Webinar: The Great Inverse Bubble

Jan. 26, 2022 11:00 AM ET18 Comments16 Likes

Start Your Free Trial of Beating the Market Now!

The following text is a transcript for our readers who would like to follow along:

Daniel Snyder

My name is Daniel Snyder. And on behalf of Seeking Alpha, I wanna welcome you to this special online webinar, The Great Inverse Bubble. The past three years had been nothing less than remarkable when it comes to returns in the stock market. The S&P 500 was up 31 and a half percent in 2019, 18.4% in 2020, and 28.7% in 2021. We're talking about a phenomenal moment in history where you could've doubled your money in the markets in just three years. But what about now? So far this year, we've seen volatility in full force in the market taking a hit with 2022 being a midterm election year, along with the Fed now talking about quantitative tightening and at rate hikes volatility is not expected to subside anytime soon. There's no doubt adding these factors into a red-hot market and slowing growth can lead to challenges when finding stocks with fantastic upside potential. That's why it's never been more important to be hyper selective when it comes to choosing which companies to invest in for the long haul. And it's why we've asked Louis Stevens to join us for today's webinar. As you'll soon see, Louis is one of the best at breaking down companies, looking for what he calls his crucial characteristics. This is a proprietary set of criteria, which he's discovered, had been present in many of the companies with the biggest gains over the last 50 years. Using this criteria, Louis is able to pinpoint companies forming what he calls the great inverse bubble, which has given investors an incredible opportunity right now in a handful of stocks. Louis runs the highly-rated Seeking Alpha marketplace service Beating the Market where he has built a set of model portfolios using his methodology backed by his team's extensive research and data crunching. You can find out everything about Beating the Market by taking a free two-week trial. I'm gonna go ahead and ask our team to add that link to the chat box for you right now. Also, please leave any questions you might have in the chat box as well. I know Louis is looking forward to getting to those at the end. Now, before I bring him on, I'd love to just gauge the sentiment of everyone tuning in today. So on your screen, you'll see a poll box here, and just a second, with a question of, since the market has started off on a downswing this year, what is your opinion on where we are headed? Are we going back to all-time highs, sideways for the most part, or an all-out bear market? Give you just a few seconds. So we got John tuning in from sunny Dallas, Texas. Welcome, John. Thanks for joining us today. All right, so as of right now, there's about 300, a couple of hundred people now that are answering. We are kinda hovering with 60% leaning towards sideways for the most part, about 20% back to all-time highs, and 20% down in an all-out bear market. Now let's go ahead and wrap this poll up here. And now for the man you came to see, let's bring in Louis Stevens.

Louis Stevens

Hello, Daniel, and hello to everybody joining us. I'm glad to be here today.

Daniel Snyder

Yeah, my pleasure, Louis. Now, I know we all can't wait to hear what you have to tell us about inverse bubbles and how to find the companies which are currently in them. But first, why don't you take a little bit of time and just tell us how you got started investing in the stock market?

Louis Stevens

Well, Daniel, when I was first exposed to the stock market, when I was just 10 years old. At the time, an uncle of mine was serving an OIF, that's Operation Iraqi Freedom, and he would call home to order his affairs every so often. And when he would call, my family would sit me down in front of CNBC and they would ask me to read the LOW's ticker to 'em, L-O-W, Lowe's home improvement. In hindsight, these were extremely formative experiences for me. As I say, the apple does not fall far from the tree. Later in life, I joined the army, started making some money and began investing in very seriously. It became my obsession very quickly. I was extremely driven to be a successful investor.

Daniel Snyder

Yeah, aren't we all? I mean, so what was your experience like in those early years once you started putting your own money to work in the market?

Louis Stevens

Well, Daniel, it wasn't so great. I made every mistake in the book and even some that weren't in the book. I followed rumors, news flow on CNBC and Bloomberg and found myself constantly offside in the market, getting whipsawed back and forth. My start, in a word, was a disaster. But the biggest mistake I probably made was because of my intelligence in certain areas of life, I thought I could conquer the market very easily. I thought just Google and E-Trade, and an E-Trade account were enough, I quickly learned that there are rules not immediately obvious in the stock market. In short, the market taught me very hard lessons early on.

Daniel Snyder

Yeah, and it loves to do that, doesn't it? However, you're still here today with some real success and lessons to share. So what were your next steps that have gotten you to here where you are now?

Louis Stevens

One thing I didn't falter on was my determination, right? I was going to do everything I could to become a successful investor. The first thing I did was I studied everything I could get my eyes on regarding the market. I got an MBA from the University of Florida. I read all of the books that you're supposed to read, like "Intelligent Investor" and "Security Analysis." I read books cover to cover. I read these books, "Security Analysis and "Intelligent Investor" cover to cover, every single page. And as an aside, I'm here to report to you today, the listeners, that you do not need to do that to be a successful investor. If you enjoy reading, maybe you can read the 1,200 pages there. Now this education did get me to stop bleeding my account, but it wasn't enough to get me where I wanted to be, which was understanding what creates these life-changing investments we've seen throughout the years.

Daniel Snyder

All right, that makes sense. So let me ask you this. What did you finally do to turn the corner?

Louis Stevens

Sure, so I started breaking down every single company which had huge moves over the last 150 years. I'm talking about going back to the railroad stocks of the 1800s, but I concentrated mostly on the last 50 years. And that's when I discovered this concept, and why everybody's here today, of inverse bubbles.

Daniel Snyder

All right, hold on. Let me stop you right there. So I had never heard of the term inverse bubble before we scheduled this webinar. So can you take a moment to explain to our audience what that exactly means?

Louis Stevens

Sure, I'm gonna share my screen here so everybody can see this slide show presentation we've created. Let's see. We're all set there. You can see it, all right.

Daniel Snyder

Yup, looks good.

Louis Stevens

Well, sure, all right. I understand this chart or this slide is a little bit much, but allow me to explain. Well, before I talk about inverse bubbles, I want to take a second to talk about what a bubble actually is. Now a bubble on the slide is on the left. A bubble is when too much money gets jammed into an industry that is too small relative to the size of investment. You can see this on the left. For example, dating back to the 1850s, it occurred to everyone that railroads were the future. Now this future would take place over about 200 years, but the market participants got very excited and jammed 200 years' worth of money into railroad stocks in the span of about 12 months. This is what creates bubbles. Now an inverse bubble, which you can all see on the right-hand side here, is when a small scrappy upstart launches a 10 times better product within an existing stagnant and mature industry. These industries often have very low customer satisfaction, have high levels of competition, and are often fragmented. With their 10 times better product, these small scrappy upstarts gradually consume market share driving revenue and earnings growth and returns for their shareholders. In a sense, the existing stagnant and mature industry becomes a bubble. And the company that offers a 10 times better product deflates that bubble by gradually consuming market share from the existing players. We can imagine the small scrappy upstart eating through the large total addressable market of the stagnant and mature industry taking market share from the existing players.

Daniel Snyder

So let me jump in real quick. I did see a question come across here from David about what is TAM. David, that is total addressable market. Bard, that's for you as well. There you go. Thank you for jumping in to answer that. But so to boil this down, you're reminding us of how innovation wins, right? So can you give us an example of a past inverse bubble in regards to an individual stock?

Louis Stevens

Of course, Daniel. Walmart is the perfect example. Back in the '70s, mom-and-pop grocery stores ruled. The grocery business was an existing stagnant and mature industry with many competitors. The Walton family launched Walmart, offering consumers a product that was 10 times better than anything the mom-and-pop grocery stores could offer. With their 10 times better product, small and scrappy Walmart, it was small and scrappy at the time, gradually consumed the grocery budget of America, driving revenue and earnings while producing significant returns for Walmart shareholders along with the Walton family.

Daniel Snyder

So the next question, if I can jump in, is, I'm sure we all have, is how do you identify these industries which are stagnant and mature and quite simply disruptable?

Louis Stevens

Well, Daniel, many analysts take a top-down approach: looking at the broad market first, I think many people start with the broad market, and whittled down to individual names from there. But at Beating the Market, we take a bottom-up approach. We sift through thousands of companies, which we call, using a definitive list which we call are crucial characteristics. These are a set of non-negotiable factors that the companies we invest in must have. Over time we've concluded that this framework has been the formula which has driven most of the big, most of the biggest gainers in the history of the stock market.

Daniel Snyder

So these crucial characteristics, can you tell us how many are there and can you explain a little bit about them?

Louis Stevens

Great question. There are actually 23 that we have. And while it's beyond the scope of today's webinar, I'll touch on a few. Before I changed the slide, I do wanna highlight, this is the by-product, what you're looking at, this is the growth of $10,000 in Walmart over the course of 20 years, and this is the fruits of that inverse bubble. So our crucial characteristics, I'll touch on a few. One of the factors we look for is financial strength. It's important to own companies with tons of cash, very little debt, if any at all, in a strong, and strong cash flows, or a very visible path to strong cash flows in the future. Another factor is rapid sales or revenue and earnings growth. Sustained rapid growth indicates that a company is gradually consuming market share within an inverse bubble. The revenue is there. Our company just needs to keep eating away at it year in and year out. And lastly, another factor we look for is whether a company is run by its founder or founders. Sometimes there are founders running the companies simultaneously, and we're not alone. In an article a few years ago, Harvard Business Review shared research in which they found that an index of S&P 500 companies in which the founder is still deeply involved performed 3.1 times better than the rest over the last 15 years. To make this more concrete, Walmart was a success because it became the mission of the Walton family to make it so. More recently, we've seen founder-led companies like Tesla, with Elon Musk at the helm, almost single-handedly willing the company to greatness and rewarding shareholders in the process. Now while these factors along with the other 20 are important individually, the real power is when they are all present and just at the start of an inverse bubble.

Daniel Snyder

Yeah, I love that research you just brought about founder companies outperforming. I think about Amazon with Bezos, Meta, previously Facebook, with Zuckerberg, Ted over at Netflix. There just seems to be so many. But to get back on track, we've seen some past examples of incredible gains, right? But what about now? Can you give us an example of a company in the early innings of what you consider an inverse bubble?

Louis Stevens

Well, Daniel, here's the slide, we're a little bit of lag there, but this is the slide illustrating the outperformance of founder-led companies created by Harvard, Harvard Business Review. So to answer your question, Daniel, there's presently a $176 billion bubble that we believe is on the verge of deflating. This bubble is made up of the $176 billion worth of fees charged to consumer banking clients of America's traditional financial institutions. They include interest expense on credit cards, interchange income, annual fees, penalty fees, such as late fees and overdraft fees and deferred interest schemes attached to credit cards. And the slide show, the slide that everybody can see lays out these fees very plainly from 2016 to 2020. Now many have been critical of these inflated fees. Think of them like late fees for returning a video to blockbuster in the '90s. Pretty unsustainable, nobody likes them, and there are some who believe there's a better way. Four among them, interestingly enough, is the creator of the entire credit card system that runs on Visa and MasterCard's rails. Yes, you heard that correctly. The foremost critic of these fees, currently, the foremost critic is a gentleman named Dee Hock. Here's what he had to say. "From the beginning, I worked for the transition, from the beginning, I worked for a transition from the concept of the credit card to a debit card to use the jargon of the day. It was my hope that the revenues of issuers would evolve from the reliance on interest on credit cardholder debt. It was my hope that this would distribute costs between the most affluent and least affluent customers. 28 years later, that has not happened, and interest on debt of those who need to pay monthly support free service to the more affluent." So to put this in, because it's taken us almost a year to really dissect this core. So to put it into plain English, this is Dee Hock, the creator of Visa, the creator of this $500 billion company, he's about 90 years old; this is his scathing criticism of the current system that has produced the $176 billion worth of fees, one of which is the interest on credit card debt, and we heard Dee Hock criticizing the fact that this even exist. In this quote, we read Dee Hock explain why he believes Visa and the banks operating on Visa's rails have become a failed experiment, a failed experiment worth $176 billion. When the creator of Visa speaks, we believe it's worth listening.

Daniel Snyder

Louis, those numbers are just staggering. And Dee's words, I mean, I never heard of Dee Hock, creator of Visa, but, I mean, obviously it's not every day you hear a founder go and trash his own work, right? So now is there a company out there currently offering a 10 times better product that could eat away at the existing player's market share of, say, Visa?

Louis Stevens

Well, Daniel, we've found one which meets all of our criteria. Affirm, symbol AFRM. Affirm provides credit to consumers up to $17,500 with no hidden fees, late fees, deferred interest, or accruing interest on debt, right? It's competitors simply cannot claim this just as blockbuster could not claim zero late fees when Netflix hit the scene. Affirm offers a true 10 times better product. In fact, it recently grew its active users at 124%. And we expect Affirm to continue its exponential growth and user count.

Daniel Snyder

Wait, wait, wait, wait, hold on. So let me make sure I'm understanding this correctly. You believe Affirm's growth is almost, even right now, inevitable?

Louis Stevens

Yes, Daniel. And this is how inverse bubbles work. Human beings will act in their own best interest. They will flock to a product or a service that is 10 times better than the current offering, just as they flocked to Walmart, Amazon, and Tesla over the last 10 to 50 years. Over time, that 160, $176 billion bubble will gradually deflate as Affirm consumes market share year after year for decades to come.

Daniel Snyder

Okay, I can see that. All right, it'll be interesting to see how that inverse bubble plays out. Is there any other examples you might be able to will, be willing to share with us today?

Louis Stevens

Absolutely, Daniel. Another inverse bubble that's set to burst is worth $404 billion. This is the cost US citizens incur each year when buying and selling homes. They pay this in the form of expenses related to commissions on the sale of homes specifically.

Daniel Snyder

Well, I mean, I think I can vouch here. As a recent home buyer, I can definitely empathize with the pain of going through that process. So how do you see this inverse bubble deflating in the years to come?

Louis Stevens

Sure. So a small upstart company has built a 10 times better product that integrates the entire home buying and selling process into one seamless, convenient, and usually less expensive offering, as you can see on the slide show, on the slide behind us. Over the long run, this company has ambitions to remove the commission component of the transaction entirely. Talk about a 10 times better product. Through the use of AI, artificial intelligence, and machine learning and verticalization of its offering, Opendoor can execute a real estate transaction within days instead of the usual weeks or months it takes a real estate transaction under the current paradigm. In many cases, this more convenient process is also less costly for all parties involved. For those who've bought or sold a home before this reduction, and time and stress might sound almost too good to be true, but too good to be true is a hallmark of companies growing within inverse bubbles. It is this factor that allows these small scrappy upstarts to consume market share over years and decades and in turn grow revenue and earnings while driving returns for shareholders.

Daniel Snyder

All right, all right. So let's break this down in summary. The stocks you mentioned today were Affirm, ticker AFRM, which you see pretty much eating Visa's lunch; and Opendoor, ticker OPEN, which is going to dramatically change the way real estate transactions are held. And I know mine, I mean, you get caught up in every different direction, it definitely is a dragged out process. So both of them sound actually kinda promising. So these two stocks have really been in the limelight, limelight the last two months. So I guess we're just gonna have to keep eyes on 'em and see where they go from here, right? But I have to say, this has been really great. Thank you so much for sharing these and the examples that you gave of the past inverse bubble in regards to the railroads. I think it really helps it click for me and I'm sure most of our audience would agree. And I'm sure we have a ton of questions waiting for you. But first, I just wanna remind everyone that you can gain access to everything Louis and his team offers at Beating the Market by taking a free two-week trial. And I'm gonna take a moment to request that our team add that trial link for Beating the Market into the chat, just as a reminder for you. And let's now get to the fun part. Should we get to some Q&A?

Louis Stevens

Sure, I would love to, Daniel.

Daniel Snyder

Perfect, let me just take a moment and see what our team has pulled from the chat. So it sounds like the first question says, "Your scrappy stock sound like what are usually termed disruptive stocks." Do you have any thoughts on that?

Louis Stevens

Sure, and I think that disruptive is an apt term. I think that's an applicable term. We believe that when you highlight what's at stake, what is the current capital outlay, it puts things into perspective. And the idea that you deflate that current capital outlay, whether it's $176 billion or $404 billion, you deflate it into the company's revenues or free cash flow or earnings and that company expands as that deflates into it. We just think that having that depiction better communicates the idea because we hear disruptors, I think disruptors is, I was watching a video last night with the CEO and he was talking about disruption, I think it is a common theme, it's inherent to our economic system. Creative destruction might be another term for it, where we create new things like the automobile and we destroy old things like the horse and carriage. So there's a lot of ways to describe this phenomenon. Our mission, along with Seeking Alpha, in partnership with Seeking Alpha, is to go out and show investors, "This is what to look for in terms of finding companies that can really generate exceptional returns over 3, 5, and 10 in a multi-decade period. So yes, I think disruptors could be one characterization, but it's all kind of in the same vein of what's driving value in the stock market.

Daniel Snyder

Yeah, it sounds like the big, what we mentioned earlier, doubling down on innovation, right? Innovate or die. So let's get to the next question here. It says, "The stocks you talk about in inverse bubbles are hyper-growth stocks and they have seen weakness lately." There's another question actually that came through. It says, "Affirm is currently down about 68% from all-time highs of November 2021." So this person asks, "Why is now the time to get into these?" Do you have any comments on that?

Louis Stevens

Well, sure. I think the the old trite, adage is buy low, sell high, right? And I think an even better quote is from Charlie Munger in which he said, "The lower a stock fall, or the more the stock fall, the more a stock falls, the less risky it becomes," right? So every company we discussed, and I wanna be very clear about this. Every company we discussed has a risk and a return attached to it. There is inherently risk in buying equities and that needs to be, that needs to be appreciated and understood. Nothing is guaranteed. But when you look at the risk associated and match that with the return, you can make a more informed decision. And the more a stock falls, the higher the potential return, and if risk is static, that makes the risk return equation more attractive. So at these levels and should they fall more, we don't know what stocks will do in the near term. Our timeline is always 36 to 60 months. But should they fall more, the risk return equation will just continue to build in our favor. So we've been accumulating more as they've fallen and we could not, and really we couldn't be more grateful for the stocks to continue to fall as we're able to just buy them at these prices where the return, especially for Opendoor, if our view vision of the company, if the founder's vision for the company materializes, it's just, in our estimation, it's like buying Amazon in 2002, 2003 at the very bottom of the market and the apex of pessimism.

Daniel Snyder

Yeah, no, I know a lot of the conversations I've been having lately as well are around let the prices fall, right? We wanna buy at a cheaper level because obviously we're setting up for the continuing decades ahead, being younger in age. I love this next question, though, because around Affirm disrupting credit card industry, credit cards have interest rates, right? Opendoor kinda help with the real estate industry, mortgages have rates as well. So with the Fed ready to raise rates, how is this going to influence these type of stocks?

Louis Stevens

It's a fantastic question and we get asked it very often. In the case of Opendoor, it's our fundamental belief that Opendoor will actually do better in a buyer's market or, yes, in a buyer's market where home prices are not skyrocketing, where there aren't multiple offers attached to each transaction. Fundamentally, Opendoor is a liquidity provider, meaning that it exchanges money for convenience and definitiveness. You can sell your home within 12 to 72 hours, no questions asked. But you do pay, just like going to the movie theater, you will pay a little bit more for the convenience in the security of that transaction. In the case of Affirm, which, at the heart of Affirm, is the idea that artificial intelligence and machine learning and the use of data is going to completely restructure the consumer credit ecosystem. And it's almost beyond the scope of our discussion today because there is a lot of nuance to it in terms of Affirm disrupting the traditional merchant acquirer, the issue in bank, the acquiring bank, the merchant, and the consumer in the card rails, in between those four parties. Visa, excuse me, Affirm reorients that entire structure and includes, and takes data from the product manufacturer from the merchant skew level data, data from the consumer, in terms of like really interesting data, orthogonal data as they call it, in terms of like how often does the consumer log into the app. When it logs in, when the consumer logs into the app, what stores does it go to? The Affirm app specifically. Or when it goes to the merchant's web page, what does it click on specifically, what does the consumer click on? What do they add to their cart? How often do they abandon their cart? Who's more likely to default? Somebody buying at 3 a.m. or 4 p.m., right? There is this avalanche of data that Affirm is incorporating into this consumer credit ecosystem and making the, in terms of making the vision that Dee Hock has laid out, kind of come to fruition. Dee Hock, the creator of Visa, that he's been critical of the current paradigm, which I briefly touched on, as not living up to that vision. So in terms of higher interest rates, the big fear is that it will, there's a few fears, but maybe one is that higher interest rates will dampen consumer spending, we could enter a recession. But we believe that the force of Affirm's datafication of the consumer credit ecosystem is just going to be so powerful that it can grow irrespective of the macro headwinds. And this is a very important component of inverse bubbles, right? Because when you're investing in Coke or you're investing in Costco or Walmart, right, these companies are largely dependent on two factors: GDP growth and inflation. So if the Fed is going to leverage its tool, the tools that it has to dampen inflation and potentially send us into a recession, in which GDP declines, the foremost, the foremost, those that will be affected to the greatest degree, and this is proven decade after decade, the irony is that the Affirms and the Walmarts in the '70s or the Amazons in the 2000s are the most volatile in the near term. But the companies that will be affected to the greatest degree will be those dependent on GDP growth and dependent on inflation, both of which will get removed as the Fed, potentially, and this is a whole different discussion 'cause we have a take on macro, as impossible as it really is to predict. But those will be the companies that, in our estimation, are impacted the most when the, quote, unquote, Fed pulls the punch bowl.

Daniel Snyder

Yeah, no, you did a deep dive just now of Affirm and really going into their business structure. So I wanted to follow-up with some of these questions that came through, specifically in regards to Affirm and then maybe we'll touch on some about Opendoor as well. With Affirm, one question came through, which is why is Affirm not making money yet, right? And I think that's more about the business structure. So could you just take a moment to help us understand how is it that Affirm makes money and how is it, where's the opportunity within their business model?

Louis Stevens

Sure, so Affirm has approximately 60% gross margins. So on a unit economic basis, it's profitable, right? A hallmark of the dot-com bubble was they were selling hamburgers that cost $12 for $10, right? There was literally companies with negative gross margins. Affirm's unit economics are very profitable. As for why is it not generating free cash flow, well, if you look at its head count growth, it's one of the fastest growing companies in the world in terms of adding new employees. If you think about what it's done in the last 12 months, it's added partnerships with Amazon, Walmart, Shopify, the exclusive buy now, pay later provider, of Target. So as the saying goes, "You gotta spend money to make money." And the level at which Affirm is scaling, and now they're expanding into Australia, they're hiring in Poland, we are concerned about it as well. We are monitoring number one, dilution because if you're not generating free cash flow, there's a chance that you start destroying shareholder value by issuing new shares or issuing convertible debt or adding debt to the balance sheet. So we're very attuned to the management of the balance sheet, the cash flow statement from Affirm. And they have an excellent CEO and CFO. The CEO, Max Levchin is incredibly all in. I think he owns between, the numbers, precise numbers escaping me, but it's between 10 and 20%. Now, as for the unit economics specifically, Affirm generates money in a few different ways, one of which is interest expense on those, the loans that they provide to consumers. Importantly, I touted the fact that they're eliminating one of the most significant profit centers of credit cards, but importantly, what you agree to pay at point of sale. If you get a loan for $1,200, with 15% interest and you'll pay that back over 12 to 24 months, whatever it may be, if you don't pay them back, right, there is no accruing interest. So what you agree to pay at the point of sale is what you will pay. There's no hidden fees. There's no deferred interest schemes. There's no, again, accruing interest on revolving lines of credit. What you agree is what you pay. Now what's interesting, and that is a portion of their revenue right now, but what's very interesting for us is the potential for Affirm to achieve a certain level of network effects where it creates its own closed loop system apart from the card networks, the issuing bank, the acquiring bank, the merchant and consumer, right? And this is very plausible that they do this. And in fact, they, if you go and use Affirm at Peloton, it's a closed loop system, there is no interaction with the card networks. So what's very interesting for us is that Affirm in the future could generate the majority of its revenues through its merchant discount rate. And in the new paradigm, and the merchant discount rate is the fee that the merchant pays to Affirm for Affirm facilitating the loan or facilitating the credit product for using data to identify what offers, what specific credit product the consumer will want or needs or can get. Affirm uses data to increase average order volume. It uses data to increase the conversion rate, right? So the merchant discount rate, which is the fee that Affirm charges a merchant, let's say, it's Peloton, let's say it's Amazon, because Affirm is the exclusive buy now, pay later provider of Amazon, Affirm's use of data allows it to create better outcomes for the merchant, right? And Affirm is able to charge between four and 7%, sometimes more to the merchant because using data, it creates such superior outcomes for Amazon, right? Now I'll get off my, I'll stop, I'll make this succinct. In 2016, there was the Walmart, 7-Eleven, Target, created the MCX, the merchant exchange, right? They were so fed up with the current paradigm that Dee Hock has criticized, that Walmart, that Target have now, they criticize, that they tried to create a competing Visa, the MCX. Go on Google, Wikipedia MCX. You can read, it was a consortium of companies that were so sick of the, in my opinion, it's fine, but when there's better alternatives out there, it becomes rent-seeking and usurious. Because the value that Visa is creating for these companies does not match the fee that is being charged to these companies, right? So in an Affirm world, there's data being used from the product manufacturer, the merchant, the consumer; it's extremely robust. As I said before, orthogonal data, completely independent from the transaction, and this allows Affirm to create better outcomes for all parties involved and therefore charge a higher rate. And I'll conclude on this. These consortium of companies created the MCX because they're so sick of what the rent-seeking and the bad value proposition from Visa. It is no coincidence that the same companies have now chosen Affirm to create a new, to quietly, in our opinion, I'm saying this on Seeking Alpha, to a lot of people now, but it's no coincidence that these same companies that tried to create a new Visa have all partnered, the largest commerce companies on earth, have all partnered with Affirm. These are very intelligent people at the helm of these companies. They're not taking these decisions lightly, at Walmart, at Amazon, at Target, at Shopify. They have chosen Affirm very intentionally and we think that it all sort of aligns with the work that we've done.

Daniel Snyder

Yeah, no, Louis, there's a lot of great points in there and I appreciate you taking the time to elongate that answer and really break it down. Now we are getting close to running out of time here in a little bit. So we're gonna start picking out a few more of these questions to get to. But this one really just falls in line with what you were just talking about that came through the chat. And it says, "What prevents Visa from changing its fees to become more competitive," right? So I know you were talking about Affirm and how they're really charging the merchants, but I think this viewer is saying, "Why can't MasterCard or Visa or whoever else," they already charge merchants as well, I believe, they're just charging both sides of the transaction. So I think they wanna kinda understand from your viewpoint why, what prevents Visa from just saying, "Hey, they're taking our market share. Let's try to stop that."

Louis Stevens

Well, I think the answer would align with why wouldn't the mom-and-pop grocery stores, when Walmart was disrupting mom-and-pop grocery stores, why wouldn't they just get better at supply chains? Why wouldn't they, why don't they just verticalize the offering? Why don't they use used robust data and logistics to create a new product, right? Visa would need to, basically, restructure its entire business, it would need to create devoted artificial intelligence and machine learning teams that would incorporate the issuing bank, the acquiring bank, the merchant, the consumer, the product manufacturer. It would need to restructure the entire configuration, the entire current configuration. Affirm guts most of the communication between those four parties and essentially just puts it all on top of the Affirm platform. It can offer the payments ledger. It's in partnership with Marqeta, which allows it to be the issuer, the card issuer itself. So in short, and it is a rather complex kind of ecosystem that's taken us a very long time to really understand, and we have a devoted analyst to the entire space named Jared Simons at Beating the Market. But in short, it would take Visa, and in concert with the acquiring, with the issuing, with the merchant, with the consumer, banks and merchant and consumer, in concert, it would require them to completely restructure and become one entity. But that is not going to happen. The banks are not going to be creating AI and machine learning teams, maybe they do. Maybe they do, somewhat. We've seen some very interesting traditional financial institutions. And I do wanna say, we're actually very bullish on traditional financial institutions. We think they're gonna be around for the next 100 years. I don't want to, these fintech apps are not holding anybody six, seven, eight, nine-figure accounts anytime soon. We're very confident in that. So it would require an entirely new structure, it would require traditional banks to become extremely smart overnight, almost as if the mom-and-pop grocery stores created new logistics systems overnight.

Daniel Snyder

Yeah, no, that makes a lot of sense. To summarize it, I think the best visualization that I have of it is which is easier to do, right? Is it easier to build a new skyscraper or have to renovate an old one, potentially tearing it down just to rebuild a new one, right? It's kinda like the analogy, that it sounds like. And going off that, I mean, let's wrap up Affirm and kinda switch gears to Opendoor a little bit, 'cause we did have a question come through that you were mentioning the machine learning and the AI side of Opendoor. But someone brought up Zillow trade to kinda corner the real estate market with AI and machine learning. So what is the difference between those two?

Louis Stevens

Sure. So I think to lend a little bit of credibility to our take on Opendoor, if you join Beating the Market and you go through our work on Zillow, and if you do join, feel free to reach out to me and ask for this work. Over the last 12 months or so, I sat in on every call with, every earnings call, with Allen Parker and Rich Barton, the CEO and CFO of Zillow, and I listened to these calls, and I listened to the inflection of the voice of these two individuals and I heard their emotions attached to this business. And over the course of 12 months, you'll see my writing become, and I was, I had owned Zillow from about $60 a share, and over the course of 12 months my writing became more and more disparaging of their communication about this new business, this iBuying business, this digitalization of the real estate, of the real estate transaction. And I just analyzed these two individuals and really tried to get a grasp of, "Are these people just faking it? Are they really doing this business model? Have they created anything proprietary," right? And I think it's a good question, because Google was the 23rd search engine to come about, right? I think a lot of people at the time said, "What makes Google special? It's the 23rd search engine. Why should I care about Google?" But it was the team, it was the proprietary technology, the AI being built, right? Sergey Brin or Larry Page, they were asked, "What are you building in terms of Google?" And they responded, "We're building an AI," right? At the time, really that was very avant-garde. And it was search, it was search. So we dissected kind of, "Are these, is this Yahoo? Are they faking this?" And Rich Barton, these are fine people doing the best. And I don't wanna be very, I'm not being very critical of these individuals, but objectively, we were listening to these calls, studying what they were saying, and I remember one Sunday morning, and you can go into Beating the Market and go to the article "We Sold Zillow," right, because I titled it "We Sold Zillow." Sunday morning I'm working on Zillow, they have their earnings report coming up and it just dawned on me. There's just this wave of an epiphany. And I'm like, "They're not going to do this. Zillow cannot do this. They have the Zestimate. They're serving real estate agents which is conflicting with the iBuying business, which promises to reduce the need for real estate agents. The CFO is, he sounds very doubtful on the calls. He's saying, 'Well, as we ascertain the possibility of this business succeeds,'" you know? So I just said, "We're selling the stock," a couple of days earlier. And to be sure, we are not perfect. This is not the big short. I wanna be very clear about this. This is not the big short. But it was a good play. 2021, I don't think, has been, 2021, 2022 has not been easy for anybody. I had that epiphany. The next day, and what was interesting, hedge funds were pitching. The week before it was rallying on strength because there was an article on Seeking Alpha that detailed that hedge funds were pitching Zillow and was rallying on strength. The next week, Monday morning, I believe it was Monday morning. In Beating the Market, there's a log of all of our transactions, all our buys and sells. I came out and I published We Sold Zillow at $100 a share, $100 and 50 cents a share, something like that. Two days later, they got on their earnings report and they announced, "We're done with iBuying." Now, simultaneously, we're studying Opendoor, listening to the calls, listening to Carrie Wheeler, Carrie Wheeler, listening to Eric Wu, understanding the business model, understanding the cultural dynamics within the walls of Opendoor and our confidence is growing. So simultaneously, we're looking at Zillow for a year, my writings becoming more and more disparaging. Simultaneously, we're increasing our waiting on Opendoor, which it's been challenging because the macro and the panic selling and the margin calls and algorithms and all of that stuff. But simultaneously, we're becoming more and more confident on Opendoor. And if you listen to the last earnings report, it's a tour de force. If anybody's going to make this business work, it is these individuals. They are absolute operators, Eric Wu, Carrie Wheeler. Check out, there's very interesting people at the helm of former CTO at Square, Ian Wong. These are very interesting individuals. And we believe that they are creating, what, the, effectively Google, but for the real estate industry.

Daniel Snyder

Yeah, no, that's a great point. To almost wrap it up here, let's go with two more questions here real quick. I feel like I know the answer to this one. But just because it was asked, I wanna make sure that we get to it. Do these two stocks, Affirm and Opendoor, currently meet the strength of financials test that you're talking about within your characteristics?

Louis Stevens

That's a great question. And I think, it's a fantastic question. And if you join Beating the Market, you'll see a list of stocks that I shared today in which I detailed, we at Beating the Market, we are big free cash flow and we also like share repurchases and that at least a portion of our portfolio, but we like big free cash flow and we like rapid growth. And if you're growing rapidly, at least don't hemorrhage cash, right? And Affirm and Opendoor, objectively, they are, there's a pretty significant cash bleed. As an aside, Tesla was not free cash flow positive from 2005 to 2018. And that was when 10,000% returns were generated, so it's not an absolute pre, it's not a prerequisite that these companies be free cash flow positive today or tomorrow as long as we understand the vision, understand what, why management is spending the money in the way that they are. Now, with that being said, Affirm, I believe after, what's been very heartening for both companies. Opendoor raised capital at like in the mid '20s. They raised a huge tranche of capital in the mid '20s, right? We've seen Peloton recently. Unfortunately, management did not raise capital at the highs. If management had raised capital for Peloton when it was trading at 150, 160, today Peloton would be a completely different company, right? Today it would be trading at three times net cash. The market would be nowhere near as pessimistic, but instead they raised capital at the bottom. Opendoor's management, and this speaks, this is a testament to the culture that's been built at Opendoor, which we've studied very rigorously, they raised capital at the very crest of their share price in 2020. So they're extremely liquid, extremely solvent. And they also have, some people, not everyone agrees with us on this investment and that's perfectly fine, but they have a very robust inventory currently diversified across many markets across the United States. In the United States, real estate does not move in, it's not like the QQQ and in growth stocks. They're not all going up at the same time. Real estate, even during the cataclysm of the great recession, once in 200-year event, there were some markets that were strong, there were some markets that were very weak and even the weak markets were gradually weak. So they have a lot of inventory that they're going too that they've been scaling up and that's why you see some deep, deeply negative free cash flow numbers. But we believe, fundamentally, that Opendoor will be free cash flow positive somewhere around 2024 or in the latter half of the 2020s. And we see the vision, we see how this will play out. And to be sure, the free cash flow yield or, excuse me, the free cash flow generation, the margin, will be very modest. It will be retail margins just like Amazon, retail margins just like Walmart, which can produce very large, very successful investments. In the case of Affirm, similarly, just an absolutely exceptional job of raising capital when there was exuberance priced into their shares. Affirm, I believe, and I would have to check, we have a pretty significant coverage universe, and forgive me for not having the numbers specifically, but I believe they raised a set of convertible, they did a convertible raise in which they added another couple billion to their balance sheet. And at the time, underwriters were more than willing to just upsize it. I think they have close to four to $5 billion in cash on their balance sheet right now. Partnerships with Amazon, Walmart, Target. A lot of adversity in the share price. So it's keeping 'em hungry, and we just couldn't be more excited about Affirm and Opendoor for the future.

Daniel Snyder

Yeah, no, that's awesome. Glad you mentioned those both. Again, just a reminder for everybody. The ticker symbol is AFRM for Affirm Holdings and OPEN for Opendoor Technologies. And as you were talking, I was just taking a moment to look on seekingalpha.com here. I see Affirm's share prices hovering around 54 and a half, and Opendoor Technologies is hovering around $9 today. And funny enough, as we've been talking this hour, the overall market has been paring some of those losses that we've seen from earlier today. So I wanted to save the best question, I think, for last. And it's a question that everybody's been asking, pretty much everyone else. And it's in regards to these stocks that you're mentioning right now that have been absolutely hammered in the recent term, what is it that you see that the market isn't seeing?

Louis Stevens

Well, Daniel, and to our audience, I don't know that it's necessarily what we're seeing that the market isn't seen. I think that the market goes through its kind of emotional phases. I would say that there is, if Affirm or Opendoor had fallen 50% or 60% or 70% from their highs, and Affirms highs, at Beating the Market, our average is between 60 and 80. So we're not, that's when we did the bulk of our purchasing. We did a lot of it in May of 2021. We waited until it had fallen from February of 2021. I don't necessarily think that there's anything wrong with their share, but I think Opendoor right here, you can, I think it's truly, if Opendoor succeeds in its vision, this is post dot-com 2002 pessimism, it's not going to get worse really for Opendoor from here. Because if it can prove that it can do this business model in a high inflation environment with rising rates and cataclysmic stock declines and extremely volatile real estate markets, if it can prove it, through the pandemic, through this, over the next couple years, then what is $9 a share is going to prove to be just truly a generational buying opportunity. And I think at $6 billion market cap or thereabouts, it's really hard. With their vision and their TAM, it's kind of hard to argue with that. Again, nothing's guaranteed. So I would say, if these were the only two stocks that have fallen, I might be concerned. But if you look into the growth realm, I think Shopify, which ironic, for those kind of just getting into the market or even, to refresh those that are forgotten, Shopify was seen as a terrible company in 2015, 2016. The Citron bear reports, which more power to the bears in the short reports. We're not disparaging them. I think they're an important part of the market. But Shopify just had so much pessimism priced into it, shares that, the drop shipper fad, it was gonna lose half its merchants because they're all just fake brands. I mean, Shopify was not the juggernaut it is today and I think sometimes people forget about that. But today it is that juggernaut and people think, Tobi Lutke, the CEO, is one of the greatest CEOs of the last 20 years, and they have Figs and Allbirds and a few public companies, and a lot of brands that are just gorgeous and are running their logistics and have their developers working in the Shopify computer environment. It's a juggernaut, is my point. The company recently fell 60%. I mean, it's certainly not, this is certainly not idiosyncratic to Opendoor or Affirm. I think that there's like three stocks that, growth stocks that haven't fallen 40 to 90%. And among those, we have Snowflake or Datadog, right? So the only two and they're trading on astronomical valuations. So I think that, as Charlie Munger says, has said, "The lower the stock goes, the less risky it is." None of these bets are guaranteed. But at Beating the Market, that's why we diversify and we buy a collection of very high quality bets like Opendoor, like Affirm that are growing. Opendoor just grew 1,000% or thereabouts and it will likely grow at a similar level. This quarter, it's very easy comps so don't expect that for very long. It would become larger than the world's GDP if it could sustain that growth rate. And Affirm, we think it'll grow between 80 and 100% in Q4. That's what it will print soon. And so we own a collection of these founder-led, very strong financially. And to the person who asked about the cash flow situation of Affirm and Opendoor, you're completely correct. And if you check out Beating the Market, you'll see that, I would contend 60 to 80% of the companies we buy are either free cash flow positive and growing rapidly or they are right about breakeven with just a little bit of free cash flow. Or in some cases, where there's, we love the founding team, there's rapid growth, we understand the vision, we understand why it's free cash flow negative, will venture out into Affirm and Opendoor and feel very comfortable, including these in a basket, in the first five basket of companies.

Daniel Snyder

Yeah, Louis. No, this has been a ton of very useful, very actionable information. And I just wanna remind everybody about your service being the market, we mentioned it at the beginning, but it hasn't really come up in the conversation. Again, is that you are looking at longer term plays. And we talked about these companies that are, might be cash negative right now, but you're playing the long game and watching these companies and you believe in their stories. So I just wanna make sure that we have that understood by our audience as well. Louis, I gotta thank you for your time today. We're running out of time, unfortunately, but thank you so much for taking part and walking our entire audience through the details of Affirm and Opendoor. And I just wish that everybody take a second, check out your free trial for two weeks of Beating the Market with Louis Stevens and his team. There's a lot of great information in there, such as the 23 characteristics he was talking about and all the companies and modern model portfolios that they've been doing research on. Louis, thank you so much once again for joining us today, we really appreciate it.

Louis Stevens

Thank you, Daniel. And to everybody listening, it was such a pleasure to be able to share these ideas with you and thank you for attending.

Daniel Snyder

Yep, and just a reminder, if you guys wanna get in contact with Louis, sign up for that two week free trial and you'll be able to message him on the other side. All right, everyone take care and have a great rest of the day.

Start Your Free Trial of Beating the Market Now!

This article was written by

Louis Stevens profile picture
14.44K Followers
A community achieving financial freedom through visionary investing
Hello! My name is Louis Stevens, and my team and I serve investors of all shades, just like yourself, through Beating The Market on Seeking Alpha. A simple way to think of our investment style is as follows: "We bring the potent, life-changing, wealth-creating dynamics of Venture Capital to public markets where these dynamics are accessible to everyone!"

Check out a small snapshot of our performance via TipRanks: https://www.tipranks.com/bloggers/louis-stevens

Some credentials of mine: U.S. Army Officer (Reservist), BA Political Science, MBA University of Florida, inventor of the L.A. Stevens Valuation Model, author of "Security Analysis for the 21st Century"

Follow

Recommended For You

Comments (18)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.