TODD WENNING | From Flyover Stocks

In this episode I chat with Todd Wenning, a seasoned investment professional with experience at Ensemble Capital, Morningstar, and the Motley Fool about some of the most critical aspects of successful investing: moats, management, and buying companies at the right price. We based this conversation on this Venn diagram that Todd published on X (Twitter) in 2017.

What sets great companies apart? Todd explains the concept of economic moats. These moats, like those surrounding medieval castles, provide a protective barrier against competitors, allowing companies to maintain their competitive edge over the long haul. Think of companies like Costco and Apple, whose solid business models and strategic management decisions have helped them weather storms and emerge stronger than ever.

But it's not just about picking the right companies; timing matters too. Todd emphasizes the importance of patience and strategic decision-making when entering the market. Rather than diving in head-first, he advises investors to wait for the right opportunity and build conviction over time.

The other key aspect of successful investing is quality of management. Even the strongest moat can dry up in the hands of poor leadership. Todd shares insights into what makes a great leader in the world of business, highlighting traits like capital allocation skills and strategic vision.

Capital allocation, as Todd explains, is a nuanced art that involves deploying resources wisely to maximize shareholder value. Whether it's reinvesting in the business for growth or returning capital to shareholders through dividends, the decisions made by management can make or break an investment.

Valuation is another crucial piece of the puzzle, and Todd demystifies the process by discussing the discounted cash flow (DCF) model. By combining DCF with other valuation multiples, investors can pinpoint the optimal entry point for their investments, ensuring they buy at a price that offers a margin of safety.

Todd stresses the importance of building conviction in your investment thesis and staying the course, even when faced with market volatility. By focusing on companies with durable competitive advantages, sound management teams, and attractive valuations, investors can set themselves up for success in the long run.

HAPPY INVESTING!

For those eager to dive deeper into Todd's investment philosophy and to discover hidden gems in the market, visit Flyover Stocks.

TRANSCRIPT FOLLOWS AFTER THIS BRIEF MESSAGE

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EPISODE TRANSCRIPT

Chloe: Stocks for Beginners. Phil Muscatello and Finpods are authorized reps of Moneysherpa. The information in this podcast is general in nature and doesn't take into account your personal situation.

Todd: So companies are not static assets. I like to say over time they'll grow. So the company you bought 20 years ago, not the same company you have today. So they do have to change, and you have to adjust with that as well. But management does, too, based on the stage. So you don't want a visionary CEO coming into a very stable type of business. You want to see somebody who's going to execute on the blueprint. So more of an optimizer. And so sometimes in the company's lifecycle, you do need a visionary to reenter the business of the stable business because they're starting to decline. And so at that point, you need a visionary to come in and reset the company's vision. And then once the blueprint for success is achieved, then you have an optimizer come in and execute the plan.

Phil: Hi, and welcome back to stocks for beginners. I'm Phil Muscatello. What's a moat, and how can you identify companies that have one? And where do you find quality management? And lastly, how can you buy a company like that at the right price? Here to explain his investing philosophy is Todd Wenning. Hello Todd.

Todd: Hello. Thanks for having me.

Phil: Thanks for coming on. Todd Wenning has spent two decades in the investing industry, representing the buy side with Ensemble Capital, the sell side with Morningstar, and the retail side with the Motley fool. He's now launched his own Flyover stocks newsletter to help investors find overlooked quality companies. And we're basing this interview on a Venn diagram that you published on X back in 2017, which we'll show in the episode blog post for listeners who are interested.

A moat is a durable competitive advantage that enables a company to out earn costs

So tell us, what is a moat?

Todd: So a moat is a durable competitive advantage that enables a company to out earn its cost of capital over a long period of time. So a lot of companies are cyclical and they have strong returns on invested capital when things are going their way. But that's not sustainable. Eventually the market changes, competitors enter their market, and without having an economic moat in place to defend their economic position, the returns on invested capital reduce closer to their cost of capital. And that makes the company less cash generative and less valuable to their shareholders.

Phil: It's something that Warren Buffett has spoken. We all have the Warren Buffett quotes, and he really loves a moat, doesn't he?

Todd: He does.

Todd: And I think for that very reason. Um, Buffett likes to invest for the long term, and it's very difficult to forecast businesses unless you have some confidence in your ability to forecast that business, which, when you have an economic moat, makes it a little bit easier to try to understand. Okay, in 510 15 years, what might this company's economics look like? Do they look favorable? Can I forecast them with any confidence whatsoever, or am I basing this completely on an industry or sector cycle that can come and go over a short period of time?

Phil: I'm always interested in the way people, the psychology of investing works. And then sometimes people use this concept of emote to confirm their own bias about a particular company. How can you identify a moat with confidence without falling prey to confirmation bias?

Todd: Right.

Todd: I think it really helps having a framework in place. So when I worked at Morningstar, we're drilled on sort of the five sources of economic moat. So it's intangible assets, switching costs, network effect, low cost producer, and what's called efficient scale, which is a debatable fifth moat source. But it's basically if you have a rational oligopoly where you have a few companies competing and the entrance of a fourth competitor or a fifth competitor would reduce the returns on invested capital for everyone, so there's no economic incentives to enter. So that's the efficient scale. But the point is that if you can't put their economic moat in one of those buckets, it doesn't exist. So you have to figure out, okay, this is an intangible asset moat, or is it a switching cost moat? And then be able to substantiate that with fundamentals and numbers. So if you just have a qualitative assessment of a moat, but you can't see the moat manifesting itself in the numbers, it's hard to make a case that there's an economic moat. So you want to see a track record of a company that has outearned its cost of capital over a number of years. Usually when that's the case, if it's, say, out earning its cost of capital in eight of the last ten years, or ideally ten of the last ten years, there's something going on there that's worth investigating.

Phil: Have you got an example of a company like that?

Todd: Sure.

Todd: I mean, I think a company like Costco comes to mind. Where you can easily point to the economic moat. There's a couple of ways you can do it. So one way is just the high renewal rates of the members. And importantly, the renewal rates have been trending upwards. So the customers have viewed the Costco moat as their products and services as more relevant over time, which makes it harder for someone else to come in and compete in that market. You have to do something better than Costco is doing, which is very difficult to do because as Costco part of their strategy, their long term strategy has been to uh, share their economic benefits of scale with their customers. So rather than keep all the additional margin that they could for themselves, they reinvest that back into the business as low prices for their customers, which in turn gives them bargaining power over their suppliers. Because suppliers know that if they get their product on a Costco shelf, it's going to move and they're going to.

Todd: Generate a lot of money.

Todd: And so the suppliers, uh, want to work with Costco because that's where the customers are. And the customers come to Costco because.

Todd: That'S where the products are.

Todd: And so it has a reinforcing, ah, virtuous cycle. And so I think the Costco moat is partly the intangible asset moat source of Costco. There's also switching costs involved, perhaps not the same degree as say uh, a business to business software platform might be, but there are certainly switching costs. I mean I'm a Costco member and for me to switch to somebody else would require some significant change in my buying behavior. Or maybe my Costco moves to a different location is too far away or something like that.

You want to avoid situations where moat starts to erode very quickly

Phil: And moats can drain as well. Have you got an example of a company whose moat existed at one point and then has disappeared?

Todd: Sure, that's what you want to avoid because if a company has a moat today and has for a while and investors are still remaining pretty confident in its moat, it's going to trade typically with the premium to the market. And what you want to avoid are situations where that moat starts to erode very quickly. Because once investors get a whiff that those advantages are over or soon to be over, they quickly sell off. It's just the multiple contracts and earnings slow down and it's not a good combination for investors. So you have to really focus on what I call moat trend. Again with Costco as the example, which uh, I own, by the way, full.

Todd: Disclosure, if the membership renewal rate starts.

Todd: To decline, that would be a concern to me because that's telling me that the relevance of Costco has declined. And so that's a warning sign to me that something else might be going on. A classic example of a moat that went away is Kodak.

Todd: Right.

Todd: That's one of the classic ones.

Todd: So Kodak had a wide moat that.

Todd: Was based on its film business, its analog film business. And what's interesting is that Kodak actually had the first patent for a digital camera. They just didn't market it because that would have undercut their film business.

Todd: And so I always like to say that moats erode from the inside out, we often talk about how external new.

Todd: Competition comes in and undercuts the company, and that's why they go under. But something internal had to happen before that external event happened. And so with Kodak, you can see the example being that they could have sacrificed their film business to some degree, not all of it, but some of.

Todd: It, to begin to enter into this digital business. But they refused to.

Todd: Now, a company like Netflix, which I don't own, but I'm familiar with, uh, they have been very successful in reinventing themselves over time. So they had the dvd business, which they got rid of over time, and.

Todd: Switched to digital, and then now they're.

Todd: Doing their own content. So they have been able to reinvent themselves over time. And when you're dealing with technology, especially or media, you have to reinvent yourself frequently. You have to be able to go after your own cash cows if that's where things are indeed going. That's a difficult challenge for any management team. That's not be taken lightly by any means. But I think that's what you have to be cognizant of is how is management thinking about the next five years? And are they positioning themselves in a way so that their moat does not erode? Because that would be very bad for everybody.

The key with management is finding a thoughtful approach to capital allocation

Phil: Well, that's a perfect segue, because we're looking at the tie in between moats and management. And obviously, the management has to be able to identify their existing business and keep on enhancing that business. But then they've got to be looking for challenges on the horizon as well. So what are some of the important factors that you look for in finding quality management?

Todd: I think the key with management is finding a thoughtful approach. That's a pretty broad thing to talk about, but I think that's what you want to see. And I've seen enough management teams where when it comes to capital allocation, there are some that are clearly not thoughtful. They might be good managers of people, and that's how a lot of them. And there's a famous Warren Buffett quote about how managers come up through different ranks. They don't come up through the ranks to be capital allocators. And so you often see ceos and cfos who just aren't necessarily thinking about, in a thoughtful way about capital allocation. Should we be doing buybacks here? Should we be paying a different type of dividend? Should we do special dividends? And so you'd like to come across, or I like to come across ceos and cfos who are very thoughtful about their allocation, how they're allocating it, how they're acquiring businesses, just in a thoughtful way, thinking about value, thinking about returns on invested capital.

A lot of companies use adjusted EBITDA to incentivize management

And that turns into also another part of the management equation, which is incentives. So you often look at management incentives and it's adjusted EBITDA or something that is very changeable. I guess it's a non gaap measure, and there's various ways they can change those to fit what management wants them to be. And they're also not as close to what shareholders want in terms of metrics as, uh, say, net income or pretax income or return on invested capital. And so you have to ask, well, who are they working for if they're incentivizing themselves on these different metrics that are not aligned with shareholder interests? And so you see a lot of times acquisitive companies in particular use something like adjusted EBITDA to incentivize management. So you have to understand that sometimes they will incentivize themselves that way. But then you look at, okay, what adjustments are they making? Is there a wide difference between their adjustments and the stated EBITDA? So you have to do a little extra detective work sometimes to understand just how they're incentivized and if they're aligned with shareholder interests.

Speaker E: Can we just dig a little bit.

Phil: Deeper into adjusted EBITDA? I always like to try and break down jargon for, uh, beginner, uh, investors. Let's look at that a bit more closely. What is it?

Todd: So, EBITDA is earnings before interest, depreciation and amortization. And the adjusted part is, usually includes things like they back out stock based compensation, acquisition costs, and things that they don't consider to be recurring expenses or at least reflective of the underlying business. Now, I sort of roll my eyes at some of those. So if they do an acquisition once in a while, I can maybe see backing out acquisition costs to make it more apples to apples comparisons, but with stock based compensation, I mean, that's an expense, that's a recurring expense. If they are frequently restructuring their business. That's also not a good sign in general, but they should be including that in their reported figure and not adjusting that out, because that's a recurring expense. So you have to be cognizant of what they're taking out and ask yourself.

Todd: Why they're taking that out.

Todd: And that will help smooth their returns over time if they start taking out more adjustments.

Todd: M just reminds me of a quote.

Phil: I saw on Valentine's day the other day on X, and what was an investor who said, happy Valentine's Day, I'll be your EBITDA. Uh, I'll be anything you want me to.

Todd: That's right. Yeah.

Todd: And Charlie Munger's got a great quote about how they're not the right type of earnings, I'll put it that way. And so they're not a good replacement. And because they don't take into consideration the capital expenses or the capital spending necessary to sustain the business. So if you're backing out, depreciation, amortization, that's tied into what you have to invest in the company to continue the growth over time. So all of those factors matter. And so, for me, the further down the income statement they're incentivized on. So, ideally, pretax income or net income.

Todd: Or EPS, those are all preferable.

Todd: A lot of times, they're hard to find. So, again, I think that also speaks to the thoughtfulness of the board as well. So if you have thoughtful board who understands that what you want to do is maximize per share value of the business, you should be incentivizing management on a per share basis, or at least incorporate some sort of return on invested capital or return on equity metric, so that management isn't incentivized just to grow the business for the sake of growing it, but they're growing it in order to increase value, because you can increase earnings without having a value accretive investment from the company standpoint. So they can invest in projects that generate below returns on invested capital, but that could increase earnings. That doesn't mean that those earnings were the right for the company or for.

Todd: Shareholders in the long run.

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Markel: Whether it's a high growth company or a slow

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Phil: You what are some of the things you like to see in capital management? And surely it's going to be different for every company in every situation, right?

Todd: And it will be. I mean, whether it's a high growth company or a slow kind of legacy company, there's different attitudes you want to see for management. So again, thinking about incentives, if you have a management team that's still in their early growth phase, they should be incentivizing in terms of revenue. In that sense, they should be focusing on growing the business. If you have a more mature business where it's more of a legacy moat. So it's a moat that's been in place for a long time, you want to see them create or, uh, execute on their blueprint. Right. So an early stage company, there's no blueprint for success. Not yet. So that's why you want to continue to grow the company, see where it takes you. But eventually, when the company does have a blueprint for success, and here's how you're going to sustain and grow margins, here's how you're going to generate returns and invested capital. You want to see them execute on those things. And so at that point, you do want to see the board start to shift the incentive structure towards shareholder returns.

Todd: It's not about just reinvesting in the.

Todd: Business as fast as possible. It's about doing it in a more thoughtful way and maximizing shareholder value.

Todd: So I do think that's the right way to think about it.

Todd: Again, thinking about thoughtfulness at every stage. So companies are not static assets. I like to say over time they'll grow. So the company you bought 20 years ago, not the same company you have today. So they do have to change, and you have to adjust with that as well. But management does, too, based on the stage. So you don't want a visionary CEO coming into a very stable type of business. You want to see somebody who's going to execute on the blueprint. So more of an optimizer. And so sometimes in the company's lifecycle, you do need a visionary to reenter the business of the stable business because they're starting to decline.

Todd: And so at that point, you need.

Todd: A visionary to come in and reset the company's vision. And then once the blueprint for success is achieved, then you have an optimizer come in and execute the plan.

Phil: That's a really interesting thing to look at. What's an example of someone like that.

Todd: Where you've had a company that really.

Phil: Needed a visionary to change things, then an optimizer to take over when the visionary might, I don't know, need his talents or their talents somewhere else?

Todd: Yeah, I think Apple's a classic example there where until Steve Jobs came back, they were sort of floundering a little bit, but they were focused on the computer hardware. And jobs came back and revolutionized the company with the iPhone and all the ecosystem around, you know, unfortunately, he left for unfortunate reasons. And Tim Cook came in and just by good fortune, became an optimizer, and he really executed the playbook extremely well and increased the value of Apple by quite a lot. I mean, I forget on m the top of my head how much, but a huge amount. So we took what Jobs did and got Apple back on the playing field, so to say. And then he came in and executed the blueprint for success over and over and over again. And whether or not that continues, we'll see. But he has clearly done a great job of that over the past however many years he's been CEO, at least seven or so years by now.

Phil: I also remember an example of a company. I think I talked about this company with Simon Erickson, who is our, uh, mutual colleague, and it's Markel. And the way that they seem to be really excellent capital managers in that they're always acquiring businesses, but they always seem to be like accountants with a superpower to find the right kind of business to fit into their portfolio of companies. Do you have any views on Markel?

Todd: I've owned Markel for some time, and I've seen Tom Gaynor, their CEO, present many times and talking about a company with great integrity and character. I think it's hard to argue that with Markel. One of the things I love in a company is m the ability to sleep well at night, knowing that the management team is constantly thinking about creating value and waking up thinking, oh, uh, here's how I'm going to increase the value of Markel today. And value is increased in incremental changes. Once in a while, companies make big acquisitions or something, but typically, it's done in these small, imperceptible ways, and over time, they compound. And when you have a great corporate culture of high integrity, you're going to attract people to that who are thinking long term, who are thinking about creating value. They're not going to fleece their customers. They're not going to fleece their shareholders. They're thinking exactly the way you would want them to if you were running the business. And so Markel, for me, is one of those companies that is a great example of the type of management team and character that I want running the show.

Phil: And they're often talked about as being like a mini Berkshire that's got the insurance business providing the pool of money in which they then go and invest in other companies acquiring other companies.

Todd: Yeah, I mean, that was certainly the playbook. I know.

Todd: I've heard Tom Gaynor talk about the story before where he was a sell side analyst, I think, at Da Davidson, and he was assigned to cover Berkshire, and I believe he was living in Richmond, Virginia, at the time, and he got an opportunity to work at Markel, or he applied for a job and then kind of pitched this idea, saying, like, hey, look what Berkshire's doing. We could do the same thing at Markel, and the rest is history. So I don't think there's anything saying that he hasn't been exactly trying to do that. It's a slightly different business in the sense that the Markel ventures is a little bit different from what Buffett's done with some of his work. But overall, I think it's very difficult model to replicate the Berkshire model. So I wouldn't want to see Markel and Tom Gaynor taking that too seriously. I think certainly using them as a blueprint is fine and is a very noble thing to do, but I do think you need to do play your strengths, and certainly Munger was, and Buffett is really exceptional thinkers and capital allocators.

I wrote a book on dividend investing in 2016 called Dividend Edge

Phil: So one way of allocating capital is with a dividend. What are your views on a dividend yield and the sustainability of that dividend and the quality that it shows that a dividend is paid to shareholders.

Todd: Yeah. I wrote a book on dividend investing in 2016, and the reason for that was, uh, when I was at Motley Fool, I worked at Motley Fool UK. And in 2010 and 2011, I worked for a service called Dividend Edge. And we went, created that one. And we're focused on dividend paying stocks.

Todd: And part of the reason I got.

Todd: Interested in dividend investing was an earlier job. I was helping some portfolio managers at a bank manage the wealth of these very wealthy families in the Washington, DC area. And they were clients for 50, 60 years or even more in some cases. And you could see the dividend income they were generating from some of these blue chip investments that they have held for 50, 60 years. So Procter and gamble three 3M had these really tiny cost bases on these stocks and were just generating just gobs of dividend income, and they could live off that. And I thought, that's just great. I mean, if you can be patient and find the right companies to ride, by the time you get to retirement, you don't really need to be aggressively investing anymore. You can live off the dividend income.

Todd: And so I started learning more about.

Todd: Dividend investing, and when I was writing for Motley fool in the UK, the, uh, UK has a much more passionate dividend investing following than, say, the US does, which is more growth focused. I really enjoyed learning about dividend investing.

Todd: And one of the great things about.

Todd: Dividend investing is that, well, there's two things. One is that the companies have to generate cash flow. You can't pay a dividend in earnings. You have to pay a, uh, dividend in cash, right? So you have to generate cash flow. The other thing is that when a company pays a dividend, it reduces the sandbox, so to say, for management to misallocate capital. And you can say, well, if you don't trust management, you should have them reinvest everything. But I do think that on average, you do want a smaller sandbox for management teams. Uh, there's exceptional managers out there who don't pay a dividend, which is the right thing to do, like Buffett himself. But I do think for most management teams, using a dividend, and because a dividend, in most countries, the tradition is as a progressive dividend policy, so they pay a certain amount every year and they don't go below that. They try to increase it with earnings growth over time. And it's actually a sign of weakness if the dividend decreases. Other markets, other countries don't have the same tradition but certainly in US and UK, there's more of a progressive dividend policy. So you do want to see management have less to work with and be more thoughtful. So if you restrain the amount of cash flow they have available to reinvest, they can be more focused on, okay, we have this much capital, let's make sure we're investing it in high return projects and not blowing it on things that are growth for growth sake, for example.

Phil: That's an interesting point, isn't it? That you want to limit the management's ability to blow the money on projects that, uh, might be vanity projects or things that go wrong. Because often this is where things go wrong. They make a wrong acquisition, or they allocate capital to a new project. And you want to keep them restrained to a certain extent, don't you?

Todd: Right.

Todd: I think you want to trust management. You don't want to invest in a management team you don't trust. But at the same time, I do think that there is value. And there's actually been some papers written. It might be a little dated now, but 2003, I think Cliff Asness and Rob Ardnot wrote a paper called Surprise. Higher dividend payouts lead to higher earnings growth. And one of their conclusions was that this was one of the reasons for the reason that higher dividend payout ratios did create stronger dividend growth was just this, that it reduced empire building. It reduced the risk of empire building on management's behalf, and it made them more focused on, here's how we have to allocate the cash flow that's remaining. And so I do think there is a lot of value in following dividend stocks for that reason.

Phil: Now, the last part of the puzzle and your Venn diagram is price buying at value. Tell us about how you broadly look for the right price to buy a company at.

Todd: That's always the biggest challenge. I think the valuation is sort of the beginning and the end, I would say, of the research project. I think a lot of people will say, oh, I look at valuation last, but I think most of us screen for companies or attracted to certain opportunities when we see something in the multiples or there was a stock sell off or something. So we're initially thinking about valuation, and then we get into the business, and that's where I spend 90% of my time, is trying to understand the qualitative aspects of the business. Does it have a moat? What's the moat? Trend. How does management behave? And so, um, on. But then I also have to confirm that it is indeed a good price to pay. So there's a couple of steps I take. One is a discounted cash flow. I do this with every company that I invest in. I want to see what the explicit forecast is. So a lot of people will just buy on multiples, which is fine, but in every multiple, there's an implicit forecast. So you're saying that based on this multiple, this growth is going to happen over the next five or ten years. This earnings growth can happen in the next five or ten years. But when you have a DCF, you are explicitly showing your forecast, and that way it can hold you accountable for whether or not you think the company.

Todd: Is following what you expected.

Todd: So I tend to take a blended approach. I rely mostly on my DCF, but I also like to confirm that with multiples by looking at, okay, here's where it has traded historically. Here's what some of its competitors are trading for. Do I think those are apples to apples comparisons? But ultimately, I think it comes back to the DCF. I'd like to see all those things in agreement. It's kind of a screaming value, where the DCF makes it look cheap, the multiples make it look cheap, and everything seems to make rational sense, at which case that seems to be a good buying opportunity, or at least getting to know the business, or at least making an initial investment in the business. I rarely make a large initial investment in a business. For my portfolio, I usually start small and over time, over, say, two or three quarters, as I follow the company and get to know it better, then I'll increase my position sizing over time. Once I have built conviction in that name, because some of the mistakes I've made in my investment career have been not having that conviction. So once something happens that the bad earnings report, I get spooked and I sell. And Zach, wrong time to do it. I should have been adding money and not selling out. So I think building that conviction part of it's so important, that's more the qualitative side, right? That's where understanding the business really well. And that way, when bad news happens, you can, ah, uh, that's really not a big deal. That's just a short term blip. That's just seasonality or something that's not impacting the core part of this business.

DCF is future cash flows discounted back to the present at a suitable rate

Phil: So you personally calculate the discounted cash flow. Just explain again for beginners what the discounted cash flow is and why it is so important for working out the price to get in at a company.

Todd: Sure. The value of any cash flow producing assets is. It's future cash flows discounted back to the present at a suitable rate. So, whether it's real estate, or whether it's an annuity, or whether it's a stock or a company, you're looking at the future cash flows. You discount them back to the present to figure out, is this worth buying at this price? So, let's say you looking at a stock that's trading for $50 a share, and you do the math, and for the discounted cash flow, you make your sales forecast, you make your EBIT forecast, you make your capex forecast, you figure out what the future free cash flows are of that business. To the best of your knowledge, you discount those future free cash flows back to the present, and let's say it works out to $60. Well, then you say that the stock is relatively, uh, absolutely undervalued. It has, I think it's, what, 13%.

Todd: Up to the stock or, uh, to.

Todd: The fair value at that point. So you can go from $50 to $60. So you have that margin of safety when you're buying that, you're not likely. Assuming that your forecast comes true or approximately true, there's not a lot of downside that you would have versus, say, if you did the math and it was $40 a share, then you're buying dollars, in which case, if the stock goes down or doesn't hit your forecast, you don't have as much. You have no margin of safety, and you're just following along with the stock. So, ideally, you want to buy an asset for less than it's worth at present. And that's what a, uh, DCF tries to do.

You don't necessarily put all your money into a company straight away

Phil: And it was interesting, your comment that you don't necessarily put all your money into a company straight away. You do it over two or three quarters. Do you find that really helps your investing to really get to know the company, and especially when you do have skin in the game? Buying in?

Todd: Yeah, I think so.

Todd: I think buying in slowly, to the point where you have a lot of comfort. You can read an, uh, earnings report, or you can listen to a conference call and know exactly what the reaction should be. I think that's when you know you have enough understanding of the business. So the first time you buy, invest in a business. You might have read their press releases or their earnings reports in the past, but once you're invested and you get the fresh press release and the earnings report, if you aren't sure if this metric means good or bad, you don't know the company well enough yet to escalate your position. So once you are at a point where you're starting to read the press releases and saying that was a really good number, they hit that revenue per user number really well beyond what I expected, then that's a really positive sign.

Phil: Right?

Todd: But if you don't know what that means, or if you don't have a feeling of what a good number is, then you don't know enough about the business to have really deep, strong conviction in your forecast. So I think as you develop more conviction in the business, then you can increase your portfolio position sizing.

Many new investors fall into a trap when a stock drops dramatically

Phil: And of course, one of the traps that many new investors fall into is that they see a stock tumbling and they think, oh, it must be a good time to get in. And it's easy to think that if a stock falls a long way due to a small amount of missed earnings, that it's automatically a bargain. How can you dig a little bit deeper to avoid this kind of trap which we all fall into?

Todd: Right?

Todd: Yeah, I think it comes back to this conviction. So I've been a part of a lot of situations in which a stock has dropped 20, 30% in a short period of time, maybe after an earnings call or maybe after a series of bad headlines or something, and it comes down to, again, this kind of conviction check. How much do you believe in your thesis now? You might have some new information and say, well, that disproves my thesis, in which case I should sell, because it could get a lot worse. And that happens, too, where you've developed conviction and you refuse to change despite new information when you should have sold after the drop rather than buy more. So there is a balance. There's a tricky balance, always to try to keep yourself honest, to say, if this happens, I need to sell. And that's where what's called a pre mortem comes into play, where before you buy a stock, write down the reasons why you would sell. And if one of those reasons or two of those reasons occur, you sell just to keep yourself intellectually honest, because there is a tendency the longer you get to know a company, you put.

Todd: A halo on them and you say.

Todd: Well, you have thesis drift, right? You start to accept things that you wouldn't have accepted initially. And so you always have to be careful and be mindful of that, that, uh, once you follow a company, once you start following a CEO, uh, once you start understanding the business and really buying into what they're selling, you can get trapped. And so you have to be very careful and keep yourself self aware of that.

Tod Wenning writes a monthly newsletter called flyover stocks

Phil: So, Tod, tell us about flyover stocks, your newsletter, and how listeners can find out more about you and your work.

Todd: Sure.

Todd: So Flyover Stocks is a Substack newsletter, and every month we profile a company that I consider to be overlooked and nevertheless is a great management team led by thoughtful capital allocators and a wide economic moat. So I like to find these companies, then they're out there. I wrote a series for Morningstar back in two, uh, thousand and 13 to 2015 called seeking small cap moats, where we look for small companies that were overlooked for one reason or another. A lot of times they're not based in a major city, they're out in Iowa or Utah or something. And the sell side analysts haven't caught up to them yet, but we think that they're worth profiling because they have an opportunity to grow and fly under the radar. So that's what I was trying to do here again with fly stocks was try to find these companies, whether they're in the US or elsewhere, that just don't have as much attention as some of the, especially right now, the magnificent seven get all the attention and some of their related companies get all the attention in the media. So trying to find some of these companies that are worth for investors to get to know. And so I do one a month and I write just investing commentaries in between to try more education, evergreen education type of posts and share my thoughts on things. So you can find me at flyerstocks.com you can find me on Twitter at Tod Wenning. I'm on threads at Todd Wenning and you can always dm me. My messages are always open.

Phil: And of course we'll put all those links in the episode notes and the blog post as well. Tod Wenning, thank you very much for joining me today.

Todd: Thanks for having me.

Chloe: Thanks for listening to stocks for beginners. If you enjoy listening, please take a moment to rate or review in your podcast player or tell a friend who might want to learn more about investing for their future.

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