Interview (#2): Diego Gómez
This is the second part of a series of interviews that I want to share with subscribers. My goal is to chat with outstanding investors that I respect and admire, look into their investment process and try to understand how they have arrived where they are.
Our guest today is Diego Gómez. Diego is a good friend and one of the best Spanish investors I know. You won't find much information about him outside of this interview or his Twitter account, which is why I'm so happy to have him on the blog. It’s a pleasure for me to use this opportunity to learn a bit more about the way he understands investing and get to know the work process that has led him to obtain an annualized return of 14.4% from 2012 to 2022.
I am sure that this interview with Diego will be of great interest to both professional and retail investors.
Disclaimer: before I start, I would like to say that this interview should have been published a couple of months ago. Since becoming a father it's been difficult for me to gather enough time to write posts like these that stray from the main script of the blog. I want to thank Diego for his patience and understanding. Although the share prices of the companies discussed in this interview have changed quite a bit since Diego sent me the first draft of the interview, the lessons that can be drawn remain just as valid.
Could you tell us a little bit about yourself and how you got started in investing? I especially like asking this question to people who, like you, have a full-time job but are disciplined enough to keep growing as investors in their off hours. What habits have helped you get to where you are today?
First of all, thank you for having me for this interview. Just as you said in your introduction, I am a private investor, I have a full-time job in the financial department of a multinational company in the retail sector and in my spare time my main hobby is reading and thinking about companies, investment and financial markets in general.
I studied Business Administration and Management and a MBA in Banking and Financial Markets after I finished my degree in 2010. Even though I have continued working in finance, my current job is more related to accounting and administration. However, I have dedicated a lot of time to learning about financial markets as well as about businesses and investing.
I owe part of my love for investing to my father, who has always been an entrepreneur and has been investing in the stock market since the 1980s. Seeing him studying businesses, investing, obtaining good returns and also learning that some investments do not go as one expected, helped me to achieve the necessary courage to look into something as seemingly boring as the stock market can be for a 22 year old guy.
In 2010 I started working in the Management Control department of a company in the energy sector and in 2011 I moved to the Finance department of my current company. Both were full-time jobs. In short, the very little time that I could put into investing was reduced to weekends and weeknights. Anyone who has ever worked in this world knows that managing a portfolio, searching for new ideas, keeping up to date with what is happening in the world, monitoring the companies you invest in… It’s all very time-intensive. Perhaps less so with an index investment style, or if you invest in funds managed by others, but that was not my case. I wanted to manage my own portfolio, have power over it, decide where to invest, and see how far I could go. I had no choice but to dedicate at least 4 hours a day.
I really didn't need any discipline. Liking what you do is the most important thing. If you see it as an obligation, then you will never go as deep as necessary. In that case, you’d better invest in funds or an index. As for me, there was no need for discipline, that I was over-involved and there are times when it is necessary to stop and enjoy other things in life.
Anyone who follows you closely will notice your interest in business models that stand out from the rest. What characteristics do you look for in a company when it comes to investing, and which ones do not usually meet your standards?
The truth is, I look for the usual in quality companies: I want to be able to understand the business model well and to estimate where the business and the industry will be in the next 5-10 years, I want to see some kind of competitive advantage that will make the company stay above the competition while maintaining a return on capital and high margins. Also, there should be opportunities to reinvest capital at high rates of return (even better if organically), and it should be run by a capable, intelligent and opportunistic management team. And lastly, valuation should be attractive enough.
A company doesn’t meet my standards if I cannot fully understand the business model or, even if I do, I can’t see a sufficient competitive advantage to have them in my portfolio in the long term.
Over time, you realize that investing does not need to be very difficult, in fact, on many occasions, the most obvious and easy investments are the most profitable in the long term. So in general I have usually tended to reject more complex theses and stay with the simplest and/or obvious ones.
Have you always been interested in these types of companies? How has your investing style evolved over the years?
I haven’t. Back when I started investing, I was heavily influenced by the great recession of 2008-2009. At that time the falls in the equity markets were especially strong. At first I focused a lot on the quantitative aspects of the analysis, as I always wanted to achieve a very wide margin of safety for each investment, so that it was impossible to experience a fall such as the ones the market had suffered in previous years. I read Benjamin Graham and the most relevant chapters of the Intelligent Investor. I ended up investing in highly undervalued companies, including the classic net-net opportunities that over the years have gradually disappeared. The returns I achieved were not bad at all, but if we look back, if I had spent those years investing in the quality companies I know today, and held them up until now, my performance would have been much better – and in terms of taxes paid, it would have also been much more efficient.
In 2014 and subsequent years, classic value investing became more complicated due to fewer opportunities, and I gradually shifted towards investing in higher quality companies. At the beginning those companies were only a small part of my portfolio and little by little they represented the vast majority of it. That was also when I joined Twitter and met other investors, generally from the US and Canada, who shared their thoughts on these companies and helped me continue growing.
I would say that my current portfolio is a combination of high-quality companies (80%) and some deep value investments (20%). Sometimes I also employ some leverage to take advantage of special situations such as merger arbitrage (currently IDFB and SMU.TO).
Those who know you can attest that you are a very selective investor and have a good nose for identifying potential issues that perhaps others are unaware of or underestimate. As some of our friends often say, if an investment idea meets Diego’s requirements, then we may be facing a real opportunity. How does one develop that ability? How can one be so selective in a time where there are hardly any geographic limitations to investing and where investment ideas abound?
As you say, there are many investment opportunities, so we must be very selective when it comes to our portfolio. This forces you to constantly say no to potential investments. It is difficult to explain, but as soon as I identify a new potential investment idea, I always start my analysis with the mindset of “I am going to rule it out”. If the company wins me over little by little, then I will change my mind and add it to my portfolio or my watchlist. But I consider it very important to start the analysis from that skeptical point of view and not having been influenced first by other investors. This does not mean that you cannot take ideas from others – I usually do. But when you start your own process of studying and understanding a company, I believe you should be the one doing your own homework from scratch.
Over the years you gradually develop a sense of smell that helps you rule out certain businesses in a very short time. There are many small red flags – the management team being too marketing-oriented or not humble enough, for example. Sometimes you sense things during interviews. Other times either the business model or the company’s accounting are just too complex.
Could you tell us about an idea that is currently part of your portfolio and about another that meets your requirements but is not for price reasons?
The main company that I added to the portfolio this year is Netflix. It’s the leader in TV streaming content, it has more than 200 million subscribers worldwide. It was the first company to get into the business and has pretty much invented the market category. At the beginning – and until not many years ago – nobody believed its business model would be viable. For some time now it has proved that it is indeed viable and, what's more, all the legacy competitors have now decided to copy them and migrate their business towards streaming. The important thing is that from the market’s perspective, traditional TV is the loser in the medium and long term, and streaming companies are the winners. Although Netflix is not the only player, the market is so big that there is room for everyone.
As for Netflix's unit economics, its main expense item is content amortization. Some investors have attacked the company, arguing that the amortization reported is not accurate and therefore the EBIT reported is not real either. Netflix amortizes content production in 4 years. As the capex has grown a lot in recent years, there is some lag between capex and amortization. Over time, this lag should be minimal, especially after Netflix announced this year that they expect to spend no more than $17B on content.
Netflix’s main competitive advantage is content distribution. How much would it cost to replicate a subscriber network like the one Netflix has (more than 200 million with good ARPUs)? There’s an example of another company that is trying by all means – Disney. And even though Disney has the world’s best IP, it is burning a lot of cash to grow. It is very likely that it will eventually reach the same level of subscribers and revenue as Netflix, but the cost for Disney is going to be high, probably between $20 and $30B. But Paramount, HBO, Peacock... they can't burn that much cash. This makes me think that there will be 2 or 3 successful players worldwide. The rest will be residual players and won’t reach profitability.
Regarding monetization, some say that Disney+ is catching up with Netflix in terms of subscribers, but their revenues are totally different. No one comes close to Netflix’s ARPU. Disney’s subscribers around the world pay an average of $4 per month. Netflix’s subscribers pay $12.
In early 2022, Netflix's subscriber growth rate slowed and there was even a small reduction in the total number of subscribers in some quarters. This made the management team focus on further monetizing the business, in case the subscriber growth rate didn’t bounce back. They are trying to achieve this by doing two things: a new ad supported tier and putting a stop to users sharing passwords with people outside the household.
On the other hand, Netflix also increases prices from time to time. Although there’s a temporary churn increase, it goes back to normal after a while. We believe that there’s still room to increase prices in all markets. Even in the US, which has the highest subscription prices, there would still be plenty of room for price increases when compared to what cable users pay.
With the increase in sales due to the growth of the subscriber base, advertising, price increases and the company's fixed cost structure, the operating leverage is very high. As long as they keep the same levels of investment in content, around the $17B range, the EBIT margin, which is currently around 19%, could easily reach 30%+ in a few years.
As for Netflix’s management, Reed Hastings is one of those geniuses like Elon Musk, Mark Zuckerberg or Daniel Ek. What was Netflix like before 2010 and what is it like now? Back in the day they bet their strategy on streaming, and everyone thought they were crazy. Netflix made Blockbuster go bankrupt and after that it did not remain a mere distributor, but instead bet on content creation and won the battle again, but this time against giants with many more resources than them.
In terms of valuation, if we estimate 500 million subscribers for 2030, with an ARPU of $20 per month in the US and $14 internationally, and an EBIT margin of 30%, Netflix would reach $90B revenue by 2030 and an EBIT of $27B. At 15x EBIT, Netflix would be a $400B market cap company. Besides, a big part of the FCF of these 8 years might return to shareholders in the form of share repurchases. It could very well add another $100B, turning Netflix into a $500B market cap company. Today, Netflix is a $130B business. According to earnings estimates for 2023, it is trading at 30x, which is not low in itself, but we must take the business’ tailwinds and quality into account.
Transdigm Group is a company that I have followed for years and that I unfortunately sold during the pandemic. I have been following it ever since and I would like to become a shareholder again, but valuation is keeping me out for now.
It has all the things I look for in a serial acquirer: high-quality company controlling hundreds of small monopolies with high returns on capital and high margins in an industry with structural tailwinds, run by a very smart management team, with an spotless track record. And last but not least, they have managed to withstand the COVID crisis without diluting shareholders, even when they are one of the companies that took a bigger hit, and also have a huge amount of leverage (net debt/ebitda ratio above 5x). This proves the incredible quality of the business.
You are one of the first investors in my close circle who understood the Constellation Software opportunity in 2012 and one of the very few who have been shareholders of Berkshire Hathaway since 2014. What is it like, holding a stock for so many years? How does one know when it’s time to pull back and when it may just be a temporary blip?
In order to hold a stock for so long, you have to deeply believe in the business model and trust the company's management team 100%. This is very important because as time goes by the business is always going to run into bumps or the market or other investors are simply going to punish the stock even if there are no major problems and, as an investor, then you will have some doubts.
That is why what I answered to the previous question is so important. It is key to have a good understanding of the company's business model and where it is going to be in the next 5-10 years. As for the two companies I mentioned before, I think I have a good idea of where they will be, and I feel extremely comfortable with both their management teams. To be honest, these two companies are the only ones I would comfortably invest 100% of my portfolio in.
Sometimes we can sort of know if a company is facing temporary problems, but in most cases it is impossible to know whether these problems are temporary or there to stay. Meta Platforms is the most recent case. I won’t know whether it is a mistake to hold my shares at the current price until a few years from now. I believe that a good part of the company's problems are temporary, but only time will tell. As I said before, you have to make sure that the business has competitive advantages, that it is well managed and then let time run its course.
When you hold a stock for so many years, in some way an emotional bond is born – with the company, the management team or even with shareholders you get to exchange ideas with, because you share the way you understand the investment. Do you think that this bond forged over the years can be a double-edged sword, and that it can make us less flexible when it comes to changing our minds about an investment?
Yes, you absolutely develop an emotional bond with the company, management and shareholders. It can indeed be a double-edged sword, you must be aware of it and always remain skeptical. But, on the other hand, that bond with the company and everything related to it makes you know the company quite well – better than most investors – and it makes you gain a lot of confidence in the business and the strategy, which is essential when the bad times come. They always do.
For example, Constellation Software is my largest holding, I've been investing in it for 9 years and I feel that emotional bond. But that does not stop me from continuing to study the company, following their capital allocation closely and so on. And always from a skeptical point of view.
Could you tell us about any recent or not so recent investment mistakes? I would like to know the whole process. What first led you to consider that investment and what was the process of realizing that the situation was not as you had initially believed?
I made a mistake with Fannie Mae and Freddie Mac’s preferred stock. The idea emerged around 2014, when I had just invested in warrants from Bank of America. The US financial industry was coming out of the biggest recession since the great depression of the 1930s and companies like BAC were extremely undervalued and had capital instruments issued as part of the bank bailouts in 2008 and 2009, which were (and still are) rare. As I continued my research about the industry, I came across preferred shares from GSEs (FNMA, FMCC). There were several well-known investors who had recently written about them, Bill Ackman and Bruce Berkowitz. And from there I began to dig deeper. The truth is that this investment thesis had a very high legal and, above all, political component. Operating performance did not matter, at all.
At first I ruled out the idea because the Obama administration was unlikely to change anything and the legal aspect was going to take a long time. But everything changed, or so I thought, at the end of 2016 with the arrival of the Trump administration. They said that the status of the GSEs would change, they would recapitalize the entities and bring them back to the stock market. It was a dream for preferred stockholders, they would return to face value or close to it, when they had just traded at 20 cents. That's when I decided to invest.
Over the years, and for different reasons, the investment thesis did not fully materialize. First of all because, although the Trump administration took steps towards recapitalization, they never ended privatizing the companies. In the summer of 2021, one of the main cases reached the Supreme Court, where against all odds they once again agreed with the US government to the detriment of common and preferred shareholders. The story is not over yet and possibly at some point shareholders will get their happy ending, but I will no longer experience it as such. Right after the Supreme Court ruling came out, I decided to sell, capitalizing my loss and, therefore, my investment mistake.
I made quite a few mistakes with that one: first, it was too complex. The stock heavily relied on external variables that are unpredictable, involving politicians and court rulings. Time went by with little progress and I decided to wait, but I should have cut my losses sooner. And finally, there was a time when it was a relatively large holding in my portfolio, and the sensible thing to do would have been to sell some shares or even hold, but not to keep adding.
Peloton Interactive is another company I was wrong about. This company greatly benefited from COVID. With the stay-at-home restrictions, being able to exercise at home with personalized workouts and high-level equipment was in very high demand. The company went from 500,000 subscribers to over 2.5 million in less than 2 years. The euphoria of the market convinced the company that this growth was not temporary. In the second half of 2022, as the vast majority of mobility restrictions were lifted, growth came to a screeching halt and valuation was unsustainable. In addition, founder and CEO John Foley mismanaged the company and greatly increased the cost structure. When demand fell, the company ran into huge losses and even jeopardized its viability unless massive cutbacks were made.
My mistake was buying one of the greatest beneficiaries of COVID at such a high valuation. At that time there was a large valuation bubble for different types of companies – one of them was the “COVID winners”, and I just couldn’t see it. I was carried away by the great growth reported, how excellent all metrics and user reviews were and how much they loved the brand... but a good part of all these were influenced by the pandemic. I bought shares in early 2021 for around $150 and recently sold for just under $10. You have to be very careful not to simply extrapolate growth and also be careful with the valuation. No matter how good the company is, an excessive valuation can be a terrible investment.
For those who love investing, but cannot commit to doing it full-time at the moment and must balance it with a 9-to-5 job, how can you lead a balanced lifestyle without neglecting such important stuff as family relationships and personal fulfillment? What would your advice be for someone who has most of their wealth invested in individual stocks, who has to keep track of their investments, but also has a family that needs attention? How do you do it all?
It’s difficult to give an answer that works for everyone. Each person must find their own way of doing things based on the time they have and what they want. In my case, until a few years ago I could spend a bit more time choosing and monitoring the companies I invest in, but since then I have not been able to spend as much on it. This has also been one of the catalysts to invest in higher-quality companies – I don’t have to follow them as closely, and I can also diversify the portfolio a bit more.
But another option that I considered and that may surely be valid if you have, for whatever reason, less time for reading and studying companies, is to continue investing through investment funds. Of course, funds that follow an investment philosophy that resonates with you and with trustworthy managers who are doing things right. It’s true that there are annual fees, but it is also true that here, in Spain, there are tax benefits as well. Knowing how to take advantage of that can be very important for a private investor.
Correct me if I'm wrong, but given the performance of your portfolio in the last decade, I guess you are closer than ever to becoming a full-time investor or at least to considering that possibility. What would you recommend to subscribers who aspire to one day become full-time investors? What would you have liked someone to tell you to avoid taking longer or wrong paths?
Being a private investor is not easy. In my opinion ideally you should have a 7-figure capital and have been through a real bear market. But that’s not my goal anyway, I’m very happy with my current situation – I have a very satisfying full-time job which takes up most of my time. It has been very fulfilling, both at a personal and financial level, as well as for my professional development and, to be honest, I am very grateful to my company for the opportunity they gave me back in the day. Then, in my spare time, I keep learning and reading about companies I’m interested in.
It seems like a good combination to me. I admit, though, that sometimes I would love to have a little more time to work faster in my analysis, but it is also true that, with a portfolio of quality companies, once it is solid, built you don't have to spend as much time on it either, and if you don’t have any other occupation you can end up overthinking and rotating the portfolio more than necessary.
My advice for private investors would be not to rush, to enjoy the process and little by little results will come. Haste makes for a poor advisor in this business. In my experience, almost every time I've tried to make a quick buck with a short-term investment, it didn't work out and both time and capital would have been better spent on longer-term opportunities.
Diego, thanks for visiting the blog and for sharing your thoughts with us.
Thank you very much for thinking of me for this interview. I’d recommend subscribing to Finding Moats to all readers who are interested in the analysis of quality companies– he does such an amazing job with his research, and FM is one of the best investors in top-quality companies I know.