pretty important. It does help expand our circle of competence. But the kind of businesses we try to invest in, we just stick to those that can be understood by a reasonable, intelligent person that does a lot of writing. So I don't think it's beyond the capabilities of anyone listening to this podcast to understand what damage it does. If you get into specifics, that's all well and good. But really, if you can understand the process of what they're trying to do and the outcome of that and whether it's demonstrable and the numbers, then you're a pretty good spot. So, you know, they're making claims that they can reduce the cost to their to their customers. What are their customers saying? What is the results? It's coming through in their financials. What is the customer retention rate looks like? So if they are back in those kind of claims, you'd be expecting their customers to stick around. And in this case, and you've got ninety five up to ninety seven per cent customer retention rates year on year, it means that their clients are genuinely getting value out of the products that they're selling. So you need to cross-check what you think you know about the business against the actual results of the company. And in doing so, I think you can get pretty close to the answer without becoming a sort of 100 percent sort of nerd on the topic and having to understand down to the specific level exactly how they're generating those numbers. We understand the unit economics. We understand the products. We understand the business. But at the end of the day, if you're getting stuck in the monisha, sometimes you're missing the forest from the trees. [01:03:37][107.2]

Bryce: [01:03:39] And that's what we love about investing. I think, you know, it just gives you exposure to so many niche industries that you'd never otherwise be reading about. Well, can't say that for everyone, but I certainly wouldn't be reading about these sorts of industries. Now, I think before we get to our final three questions, this is actually the first guest we have asked this question. We are in the process now of building out the Equity Mates hypothetical portfolio. And the component of that is to get a stock on a watch list, not a buy, hold sell recommendation, but purely a watch list from all of the guests that are experts that we interview. So if we were to take the Ritchie Brothers Verisk Analytics or NIMET Check group of those three, if you were to just choose one to put on a watch list, what would that be? [01:04:25][46.4]

Nick: [01:04:26] I think it would be Ritchie brothers. And the reason I say that is I think I wouldn't be I wouldn't be true to form if I'd been lying the boot into the Australian stock market by saying it's overvalued and then not be somewhat price sensitive. So Nemecek is rerated pretty heavily. Since we bought it, we've actually been trimming that position. And Verisk as well from the multiple point of view, certainly getting up to a point where we're looking to take some capital out. So the Ritchie Brothers is sub 30 times earnings and the near term is sort of clouding of the possible earnings power of this business over the next few years. So I'd vote for Ritchie Brothers. [01:04:56][30.3]

Bryce: [01:04:57] Nice for the inaugural watchlist. [01:04:58][1.1]

Speaker 3: [01:04:59] Yes, I love it. [01:05:01][2.8]

Nick: [01:05:02] Please don't get me back on the show up here. Don't perform [01:05:04][2.3]

Speaker 3: [01:05:06] well. It's out there now. [01:05:07][1.2]

Alec: [01:05:08] So, Nick, as Bryce said, we do like to finish this interview with the three same final questions before we do. I'm sure a lot of listeners have had their interest piqued hearing you talk about your investing philosophy and then applying it to some specific businesses. If people want to find out more about you, follow you online or find out more about Fairlight, what would be the best place for them to do that? [01:05:33][24.2]

Nick: [01:05:33] Easier. Check out our website. Fairlight aimed at you and you can sign up for our distribution list and we'll punch you out. Monthly insights to your email address and what we try to write about there is either a stock or a topic of interest that won't blast you with sort of how markets moved over the last month. I think there's enough of that out there. But we do try and do the covers a little bit on on how we think and reveal a little bit about some businesses that we think are interesting. [01:05:56][22.8]

Alec: [01:05:57] And that's why I love that. I don't think there's enough of that out there. I think there's way too much of that out there. So, yeah, it's said that the content isn't just what it markets do yesterday. [01:06:07][9.7]

Nick: [01:06:08] Yeah, exactly right. [01:06:08][0.7]

Alec: [01:06:09] We agree. We'll get to these final three questions. The first one is, do you have any books that you consider must read and now this can be investing or otherwise? [01:06:18][9.6]

Nick: [01:06:19] Well, I think that you've probably heard enough of Buffett, Peter Lynch. Fisher, over the last few months, you've been doing this all of those or required reading, and I'll take those as read, but a few that have spoken to me over time and a couple of the more recent the first one that I read quite some time ago, that really struck me as an interesting read. If you guys read Endurance by Ernest Shackleton, know the story of schedule, it's an incredible story. So it was it was Ernest Shackleton failed attempt to cross Antarctica aboard the South Pole. And not only did he style, but he did manage to step foot on and talk to you because his boat was his ship was trapped between ice and cracked up and ultimately sunk. And he and his crew drifted on drift ice until they hit a place called Elephant Island, which is really a remote spot. And Shackleton realised that they were so far out of regular shipping lines that the chance of the ultimate rescue was pretty remote. So instead, he set sail with the crew of five members on a 20 foot skiff for a smaller island called South Georgia, located off Argentina. And his crew was left on Elephant Island, living off seal meat and living under an upturn for almost two years. They survived. Yeah, exactly right. And so ultimately, Shackleton returned with a rescue mission and one hundred percent of his team survived. It's one of the most remarkable stories of teamwork, navigation and survival, in my view, ever written. It's quite astonishing to put that one out. There is a really interesting, true story and one that resonates with me from a teamwork point of view. The other two, I notice that you had Ed Cowan from Trading Partners on during June and the Light team were quite good friends with the two guys, both specifically Tom and Hamish, over the years. But we share a mutual appreciation for the importance of company culture and so on. That I've read recently is called powerful. I don't know if you guys read that one. It's it's the story put together by the chief talent officer at Netflix, a lady called Patty McCord. And it's not the memoir of Netflix, but instead offers some really refreshing insights into how to build a high performing culture that can really adapt to what we're saying in the business world at the moment. And it suggests amongst many things that these will resonate with me pretty strongly and probably you guys as well in the corporate structures that maybe you found yourself working in, but ditching the dreaded annual performance review and many of the company perks that have been sort of employed to motivate or try to motivate team members. Instead, it really puts forward the notion of providing people with really challenging work and encouraging productive debate across all levels of the organisation and making sure people are empowered to get their jobs done and work quite autonomously, creating that real sense of mission. It's a really useful raid if you're looking to build a business or analysing companies for a possible investment, if you want to understand the culture and the last one along the side. And it's only because I've been writing about these, I put them down as a theme. But the other one is Creativity by Ed Cartwell, who's the long time president of Pixar. Of course, Pixar created some of those great stories that I'm going to learn a lot more about now that I've become a dad, a great, great programmes such as Toy Story and some of those other amazing creative movies that we put together. The key point in that book is that having a good team is more important than having a good idea and never blame the families on a single person. Always hold the entire team responsible for your decisions. And there's one company that really resonated with me. And that's essentially if you give a good idea to a mediocre team, they'll screw it up. If you give a mediocre idea to a brilliant team, they'll either fix it, throw it away or come up with something that I think that's one hundred percent true. So I think that culture based strategy one hundred times out of one [01:09:54][215.0]

Bryce: [01:09:55] and [01:09:55][0.0]

Alec: [01:09:56] I like that. I like that three great book recommendations. So the second question that we have is what's your go to source for investing and financial information? [01:10:05][9.6]

Nick: [01:10:06] Yet we really heavily on the literature that's actually produced directly by the companies. So annual reports, quarterly releases, conference notes, proxy statements. So it might be boring, but we find it collating the information from the source, rather than relying on brokers or blogs or other authors out there helps us form independent views. And I think that independent using a critically important if you make mistakes and we do also try to speak to management to glean some insights regarding culture and strategy. I know that's not available to everyone, but it's something that's been pretty important to our process. I've definitely read as many of the facilities out there. So if you go to the survey net filings that you can find letters that are put out over time, you can you can really come across some interesting things. And then the usual suspects in terms of financial press is a good place to understand what's happening from a strategy point of view. So we read The Wall Street Journal or the usual suspects, but there's nothing for changing that. But being broadly informed is a very good place to be. [01:11:03][56.8]

Alec: [01:11:04] Nice one. And then the last question, if you think back to your early days as an investor when you were just starting out and investing in that first air conditioning company whose name has escaped me at the moment, [01:11:17][12.5]

Nick: [01:11:18] it hasn't escaped something. It's called air conditioning. It's etched in. To my mind, [01:11:22][4.1]

Alec: [01:11:23] you go hasty's, if you think back to those days. What advice would you have for your younger self? [01:11:28][4.5]

Nick: [01:11:28] I'll answer it from an investment point of view. And if we had time and you have the appetite, I can give you on from a personal point of view. But from an interesting point of view, I think if you study the characteristics of most highly successful investors and traders, you'll find they possess a pretty common set of characteristics. And I think that really comes through in. Guys like Stanley Druckenmiller, for instance, has been honing his craft over so many years and maybe was perhaps blessed with some of these characteristics from birth. But before that come to mind mental flexibility. Second is an ability to think independently. Third is a tireless inquisitiveness and perhaps most importantly, a deep self-awareness. But if I was going to give my youngest self some advice to concentrate on just one of these characteristics, it would be to become ruthlessly accelerate my development of mental flexibility. I have a deep respect for the wisdom of crowds and don't be contrarian for the sake of it, only when it makes sense. In other words, be sure that the wisdom of crowds is truly turned into the madness of crowds before taking contrarian bet. And it just doesn't make sense to do so otherwise and then get very, very good at blowing up your closest held personal beliefs when faced with compelling, contradicting evidence. Sort of being belligerently stubborn has no place in finance, and for that matter, I don't think much at all. So that would be my advice to my younger self from my investing point. [01:12:45][76.7]

Bryce: [01:12:45] They love it, Nick. We'll leave it there. And, you know, it's been a fascinating conversation. As we said at the start of the show, the small caps space is always something of interest for us and for our audience. So we really appreciate you coming on the show and not only sharing with us three stocks that you're interested in, but giving us the inaugural watchlist stock, which are super pumped about how terrifying. We can't thank you enough for sharing your insight with us tonight. So very much appreciate you coming on the show. And we look forward to staying in touch and watching the progress of Fairlight so big. [01:13:20][34.3]

Nick: [01:13:20] Thanks. Thanks, Bryce. And thanks again. And congratulations to you guys for building a what seems to be a growing and very insightful podcast. [01:13:27][7.8]

Speaker 5: [01:13:28] Thanks, Nick. Thanks for listening to Equity Mates investing podcast production of Equity Mates Media. Please remember that everything here in Equity Mates investment podcast was general advice. Only the content has been prepared without knowing the personal objectives, specific financial circumstances or goals. The host of Equity Mates investment podcast may maintain positions in the companies discussed before considering any investment. Please read the product disclosure statement and consider speaking to a licenced financial professional. [01:13:28][0.0]


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