TIP356: Investing Mastermind Q2 2021

Episode Summary

Executive Summary: This Q2 mastermind episode covered three practical investing themes: Toby argued that value investing is back in favor as markets rotate from speculative growth into higher-quality value; Jake recommended an intensive Buffett-based self-education curriculum and discussed investor psychology; Wes explained why ETFs are structurally tax-efficient. The second half focused on Dick’s pitch for Franklin Covey as a potentially asymmetric, subscription-driven business with meaningful upside but real concerns around moat durability, incentives, and execution.

Main Topics: Value investing cycle and factor rotation (Priority: 5/5): Toby argued that value has been outperforming since late 2020 as markets rotate away from speculative growth names like ARK-type stocks and Tesla. He described a shift from lower-quality, distressed value early in a recovery to higher-quality value later in the cycle. Building an investing education 'MBA' with Buffett materials (Priority: 5/5): Jake proposed a structured learning path centered on Warren Buffett’s essays, a detailed Berkshire Hathaway history book, and annual meeting recordings to help investors learn directly from source material and develop durable judgment. Investor psychology, willpower, and avoiding bad behavior (Priority: 4/5): The group discussed how successful investing often requires environmental controls rather than raw willpower, including limiting exposure to noise, using rule-based systems, and separating speculative behavior from long-term capital. ETF tax efficiency and in-kind redemption mechanics (Priority: 5/5): Wes explained how ETFs avoid realizing many capital gains through in-kind creations/redemptions with authorized participants, making them much more tax-efficient than mutual funds, hedge funds, or direct taxable accounts for active strategies. Franklin Covey as a SaaS transition and potential asymmetric bet (Priority: 5/5): Dick presented Franklin Covey as a business transitioning from legacy training/on-premise revenue to a subscription-driven SaaS model, with improving economics, rising deferred revenue, and a possible valuation rerate if execution continues. Bear case on Franklin Covey: moat, incentives, and execution risk (Priority: 4/5): The group raised concerns about the durability of the brand moat, competition from other training platforms, management incentives tied to adjusted EBITDA, restructuring costs, and whether the company can sustain content and sales execution.

Key Arguments: Value has likely been strengthened by the pandemic-era rotation out of speculative growth and into cheaper, higher-quality businesses. Factor performance is noisy, but the market seems to cycle from distressed value to quality value as recoveries mature. Rising long-term rates may be intuitively supportive of value, though the link is hard to prove statistically. A serious investor should learn from primary sources: Buffett’s essays, Berkshire annual letters, and annual meeting videos. Investing success depends heavily on controlling your environment and inputs, not just on willpower in the moment. ETFs are tax-efficient because they can redeem securities in kind, avoiding taxable sales inside the fund. For long-term active strategies, ETF wrappers preserve optionality by deferring taxes and reducing embedded liabilities. Franklin Covey’s SaaS transition could create a high-margin, recurring-revenue model with strong retention and cross-sell opportunities. The bull case for Franklin Covey rests on subscription growth, high incremental gross margins, and a larger international rollout. The bear case is that leadership/personal-development content may not have a wide moat, and management may be incentivized to present adjusted metrics favorably.

Data Points: Value factor outperformance start: Since September 2020 - Toby said value began outperforming from around September last year and has remained relatively strong. 10-year Treasury yield low: 0.57%-0.6% - Toby referenced the pandemic-era bottom in the 10-year yield. 10-year Treasury yield recent range: 1.56% to 1.73% - Toby used this to discuss how rates have risen from lows and may have helped value. Quality factor performance: Down over a rolling 3-year period - Toby noted that quality has looked poor versus lower-quality names in the recent cycle. Franklin Covey subscription revenue mix: 60%-70% currently - Dick said recurring/subscription-like revenue has risen from the legacy model to a majority of revenue. Franklin Covey target subscription mix: 90% within a few years - The company is aiming for most revenue to be subscription-based. Franklin Covey incremental gross margin: 85% - Dick cited high incremental gross margin on the all-access pass subscription product. Franklin Covey add-on sales: ~50% of original sale amount - Dick said the company often generates additional sales equal to roughly half of the initial deal size. Franklin Covey deferred revenue: More than $100 million - Used as evidence of signed but unrecognized future SaaS revenue. Franklin Covey valuation: 11x-12x free cash flow - Dick argued the stock looked cheap after adjusting for SaaS economics. Franklin Covey share price: $31 - Dick referenced the current stock price at the time of the discussion. Franklin Covey upside view: Could be worth at least $60 - Dick’s rough estimate of intrinsic value based on transition progress. Sales rep long-term productivity target: $1.3 million annually - Dick cited management’s target for fully ramped salespeople over a five-year period. Sales team performance vs. expectations: 20% above metrics - Management said the sales team outperformed expectations on the recent earnings call. Revenue retention: 90%+ - Dick highlighted strong retention in the subscription business. New content spend: $5.4 million last year - Jake/Toby discussed ongoing investment in new content creation and digital upgrades. Restructuring costs: $500k, $700k, $1.4M, and $1.6M - Dick flagged repeated restructuring charges over multiple years as a concern. Berkshire annual meeting recordings: Available starting in 1994 - Jake suggested pairing Adam Mead’s book with Berkshire annual meeting videos from 1994 onward. March 2020 market drawdown: Intra-month ~50% drawdown - Wes referenced how value strategies experienced severe volatility during the pandemic crash. Workshop/book length: ~250 pages - Jake described the Buffett essays compilation as roughly 250 pages. Franklin Covey historical return: 10-bagger since 2009 pitch - Toby recalled passing on it in 2009 and later seeing it become a 10x investment.

Pivotal Quotes: "Momentum sucks, quality sucks, size rocks, value rocks, beta rocks." — Wes: Wes summarized recent factor behavior in a blunt shorthand during the value discussion. "If you’re serious and you actually want to be an investor, I’m not sure that there would be a better way to spend your time." — Jake: Jake on studying Buffett source material, Berkshire history, and annual meetings as a self-directed investing curriculum. "ETFs are like 1031 for stocks." — Wes: Wes explained the tax-deferral analogy for ETF in-kind redemptions.

Implications: Listeners should focus on process: study primary sources, control behavior, and use tax-efficient structures. Franklin Covey may offer upside if its subscription transition endures, but its moat and incentives deserve close scrutiny.