Brian Feroldi: Why He Buys Stocks at All-Time Highs

Let's take it over to the actual financial statements. This is where, you know, you truly are a wizard. You've walked through them with people for probably a decade plus. What are you actually looking for when you go to a financial statement? >> So, um, what I'm looking for is highly dependent on what phase of the business growth cycle a company is in. There are some companies that are in the startup phase that are actively losing huge amounts of money. they're purposely overspending in an effort to build out their their business model over time. Uh other companies like an example of that would be like SpaceX. SpaceX is losing gobs of money uh right now, but they're in even though they're what $ 1.5 trillion company, they're in the startup phase. So you obviously when you're looking at their financial statements, you have to look through that lens when analyzing are they doing a good job uh or not. Take that. A company on the other side would be like Apple. Apple is very clearly in the capital return phase. Their their their financial statements are fully built out. Their margins are fully optimized and they're act they've been returning capital to shareholders for 10 plus years now through the dividend um and the buyback. So the first question you to ask when you're looking at financial statements is what phase of the business growth cycle is the company in and what is the thing that management is is optimizing the business for? Elon is optimizing SpaceX for topline revenue growth. That is the metric that you should look at when analyzing how are they doing as a business. Revenue uh grow gross margin and then and then the burn rate. Those are the key metrics there. Take a company like Apple. Apple would love to grow its topline but that is not the absolute focus of the business. The focus of the business is maximize margins, maximize return on invested capital and maximize capital return program in order to power returns for shareholders. So when you're analyzing a Apple's business, you need to look at things like return on invested capital. You need to look at what gross operating and net margin is. Things like the company's tax rate come into come into play and and the company's balance sheet is being used to buy back stock or pay dividends. So the lens that you look through financial statements depends highly on what management is trying to do. >> What's a stock that you think might surprise people, but you would say has, you know, a flawless balance sheet or a flawless financial statement when you look at it in perspective of what you just said? >> Oh, um, Meta Meta has one of the best balance sheets, um, on Earth, or at least it did, um, at least it has, uh, historically. It's had extremely clean financial statements throughout its life. I believe even when Meta came public way back in 2012, it was profitable. Um, how many companies that come public nowadays are actually showing profits. In addition to that, Meta's margins have been fantastic basically along the entire way and they've done so without any leverage whatsoever. They've always had an extremely clean, easy to understand um, balance sheet. So even though their size is enormous, even though their complexity of the business is is fairly complex given all the the components that they have to it, they have been a company that might sound complicated to analyze, but I have always found to be quite easy. >> What's some of the traps that people fall into when reading financial statements? >> Oh, traps. Oh, there's so many that you can um that you can do. Uh I would say the the most common trap that that I see um is just focusing on the growth rate. people when when you're looking at um when most people are looking at quote unquote financial statements, what they're really doing is looking at the headline numbers. The headline numbers are what's the revenue growth rate and what's the what's the earnings per share? And specifically, did the earnings per share beat or miss estimates and and and by how by how much? Um I would say that um revenue is a cleaner number and one that you should we should focus on. The revenue growth rate really matters for basically every business. Earnings per share is a number that is so easy to manipulate and there are so many pitfalls that naturally exist in financial statements that overemphasizing earnings per share is a very common mistake that people make because we've all taught when you get into uh investing what's like the one valuation metric that gets hammered in people's heads price toearnings ratio right is the thing that is so commonly said what is the company's price to earnings ratio Price earnings ratio made a ton of sense when GAP accountant GA gap accounting was created a hundred years ago, right? When when companies were industrial uh businesses using using the price to earnings ratio made a ton of sense. More modern businesses that have software or asset light or heavily used stockbased compensation, the price toearnings ratio has become a far less useful metric than it has been than it has been um historically. So I would say the biggest mistake I made I see people making with venture samples is overemphasizing the importance of earnings and not understanding the components that go into making those earnings. >> It's a great point. How much exposure do you have right now in your own portfolio to the AI trade? We've mentioned it a couple times here as one of the newer areas that is really picking up steam. >> Uh it depends on if you mean direct exposure or indirect um exposure and it depends on also what you mean by the AI trade. For example, um Tesla is one of my largest holdings. Is Tesla an AI company? >> I think it's humanoid robot, [laughter] >> right? Te Tesla is more of an auto business with an AI call option uh built into it. How about Google? Is Google an AI company or is it an advertising company? Is Microsoft an AI company or is there is it a enterprise software uh company? So I think if you say how much AI exposure have you're mostly talking about the AI pure plays out there which is largely the AI providers like um Nvidia like Micron uh like sand like SanDisk. So the direct the direct companies out there I am underexposed directly to those names because of the the factor that I mentioned before. Many of the companies that have really boomed because of the AI super cycle um had business models that I was unattracted to prior to the boom. In fact, for many years now, me like many other people have thought like well what goes up will eventually come down. The AI trade will eventually unwind and many of these businesses um uh will get hurt. So I would say I am underexposed to the components that are benefiting from the AI boom right now. Having said that, I do have exposure to those companies through ETFs, just not directly through individual stock picks. >> Got it. I want to talk about your valuation approach because it sounds like, you know, sometimes you could be looking at a stock and people think that that's a pricey stock, but you potentially saying, "Hey, it fits all my molds. It's got recurring revenue, right? I am going to purchase this." I'm curious. You talk valuation, then I'd love to hear about some stocks where it was, "Hey, everyone looked at the stock and just had a huge runup, but I was bullish on it and I still bought it anyways." or maybe vice versa. >> Sure. Uh first off, valuation is one of the trickiest things about investing. Full stop period. There is no always that applies to to valuation. It's always well it depends is the real answer to to to to valuation as as a general statement. And boy is this um a general statement. the higher quality the business is and the higher the growth rate, the less I emphasize valuation and the lower quality of the business and the lower the growth rate, the more I emphasize valuation. So, one of my best purchases of all time was back in 2011 when I made my first purchase of Amazon. Now, if you looked at Amazon through a classic valuation lens, even back in 2011, there was no metric that you could look at that said this stock is cheap. None. Like I think when I bought it, the PE ratio of Amazon was like 500, right? Or or some insane number like like that. However, and and the market cap I think was like 50 billion or some some huge number compared to the the underlying financial statements um of of the business. Now, at the time, I said, "The quality of this business is so high and the growth potential of this business is so high that I'm going to deemphasize valuation. I'm going to kind of hold my nose with valuation and buy anyway." And I bought the company essentially at an all-time high. Looking back, that was one of the best purchases I've ever made because the quality of the company and the growth rate of the company has persisted what 15 plus years later. Uh you could say the same thing about some other quality purchases that I made at all-time highs. I bought Visa at an all-time high. I bought Mastercard um at at an all-time uh high. Um so comp so several times the best purchases that I made were when companies were trading at an all-time high. Did not look optically cheap, but their valuation was very high and their growth rate was high and very durable. And each of those purchases proved to be a market beating uh uh a purchase. So when it comes to when it comes to valuation, the higher the growth, the higher the quality, the less you should emphasize it. And the lower the growth and the lower the quality, the more you should emphasize it. Thanks for watching today's video. If you enjoyed it, go check out the Wolf Financial Newsletter. Did you know that we make a ton of content? We host 60 plus hours of Twitter spaces and live streams every single week. We're posting on the timeline over and over and over. 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