Value Hive: 3 Big Things with Matt Sweeney

Good morning and Happy Wednesday! 

This week I’m trying a new content format called “3 Big Things,” or “3BT”. 

3 Big Things distills all my podcast episodes into bite-sized mini-essays. Each piece features the following: 

  • One Conversation (Stocks, Psychology, Markets)
  • One Framework (Mental Model, Analytical, Behavioral) 
  • One Idea (Long or Short)

We’ve got 130+ episodes to break down, and I can’t wait to share these pieces with you. 

Let’s kick this series off with my episode with Matthew Sweeney of Laughing Water Capital. Before we begin, make sure to follow Matt on Twitter @LaughingH20Cap

Also, make sure to listen to the podcast here.

Alright, let’s dig in. 

One Conversation: Ask These Four Questions Before Making Any Investment

One thing I love about Sweeney’s approach to investing is that he keeps this very simple. No matter the company, Sweeney must answer these four questions before spending more time on an idea: 

1. Is it a good business?

A “good” business has many flavors. It could be a high-margin, sticky SaaS product like Avalara (AVLR) or a low-margin retailer like Costco (COST). 

However, Matt prefers businesses that generate high ROIC (or a path towards high ROICs), have lived through multiple market cycles, and have a long runway to reinvest their earnings. 

2. Who are we partnering with?

This is all about management. For example, Matt asks a few questions: Are they quality/trustworthy people? How much stock do they own? Do they have a history of effectively allocating capital? 

3. What happens when something goes wrong?

Every company eventually experiences a downturn. How the company (management, employees, and customers) responds to adversity matters. Ask, “how did this company perform during the last two market downturns?” 

Analyzing how a business performed during a prior downturn will offer a framework for interpreting the next downturn.

4. Why might it be cheap?

Matt saves the best question for last. Investors should meet low-P/E stocks with high skepticism. Given the legions of quantitative models/screens and quant shops, it forces you to wonder, “why am I being afforded this opportunity?” 

Think about it like a venture capitalist. Suppose it’s taken a startup 18 months to raise capital, and suddenly they’re knocking at your door. Any VC worth their salt would say, “why did all the other VC firms pass on this idea? What am I missing?” 

95% of the time, stocks are cheap for a reason. Mr. Market’s pretty darn good at his job. 

I like Matt’s thoughts on “cheap” stocks … “the least attractive ideas that I read are ones based on valuation and price. If your pitch starts with ‘this stock trades at 16x P/E and I think it should trade at 20x P/E, it’s usually a no.” 

One Framework: The Good Co./ Bad Co. Idea Framework

One of Matt’s favorite idea frameworks is “Good Co. / Bad Co.” In short, Matt seeks businesses that operate two business segments where one earns profits and high returns while the other loses money. 

Let’s use an example from my post, Stocks That Don’t Screen Well: Why It Happens & How To Find Them

Suppose we operate a dental care manufacturing company that makes and sells toothbrushes and toothpaste. The toothbrush segment is a good business and generates $1.50/share in earnings. However, our toothpaste business sucks, losing ~$1.00/share in profits annually. 

The combined business earns $0.50/share in earnings. Here’s the exciting part. Our business generates $1.50/share in earnings when management closes/sells the toothpaste division. 

These ideas don’t need markets to re-rate or interest rates to drop. Like Sweeney says, “I just need a management team with skin in the game that doesn’t want to light money on fire forever.” 

You can read one of our Good Co. / Bad Co. ideas from last year here (disc: we do not own shares).

One Idea: Houghton Mifflin, Inc. (HMHC)

During the podcast, one idea Matt mentioned was HMHC, a K-12 education curriculum provider. Matt first introduced the idea in his H1 2021 investor letter, which you can read here

Matt outlines why you should care about the value proposition in his letter (emphasis added): 

“Following the recent sale of their publishing division – which has not shown up in quarterly financials yet – the company will soon be net-debt free. While looking backwards shows a limited ability to generate free cash flow, the future looks much brighter. 

A new management team joined in 2016/2017 and set the company on a course toward a digital-first approach to curriculum, which has many benefits, including a fixed cost base that is now ~30% lower than it was in 2016. As a result, management has indicated that going forward they expect that annual billings above ~$850M will convert to FCF at ~65% margin.” 

Matt also breaks down what things could look like if things go right (emphasis mine): 

“Despite these signs of improvement, if we simply assume that “normal” billings remain the same as the last five years, and that massive Federal stimulus will lead to an uptick from “normal” over the next 3 years, then with reasonable assumptions HMHC’s FCF yield approaches 25%.

With this gusher of cash set to arrive, perhaps the biggest risk is that management and the board fail to allocate it effectively.

The company is currently in a tender/activist battle between Veritas Capital and Engine Capital. You can also read Laughing Water’s letter to HMHC’s board and employees here

Wrapping Up: Feedback Encouraged

That concludes our first editions of Value Hive: 3 Big Things. Please let me know what you think and how I can improve on these going forward. 

I want to provide the most value in the most concise manner possible. And consolidating 90 minutes of a podcast is a challenge. So don’t hesitate to reach out if you have any feedback!

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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.


Investing & Personal Finance

AK is the founder of Macro Ops and the host of Fallible.

He started out in corporate economics for a Fortune 50 company before moving to a long/short equity investment firm.

With Macro Ops focused primarily on institutional clients, AK moved to servicing new investors just starting their journey. He takes the professional research and education produced at Macro Ops and breaks it down for beginners. The goal is to help clients find the best solution for their investing needs through effective education.

Tyler Kling

Volatility & Options Trader

Former trade desk manager at $100+ million family office where he oversaw multiple traders and helped develop cutting edge quantitative strategies in the derivatives market.

He worked as a consultant to the family office’s in-house fund of funds in the areas of portfolio manager evaluation and capital allocation.

Certified in Quantitative Finance from the Fitch Learning Center in London, England where he studied under famous quants such as Paul Wilmott.

Alex Barrow

Macro Trader

Founder and head macro trader at Macro Ops. Alex joined the US Marine Corps on his 18th birthday just one month after the 9/11 terrorist attacks. He subsequently spent a decade in the military. Serving in various capacities from scout sniper to interrogator and counterintelligence specialist. Following his military service, he worked as a contract intelligence professional for a number of US agencies (from the DIA to FBI) with a focus on counterintelligence and terrorist financing. He also spent time consulting for a tech company that specialized in building analytic software for finance and intelligence analysis.

After leaving the field of intelligence he went to work at a global macro hedge fund. He’s been professionally involved in markets since 2005, has consulted with a number of the leading names in the hedge fund space, and now manages his own family office while running Macro Ops. He’s published over 300 white papers on complex financial and macroeconomic topics, writes regularly about investment/market trends, and frequently speaks at conferences on trading and investing.

Macro Ops is a market research firm geared toward professional and experienced retail traders and investors. Macro Ops’ research has been featured in Forbes, Marketwatch, Business Insider, and Real Vision as well as a number of other leading publications.

You can find out more about Alex on his LinkedIn account here and also find him on Twitter where he frequently shares his market research.