Jason Karp – Opportunities in Public and Private Markets - [Invest Like the Best, EP.86]

I believe that any investment strategy that will deliver strong returns in the future must evolve. Any strategy should rest on rock solid foundational principles, which change rarely if ever—things like price discipline, or business growth. But the features of the strategy must keep getting better, because the marketplace is incredibly competitive. That evolution is the topic of today’s conversation with Jason Karp. Jason is the founder and CIO of Tourbillon Capital Partners, a multi-billion dollar asset manager based in New York City. We cover a ton of interesting ground. We start with what has happened in public and private markets, discussing the role of quants, passive indexes, and value vs. deep value investing. We compare the relative merits of investing in private equities, and where and how opportunities arise. We then focus in on two interesting private investing trends: the health and wellness sector and the cannabis industry. First, we discuss Hu kitchen and Hu Products, the food business that Jason started with his family several years ago in response to personal health challenges. Second, we discuss his evolved views on Cannabis as an investment space and why it may also represent a massive growth opportunity. You all know I value transparency, so it is important to note that since I recorded the conversation, my family became an investor in Hu Products. It has been a fascinating means to learn about the food, health, and wellness industry which has grown rapidly in recent years. We were customers of Hu in New York City long before I even knew Jason, which made that part of the conversation especially interesting for me. This episode re-enforced my believe in pushing one’s investing strategy to adapt to change market conditions and competitive pressures. If we have any hope of beating Vanguard, we can’t ever rest on our laurels. This was an especially eclectic and fun conversation, I hope you enjoy my chat with Jason Karp. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag Show Notes 3:06 – (First question) – Jason’s view on private markets vs public markets and how his view has evolved 6:02 – Phase of the private markets where companies can achieve huge size and scale without going public 10:31 – Framework of Jason’s value-based investing strategy 13:47 – Reverse discounted cash flow 16:27 – Are there areas of the market that are easier to predict using Jason’s models 20:29 – Tech dominance the longer they are around 21:01 – Jerry Neumann Podcast Episode 22:08 – How markets have changed over Jason’s career 25:58 – Types of edge that you can have in the market 30:00 – Broad examples of sectors that are high-quality, but momentum is hurting them 31:32 – Backstory of Hu Kitchen 38:33 – Investment research into health and wellness 42:56 – State of acquisitions, particularly in consumer product goods 47:13 – Jason’s research into Cannabis 50:43 – The misperceptions of Cannabis 56:30 – Why cannabis is a more important sector to consider than crypto 57:51 – What are the most important levers to growing a business 1:02:24 – Biggest lessons learned in hiring good people 1:06:10 – Investing lessons 1:09:27 – Kindest thing anyone has done for Jason Learn More For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on twitter at @patrick_oshag

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:32Patrick O'Shaughnessy?

  This podcast is sponsored by CFA Institute, the global association of investment professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals, working to build an investment industry where investors' interests come first, financial markets function at their best and economies grow. The Chartered Financial Analyst credential is the most respected and recognized investment management designation in the world. The views expressed in this podcast do not necessarily represent the views of CFA Institute. Hello and welcome everyone. I'm Patrick O'Neal and this is Invest Like the Best.

• 1:15Patrick O'Shaughnessy?

  This show is an open-ended exploration of markets, ideas, methods, stories and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com.

• 1:31Speaker 02

  Patrick O'Neal is the CEO of O'Neal Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Neal Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Neal Asset Management may maintain positions in the securities discussed in this podcast.

• 1:56Patrick O'Shaughnessy?

  I believe that any investment strategy that will deliver strong returns in the future must evolve. The strategy itself should rest on rock solid fundamental principles, which change rarely if ever, things like price discipline or business growth. But the features of the strategy must keep getting better because the marketplace is incredibly competitive. That evolution is the topic of today's conversation with Jason Carr. Jason is the founder and CIO of Turbion Capital Partners, a multi-billion dollar asset manager based in New York City. We cover a ton of interesting ground. We start with what has happened in public and private markets, discussing the role of quants, passive indexes, and value versus deep value investing. We compare the relative merits of investing in private equities and where and how opportunities arise. We then focus in on two interesting

• 2:39Patrick O'Shaughnessy?

  private investing trends, the health and wellness sector and the cannabis industry. First, we discuss Hugh Kitchen and Hugh Products, the food business that Jason started with his family several years ago in response to personal health challenges. Second, we discuss his evolved views on cannabis as an investment space and why it may also represent a massive growth opportunity. You all know that I value transparency, so it's important to note that since I recorded the conversation, my family became an investor in Hugh Products. It's been a fascinating means to learn about the food, health, and wellness industry which has grown so rapidly in recent years. We were customers of Hugh in New York City long before I even knew Jason, which made that part of the conversation especially interesting for me. This episode reinforced my belief in pushing one's investment strategy to

• 3:22Patrick O'Shaughnessy?

  adapt to changing market conditions and competitive pressures. If we have any hope of beating Vanguard, we can't ever rest on our laurels. This was an especially eclectic and fun conversation. I hope you enjoy my chat with Jason Carr. I'd love to talk about your view on private markets versus public markets, generally speaking. We'll go into a number of different examples, but that dichotomy I know is something you and I have talked quite a bit about. I'd love to get your take on how the difference has evolved.

• 3:51Speaker 03

  Yeah, so I think there's obviously similarities between publics and privates. And the most glaring similarity is that they're both companies that hopefully have economics and good margins and generate cash flows and ultimately should be valued by the discounted cash flows that that business will produce. I think the rise of quantitative investors and the rise of passive investors, which tend to be, in the case of quants, they tend to be very short-term and they focus more on what actually makes stock prices move in the short-term as opposed to what are these businesses worth. And in the case of passive, they tend to be indiscriminate allocations towards themes and sectors and factors and markets where you're buying everything within the S and

• 4:36Speaker 03

  P or you're buying everything within the triple Qs. And that has created over the last five years, I've been in the public markets for almost 21 years now, and that has, I'd say the last five years have become pronounced in terms of the dislocations between fundamental values of companies and their prices. And the reason is, is because if you look at 10 or so years ago, and there's statistics on this that we've been able to capture from prime brokers, investment banks, between 40 and 50% of the daily trading volume of stocks used to come from what they'll call fundamental discretionary managers. People who actually have opinions about companies, people who have opinions about what things

• 5:17Speaker 03

  are worth, and they're making decisions every day and buying stocks based on what they think these companies are worth or not worth. Today, that number is less than 10%, which has been well documented by several banks. So 90-plus percent of all trading activity is coming from non-fundamental sources. It's coming from passive, it's coming from quant, it's coming from CTAs, it's coming from people who are trying to capture risk premia. And knowing that means that stocks aren't trading, the marginal setter of price is not someone who's actually thinking about what does this company do, or what is this worth, or what is it not worth? And the private markets fortunately have not had that issue.

• 6:02Speaker 03

  Private markets are subject to a lot of other issues, but the public markets, you can get substantial multi-year.

• 6:11Speaker 03

  Not multi-month or multi-day. You can get sometimes multi-year dislocations from passive and probably less so from quants. But the good news is for public investors is, you know, in our work, the time for convergence between cash flows and fundamentals of a business and stock price usually is three to five years at worst. Sometimes it can be faster. And what's going on in the private markets right now is equally fascinating. And it started primarily, or this kind of, let's call this, we're in a phase. This phase started with Uber where companies were able to achieve spectacular size and scale without having to go public. And that's been a game changer.

• 6:57Speaker 03

  You know, if you go back 10, 15 years, and certainly any time before that, companies never got that big before they had to get public. And it was sort of a rite of passage you needed to do. And there were many reasons for it. The capital markets were much less efficient. So finding and getting access to a lot of different investors wasn't possible 30, 40 years ago. And there was also a real discipline about reporting in saying, okay, now our company is ready in terms of governance, in terms of financial reporting, that we can expose everything to the public markets for anyone to pick at. And the last five to 10 years, particularly I'd say five years, there has been an explosion of private capital.

• 7:39Speaker 03

  VCs all the way up to what I will call sort of very slow growth private equity capital. And the trends behind that are ironically linked to the trends that I said to you about what's going on with public markets. And I believe that the trends of why people have been allocating so aggressively to privates is because the public markets have gotten harder. And people don't want to deal with daily, weekly, monthly, mark-to-market.

• 8:08Speaker 03

  The private markets, you know, when there is a problem, when Travis, the CEO of Uber, is in a scandal and gets fired, you hear some rumors and comments that there's some secondary trading of the private Uber shares that's down 15% or 20%, but you don't get a statement in your mail, or you don't get an alert that Uber's down 20% to 30%, you don't panic. You don't really think about it. Whereas if Uber was a public stock when that happened, it would have been down 30%, and people would have completely panicked, and they would have thought, "I hate this business. I don't want to deal with this kind of volatility." And so, you've had a massive, and some of this is related to QE and low interest rates, and people needing yields, and not having to worry about where

• 8:49Speaker 03

  they're going to make returns. You've had a massive influx of capital into all aspects of private equity, primarily, in my belief. I don't think it's necessarily a better asset class, per se, than public stocks, but it has a few extra features that make it much better for investors, which is, you don't have the ability to panic. Can't mess it up. You can't mess it up. And you don't get marks. And, you know, I sit on the board of an endowment, where I'm the chairman of the investment committee. And when you're going through your portfolio, where you have fiduciaries, and you have a budget, and you can't lose money, you really prefer things that are low vol and don't have marks versus

• 9:29Speaker 03

  things that are high vol and do have marks. And so, I think the private equity market is, on the one hand, and this is going to sound almost paradoxical, but on the one hand, I think the private equity market still offers, as a market, I'm not saying allocate to large private equity funds, but I'd say the private equity market still offers some incredible sources of alpha, where there's a lot of edge left. You're not competing against quants or passive. Yet.

• 9:59Speaker 03

  Yes, maybe.

• 10:00Patrick O'Shaughnessy?

  We're coming.

• 10:01Speaker 03

  And so, there are, and I think most importantly, there's still a much more linear relationship between effort and outcome in the private equity space, whereas the public market space, and again, depends on your time horizon. If your time horizon's five years plus, there's a very linear relationship between effort and outcome. If your time horizon is what 99% of active managers have, which is a quarter, or less, even a year, you can generate substantial losses while you're waiting for certain fundamentals to play out, and if your investors don't tolerate that, you're out of business. And so, I think the private equity market, on the one hand, is certain types of privates

• 10:45Speaker 03

  I still think are really compelling, particularly in areas outside of tech, and we can go through that in a second. And, on the other hand, I think there's so much capital in the space that you have to be much more cautious now.

• 11:00Patrick O'Shaughnessy?

  Valuations have certainly come way up.

• 11:01Speaker 03

  About valuations, about even business models.

• 11:03Patrick O'Shaughnessy?

  So you mentioned that you're a value investor, that's maybe in your DNA. I always like to kind of poke and prod on people's, the most base level framework that they think about potential investments and like where the opportunity lies. One that I always come back to is Michael Mobison's expectations framework, where you've got perception, you've got reality, that's price and fundamentals, and then you've got like catalysts, and catalysts drive convergence of those two things. Is that how you would boil it down, when you say you're a value but not a deep value investor, that's kind of what comes to mind? Is that a fair representation? I would love to hear that base level framework.

• 11:34Speaker 03

  And I wrote a very controversial letter, I believe it was the summer of 15, about why I thought deep value investing was dead. Deep value, and it's a very important distinction. And the reason was, and then I'll get to how I think about value versus deep value. The reason was, was I think the first kind of deep value principles obviously came from Graham, and Dodd, and Buffett. And, that was during an era in the 40s, 50s, and 60s, where markets were wildly inefficient, people literally didn't read 10 Ks and 10 Qs, there was no electronic information, there was no email, obviously, there were no computers. And so, you could actually find things that were trading less than their cash. That actually existed. And you could find businesses that were horribly, horribly misunderstood.

• 12:20Speaker 03

  But we did a few searches on Amazon and on Google. This is now three years ago. I'm sure it's worse today. There were 8,000 books referencing value investing. Eight thousand. There were dozens and dozens of websites referencing value investing. When you have that much competition in something that's been around now for 50, 60 years, to presume that it works just like it did is literally insanity. And the problem is with the value investing today as a broad category is that the markets are pretty efficient now. So when you find something that trades at five times earnings.

• 12:58Patrick O'Shaughnessy?

  Probably should.

• 12:59Speaker 03

  It probably should. Now, maybe one out of 10 times it shouldn't, and if you catch that one out of 10 times, you're going to make a lot. But in most of these businesses, these are severely impaired, declining businesses where your perception of what the ultimate cash flows or earnings of this company are, you have no idea. And they could deteriorate far faster than people think. And so I prefer, if I could find deep value where the cash flows are growing, which is extremely rare, then that's the best-case scenario. But my primary first variable is are the cash flows growing? Because growth solves a lot of sins. And I mean real growth. I don't mean just sort of fake financial engineering growth.

• 13:44Speaker 03

  I mean actual growth, organic growth. And if the cash flows are actually growing, you could be wrong on the valuation. You could be wrong by a lot if they're growing. So in the case of certain types of stocks today, FAANG is very controversial right now. And Facebook is particularly controversial because of the Cambridge Analytica scandal and the fear that they're disclosing too much data and the delete Facebook meme, et cetera. But Facebook's growing their earnings by at least 20%. And there's a lot of levers they haven't pulled yet. And so what we do, similar to what Mobison advocates, is we do a lot of what we call reverse DCF, or reverse discounted cash flow, where we actually take the price today.

• 14:28Speaker 03

  And instead of a typical discounted cash flows, you make projections about what the cash flows will be. You discount them back. You say, this is what it's worth. A reverse is you actually try to figure out what's priced into today's stock and what would have to happen for it to be worth this. And if you have, let's just abstract for a second and say it's not Facebook. But if you have an asset that's growing earnings 20%, your money is doubling roughly every three and a quarter years. So your earnings are doubling every three and a quarter years. So if you could have a five-year time horizon, and let's say your money goes up fourfold or threefold over, we'll call it a five or six-year window. If you buy that at a reasonable price, there's literally no way you lose money.

• 15:10Speaker 03

  If its cash flows grow threefold and you bought it at a reasonable price, there is no scenario where you lose money. If the multiple gets cut in half, you still win. If the multiple gets cut by 75%, you still win. Assuming you bought it reasonably. I'm not talking about something that trades at 500 times earnings or anything like that. And so growth, having underlying growth of the cash flows, solves so many problems. And so I always look for things that actually are generating some form of growth. Because I don't know what the multiple is going to be in two years. I don't know what people will pay for it in two years. I just know I have a lot more cash flow in two years than I have today. And I underwrote it well. And so whereas with deep value, most things that are on my screen today,

• 15:54Speaker 03

  that, and by the way, you know, most deep value, you can do a simple 30-second screen for that any-

• 16:02Patrick O'Shaughnessy?

  Anybody, what the computer can do.

• 16:03Speaker 03

  Any 15-year-old could do to say, oh, here are all the cheapest stocks in the S and P right now. And they all look like six times to nine times earnings. And you know, obviously, you can get into all the debates about whether earnings matter and whether you should value it on EBITDA, et cetera. But in the case, all the cheap stocks have things that are very, very wrong with them. And so you're inherently in an adverse selection pool to try to find the sort of frog that you can kiss that turns into a prince. When most of them are frogs and you're- Going to get warts all over your face. And so I just think there's an easier game to play, which is instead of looking for deep value, look for value.

• 16:46Speaker 03

  So instead of looking for things that trade at six to eight times earnings, look for things that trade at maybe 12 to 16 times earnings, but actually have a lot of growth behind them. So that if you're wrong on certain things, the growth will solve all ills.

• 17:00Patrick O'Shaughnessy?

  Are there areas of the market that you find, so a key part of that is an understanding of that cash flow or earnings growth over the next three to five years? Forecasting this kind of stuff is notoriously hard, just statistically. Are there parts of the market that you find lend themselves better to that kind of work? And maybe parts that are just very difficult and you avoid when you're trying to forecast that that far into the future?

• 17:20Speaker 03

  Yeah, so I think the underlying cyclicality of the business is very important. Because cycles come and go. I think recognizing the nature of the business. So let's just contrast for a second. So let's say you're looking at a shoe company that has a set of shoes right now that are in fashion. And I'm actually not referring to a specific public company. I'm just using fashion as an example. Fashion is notoriously something you can't extrapolate. Because the trends can go from on to off in a year. And you know, this is like what Crocs went through when it first came public. Crocs was a very hot stock. And then people realize like, they're really ugly. They happen to be comfortable and outside of chefs and doctors, like, I don't know if I'm going to walk around outside

• 18:03Speaker 03

  with these clogs that look like Swiss cheese on. And so they went from hot to not in the period of a year. You could do no extrapolation. And then you have a whole segment of the economy that is what people call cyclical, which is really dependent on GDP. And when things are booming, people are buying more steel, they're buying more metal, they're buying more commodities, they're building more, people are making more discretionary purchases. Those are all things that are cyclical. And then on the opposite side of things, things like staples. Food is non-cyclical. People didn't stop eating in 2008 at the bottom of the recession. Now, they chose to spend less and they chose to be smarter about where they spend. And so, certain things like high-end restaurant consumption went down.

• 18:48Speaker 03

  But, one thing I think is essential when you're trying to measure persistence, is just thinking about the underlying business itself. So, businesses that are much more prone to subscriptions, that are much more prone to daily use and daily habit, tend to be easier to bank on. And, you know, with a name like Facebook, or Netflix, or Amazon. The one thing I'll say about all four of the FAANG stocks, Google, Netflix, Amazon, and Facebook, and then I would extend even to Microsoft and Apple and some of the others, is they've all become deeply entrenched in your daily habits. To the point where you can't even imagine what it would be like, in most of those, to not... I mean, I can't even imagine what it would be like to not have Amazon.

• 19:32Speaker 03

  And if you watch a lot of content on Netflix, you probably can't imagine what that's like. And for people who traffic on Instagram, and I think Instagram has been the saving grace of Facebook. I'm not really on social media at all. I've never posted on Instagram, but I do follow Instagram because CPG businesses thrive on Instagram. And it is an incredible platform for undiscovered brands. Instagram is so powerful for business that I don't see it going anywhere but growing a lot. And, I think several of those businesses, not Netflix, and not Amazon, but Facebook and Google are surprisingly cheap for how deeply ingrained they are into your daily habits,

• 20:16Speaker 03

  for their cash flow profile, for their balance sheet, for their growth. And I think that's why they're so loved by a lot of investors. Because, when you compare other stocks that trade at similar multiples, you know, we're talking teens, teens multiples. You know, there's wild cyclical companies with grossly inferior margins, grossly inferior business models, grossly inferior balance sheets that are trading at the same multiples. And so, if you're actually doing relative comparisons and saying, "I could own this cyclical for 19x earnings, where if we go into a recession in the next year and a half, their earnings are going to get cut in half." Versus I could own Google x cash for the same multiple. It's nuts.

• 21:01Patrick O'Shaughnessy?

  Two really interesting points, given all your comments. So the first was, if you look back at, basically take Facebook's current earnings and look back at its historical since IPO price compared to today's earnings, there was like 24 months when you could have bought it for less than seven times today's earnings. So outrageous multiples at the time, but fast enough growth. I think people just do a bad job at edges of understanding extrapolations and growth trends and leave mispricings at both ends of the spectrum. And then the second point you make me think of is a conversation I just had last week with actually a prior podcast guest named Jerry Neumann, who's a venture capital investor here in the city. And he's studied technology cycles like in great depth and done a lot of work on the Carlota Perez innovation cycles.

• 21:44Patrick O'Shaughnessy?

  And one of the things that she found was after the bust, the 1999 being the bust for technology, you get this long like deployment age where the turnover in the dominant companies, we're all used to high turnover in tech companies dominance, but it actually goes way, way down. And so maybe in the next 10 years, he's studying this right now, like maybe in the next 10 years, all the names you mentioned are going to have this sort of hegemonic dominance that people aren't properly discounting and anticipating. Fascinating stuff.

• 22:08Speaker 03

  I think that's right. I think that's right. I think, I think people are definitely underestimating the, the scale power. But look, I'm always open minded and I have to take both sides of the coin in terms of my view. Facebook kind of came into public being like in a major way in 2006, 2007. That's 10 years ago.

• 22:27Patrick O'Shaughnessy?

  Crazy.

• 22:28Speaker 03

  So it would be foolish to presume that it cannot be disintermediated just because it's so big and so readily used, given that it just kind of came into the public perception only in the last 10, 11, 12 years.

• 22:40Patrick O'Shaughnessy?

  So one of the last kind of major questions in, in the public markets, and we'll get back into some of the interesting private stuff is almost like, like you know, you mentioned more than 20 years now doing this, almost like a retrospective of sorts, the major stages of evolution that you've seen markets, hedge funds, market participants go through and kind of what you think about building an edge into the future. So maybe what stopped working and how you think about building something that will work from this point forward.

• 23:06Speaker 03

  Yeah, so I think it's probably worth going through the, the history of the markets since I've been in them, which I got into the markets in the summer of 1998. My first job was as a quantitative analyst for a hedge fund, straight out of Wharton undergrad. And one of my first tasks for my boss at the time was to effectively do a report on what was going on with long-term capital, which was what happened in the fall of 1998. And amazingly, back then, there've been, call it three, I'll call it arms races within quant and a non-stop arms race going on within fundamental discretionary managers.

• 23:47Speaker 03

  And the first arms race kind of ended when long-term capital happened for quants because it was so explosive and so bad. And back then, it was basically just statistical ARB spread capture with a lot of leverage. But it's worth remembering that when I began, having a Bloomberg was a unique advantage. I probably knew 20, 30% of my colleagues had Bloombergs back then. Most people weren't using the internet for everything in 1998. I had friends and analysts who would routinely go to the New York Public Library to get caves and cues from the past. The SEC website was not working particularly well back then. And so, the kind of edge you could have even 20 years ago was massive relative to now.

• 24:31Speaker 03

  Not to mention that prior to 2002, 2002 was the beginning of what they call Reg FD, or Regulation Fair Disclosure, which basically leveled the playing fields so that bigger commission-paying businesses couldn't get preferential access to management teams and the sell-side. But it was shockingly legal, prior to that, to call up a sell-side analyst at a bank who you paid a lot of money to and say, "When are you going to upgrade Yahoo?" And he would say, "I'm going to upgrade it tomorrow, and I'm going to put a $300 price on it, and the stock's trading at 150." And this is during 1999, when stocks would routinely go up 50% on upgrades. And that was legal.

• 25:16Speaker 03

  And more insanely, it was legal to call up corporate management teams and say, "How's the quarter going?", and them saying, "It's not going well." And thankfully, they changed that with Reg FD, so that the playing field was leveled, because if you were a big commission payer, you could really have an advantage. And I would say post '02, '03, and I morphed out of a pure quant role into a fundamental portfolio manager role where I was using quantitative disciplines to help me with my stock selection, my portfolio construction, my risk management, et cetera. The business started to get much, much more competitive, call it '04, '05, '06. And you've got to remember, when I started at a hedge fund, there were only a few hundred hedge funds.

• 25:59Speaker 03

  There are over 10,000 now, and that's not including all the quants who are actually working out of their apartments on systems like Quantopia where there's literally tens of thousands of individuals who are trying to come up with strategies that can beat various aspects of the market or find anomalies. And the '04 to '07 period for hedge funds was the heyday, where it was massive amounts of alpha, really good stock picking possibilities, and still a fair amount of research-based edge. And, you know, there's only a few types of edge that you can have in the market. You can obviously have a research-based or informational edge, which I believe today is mostly gone, based on both Reg FD and the rise of competition.

• 26:43Speaker 03

  You can have an analytical edge, or analytical advantage, which is you have the same information as everybody else, but you process it differently, and you process it in a way that is superior. And I believe that still exists. And then you have what I would call sort of structural edge. And structural edge is where I think there's the most opportunity. Structural edge is being able to hold things for a very long time. Having an LP base that is willing to stomach through three years of all, or having a structure that allows you to play offense when other people are playing defense. I think there are opportunities to run super net long, but I think one of the structural

• 27:23Speaker 03

  advantages of a low-net or market-neutral type of fund is that you're, assuming your portfolio is constructed properly, most people are playing defense when the market goes down. And they're playing offense when it's going up and they're playing offense when it feels good and they're playing defense when just things go down because the market's going down from beta. And so not being exposed to beta gives you a structural advantage so that when the market goes down, if you're not losing money and everyone else is, they're starting to make decisions that are non-economic. The competition has become incredibly intense and it's happened at a time also when the number of stocks that exist in the market is down by more than half in the last 20 years. So because a lot of companies have been taken private, a lot of companies have gone out

• 28:08Speaker 03

  of business, but it's mostly from M&A, it's not from bankruptcies and there's far fewer companies coming public. And so as we talked about with the case of Uber and names like that, there's companies that are just staying private much, much, much longer. And so we have some really interesting stats that we measure, but we have number of sell-side analysts relative to number of public stocks and that ratio is at an all-time high as of the end of 17. And when you just think about that and you just think about public markets and then when you get into, and this is even before quant, and then when you think about all the data that quants are now ingesting and their grossly superior ability to process thousands and thousands and thousands of data sets over what a human can do, anything in the short

• 28:53Speaker 03

  term and most quant that's ingesting a ton of data is on the shorter term of the time horizon, you can't possibly win. And so you have massive increased competition and you have the rise of quant and passive and systematic strategies. And so I think there's a few ways that we're thinking about it in terms of how do we create the most amount of opportunity to make the most amount of money. I think on the public side, the good news is, as bearish as my prognostication sounds, is capital markets are still capital markets and you'll always have winners and losers. You'll always have an Amazon versus a Walmart. You'll always have an Apple versus a BlackBerry. And if you can hold it for long enough, if you have longs whose cash flows double and

• 29:33Speaker 03

  triple over a multi-year window, and you have shorts whose cash flows massively deteriorate over a multi-year window, you will win. Now, the path from getting from A to B is much less linear than it used to be, but you will win. But you have to hold it, and you have to be there for the whole duration. And so, on the public side, I think there's more opportunity than I've ever seen in my career for duration.

• 29:56Patrick O'Shaughnessy?

  Yeah, I've heard that a few spots, yeah.

• 29:57Speaker 03

  Ever. I see more crazily dislocated stocks because they screen poorly, they look bad to quants, they're on the wrong side of passive. These are all variables that don't ultimately tell you, is this a good business, is this a bad business? And then stocks on the other side, which screen amazingly well, they're positive momentum, they look like they're high quality, they look like they have beaten earnings the last three quarters in a row, they adopt a momentum today that is so much greater than it ever used to, that they're getting very crowded with people chasing what's working.

• 30:32Patrick O'Shaughnessy?

  Are there like broad industries that are examples of that, or broad examples?

• 30:35Speaker 03

  I'd say growth tech is that right now. And look, I think there's plenty of names within growth tech that are amazing. But separating stocks from businesses, for a second, you know, growth has become over 90% correlated to momentum in the last 18 months. And it is the highest realization of growth to momentum and correlation that it's ever had. And because most of the newer types of players in the market, let's just call them passive and quants to keep it simple for now, they tend to be more trend-following, they tend to be more momentum-oriented, and they tend to be focused on what's working, which makes sense. And at the same time, you've had a lot of what I'll call sort of value-contrarian types of investors who've gotten obliterated over the last three years,

• 31:17Speaker 03

  and they're going out of business. So you have a lot of capital from the people who are trying to be the price setters, leaving. And then you have a lot of capital coming in to players who are actually doing well because they're riding the trends, which is therefore exacerbating those same trends. And so, I think there are plenty of tech names, and not just tech, I'd say things that look like Quality, Safe, LowVal. There's plenty of names that fall into those buckets that I think are very overextended. And I think there's plenty of names on the opposite side that skew a bit more value, that might be a little hairier, that might not fit into one of these easily described

• 31:57Speaker 03

  factors. I think the disconnect between the fundamental value and where the price is, is the largest I've ever seen in my career.

• 32:05Patrick O'Shaughnessy?

  So maybe you could tell the backstory, the origin story of Hugh Kitchen, why you're interested in this space and how the business began.

• 32:11Speaker 03

  I've had autoimmune issues my whole life. It got really bad in my early twenties. I was working extremely hard. I went straight to a hedge fund after college and I was working a lot of late hours and trying to do the whole work hard, play hard thing, but my life really started to deteriorate from my health. And by my early twenties, I was very ill. I was diagnosed with several incurable diseases. I visited almost a dozen doctors. No one knew how to fix me. And I ultimately realized after doing a lot of independent research and just being curious that I could actually cure my symptoms and ultimately cure my diseases through better eating, better sleeping, and better physical activity. That was, call

• 32:55Speaker 03

  it, you know, sort of circa 2002, 2003, 2004 window. And my brother-in-law, I got married in 2004. My wife's brother, Jordan Brown, was very interested in the health and wellness space and nutrition and physical fitness. And there were a few books that I recommended to him. One in particular was called The Ultra Mind Solution by Mark Hyman, which is a great book, although he's written a lot of books since then. And Jordan read that book on his way back from a bachelor party in Las Vegas when he was feeling particularly not good. And he came to me and said, that book was basically the basis of his decision

• 33:36Speaker 03

  to push me to say, hey, Jason, there's nothing in New York City, which is kind of the mecca for food, where the food is so strictly chosen, the ingredients are so strictly vetted.

• 33:49Speaker 03

  That he said, "There's nowhere in New York where you really could meet the criteria of what we wanted to do and what I believed and what Jordan believed was optimal for our health." And we looked around and we did a lot of market research and, you know, what we found was it was a really bifurcated market. You had, at one end of the spectrum, you had the very high-end, super-healthy, farm-to-table type of places, which was very slow, very expensive, fine dining. And then on the other side, this is called around 2008, 2009 timeframe, on the other side of the spectrum, you had the sort of bohemian hippie, raw food restaurants, which, you know, I'm a foodie, I like the taste of food. I don't think it tastes good.

• 34:34Speaker 03

  I mean, I think most people who are able to eat more things than raw would agree that raw food is not particularly good. And so, we saw that there was this huge opportunity in between those two poles to basically create a high-end kitchen and market focused strictly on unprocessed food. And that was the basis of it. And then, you know, obviously, as a public markets investor, restaurants are notoriously tricky businesses. The economics of them can be decent to great if you do it right, and they can be terrible if you do it wrong. I was, at the time, I was the co-chief investment officer of another fund, so I knew that while I was going to be the one who paid for it, I wasn't going to be the one who managed it. But I also knew what we didn't know. And there was a lot we didn't know. We didn't know how to run a restaurant.

• 35:18Speaker 03

  We didn't know how to find these types of organic ingredients. We didn't know how to find talent who could cook in these methods, because there's no traditionally trained, there's no chefs that are trained in cooking dairy-free, gluten-free, refined sugar-free, which are some of our, what we call, guardrails. And so, it was a really interesting process that took several years with many consultants and many business plan iterations. And the kind of ultimate outcome of all this was Hugh Kitchen, which is our restaurant in Union Square, that now serves between 1,000 and 1,500 people a day. We have a very wide offering and our kind of two primary criteria in anything we put

• 36:02Speaker 03

  in the restaurant is, number one, it has to be delicious. We won't put anything in that actually isn't delicious. And we have a phrase that we call "the kid test." Does it pass the kid test? So, I have two children, and if we give them something, they have to think it's actually delicious before they know that it's healthy.

• 36:18Patrick O'Shaughnessy?

  It reminds me of there's a great venture capital firm here in the city called the Collaborative Fund and they're basically their entire investment thesis is what they call the villain test. So it has to be good for the world, so to speak, but also be good for you. And if it doesn't, it's basically the same as the kid test. Food fits the kid test really well. That's a really interesting investment idea that Hugh seems to follow.

• 36:39Speaker 03

  And I would say that shockingly, a lot of healthier food concepts and companies don't actually adhere to the it has to taste good principle, which is really odd. And then, so that's the first piece is it has to be delicious. But the second piece is we have very strict guardrails. And our guardrails are what guides us in terms of what are things we won't do. And I would say even today, you know, when we first started Hugh, which was at the end of 2000, it opened for business at the end of 2012, we were very fringe. It was very cutting edge. Nobody was doing this. In fact, a lot of people told me not to do it because they thought the business model wouldn't work because we were using very, very high end ingredients that were strictly vetted. And so, you know,

• 37:24Speaker 03

  our two main criteria was delicious and then it has to adhere to our guardrails. And we've never deviated. And we've had many situations which were against our profit motive. And I think one of the nice things is, is when we launched it, it was fully internally funded. We took no outside investors. And the main reason wasn't that I was fortunate enough to be able to have funded it. The main reason was that I didn't want people with too much of a profit motive.

• 37:53Patrick O'Shaughnessy?

  Coming up the works.

• 37:53Speaker 03

  Yeah, coming up the works, you know. And, and I think there were many instances where, you know, and I think this is something that requires a fair amount of education and learning about how unhealthy and deleterious a lot of the kind of modern ingredients are. But if I had investors kind of breathing down my back, saying, why are you using organic free range chicken when the cost of goods are twice the price of free range chicken? You know, the customer probably won't know the difference if you just use free range chicken and we'll make twice the profit margin. I didn't want to ever have that conversation. And so when we created Hugh Kitchen, it was Actually more of a passion project where I was hoping to break even, maybe make a

• 38:34Speaker 03

  small return on it, but more importantly, be able to eat what I wanted to eat every day, be able to never have to question what was put in this, which it's kind of horrifying when you learn what a lot of restaurants put in things. And I also wanted to see if we could prove to New York and more broadly the country and maybe even the world that there are economic ways to produce the highest quality of ingredients in food that customers will like and not pay through the nose for. The interesting thing about the health and wellness space, so I think within privates and publics, there's just not many ways to play it yet publicly. I think health and wellness as a category is one of the most compelling areas to be

• 39:18Speaker 03

  doing investment research right now, both on private side and on public side. And the reason is, is that health and wellness, and let's just confine it to food for now, but there's, health and wellness is a much broader category that can include fitness in businesses like Peloton, it can include medical devices that allow you to measure all aspects of your health and your health outcomes better, and obviously things like Fitbit and companies like that fall into that bucket. But the changes that are going on in food now and the consumer attitude towards food and beverage, you know, I'll just call it food for now, is so profound because once you realize and once you become educated on how toxic a lot of this food is, and everyone

• 40:01Speaker 03

  knows that our modern ailments are a function of our lifestyle and our food, I don't even think there's a dispute about that, but because it's kind of like a glacier melting, it's not something on people's mind every day. And so people would rather take a pill, if they have type 2 diabetes that they got in their 30s or 40s from probably eating a poor diet, they'd rather take a pill and go on insulin than actually take the time to realize what caused my diabetes, and it turns out that most type 2 diabetes can actually be easily reversed with diet and lifestyle. And so there is a tectonic shift happening, and it's really been spearheaded by what I'll

• 40:45Speaker 03

  call both the millennials and current mothers. And many current mothers are not millennials, they're older than that, but let's just call it sort of this newer generation is much more digitally aware. They care much less about brands than they used to, meaning 20, 30, 40 years ago, you cared about, is this Cheerios? Is this from General Mills? Is this from Kellogg? Is this from Campbell's Soup? And there was this blind-

• 41:13Patrick O'Shaughnessy?

  Kind of like a reduced search cost or something. You could trust the brand.

• 41:15Speaker 03

  Yeah, yeah. There was sort of, if it's big and it's institutional, it must be trustworthy. And something flipped in the last five to 10 years, where people just don't care anymore. And they want transparency. They want to know that there's not a profiteer behind their food. And they want to be able to think about, what is the mission behind this company? And what, why am I providing this company my business? And so I think there's a tectonic shift that's been going on in health and wellness. You're seeing it in many public stocks. It's not a coincidence that all the big food public stocks are at 52-week lows right now. Their businesses are all in trouble. They can't innovate enough. They can't innovate fast enough. The customers don't want mass,

• 41:59Speaker 03

  mass-produced, chemically laden, preservative laden food. They want things that resemble real food. And so I think these trends, and we've done a lot of polling, we've done a lot of survey work, we get a lot of feedback from our Hugh Kitchen Restaurant, where I can tell you with high conviction, that this trend is not going to reverse. And the main reason it won't reverse is because once you learn about this stuff, you don't go back. It's not like a fad, where you try it, and then you realize, eh, that didn't work for me, I'm going to go back. Once you realize that some of these preservatives and chemicals, and things like glyphosate, which Monsanto produces, it's part of the chemical in Roundup, that they spray on most conventional crops, it's not on organic crops. But once you realize

• 42:44Speaker 03

  what glyphosate does to animals, and does to children, and does to adults, you never go back. You never think like, okay, I learned how bad it was, I'm going to now actively want to consume this stuff. And so, I think this is one of the biggest mega-trends. Food is one of the biggest industries that's been around since the dawn of man. We always have to consume it. And I think the ways we approach this from an investment perspective are immensely important.

• 43:10Patrick O'Shaughnessy?

  In both markets?

• 43:10Speaker 03

  In both markets. The interesting thing going on in the private markets is, I'd say the last two, three years, and this is not just within what we'll call consumer packaged goods, or CPG, but it's happening in all kind of fast-growing segments of the economy that are in private companies. Is many companies are getting bought, I'd say particularly in CPG, for their revenue. And the math happens to work for when a big food company buys a small food company. So for example, Kellogg's just bought the RX Bar. RX Bar started four to five years ago out of Chicago. They had really great branding. You've probably seen it all over the place. Airports everywhere. It's all about, and it really appeals to these trends that I mentioned in terms of Simple ingredients.

• 43:55Speaker 03

  Simple, there's only three, three almonds and one egg white and two peanuts, et cetera. And they really captured it in the packaging. And they achieved very rapid distribution in a very short period of time. And Kellogg's just came in, I want to say it was a month and a half ago, two months ago, and paid, I believe it was $600 million. Where it wasn't, the revenues weren't fully disclosed, but we had heard that it was around $100 million. And Kellogg's paid six times revenue for it. It's unknown if they were actually profitable. It's unknown how much EBITDA they were generating, but I assume it's de minimis. And it's not as ludicrous as it sounds from a multiple perspective, because what these,

• 44:38Speaker 03

  and this happens in the beverage space, particularly in alcohol, is the arbitrage that these big buyers have is distribution. They're just scale economists, yeah. Kellogg's is already shipping massive numbers of trucks all over the country to every grocery store, delivering stuff, anyway. So now if you can just add some RX Bars onto the same truck that they're already shipping, you pick up a lot of synergy that wasn't there. And then obviously in-housing the production of it, in-housing the ingredient, purchasing. The whole supply chain, right? The whole supply chain. And so you don't ultimately know what the math is, because they usually don't disclose all the math, but it's not, it's never as bad as it looks.

• 45:19Speaker 03

  But the unintended consequence of the last four years of this happening, because there've been many companies that have been purchased for four to eight times sales in the CPG space. Big, it's always the same story. Big food buys new Young upstart. New entrant for several hundred million dollars, always looks like a ludicrous valuation. And what's happened, though, which is what you have to stay away from. Is a lot of companies are now thinking, oh, I'm just going to try to grow my revenue as fast as I can, and I'm going to find one of these quote dumb buyers because they need me, and I'm going to try to sell it to them. So I'm going to get my revenue to some minimum level where it moves the needle for them, which people believe is around 25

• 46:04Speaker 03

  million in revenue as kind of a minimum before you should approach quote big food. And then I'm just going to sell it to them and they're going to pay me some handsome multiple. The problem with this is I am a value guy at heart, not a deep value guy, but I care deeply about valuations. Care about price. Which is different. And I care about things like cash flow and margins. And I care about, does this business actually work if somebody doesn't buy it? And we are in a nine years into a bull market right now, where everyone thinks the sun's never going to set. And I've seen many cycles unfortunately in my 21 years. And when this tide goes out, and it will go out, and these companies don't actually have economic business models,

• 46:47Speaker 03

  they're going to go to zero, actual zero. And I think it's really important, and we've with Hugh Products, which we can get into in a second, but Hugh Products basically sells mostly chocolate, and we'll go into it in a second, but we made sure with our Hugh Products business, which is all sales outside of the store, that the business actually works. And that we're not, look, if we ultimately have a big exit in several years from now, that'll be great, but we also are under the impression there's a chance we never sell it. And we just want it to be a great business, which will ultimately be for our investors. We've recently just did an outside, our first outside capital round for that. But I think right now, in the private space, certainly in the CPG space and some other sectors that

• 47:29Speaker 03

  we're monitoring, there is a not quite 1999 euphoria bubble aspect, but there's definitely not enough focus on does this business work if the capital markets shut off for six months.

• 47:44Patrick O'Shaughnessy?

  Fascinating stuff. Let's talk about cannabis. So back to kind of the health and wellness theme, this is certainly the frontier or the edge of that theme. You've done a ton of personal research and work into the industry, I'll just say broadly speaking. Maybe you could share that kind of research journey and your general take on what's going to happen.

• 48:00Speaker 03

  I'm an investor at heart and I look, whether it's public or it's private, or it's off the run stuff, or it's on the run stuff, or it's traditional stuff, or it's controversial stuff. And certainly cannabis falls into a lot of the negative side of some of those descriptors. I'm naturally attracted to inefficient markets. I'm naturally attracted to growth. And I'm naturally attracted to businesses that I think have long duration to them. And I think cannabis is going to be one of the biggest industries in this country in the next five to 10 years. I think it is almost insane if you are an investor of any kind, public or private, to not have a strong opinion and not have basic knowledge on what's going

• 48:40Speaker 03

  on with cannabis. In fact, I would go so far as to say, I think it's far more important to be knowledgeable on this than it is on crypto, for a variety of reasons which I'll get into. I started spending a lot of time on it about three, three and a half, four years ago. And it actually wasn't too dissimilar to how I arrived with, at a lot of my investment conclusions from my autoimmune history and my Hugh Kitchen and Hugh Products experience, where I had something personal, I had to explore that personal issue. I learned a lot in the process. I became passionate and knowledgeable at the same time. And then I saw with kind of newly educated eyes, all these new investment opportunities, long and short, which I've been able to express both public and private in the health and

• 49:24Speaker 03

  wellness space, from that experience. Cannabis wasn't dissimilar. I've had issues with insomnia most of my adult life. I was a college athlete. I barely smoked any cannabis in college. I was also very law abiding and I really, it was pounded into my head like every other youth, that drugs were bad and alcohol was fine. And so, you know, I consumed a, probably a pretty reasonable amount of alcohol, similar to other college students, while trying to be a Division One college athlete. But I stayed away from drugs and I was pretty strict about it to the point where I had kind of a moral high ground around it. And up until probably four or five years ago, I had that same perception of cannabis

• 50:07Speaker 03

  and I bucketed it in the same group as LSD and cocaine and Molly and all these bad drugs that you hear about. And I had several friends who I deeply respect, who are brilliant in their day job and they're also very accomplished athletes, who were starting to consume more and more cannabis and giving up alcohol progressively. And naturally, I asked them, "What are you doing?" And one of them said to me, "Look, Jason, you're an open-minded, flexible investor. Why don't you do your research on cannabis before you be so judgmental? And I'll tell you, this is one particular individual who's a triathlete, he noticed

• 50:47Speaker 03

  his physical performance improved dramatically by switching from alcohol to cannabis." So I said, "Okay, fair enough. I respect you. I respect your judgment. I'll do some research." And I spent like a couple of weekends just getting my hands on, this is many years ago now, getting my hands on everything I could get my hands on. And I approached it the same way I would approach a new industry in the public markets. And I was shocked with how much misperception I had and everyone else has. The history of cannabis, it was known in the 30s that it was safer than alcohol. And there are really interesting historical reasons why cannabis has been viewed as a very dangerous drug.

• 51:32Patrick O'Shaughnessy?

  It was like a propaganda campaign, wasn't it?

• 51:33Speaker 03

  It was. In the 30s, there was a big fight between the mafia, both Italian and Irish, over whether alcohol or cannabis, this is around prohibition, would be allowed. And the mafia, who controlled the alcohol trade, won. And so they kind of kept cannabis in the shadows and they brought alcohol back out of prohibition. And then in the late 60s, early 70s, in the Nixon era, Nixon hated the hippies so much. And there was also, there was actually a race element to cannabis because there was a perception that cannabis was much more for the African-American community, and certainly in the 60s and 70s, it was the hippies. And Nixon had decided, and this is what I read,

• 52:16Speaker 03

  I mean, I don't ultimately know the truth-truth, but he wanted to make it so penal to consume cannabis, that, this is around when the DEA was created, the Drug Enforcement Agency, that they created what are called Schedules for Drugs. Schedule 1 is the most dangerous drug, which feature the stiffest penalties for if you're caught. Schedule 1 means there's no medicinal benefits, there's no point in doing research, and it's just a horrible drug for humanity, and leads to a lot of prison time. So, things like crystal meth are in Schedule 1, and crack, and marijuana is Schedule 1. Things like morphine are Schedule 2. Schedule 2, and then Schedule 3 are things like Valium, and prescription drugs that

• 52:59Speaker 03

  have some narcotic effect, but you have to be careful, but they can prescribe them readily. And putting cannabis in the Schedule 1 category in the 70s has led to 50 years, almost, of misconception, and misperception. Not too dissimilar to what's happened with nutrition. And the more I researched on it, the more I realized, so, first off, it's far safer than alcohol. There's no overdose limit. You can literally consume as much as you want. You'll get very sick, and you'll probably hallucinate and need to go to the hospital, but you can't die. You can actually die, your organs shut down, from consuming too much alcohol. So, the cannabis is actually not considered toxic. Alcohol, by contrast,

• 53:39Speaker 03

  is toxic. Cannabis, if you smoke it, is metabolized through the lungs, and alcohol is metabolized through the liver, and so leaves a lot of liver damage and related. Cannabis actually has very well-known, and very well-established medicinal benefits in a whole host of areas, which have come out really over the last five years.

• 53:57Patrick O'Shaughnessy?

  It's like CBD and things like that.

• 53:59Speaker 03

  Yeah, and from very severe conditions, there's a few forms of, rare forms of childhood epilepsy. There's a company called GW Pharmaceuticals, that actually is pioneering a drug right now, that you Uses cannabis, particularly CBD oil, which is the non-psychoactive extract, one of the extracts from the cannabis plant. It's the only way to cure this particular form of seizures. Cannabis is highly anti-inflammatory. It's very good for people who have issues like Crohn's, Irritable Bowel Syndrome, arthritis, back pain. So my journey has been a long one, where my issue was insomnia, and certain forms of cannabis are particularly good for insomnia.

• 54:40Speaker 03

  And I decided, when I was in states where it was legal, I decided that I would try, as a form of cure or treatment for insomnia, and I've tried everything. I've tried Valium, I've tried Ambien, I've tried all the prescription drugs on how to...

• 54:58Patrick O'Shaughnessy?

  Melatonin, like all those kinds of things.

• 54:59Speaker 03

  Everything. And I said, you know what? I'm gonna be open-minded. It's legal in all these states. I'm not gonna have the bias that I used to have. I'm going to try it and sort of see. And it worked surprisingly well for me. And from that moment on, which was now three years ago, I realized that I was going to spend a lot more time on the research, from an investment perspective, of this, because this is a $50 billion industry today. Only six to eight billion of it is legal. In my belief, the dominoes are falling now to progressively increase the legalization timeline. Canada, as an entire country, is going fully recreationally legal in July of 2018.

• 55:41Speaker 03

  And so I believe that the critical tipping point has happened, and whether you want to invest on the medical side, or you want to invest on the recreational side, or you want to invest in all of it. This is an industry that's been around for 3,000 years. Our first presidents actually grew hemp on their property, or they actually grew cannabis and they used it for hemp. The distinction is cannabis is the entire plant. Marijuana is the bud of the female that actually has the psychoactive properties of THC. And I think there are going to be dozens and dozens of public companies. There's currently six or seven of scale in Canada, many of which are billion-dollar companies with admittedly ludicrous valuations.

• 56:24Patrick O'Shaughnessy?

  Ridiculous, yeah, multiples.

• 56:25Speaker 03

  I wouldn't invest in those. But there's a ton of private companies, and my belief is that if you don't understand this now... You are going to miss several years of massive alpha. Because in the same way that the late 90s had massive alpha in tech. There were lots of longs and lots of shorts. There's going to be some cannabis stocks that go to zero. And there's going to be some cannabis stocks that tenfold. And it's very important, in my opinion, to understand the industry, understand the players, understand the subsectors within cannabis. And there's just a, there's a lot of different ways to play.

• 57:01Patrick O'Shaughnessy?

  It's really funny you mentioned that this is probably more important to understand than crypto. When I'm with really large groups of investors in Canada, because of the, it's amazing, right? You can get this massive difference in the perception. And they ask more questions about that than they do about crypto. That's a foreign concept here in the US still, because of the legalization problem. But what an interesting area of the market, fascinating stuff.

• 57:21Speaker 03

  And unlike crypto, again, just speaking as a guy who cares about valuation and cash flows.

• 57:26Patrick O'Shaughnessy?

  There's something beneath it.

• 57:27Speaker 03

  There's cash flows to these businesses. And some of them actually spew cash flow. And, and some of the earlier movers, depending on the subsector that you're in. Some of these dispensaries, which are the stores that are legally licensed to sell products in the states where it's legal. There's a few dispensaries in the, in the country that are doing tens of millions of EBITDA out of one store.

• 57:49Patrick O'Shaughnessy?

  Crazy.

• 57:50Speaker 03

  Not revenue, EBITDA. And so to me, if you're going to be spending time on things that are the future, that have a speculative element to them. I prefer businesses that have cash flows than businesses where I'm just doing full, I mean, all crypto is greater full theory, just to be clear, all of it. Not blockchain, but betting on a cryptocurrency is betting that someone's going to pay you more for the same thing that you bought without any cash flow generation. Whereas with this, if your cash flows grow, you could be wrong on whether people want to buy it from you or not, but you still win.

• 58:23Patrick O'Shaughnessy?

  So the last couple of questions I'll ask are on the business human capital front. So as you think about Hugh Products, you know, growing that business and you mentioned earlier the reverse discounted cash flow where you're trying to identify like the key levers that drive a business. That's about as simple a business as exists in terms of like you're making something, there's a supply chain, you're selling it to consumers, it's physical, very tangible. What do you think are, as you think about growing that business, the most important levers? And maybe this is an answer that can be portable to other people out there that a lot of whom run businesses and are entrepreneurs.

• 58:54Speaker 03

  So Hugh Products has been an extension of Hugh Kitchen. About 98% of our revenue is chocolate. Our chocolate is dairy-free, gluten-free, refined sugar-free, meets all the specs of Hugh Kitchen. In fact, we created it because we couldn't find chocolate that met our specs, so we had to create our own. And it's turned into quite a real business now. We're in over 1,600 stores today. We should be at about 2,500 by the end of the year. And 98% of it is chocolate and we have several other products. We currently sell what we call clean coffee, which is a vetted, lab-tested coffee. Most coffee is actually quite dirty and filthy. Any mass-produced crop that's not organic is always going to be dirty because there's so much business behind it in making sure that they get yields.

• 59:36Speaker 03

  But even a lot of organic coffee has mold and yeast and what are called mycotoxins, which is a form of mold, on it. And we go through a few extra steps to test it. Anyway, we are just selling simple products. Our key levers, the way kind of I think about it, is our chocolate. Traditional chocolate is viewed as a confection, is viewed as candy. Our chocolate is 70% dark. It has no refined sugar in it. And dark chocolate in particular has been proven and shown over the decades to have a very high antioxidant effect. And so it's actually, you could be argued, is healthy. Our chocolate, however, is chocolate. And so it's high fat, it's not low calorie. And for us, what's driven a lot of the increased uptake in the chocolate is that people find

• 1:00:21Speaker 03

  it to be a permissible indulgence. So instead of thinking, I'm eating candy. People seem to be grouping our chocolate in the same category as a snack, as a protein bar, where it's similar caloric level. Most Americans do not need the level of protein that they're consuming anyway, and it tastes much better than a protein bar. And frankly, we have many athletes who consume our chocolate bars as a energy snack. So what we're really focused on in terms of levers are, obviously, as a business model, we have to make sure we have a good gross margin. We distribute in a variety of ways. We distribute direct. We sell directly on our e-commerce website at hughkitchen.com. We do not sell on Amazon yet, but we will in the future. And one of our largest customers is Whole Foods, where

• 1:01:06Speaker 03

  we sell via retail. And then when you go via retail, you have several ways you can get into retail. You can distribute directly, which is very hard these days, meaning there's no middlemen. You actually deliver directly to the store. But most retailers use a distributor, which functions as a middleman, which takes your margins down considerably. So from a business model perspective, we're looking at number of units that we're selling, number of stores that we're in, number of channels. And you've heard the term omnichannel, but how many are we, how much are we selling in retail? How much are we selling online? We look at those as kind of basic KPIs of the business itself. But more importantly, because I care so deeply about this mission and the philosophy behind why we do what

• 1:01:50Speaker 03

  we do, is how we think about our customer loyalty, how we think about our customer communications, and then ultimately, how we think about our employee and our internal culture, because we have to have a culture where people actually believe this. I don't want people who are just espousing this because it's their job. I want people to actually learn. And so there's actually a fair amount of education that goes into teaching, why is unrefined organic coconut sugar better than refined genetically modified cane sugar? And we try to train our people in this, so they can understand that in the case of the former, it's much lower glycemic, it doesn't spike your blood sugar, you don't

• 1:02:32Speaker 03

  get that crash after lunch if you eat it. And with all the things that, why we don't have dairy, why we don't use gluten, why we don't use preservatives, why we don't use soy lecithin, these are all things that we have to teach people. And then ultimately, if you invest in the culture and you invest in your people, so that they become educated, then they become successful ambassadors who can actually help. Propagate our mission to a broader audience.

• 1:02:56Patrick O'Shaughnessy?

  Maybe say a few words about the biggest lessons you've learned on the human capital side. So this is something I'm spending a huge amount of time thinking about. It's sort of the most important thing, or the only thing even, is finding people who are good people, who are very good at what they do and are passionate about what they do. Any broad lessons across a lot of different firms, different industries now?

• 1:03:15Speaker 03

  Oh, yeah.

• 1:03:16Patrick O'Shaughnessy?

  That you would roll up and offer out?

• 1:03:18Speaker 03

  I've learned a tremendous amount, and I made dozens of mistakes in hiring over the years. I've had literally hundreds of people report either directly or indirectly to me in my various capacities. And I've tried to be methodical about recording those lessons and recognizing what are the mistakes that I keep making. And I would say, first off, intelligence and passion are essential. Intelligence, I'd say, in most of our circles is pretty easy to come by. Passion's not. And passion is incredibly important because you ultimately want the person that you're hiring to want to dig deeper, to want to actually enjoy what they're doing. And people are inevitably never good at what they do if they don't have some passion behind it.

• 1:04:00Speaker 03

  Probably the third variable, and I'd say most people that we end up interviewing and we end up coming across have those two always. The third variable, which is much harder to find, is emotional intelligence. And I think emotional intelligence is more important than IQ, far more important. And emotional intelligence deals with a lot of different variables, but it's really about your ability to control yourself, your ability to resolve conflicts with others, your ability to have empathy and see other points of view from other people, your ability to remain intellectually honest and rapidly change your opinion when presented with conflicting facts. These are things that, in the investment industry, are crucial. And I would say, even in the food industry and in some of the privates that I'm doing,

• 1:04:44Speaker 03

  I'd say it's equally important because... You're always presented with conflicting information. You're always presented with new facts. You're always presented with challenges and problems and difficulties. And being able to be resilient, have that grit, be able to just fall, get back up, fall, get back up, is so important. And so, we tend to skew, when I'm hiring people, I tend to skew towards athletes, competitive athletes, where they've had a lot of trial and error and failures and losing matches and losing games over time. Get teamwork out of athletics. I love to hire people who have military backgrounds, because there's great training in that. I've actually found, and this is going to be a, this is a new one, that I've learned probably in the last five years.

• 1:05:28Speaker 03

  I find mothers to be spectacular. So, it's women who've had children. Because a lot of people in the workforce are children. And they don't behave like adults, they don't resolve conflicts like adults. And I have found that women who have had the experience of dealing with children have such amazing perspective on how to manage and deal with people of all different types of conflicts, that I couldn't recommend it. From a judgment perspective, I think they are, mothers are some of the best kind of category for getting all of these factors that you're looking for.

• 1:06:05Patrick O'Shaughnessy?

  I would even add on top of there, mothers and I guess parents in general, who have dealt with a child that has any sort of issue. I find these people to be the most resilient and compassionate and hardworking and understanding. It's kind of unbelievable.

• 1:06:19Speaker 03

  They know how to balance their time, and they know how to remain organized, and they know how to remain cool under pressure. I think instead of looking for criteria on a resume, it's much better to just look at, what has this person actually been through?

• 1:06:31Patrick O'Shaughnessy?

  Done, yeah.

• 1:06:32Speaker 03

  And done, to help you understand, can they deal with these types of things? And so, I would say, as a, sort of a, because I know we're at the end, as a, as a kind of quick set of answers, that would be my.

• 1:06:42Patrick O'Shaughnessy?

  Yeah. And any, any big overarching investing lessons that we missed?

• 1:06:46Speaker 03

  Yeah, I mean, look, I would say I've gone, I've done so many different types of investing. I started as a, as a pure black box type of quantitative investor. I've done a lot of different types from event-driven to different types of distress situations, to growth, to value. I would say that particularly as it relates to the story around Hugh and health and wellness and so all the opportunities we've identified within that space and we continue to see, and cannabis, I'd say that it's very important for you to, and this is a little Peter Lynch-esque, but for you to keep your consumer hat on at all times and remember that your gut instinct about how you feel about the product and how you feel about the experience and how you feel

• 1:07:29Speaker 03

  about the interacting, if it's a business that you interact with, is so important. And it's really important to pull on the thread of as you're discovering this. So just two final examples. So when we developed the huge chocolate, and it's very delicious and it also is low glycemic and it's healthy as chocolate goes, I was eating it every day. And I remember thinking, and at this point I was the sole investor in the company, and I remember thinking, why am I consuming this every day? Because I wasn't selling it really to other people at the time. I wasn't trying to live the brand. There was no external reason. And so I started to pull the thread and said, why am I eating this every day? And first off, it's delicious, so that's obvious. And then I, I like to deconstruct my own thoughts, my own biases.

• 1:08:14Speaker 03

  And I think, okay, so I know it's delicious, but what else? And then I would dig a little deeper and I'd realize I'm someone who needs sweet once a day. I need some minor indulgence every day. I just, I have a sweet tooth, I like it. I feel guilty if I eat junk, particularly sweet junk, and I don't feel guilty if I eat this. And so I was able to kind of mentally articulate, what is it that's attracting me to this? That's making it almost an obsession? And I think, if you think about businesses like Netflix, you can do the same kind of pulling on the thread to realize, wow, I really like their original content. I like the fact that I don't have to watch commercials. I like how easy it is for Netflix to posit, what are other things I might like?

• 1:08:59Speaker 03

  And you start drilling into it and you realize, I'm not unique. This is definitely applying to a lot of people. And these are ways you can spot trends much earlier than trying to read about them, where you can just literally trust yourself as a consumer of these things. And so I make a habit of just trying lots of stuff all the time, because I want to see how my own natural instinctive reaction is. And I think I have a pretty good read at this point now of if I feel that innate draw to become obsessed with something, that it tends to actually happen for the broad audience. And if I'm an early adopter, then that means I'm going to be ahead of the trend in recognizing what may happen.

• 1:09:43Patrick O'Shaughnessy?

  I love the framework as almost like a checklist item, first step for any sort of structural long, like anything that you're making a long-term duration bet on, that if you don't have that feeling and that you can almost dimensionalize the reasons why it's so interesting, like just don't even bother. Just move on to the next thing. The last question that I ask everybody on the podcast is for the kindest thing that anyone's ever done for them.

• 1:10:04Speaker 03

  Oh, this is a good one. I've had a lot of people be kind to me. So this was both kind and impactful on me. When I was a freshman in college at Penn, I was meant to play tennis in college and I had actually switched when I got to Penn because I was very burnt out in tennis. I switched to squash. And I was a walk-on onto the team. It was a very good team, very competitive. And I went up to the coach and I'd said, you know, this was in the third week or fourth week of school, listen, I'm a very good tennis player. I've never played squash. I'll work harder than anyone. Please let me on the team. He let me on the team. And then about a month and a half later, and I was the worst on the team. I was 20th out of 20. And he really did me a favor. And about a month and a half later,

• 1:10:47Speaker 03

  I had decided to transfer from pre-med into the Wharton School. And the Wharton School had a much stricter criteria for the curriculum than the College of Arts and Sciences did. And I was very nervous that I wouldn't be able to be a college athlete and keep up with my Wharton curriculum. And so I went into the coach, it was about a month and a half later after I had joined the team. And I said, "Listen, I just got into Wharton. I'm not going to have time to play this new sport and I'm quitting." And he sat me down and he had, almost like a father figure, and he said, "Jason, I see a lot of talent in you." And up until that point, I was kind of an underachiever in my life.

• 1:11:28Speaker 03

  And he was one of the first people who really sort of saw what I think I could have become in terms of a person. And he said, "I think if you stick with this sport, you'll become excellent. I think you'll love it. I think it'll actually help you in school." And, you know, after about a half hour of this, and I'm paraphrasing because it was a longer conversation, I said, "Okay, I'll give it a shot." And, you know, I was very insecure about this decision. And it ultimately changed my life because being a college athlete while trying to be a rigorous, a very good student at what was one of the hardest schools in the country, it taught me some great skills about perseverance, about organizational skills.

• 1:12:11Speaker 03

  You know, many of my friends who were recruited to be athletes, they stopped being athletes in college so they could have more fun. I don't think I had a particularly fun college experience, but it taught me some lessons that I viewed as so essential for who I am as a person. And I regard him as one of the most important mentors in my life still to this day. And that decision to be so kind as to, instead of just saying, because he didn't need me, he didn't need, I was 20th out of 20, I was the worst player on the team, he didn't need to talk me into this. I ended up being, finishing number three on the team and being an academic All-American because I persevered through it and because of him. And it really made me who I am. So I would say that was the kindest thing someone's done for me.

• 1:12:55Patrick O'Shaughnessy?

  Great place to end. I get a lot of family answers, as you might expect, probably not enough mentor answers. So a great, a great change up there. Thanks for all the time today. This has been wide-ranging and fascinating.

• 1:13:06Speaker 03

  Thank you.

• 1:13:08Speaker 04

  Hey everyone, Patrick here again. To find more episodes of Invest Like the Best, go to investorfieldguide.com/podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com/bookclub. After you sign up, you'll receive a full investor curriculum right away, and then three to four suggestions of new books every month. You can also follow me on Twitter @Patrick_OShag, O-S-H-A-G. If you enjoy the show, please leave a quick review for us on iTunes, which will help more people discover Invest Like the Best. Thanks so much for listening.