The core idea: AI will drive a major capex cycle and significantly augment services performed by humans today, boosting real-world output. As investors, we should be thinking about which companies will capture the economics of this cycle.

Let’s start with an anecdote: before spreadsheet software came out (around 1980), it would have taken 5 accountants to do the work that 1 proficient Excel user can today.

Using the internet → being able to search for already solved problems, or interpretations of tax guidelines (instead of reading through Tax Acts) - probably doubled the efficiency / output of the average Excel finance worker.

Now AI, as a tool, has perhaps doubled efficiency again → now accountants can code and near-instantly solve problems that used to take a lot longer.

“So software (5X output) is 2.5 times as revolutionary as AI (2X output)?”

That is linear thinking. Consider this instead:

• 1 person * 5X software = output of 5 people.

• 5 people * 2X internet = output of 10 people (5 incremental).

• 10 people * 2X AI = output of 20 people (10 incremental)

So one accountant can do the work that 20 people used to do, as recently as 1980. We are talking exponential increases in efficiency / output.

<The numbers above are rough and (hopefully) directionally correct — I tried not to be too optimistic or too conservative>

Productivity has increased quickly over the last century and peoples’ lives are better in a lot of ways: less worldwide poverty, better health outcomes (before the 1940s an infection was likely to kill you), and we all have a device in our pocket with infinite entertainment. The bottom two rungs of Maslow’s Hierarchy are not a concern for most in the developed world.

“But housing is more expensive.” Yes, not everything is solved. Houses are also a lot nicer (and bigger) these days, with nice HVAC systems and amenities that weren’t common or didn’t exist when houses were cheaper.

This progress is thanks to technological innovation cycles from the industrial revolution and onwards, all the way to our current AI innovation cycle.

If you were to invest in any of these innovation super-cycles, and you picked the right companies, you would have been generously rewarded.

We are seeing increasing investment into AI. Even if everyone doesn’t hit their targets, the capital spend is so large (and fast) that it will be a boon for the economy and perhaps the stock market. This spend on trades-people, tech-people, and materials will do much more for the real world economy than when huge companies buy back their own stock with excess cash.

As investors, we should be thinking about (1) what companies will benefit from that spend, and (2) the magnitude of that spend compared to a company’s current market cap (and its theoretical profitability).

Market pundits are discussing a bubble in AI and are cautious about investing in the AI theme, expecting a crash similar to the 2000 dotcom/telecom bust (the NASDAQ fell by 75% from March 2000 to October 2002).

I am completely on the other side of the bet.

Yes capital will likely be overspent on the infrastructure eventually, but I don’t think we’re there yet. I also think it’s possible that since we are so focussed on the bubble it could push the “popping” of the bubble out further.

With that said, there are still companies I am avoiding: (1) anything pre-revenue (i.e. robotics); (2) pure hardware plays (especially cyclical), including semis; and (3) model companies (for the most part). I’m not saying these companies won’t do well over certain time periods, but I include them in the “too hard for me” pile.

On models, I am most uncertain about who will win out of the base LLM models or if they will end up being a commodity, and as a result, I have little invested there. I feel best about my investments in a selection of software companies that will sell tokens and collect some of the economics on the pass-through of compute (I’ve included some examples below). They are the platforms/distributors of the LLMs, they don’t incur the significant costs of training the models, and they can markup the cost of inference for the end user (as toll collectors).

We often underestimate the size of super-cycles in hindsight. We knew the internet would be big, but the opportunity ended up being over twice as big as initially forecasted. AI will likely end up being a bigger opportunity than we originally anticipated.

We also overestimate what new technologies can do in the short-term:

Market commentators are quick to hype new technologies, but we rarely see the benefits as quickly as they think. Human emotions overshoot to the upside then overshoot to the downside, all before realistic expectations set in. This could be why the narrative for AI stocks swung so quickly from a) over-exuberance leading up to the Summer of 2025 to b) the subsequent fall into the end of the year (“AI Bubble”).

We’re still far from seeing AI’s full potential, and it may take years to get there; life-changing technologies take time to gain widespread adoption.

To be clear, I think a bubble is still possible, and even likely in certain subsectors, but for the companies I mention below I think we are still early.

I find myself saying this a lot: “Today, AI is the worst it will ever be”

If models still make mistakes, will they ever be good enough?

Google and Anthropic’s latest models indicate that more compute and more training is leading to “smarter” and more accurate models. This could indicate we can still make the models better by throwing more compute at them.

I liked some of the comments from this recent podcast (BG2). Ali Ghodsi posits that we are already at AGI → we can create great products and unlock great productivity without even making the models better. I tend to agree, the current models are good enough to perform significant service work already (coding, customer service, marketing customization). Although they do require some human intervention, software, or guardrails to work optimally.

If that’s true, if the current models are already good enough, then will we need much more infrastructure ?

An emphatic YES:

1. as AI usage increases, so does inference compute; and

2. as long as more compute produces materially better models (scaling laws), it still makes sense to keep investing.

With that frame in mind, here’s how I’m playing the AI theme.

Mock AI Portfolio

I put together a mock AI portfolio with some of my favorite AI picks. I own all of these companies today, but I could trim or sell out of them at any time and I won’t necessarily provide an update if I completely sell out of a name or trim.

The mock portfolio is based on a $25K starting point (not real money).

I don’t recommend anyone copy this portfolio → this is intended for education and entertainment. This is a concentrated portfolio with only 10 holdings, which increases risk. If you weight one theme too heavily in your portfolio it is susceptible to large draw-downs.

For reference, in my portfolio I typically hold between 20 and 30 different companies and put max 5% into an initial position (I will let positions grow larger than 5%, but they have to earn it). I also hold companies that I wouldn’t include in the AI theme.

I have historically focused on microcaps and small caps (in the blog and my personal holdings), but you’ll notice a few of these are larger companies. This strategy change is specific to what I perceive to be the “AI Super-cycle.” I will likely be back fishing in micro/small cap land once I perceive this opportunity has passed.

Portfolio link:

Google Sheets: RTW Mock AI Portfolio
or
https://docs.google.com/spreadsheets/d/1ocOx2WNXWgNFNY7Qod7SDmWzp3DwWmT7KSVA4ciDikE/edit?usp=drivesdk

Let’s see how the basket does over the next 3 years.

I friendly-bet (only my pride at stake) that it:

1. beats the S&P 500 Total Return, and

2. <bold prediction> returns 26% per year at peak value i.e. the portfolio hits $50K at some point before December 31, 2028 (starting from Jan 1, 2026).

These bets are particularly bold because I won’t be able to sell the names if my thoughts change or reallocate cash if one of them is acquired.

We can also compare how my predictions played out 3 years from now vs what I wrote today.

The below is my high level thoughts on each company. Please double-check facts and perform a fulsome due diligence yourself if any of the companies are of interest to you.

INFRASTRUCTURE

These are the companies supporting the construction of compute intensive data centers that will be used by model companies and compute marketplaces.

The biggest risk to these companies is if breakthroughs in compute efficiency outpace the increase in demand for compute; if so, it is possible less infrastructure would be required.

#1 - IREN Ltd
(I am up multiples on my original investments in IREN and it is my largest position even after significant trimming)

Iren is a bitcoin miner that has moved into the AI data center space. They are vertically integrated, have access to power, and own/operate data centers primarily in Texas and Prince George (Canada) for now. They also have the opportunity to offer co-location as well (where a company leases the land and power from IREN).

IREN has 2+ gigawatts (GW) of power access coming online between 2026 and 2027 (for scale, that is enough electricity to power 2 to 3 small to medium sized cities).

I think the infrastructure bubble calls are early → power is still a constraint for the AI build-out and if you are hearing a lot of data center project announcements, they’re usually for 2027+.

• The co-founders (brothers Dan and Will Roberts) are capable capital allocators and are aligned (they receive significant stock awards for increases in share price).

  • Management is the primary reason for this investment. I’m not that bullish on the industry in general i.e. I will not be investing in companies like CRWV, nor other companies that have become popular because of their access to power (not saying they won’t do well).

  • Infrastructure investments have a heavy reliance on management, and their capital allocation skills. IREN’s management has built a $12B company and consistently hits their targets and deadlines.

• Speculative on my part, but I think it’s possible we could see a co-location deal for their Sweetwater campus in the next 5 months, as building out 2 GW would require significant resources.

• They secured a deal with MSFT on ~200 MW for ~$1.94B revenue per year. This comes with additional capital requirements which will increase enterprise value (not market cap/price).

  • The terms of this MSFT deal are hotly disputed (with respect to Return On Investment or IRR%). However, as a first deal it is the best partner I can think of (I might be biased → see my write-up on MSFT below). If IREN performs on this agreement (builds on-time and meets quality/uptime requirements) it will give them credibility in future deals.

  • I think it’s probable the terms of this deal may not be as good as future deals will be.

    • Management has heard investor feedback loud and clear and they will have even better perspective going into their next deal.

• Even if compute for model training slows down (though I think it continues to grow for the next 2+ years), inference will still be required. Think about some of the services being replaced or augmented (coding, customer service, marketing, legal), every service provided by AI will require inference compute. There will also be more usage of services as the models become cheaper and better (Jevon’s paradox).

I’m not sure how long of a hold IREN will be for me, this is one I will be watching closely over the next few years as it’s difficult to interpret “what’s next” until we’re a few years out. This is not a long-term compounder type company, I am just trying to capture temporarily underappreciated value in the market.

Portfolio weighting factors: (Moderate to high downside / High upside)

#2 - TSS Inc
(I originally purchased TSSI between $0.90 and $2.50, sold out completely above $20 and now repurchased just under $9)

TSSI assembles the racks that go into data centers. They employ the technical trades people who assemble and ensure the racks are working together reliably.

• Significant customer concentration risk (Dell). I’m starting with this because if they lose Dell as a customer (or if Dell exerts too much pressure on margins) the company could be worthless. This is also why it is a smaller weight in the portfolio.

  • I don’t think they will because (1) as laid out in the AI theme above, I think there will be consistent demand for years and (2) building reliable AI data centers (with evolving technological requirements) is a skill that is and will continue to be in high demand.

• TSSI helped build the xAI data centers, which would have been invaluable experience for them. These are not standard data centers and requirements are evolving constantly (liquid vs air-cooled; power requirements per rack significantly increasing).

  • If general trades (electricians & construction workers) are in high demand in these areas, imagine the day-rates of a specialized data center assembler.

  • How do I know building these data centers require specialized knowledge? Because IREN is outsourcing the supply and delivery for the Microsoft deal to Dell ($5.8B deal including hardware).

• Investors like to focus on revenue and they like predictability, but as I’ve said in previous posts, not all revenue is the same:

  • Integration revenues have consistently climbed and this is where the company is earning their income after all costs are considered (these are the revenues to focus on). They are expanding capacity as best as they can.

  • Procurement services will fluctuate wildly for TSSI, but they are so low margin that it doesn’t matter. It was inevitable that they would drop off at some point, and they’ll likely come back at some point (and drop off again after that, etc, etc).

    • I think this is a large driver of the recent drop in stock price.

• Lottery ticket on the chance that the on-site modular data centers segment gains traction.

• If the racks & chips only have a useful life of 5 years (bear thesis), then TSSI gets to redo all this work every 5 years in addition to new builds.

• Did I mention significant customer concentration risk? I’ve been burned by this in the past (Payfare).

Portfolio weighting factors: Moderate to high downside / High upside

#3 - Dell Technologies Inc

The thesis for Dell is simple, I think we could see a multiple re-rate in addition to material revenue & earnings growth, driven in part by what I expect to be earnings beats over the next ~8 quarters. The increase in earnings will come from more, and higher margin, data center contracts (higher margin than their current business).

Dell is a massive company and it will take a lot of business to move their bottom line & margins, but AI is a big opportunity. Their net income margins hover slightly below 5% and revenue hasn’t grown significantly over the last 5 years.

The market has realized this and has priced it in somewhat → the stock price has increased ~3.8X over the last 5 years. My bet is that the market is still under-estimating how beneficial the AI theme will be for Dell.

One risk with Dell is that component price increases (high-bandwidth memory & GPU chips recently) will be a headwind as it takes time to pass incremental costs through to customers. So this thesis rests on the hope that the increase in data center earnings will outweigh this headwind. Regardless, this risk is why I’ve weighted the position lower.

Portfolio weighting factors: Low to moderate downside / moderate upside

TOKEN DISTRIBUTION (TOLL COLLECTORS)

Below are some software platforms that customers may use AI inference through. I think these companies could charge a fee on the pass-through tokens for little incremental cost to the platform.

These are my favorite investments of the bunch because:

1. If my thesis works out, they will see a step change in revenue and earnings growth that the market isn’t pricing in.

2. Software multiples have been depressed due to AI fears.

3. Their base software businesses could act as a floor even if the AI theme doesn’t fully pan out for them.

As always, I will be wrong on some of this stuff, and it could be these names.

#4 - Gitlab Inc

GitLab is an end-to-end DevSecOps platform that helps teams plan, build, secure, and deploy software from a single application (available as a cloud service or self-managed). Its core capabilities are source code storage and review, task planning, automated testing and deployments, and built-in security checks.

If we think there will be more coding because of AI (more people can code, experienced developers can code more/faster, and Jevon’s paradox), it seems logical that Gitlab usage would go up. Companies still need the infrastructure, security, and workflows for developers to manage their code base (even if the work is done by agents).

Gitlab is about to release their usage based coding assistant which could (1) entice people to upgrade to a more expensive package and (2) act as a tailwind to revenue and earnings growth through token markups (lower margins perhaps, but that’s ok).

Gitlab:

• is no longer founder-led, but the co-founder (Sid Sijbrandij) is still involved (on the Board).

  • A new CEO was recently brought in as Sid stepped down to focus on his health. The new CEO, Bill Staples, has focused his efforts on revamping Gitlab’s go to market strategy, which is what he did in his previous role at New Relic.

  • Sid is still the largest block of voting shares, which is relevant because there have been rumours about a potential acquisition. I am hoping the company stays public at least until we see the effects of usage based AI.

• is trading at ~7 Price to Sales (P/S), which isn’t bad for a company with 88% gross margins, low capital intensity, and 20%+ revenue growth (especially if growth inflects higher).

• has predictable revenues; and,

• has a massive relative TAM.

Gitlab is my favorite out of the 10 picks because the AI opportunity in code is significant and already here, but that doesn’t mean the investment will work out.

Portfolio weighting factors: Low to moderate downside / high upside

#5 - UiPath Inc

UIPath is a robotic-process-automation (RPA) company. In layman terms, they set up workflows that can be performed by a computer automatically (a workflow a human normally would have done). The problem with RPA is that it’s rigid in structure and doesn’t scale well → it needs a specific set of rules to follow and specific inputs because it doesn’t handle nuance well.

In a really simple example, they could take invoices that always look the same and input them into a database over and over. But if those invoices looked a lot different (had totals in different spots, different languages, different currencies, hand-written codes), it would be difficult to code all the possible exceptions into RPA.

This is where AI fits in nicely. AI is good at interpreting less rigid data.

Though, AI in its current form isn’t great at performing even repetitive tasks on its own, it needs instructions and guardrails for what to work on.

From Sherwin Wu (paraphrased): it feels counter-intuitive that AI physical autonomy is ahead of digital autonomy; for example, autonomous vehicles are closer to a solved problem than being able to book a ticket online seamlessly through an AI agent. One of the reasons is that autonomous driving has guardrails -> roads, traffic laws, rules, etc. Whereas AI agents are just dropped in the middle of nowhere, they don’t have the scaffolding (protocols) or infrastructure in place and are left trying to feel around what they should do.

I think that UIPath’s RPA could help solve this issue for digital autonomy. Their orchestration is the structure & protocol, or set of rules, that will allow AI agents to be useful. Without it, people will be consistently disappointed, at least in the near term, as they expect AI to do more than it can.

UI Path:

• has aligned and competent management (founder-led);

• has predictable revenues;

• is the leading company in RPA

• has a massive relative TAM; and,

• is trading at ~6 Price to Sales (P/S), which isn’t bad for a company with 80%+ gross margins, low capital intensity, and 15%+ revenue growth (especially if growth inflects higher).

Portfolio weighting factors: Low to moderate downside / high upside

#6 - HubSpot Inc

HubSpot makes software that helps companies with their marketing → attracting visitors, turning them into leads, and managing sales and customer support in one place (think marketing + CRM + help desk). It’s used to run and manage e-mail campaigns, website forms, customer service tickets, and more.

Their main customers are small to mid-sized businesses (though some larger enterprises use it too).

• Marketing is one of the workflows I think could benefit from even the current AI models.

  • AI can plausibly respond to customer tickets, segment customers, and create bespoke marketing materials for particular customers or target markets.

• Hubspot likes to provide the value first and charge for it later. They are providing customers packages of free credits they can spend on current AI features, i.e. resolving customer tickets, and can consider monetization later. I like this strategy as once customers adopt a feature into their workflows, it tends to be sticky. They can always reduce the tokens offered free in the future, or increase prices.

• Small businesses don’t have as large of budgets and may be more open to a pay-for-use token model. I think large enterprise clients are more likely to experiment with in-house AI solutions.

• Hubspot is trading around ~7 Price to Sales (P/S), which isn’t bad for a company with 84% gross margins, low capital intensity, and 20%+ revenue growth (especially if growth inflects higher).

• One of the founders is still at Hubspot as the CTO, Dharmesh Shah.

• Risk: their CEO, Yamini Rangan, owns an insignificant amount of shares.

Portfolio weighting factors: Low to moderate downside / high upside

COST EFFICIENCY

These companies can disrupt entire industries by offering better customer experiences at lower costs (through automation with AI). They have
built their tech stack in-house from scratch (the incumbent competition has not), which makes it easier to roll out AI features across the platform.

#7 - Lemonade Inc
(the below is copy/pasted from my last post)

• Founder-led: two aligned and highly competent managers

  • I consider myself a good read of people/management and after watching several of Daniel Schreiber’s interviews, I think he is an Outsider.

  • Shai Wininger is the tech co-founder who previously founded Fiverr (another $500+ million company) before coming to Lemonade.

• Massive market opportunity:

  • A $6B company disrupting a trillion dollar industry.

  • Look at the market caps of competitors that are less efficient and have lower NPS scores (Progressive has a $135B market cap).

• Structural advantages over incumbents

  • They target young people (renters and pet owners) which results in lower CAC especially when they cross sell into house and car as the customers age.

  • They will always have a cost advantage because they cut out brokers (15% cost to some incumbents) and use AI to sell insurance, process claims, and support customers.

    • Even if incumbents pay someone to implement AI, if there is a recurring cost they will still be at a cost disadvantage.

    • Insurance is a commodity which means customers are highly price sensitive.

  • Higher NPS scores than competitors (Trustpilot and anecdotal).

  • Insurance companies can do better when they’re growing quickly due to float dynamics → you get paid well in advance of having to pay the claims, so if you’re growing you keep collecting more cash in advance of having to pay out claims which provides a safety buffer. As a result, insurance companies in the growth stage have a structural advantage over mature insurance companies.

I guess the risk for Lemonade is they misprice their premiums and face too many losses at once. However, I think even this risk is low as they don’t insure in areas with large catastrophic risks (think hurricane areas), and rents / pet insurance don’t see large spikes and unexpected claims.

Portfolio weighting factors: Low to moderate downside / high upside

#8 - Oscar Health Inc

Oscar Health is a health insurance company that sells medical plans and leans heavily on a digital experience (app, virtual care, care-team support) to make it easier to use your coverage.

They mainly focus on individuals and families buying their own insurance, often through the Affordable Care Act (ACA) Marketplace.

They also offer customizable plans for employers (large white space for them).

• Oscar Health is a $4B company disrupting a hundreds of billion $ industry of US Healthcare.

• The company has grown revenues quickly from ~$460M in 2020 to ~$11.3B in the trailing twelve months.

• High quality management with the founders still involved.

  • One of the founders is Joshua Kushner, a well-reputed venture capitalist.

• The market thinks the biggest risk is the cancellation of ACA subsidies. The Democrats want the subsidies to continue, and the Republicans put forward an idea where citizens would get a stipend to choose where to allocate their healthcare dollars.

  • I think in both scenarios Oscar is a winner, and perhaps even more so in the latter scenario if Oscar can offer the cheapest and most customizable insurance → it is likely citizens would choose to spend their stipend on the best user experience and value.

• You can’t look at individual quarters on their own, Oscar Health earns most of their earnings in the first half of the year and then operates at a loss in the second half (due to the nature of health benefit usage). They will end this year with an overall loss due to an ACA risk adjustment. Oscar has a large cash balance and I don’t think they’ll need funding before reaching consistent profitability.

• Compared to competitors, Oscar is highly scalable and their software is built in-house, so I think they should be a beneficiary of AI.

Portfolio weighting factors: Moderate downside / high upside

MODEL COMPANIES

#9 - Microsoft Corp

This is my only investment in the model layer. Microsoft has 27% equity ownership of OpenAI (as of their last filing, their ownership has been diluted since).

Microsoft collects a ~20% royalty on OpenAI’s direct revenue (like ChatGPT and APIs) while retaining the majority of income generated from selling the models to enterprise clients via Azure.

I think ChatGPT is currently being underestimated in the market due to the success of the recent Gemini 3 release.

“ChatGPT” is the verb like “Google,” “AirBNB,” and “Uber”; people use the company names in sentences to describe what they’re doing. The companies that are the verb tend to be the category leaders.

I particularly liked this interview with Mark Chen, Chief Research Officer at OpenAI.

OpenAI has several options to monetize but are instead focusing on taking as much market share as possible (which I think is a good strategy for now). I don’t think they’ll add advertisements to responses until it is clear they have the top model again (sometime in 2026 I’d guess).

Google will be a tough competitor. They have the best model currently, better distribution, and are a highly profitable company which gives them cash to commit to advancing the Gemini product. However, ChatGPT is the current leader in active users, has a more nimble (smaller) team, and has done a better job with product thus far.

I paid for a subscription for both Gemini and ChatGPT for my wife, I told her Gemini was the superior product (and is best at images), but she still uses ChatGPT.

I don’t know who will win the model layer in the end, but ChatGPT is not the only reason I like the investment in Microsoft.

Another anecdote: I got an e-mail from Microsoft informing me that they increased the price of my Office 365 products by 30%. Quite the price increase! I immediately considered alternatives and guess what? I am still using Office 365. They could double the price and I would likely still use Office 365 (don’t get any ideas Satya). Microsoft has incredible pricing power, even if they haven’t exploited it yet.

Yes, I use Google Docs / Sheets too, but I like Office’s desktop versions for particular workflows.

All incremental revenue from these price increases flows to their bottom line, the cost of sending those emails and increasing prices is negligible.

I think we see some of this pricing power flow through Productivity & Business Processes top and bottom line. Github is also under this segment which is seeing nice growth driven by AI coding and Copilot.

Their Intelligent Cloud segment (data centers and cloud services) is going to continue its growth based on everything AI we’ve discussed above.

More Personal Computing includes their Xbox / gaming (Activision) and Windows segments. I’m less certain of the contribution here, but this is still a capital light and highly cash-flowing business.

This interview gets a lot of flak for “popping the AI bubble,” but when I watched it, all I could think of is how well positioned Microsoft is. I think people were too focused on Sam’s responses and overlooked Satya’s comments.

I also like that the sentiment isn’t great for Microsoft compared to the other hyperscalers right now. See this recent poll from Twitter:

A lot of money can be made buying before the crowd agrees with you.

Portfolio weighting factors: Low to moderate downside / moderate upside

SEMI-CONDUCTORS

I typically avoid pure hardware companies (without a recurring software component) completely, especially cyclical ones → it is difficult to project the demand for their products reliably into the future. Even though I think Micron, SK Hynix, and Nvidia could do well, I also think their share prices will drop quickly, and well before I see signs of demand drying up which it eventually will.

#10 - Trio-Tech International

Trio-Tech is an exception to my rule above because I think it is relatively undiscovered (though it has more than doubled in the last 6 months). It is a microcap which means certain investors couldn’t buy it even if they wanted to (until there is more volume).

Trio-Tech provides back-end testing services and equipment that are critical for the complex chips used in AI, including high-memory bandwidth (HBM). They also do work in the automotive sector, particularly with EVs.

We have seen memory demand (and prices) skyrocket in the last few months due to data center demand. Micron even exited their consumer RAM segment to focus on data centers because the demand is so high.

• In their last quarter Trio-tech’s revenue took a step change. Their revenues had been flat and decreasing (YoY) for the last 3 years and in the most recent quarter revenues increased 58% YoY.

  • Their gross profit $ only slightly increased YoY, even in spite of the significant revenue growth, which is curious. Gemini thinks it’s plausible that manufacturers margins take a hit at the beginning of a ramp period, as people and goods are brought in early in anticipation of the demand.

• Trio-tech also has high insider ownership.

This is a bet that Trio-tech participates in the AI memory boom.

Insiders sold some of their stock, in December 2025, after the stock doubled in price. The sales were larger than typical for the company. Though, there haven’t been significant sales for a few years and it doesn’t look like the CEO sold any shares. This isn’t always a bad sign, but it’s never a good sign.

Trio-tech is probably the riskiest out of the 10 picks → the recent insider sales + there isn’t a lot of information available on the company, they don’t do quarterly earnings calls and there aren’t many public interviews with management. As such, I have weighted it lower in the Mock Portfolio.

I still think Trio-tech will be susceptible to boom/bust cycles in line with companies like SK Hynix and Micron. Like IREN, this is not a company I would coffee can and check back on in 10 years. I will be watching this one closely.

Portfolio weighting factors: (High downside / high upside)

BONUS: How I use AI in the research process

Here is an example of a conversation I had when researching Cogent Communications in late November (Gemini 3 Pro):

https://docs.google.com/document/u/1/d/e/2PACX-1vQe7tnGsaa8lzQxISE3tKKVS3Ycn6zhy831ygxzdGmSYswRIhn6n96JZQmylI5lj2m_Onu4SL6tZ9Ga/pub

I thought the maps outlining the overbuild were particularly cool (if they’re actually right 😅).

This conversation took between 1 and 2 hours (I was doing my standard research in another tab - financials, insider ownership, etc).

I typically am writing my next question/prompt as the AI is “thinking” → so I can read the last answer while it thinks about the next one.

To get all of that information without AI would have taken a lot longer.

The models are also good at translating different languages and I’ve used it to translate press and financial releases from Japanese companies. Though in hindsight, I feel that part of my edge is in analysing and acting on news quickly → this potential is greatly diminished for non-English reports, so I have found myself hesitant to invest in foreign reported stocks for this reason.

Always review answers with scepticism (especially calculations), double-check what you’re uncertain of, and re-think through the reasoning yourself. I pay for ChatGPT and Gemini, and use both. Sometimes I put the same question into both.

Disclosure: I don’t currently own shares in Cogent Communications.

Disclosure: All amounts and allocations referenced are as of January 2, 2026. As of January 2, 2026 I own shares and/or derivatives in GTLB, IREN, TRT, LMND, DELL, PATH, MSFT, HUBS, TSSI, and OSCR but I may have sold my positions by the time you’re reading this → I trim and sell positions often and I will not necessarily update the blog after I have sold. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — I could be wrong on these ones. Please do your own research and double-check my data & findings.

Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

While I much prefer a five-year test, I feel three years is an absolute minimum for judging performance. It is a certainty that we will have years when the partnership performance is poorer, perhaps substantially so, than the Dow. If any three-year or longer period produces poor results, we all should start looking around for other places to have our money.

— Warren Buffett

It has been nearly three years since I started this blog, so now might be a good time to take stock of how I’ve performed.

In this post I will:

• provide an update on how each pick has done (good and bad),

• share what I think about each company today, and

• as a bonus, share one new pick I recently purchased.

Here is a summary table of returns since the companies were published on my blog (links to the actual posts are provided below):

I still own 7 out of the 9 holdings, though I have trimmed some and added to others. If I still own them today I am still optimistic about their future prospects.

The average return is 159%, which I’m quite happy with especially as some of them were published more recently (all less than 3 years ago).

7 of 9 (78%) with positive returns is above my target aiming to be right 60% of the time.

My personal portfolio has performed slightly better than this over the last three years: I have surpassed +100% return in both 2024 and 2025 (more than doubling my portfolio two years in a row), after earning ~25% in 2023.

My personal results did not come from heavy concentration or excessive risk (in my judgment). Since 2023, I have:

• held between 20 and 30 positions;

• used less than ~5% leverage on average; and

• purchased small LEAPS positions (1-2% by cost) and QQQ Puts (market hedges).

Below I will go into my current thoughts on every company I’ve published on my blog. I also share the allocations for select holdings, but consider that I can trim and/or sell positions at any time and I may not own the company by the time you’re reading this.

Kits Eyecare Ltd (full pitch link) - Still Own

+357% since March 4, 2023 (+71% CAGR)

My thesis for Kits Eyecare hasn’t changed much since my original posts.

• The management team is aligned and executing well (founder-led).

• In my view, the two large tailwinds for Kits are far from over:

  • more people will need vision correction as heavy screen usage continues, and

  • the transition from in-store to online eyewear purchases, especially as virtual try-on technology improves.

• They still have a mostly capital light business model with predictable revenues.

• Competition is the biggest risk here.

Kits recently announced a new store opening in Toronto, which is interesting because part of their competitive advantage is that they don't have a lot of retail shops (lower overhead/costs).

Here is why I think this could be a good thing:

1. This is the first storefront they are opening in the last few years, so it appears they are taking a measured approach and not a blitz of store openings to increase revenues at worse margins.

2. I like that it’s in an entirely new city. If they start opening multiple stores per city, I might have to re-assess (see Warby Parker).

3. I am happy using the online ‘try-on’ feature, but I know it is a non-starter for some. Having a store for people to go in and try glasses, and get a prescription, opens Kits up to additional customers. I do think the try-on feature will get better with AI (buzzword, but could actually make trying on different glasses virtually more seamless). I think it will take years, not months though.

4. I am glad to hear they are including a coffee shop in this one as well. My wife and I stopped by their Kitsilano store and really enjoyed the vibe, though it was a bit tight in there (due to its small size and a lot of customers). We tried on a lot of pairs, wrote down the glasses we liked, and then purchased online later.

We don’t have as much tailwind from a multiple re-rating as we did before, but I think we could see Kits at a $1B market cap eventually, it’s just a matter of when.

Butler National Corp (full pitch link) - Sold

+354% since March 6, 2023 (+71% CAGR)

I wrote my reasons for selling here:

My reasons for selling were:

• Due to the capital intensive nature of the business;

• The fact that a large portion of the enterprise value is tied up in a casino with low growth (albeit with high cash-flow);

• Opportunity cost.

The stock has continued to perform since I sold, and I continue to think the Aerospace division is a gem.

One of the difficulties in running a portfolio of less than 30 companies is that even if you still like a company, you may confront selling it when you find opportunities you perceive as better (opportunity cost).

Trustpilot Group PLC (full pitch link) - Still Own

+98% since August 7, 2023 (+33% CAGR)

There was a recent short report by Grizzly Research which had a fairly narrow scope: they questioned the legitimacy of a selected sample of reviews/ratings and posited that Trustpilot manipulates or selectively enforces its policies depending on whether the company is a paid customer or not.

Here is Trustpilot’s response: https://www.londonstockexchange.com/news-article/TRST/trustpilot-rejects-categorically-false-allegations/17361644

Some excerpts I thought were relevant:

and

My thoughts:

1. I don’t doubt there are fake/paid for reviews on the site, it would be too difficult to eliminate all fakes, especially in the age of AI.

2. Assuming the above stats from Trustpilot are true, then it is plausible the short report only selected samples which confirmed their narrative.

3. I can’t know if they are unbiased in their enforcement. Similar claims were made against Yelp in the past, but my gut tells me Trustpilot puts more effort into being a good faith platform than Yelp had historically. Yelp is still around, though their earnings multiple (price and enterprise value) has underperformed since IPO (I think Trustpilot is a better business regardless).

4. Trustpilot does admit that paid customers get access to send automated review links to customers, but they also state the company has to send the review links to all customers, not selectively (not sure how this is enforced but they do mention going after customers for this). For good companies this process could help increase their rating because I think, all else equal → customers are most likely to go on Trustpilot to leave a review if they have a negative experience, however, if every customer receives a prompt/email to review a company after purchase you will likely get more positive reviews.

5. Several board members & insiders, including the CEO and CFO, purchased more shares after the short report (approx. $510K USD total). Specifically telling is the shares purchased by Hanno Damm, the CFO, as he is stepping down in 2026.

The company has also ramped up share repurchases and have repurchased over 4% of diluted shares outstanding since June 30, 2025.

My two biggest worries with the company are:

1. If SBC continues to increase; and/or

2. OpEx only comes down slowly/slightly as a % of revenue over the coming years.

Both of these are agency issues, a result of low management share ownership → if management doesn’t own a lot of shares they may be less concerned with realizing shareholder value. One mitigating factor is that part of their compensation is based on share price performance.

Management/insider ownership will be even lower once Hanno steps down from the CFO role.

Trustpilot has a nice business model with obvious network effects. My hope is they continue to compound at ~15%+ revenue growth (if they can get above 20% even better) and bring down their costs as a % of revenue at a meaningful pace. If this happens, on a long enough time horizon your IRR% on the investment should earn whatever their revenue growth is combined with any re-rate in their market multiple (good or bad).

Tiny Ltd (full pitch link) - Still Own

-56% since October 31, 2023 (-32% CAGR)

Tiny is the most controversial company I’ve pitched (likely because Andrew, the founder and largest shareholder, is polarizing), but also because their financials are confusing.

The long-term thesis is fairly straightforward, you need to believe that (1) Andrew and Chris get access to good companies that others don’t; and (2) that they are skilled enough to discern which companies are good buys at a particular price.

I believe both of those things.

Andrew started as a freelancer in a coffee shop 20 years ago and created a $275M company (with ~$30M in free cash-flow). If you looked at a historical chart for the 15 years before they came public, their earnings likely went up in a steep curve. Do you think they’ve now hit their limit? I don’t.

A complaint I see is that revenue growth has plateaued and is falling in some quarters. The reasons revenue hasn’t grown is partly due to:

1. Cyclicality of Metalab design agency (Digital Services Segment). Agencies are notoriously project-based and cyclical (boom/bust). This sort of work has become less of a focus for Tiny and their focus has shifted to predictable, recurring revenue business.

2. Sales of portfolio companies (WFH job board and design agencies), and

3. The Tiny Fund → From 2020 onwards, Tiny invested ~$40M CAD in a GP/LP structure where revenues of the underlying businesses are not consolidated on their financial statements (i.e. “hidden” from reported revenue). Had this cash gone to traditional acquisitions it would have bolstered revenue.

I think revenue could start to grow again as new cash flow (less debt repayments) is deployed into traditional acquisitions instead of the fund structures. And if revenue growth does return (resulting from short payback acquisitions) I think the stock price will follow.

The company is also available at a reasonably cheap valuation:

Tiny has complicated financial statements with a lot of adjustments, but I believe the most fair assessment of their underlying profitability is Adjusted EBITDA, less SBC. This metric excludes one-time costs or income i.e. severance expenses and gains on sale of subsidiaries, but deducts real costs like stock based compensation (SBC).

Enterprise Value is ~$465M

$38.2M Adj. EBITDA TTM, less $2.8M SBC = $35.4M

~ 13 EV to EBITDA ($465M / $35.4M)

Note: the Enterprise Value and EBITDA both include non-controlling interests (Serato & Dribbble), which can be difficult to normalize (as they don’t break out their financials); however, I think attributing ~$75M in EV to non-controlling interests is a directionally correct / fair adjustment.

A large portion of EBITDA adjustments are related to Depreciation and Amortization (D&A), but when you read the notes to the financial statements you realize that D&A is mostly made up of adjustments to intangible and non-recurring investment.

The easiest way to see this is to look at their cash-flow statement, here is an excerpt of their cash-flow statement for 2025 YTD:

… and here is full year 2024 and 2023:

Under $1M in capitalized expenses each year (on $50M of revenue), but they are showing > $35M in annual depreciation and amortization expense? You should realize based on this that net income could be understated by up to $34M (and we can see income is understated by looking at the free cash-flow) → this is why some investors get the business wrong, they think the company is unprofitable looking at standard metrics that don’t show the whole story.

Adjusted EBITDA is “bull**** earnings” for companies with maintenance CapEx, but it actually does a decent job approximating earnings for capital light companies. Sometimes you just have to add your own adjustments on top.

I also think it is quite impressive Tiny has acquired so many companies in the last 20 years and none of them need much maintenance capital at all.

Payfare Inc (full pitch link) - Acquired

-40% from April 28, 2024 to acquisition on March 3, 2025

Here is what I wrote in my original pitch:

Those risks came to fruition shortly after I posted.

Payfare’s stock increased to over $8, dropped to near $2 (!!) after the news they lost their biggest customer, and then the company was acquired at $4 a few months later.

What a rollercoaster.

I cannot say buying Payfare was a bad decision just because of the bad result. If we ran the decision in 100 different universes, how would the investment play out on average (maybe the investment would end up profitable on average)? Though, in the future I will likely allocate a smaller initial position to a company with real downside risks like this.

I ended up holding my shares and buying more when the stock dropped near $2 which reduced my overall loss when the company was acquired at $4. I still lost money overall when all was said and done. In hindsight, I think buying more at $2 was a mistake even though the result was good (reducing my loss).

Payfare had the best financial metrics I’d seen for the price (revenue growth, profitability, scalability/low CAC) up to that point, and perhaps since.

One company which I think is close (great quality for the price) is Duolingo. I initiated a position in Duolingo earlier this month at $192.

Duolingo, like Payfare, has real risks, but instead of customer concentration risk, they have AI disruption and fad risk. What I like: trading cheap on profitability & growth + capital light + founder led + predictable revenue + float-like working capital dynamics + category leader + scalability + sentiment is bad and is detached from fundamentals.

If these risks don’t materialize, I think Duolingo could be a multi-bagger.

I’ve sized the Duolingo position at 2% currently, perhaps learning from my Payfare experience to attribute lower weighting to investments with higher perceived downside risks (the principle the Kelly Criterion is based on).

Zedcor Inc (full pitch link) - Still Own

+287% since July 28, 2024 (+158% CAGR)

I still own Zedcor though I’ve trimmed the position quite a lot. Zedcor has been over a 10-bagger vs the price I originally purchased most of my shares at.

The management team is executing well and I still think the company has significant tailwinds at its back:

1. More money will be spent on security as people feel increasingly unsafe → a) faster and better distribution of news makes crime feel more common, even if it isn’t, and b) expanding income inequality could increase crime rates;

2. Transition of in-person security guards to remote monitoring (the towers are cheaper, safer & more effective).

The valuation is arguably high, but the company is also growing incredibly fast (80% TTM).

I do wonder what the market will do (to the price in the short-term) if their tower utilization drops below 90% over a few quarters.

My gut tells me Zedcor could compound for years to come.

Hims & Hers Health Inc (Father-in-law post) - Still Own

+43% since October 20, 2024 (+35% CAGR)

I bought a lot of my shares under $10 and I still own shares; HIMS is currently around a 5% position in my portfolio. The stock trades up and down erratically based on news and sentiment, however the underlying business doesn’t change nearly as much. The company has:

• Aligned and highly competent management (founder led)

• Massive market opportunity

  • I think home testing will do well and lead to significant cross-sell (optionality).

  • Peptides are a lottery ticket.

• Structural advantages over incumbents through tech-enabled platform

There are real risks here, especially with regards to competition (could squeeze margins) and regulation. They are selling essentially the same products as their competition, so they have to differentiate on customer experience (technology/convenience), cost (scale), and marketing.

Here is one thing I think the bears are missing → If the business succeeds in disrupting consumer healthcare, the market opportunity is so large that you are plausibly looking at a 10 or 100 bagger.

“Whoa whoa!”, the bears would say, “the company will likely fail due to competition, shrinking margins, and regulatory pressures.”

Ok, well let’s do some paper-napkin math:

Credit: Gemini 3 Pro
(The above is meant to be illustrative and the actual distribution of outcomes for Hims and Hers would be less extreme).

Even if we allocate the chance of ‘total failure’ to 50% (or 90%), you can make a scenario where this would be a good “bet” mathematically.

This is akin to venture capital (VC) investing, where returns are driven by a few outsized tail outcomes.

You wouldn’t want to include a bunch of companies in your portfolio where 90% of the time you had a bad result (investment stays flat or you lose your investment). Though, I think Hims and Hers’ potential outcomes are much more favourable than above → in my opinion they have much lower risk of both total failure and staying flat.

This is just an exaggerated example of how you might justify adding a company with real downside risk to your portfolio. The reality is you can only lose 100% of your investment when you purchase shares, but you could double, triple, or 10X an investment.

Regardless, if there is a real downside risk, you won’t want a lot of these investments in your portfolio and I wouldn’t allocate a lot to the investment. This is similar to what I mentioned about Payfare above; and I touched on in my post on Portfolio Construction.

Lemonade Inc (Father-in-law post) - Still Own

+286% since October 20, 2024 (+210% CAGR)

I bought most of my shares under $20 and still own shares. Lemonade is one of my top holdings at ~15% weighting.

• Founder-led: two aligned and highly competent managers

  • After watching several of Daniel Schreiber’s interviews, I think he is an Outsider CEO.

  • Shai Wininger is the tech co-founder who previously founded Fiverr (another $500+ million company) before coming to Lemonade.

• Massive market opportunity:

  • A $6B company disrupting a trillion dollar industry.

  • Look at the market caps of competitors that are less efficient and have lower NPS scores (Progressive has a $135B market cap).

• Structural advantages over incumbents

  • They target young people (renters and pet owners) which results in lower CAC especially when they cross sell into house and car as the customers age.

  • They will always have a cost advantage because they cut out brokers (15% cost to some incumbents) and use AI to sell insurance, process claims, and support customers.

    • Even if incumbents pay someone to implement AI, if there is a recurring cost they will still be at a cost disadvantage.

    • Insurance is a commodity which means customers are highly price sensitive.

  • Higher NPS scores than competitors (Trustpilot and anecdotal).

  • Insurance companies can do better when they’re growing quickly due to float dynamics → you get paid well in advance of having to pay the claims, so if you’re growing you keep collecting more cash in advance of having to pay out claims which provides a safety buffer. As a result, insurance companies in the growth stage have a structural advantage over mature insurance companies.

I guess the risk for Lemonade is they misprice their premiums and face too many losses at once. However, I think even this risk is overstated as they don’t insure in areas with large catastrophic risks (think hurricane areas), and rents / pet insurance don’t see large spikes and unexpected claims.

Evolv Technologies Holdings Inc (full pitch link) - Still Own

+101% since Feb 25, 2025

This is another one of my top holdings at ~10% weighting.

Evolv benefits from some of the same security industry tail-winds as Zedcor, but I like that their product is more proprietary (less competitors with the exact same product).

I still think they have a lot of market room to grow organically → penetration of schools, hospitals, and new potential markets (events, workplaces, etc) is still low.

The two downsides I see for the company are (1) that valuation isn’t cheap (but my gut tells me this company will rarely look cheap); and (2) that management is new / unproven and the new CEO doesn’t own significant shares. Though I have only seen good signs since he started + there was some insider buying recently.

On the valuation point I look at it like this → I struggle to see a scenario where this company isn’t a lot bigger in 5 to 10 years, the market opportunity is too big vs their current ~$1.2B (at the time of writing) market cap.

If you made it this far, thank you!

In my next post, which I plan to publish soon, I will include additional names I own and am bullish on going into 2026, under a common theme.

Disclosure: All amounts and allocations referenced are as of December 30th, 2025. As of December 30th, 2025 I own shares and/or derivatives in KITS, TRST, TINY, ZDC, HIMS, LMND, EVLV, and DUOL but I may have sold my positions by the time you’re reading this → I trim and sell positions often and I will not necessarily update the blog after I have sold. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — I could be wrong on these ones. Please do your own research and double-check my data & findings.

Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

Make your portfolio reflect your best vision for our future.

— David Gardner

As a good rule of thumb, proprietary technology must be at least 10 times better than its closest substitute in some important dimension to lead to a real monopolistic advantage. Anything less than an order of magnitude better will probably be perceived as a marginal improvement and will be hard to sell, especially in an already crowded market.

— Peter Thiel (Zero to One)

Evolv price today (February 18, 2025): $3.52 USD
Market cap: $556.9M USD

Evolv Technologies appears to be a high-quality business, and I believe an investment at today’s prices will deliver market-beating returns (note that I only hope to be right 60% of the time and I've been wrong before — see my pitch on Payfare).

What does Evolv do?

Evolv develops contactless security screening solutions that use sensor technology to detect potential threats. Its system, the Evolv Express™, allows for real-time entrance screening in high-traffic environments such as airports, stadiums, and large event venues, enhancing both efficiency and safety.

The systems resemble metal detectors, but instead use radio frequency (RF) electromagnetic sensors to scan individuals as they pass through the system. The collected data is processed by algorithms that differentiate between potential threats and innocuous items like phones and keys.

Here are a couple of images of the product and what an operator would see when a potential threat is detected:

The company reminds me a bit of Zedcor — another security hardware company with a recurring revenue component — but with a better, proprietary product. Disclosure: I also own Zedcor and I've shared my thoughts on it, including the unit economics of Zedcor’s Towers (>40% estimated IRR) in a previous blog post.

Value Proposition

A couple of reasons why Evolv’s systems are superior to traditional metal detectors:

1. They allow you to pinpoint where on the body a potential threat is located; and

2. Most importantly, they enable up to 10 times the throughput of people compared to traditional metal detectors. In part, this is because you don’t have to empty your pockets, and also because the operator knows more precisely where to focus their search.

This increased throughput can (1) create value for venues and (2) open up new use cases for entrance security in areas where traditional metal detectors may not have been considered previously.

Value creation: I have seen the screeners in action at our local hockey arena. Previously there was a long queue before every game, but since the installation of the Evolv scanners, traffic flows much quicker. Quicker entry allows the arena more time to sell food, beverages, and merchandise to patrons.

Additional use cases: The increased throughput can also improve the cost-benefit equation in settings where traditional metal detectors would cause significant delays at peak times — for example, schools, subways, and hospitals.

Evolv’s scanners are used by highly credible and discerning customers, including Disney (since 2020), multiple sports arenas (starting in 2022), and the Olympics (2024).

The company faced an FTC inquiry regarding its prior aggressive marketing claims, which was resolved on November 26, 2024. As part of the resolution, a limited group of K-12 education customers were given a 60-day window to cancel their contracts (affecting approximately 237 units). The vast majority of the cancellation rights are scheduled to expire by March 14, 2025. As of January 23, 2025, no customers had exercised their cancellation rights.

Tweets and Thoughts on Evolv

Recently I have been posting about Evolv, and other companies I own, on Twitter

Tweet #1:
Not too far in the future, I can see it being a liability if you don’t have this type of scanner installed at your school

I don't think it's unrealistic that most public high-schools in the United States will have an entrance security system like Evolv’s within 10 years. Per ChatGPT, there are roughly 23,800 public high schools in the US and Evolv has penetrated less than 2,000 thus far; this is just one vertical.

Another excerpt from a news article posted last week:

Evolv is also starting to sell their newly released bag scanning product, the Evolv eXpedite™, into schools which pairs with their walk-through scanners. This new product hints at the company’s potential optionality, although it is too early to tell viability of this product.

Tweet #2:
It is a great business where the media reports each time a customer installs your product (schools & hospitals) → It’s free advertising.

Often after a school or hospital installs an Evolv scanner there is a news story published about it. This is a business model quality I really like, which I also noted in my Trustpilot pitch → customers and users are essentially advertising Evolv’s products for free, leading to increased marketing efficiency and higher ROIC.

Note: Please reach out to me through Substack, if you know of c.ompanies that you think are worthwhile investments and (1) exhibit this quality OR (2) have high per unit IRR

Tweet #3

Here is a similar post from Stoic Point Capital Management highlighting end-users pushing for the use of Evolv’s scanners. Their page on X is worth following if you want to see the flow of published contract wins, although reading frequent news stories like these can sometimes create false conviction (recency bias).

Napkin Valuation

The company is transitioning from a business model that sells hardware bundled with a subscription to a hybrid between a (1) pure subscription / leasing model; and (2) an outsourced licensing model (where a select vendor sells the hardware). This shift makes Evolv’s financials particularly challenging to project, but should lead to higher gross margins.

Assumptions:

1. Estimated FCF margin at maturity = 25%

2. Estimated valuation in 10 years: 20 times FCF (average)

3. TTM Revenue = $89.2M

4. Current Market Cap = $556.9M

In order for us to achieve a 20% return based on the above assumptions, the company would have to grow revenue by approximately 23% on average over the next 10 years (calculation below).

• $556.94M * (1 + 20%) ^ 10 = $3,448M market cap in Year 10

• $3,448M / 20 FCF multiple / 25% FCF margin = $690M Revenue in Year 10

• ($690M / $89.2M) ^ (1/10) - 1 = 23% required revenue growth

This doesn’t factor in share issuances or cash-returns to shareholders (buybacks / dividends) between now and then.

If FCF margins are higher at maturity; if the market applies a higher multiple of FCF, or; if revenue growth is higher than 23% then our return could be even higher than 20%. Of course the inverse would lead to a lower return.

As I’ve said before, disruptors tend to surprise to the upside.

Now I know what you’re thinking… “but Evolv’s revenue growth has slowed and was below 23% in 3 out of the last four quarters!”

This is partly due to their business model transition from a hardware sales model to pure-subscription → hardware sales provide a large, upfront, low-margin revenue stream with a small subscription fee. Whereas the pure subscription model has a smaller upfront fee, if any, and the higher-margin revenues are spread out over the life of the contract.

We can see this in the financial statements, take a look at the year-over-year ‘% Change’ for each segment below, the transition has put a drag on overall revenue growth:

I think we will see revenue growth re-accelerate in the coming quarters at the same time as overall margins improve.

The company added 465 subscriptions in Q3-2024 and 470 subscriptions in Q4-2024. If we annualize these amounts we get 1,870 scanners added to a base of 5,323 at the end of Q2-2024. This would suggest high-margin growth of 35% YoY (ignoring churn), and does not factor in their latest unit cost reductions (can also pass on lower costs to customers), or new products like the bag scanner.

Unit economics

Ok, customers are buying the security systems, but will Evolv make any money?

Short answer: YES

I input high-level assumptions, including some pulled from Paris Analyst’s post, into ChatGPT to estimate what Evolv’s internal rates of return (IRR) per unit might be (I also recalculated the results for reasonability).

To get a very rough estimate for CAC, I took Evolv’s total marketing spend since 2022 and divided by the total units deployed. The results are below:

Disclaimer: The above uses high level assumptions and illustrates a scenario in which the units could have high returns on investment — a sanity check. I've included my assumptions so you can assess yourself whether they are too aggressive or conservative.

Based on the above, both of Evolv’s new sales models could produce IRR in excess of 20% which would be quite good. Theoretically the long-term performance of a stock should trend towards its IRR/return on capital rates.

As we get more quarters under the new sales models we will be able to refine our calculations. Here are a few considerations I’m thinking about meanwhile:

1. If the systems cost $25K/year or $13K/year + upfront hardware cost (excluding labour). This doesn’t feel like a significant expense for customers to budget for in Evolv’s current target markets (schools & hospitals).

2. CAC could decrease as the company scales and gains efficiencies under new leadership. This would increase IRR.

3. We know they significantly reduced the cost of their units recently. This would (1) increase IRR and/or (2) if they pass savings on to customers, increase sales growth/reduce churn.

4. I used 80% as a ball-park gross margin figure (excluding depreciation). I calculate margins slightly higher than 80% in Evolv’s historical financials, but Paris Analyst quoted rates lower than 80%.

5. These unit-rate models are particularly sensitive to customer churn rates. Even if a customer churns, in the pure-subscription model Evolv could re-purpose the equipment and in this case we should factor in unit down-time. Churn rates are primarily influenced by customer satisfaction (value/service) and competition.

Legacy Shareholder and Founder Contingent Shares

There are a significant number of earn-out shares set to expire in March and July 2026 → we're talking between $74M and $251M depending on which thresholds are hit ($12.50 to $17.50 share price thresholds). The founders and legacy shareholders will have every incentive to succeed and have the share price increase.

Achieving, or even just approaching, these share prices would represent a significant appreciation from today's level and I don’t think it’s out of the realm of possible outcomes.

Destination Analysis

Destination analysis is a useful tool for identifying long-term compounders, and it is how I identified some of the other companies I own, including Hims and Hers, Lemonade, and Trustpilot.

I ask myself: is it plausible that this company can 10X in 10 years (26% CAGR)?

I believe that given Evolv's disruptive product and the large & growing total addressable market (security is becoming more and more of a focus in society), such an outcome is possible.

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Other Considerations

(1) Liquidity:

I think I'm comfortable with the cash-flow risk now as, based on the latest business update, Evolv has (1) cash on hand of $52 million and no debt as of December 31, 2024; (2) an expectation to be free cash-flow positive by Q4; and (3) has been focusing on rationalizing operating expenses, including a 14% reduction in staff.

(2) What about management?

Evolv parted ways with their CEO and CFO after the company’s recent accounting irregularities.

The company filed a notice of late filing for its September 10-Q and their December-24 10-Q may be delayed as well. As a result, Evolv has engaged consultants (Alix Partners) to help catch up on their reporting and hire a new CFO.

Assuming the press releases are accurate, these accounting irregularities do not overly concern me. However, potential investors might choose to wait until the financials are up to date. Here were my initial thoughts from a MicroCapClub post in October (which was also posted in my chat):

[UPDATE April 28, 2025: A new CFO has been hired and their filings are up-to-date]

I don't know much about the new CEO, John Kedzierski, which could be a risk given the limited history we have about his capital allocation and decision-making. However, we have seen some promising early signs e.g. his focus on reducing unnecessary operating expenses.

John has 16 years of experience at Motorola in various roles and I believe John's value will, at least in part, stem from his ability to attract top talent to Evolv. For example, see linked article for details on their new Chief Revenue Officer hire.

The Pareto principle is alive and strong in large companies like Motorola, where 20% of employees tend to produce 80% of the work, and when you encounter one of these 20%’ers you can usually tell who they are fairly quickly.

Even though we will have a new CEO and CFO, most importantly, Evolv still has its two co-founders, Mike Ellenbogen & Anil Chitkara, who created Evolv and grew it to what it is today.

(3) Competition:

While Evolv does have a number of competitors, their product appears to be the premium option in the industry. Given the critical nature of security products, customers may be less likely to compromise on quality. Additionally, the company's impressive growth and retention metrics suggest that competitors have yet to catch up.

Further Reading

If you’re interested in further reading on Evolv, I recommend the following article from Paris Analyst, which delves into the competitive landscape (see his detailed response in the comment section) and provides select inputs on the unit economics of the systems: https://parisanalyst.substack.com/p/evlv-our-favorite-2024-black-friday

Background on Evolv’s founding story: https://evolv.com/resources/blog/the-road-to-now/

Disclaimer: As of February 18, 2025, the author owns shares and/or derivatives of Evolv Technologies Holdings Inc. I am not a registered investment or financial advisor. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data, findings, and calculations. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

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You have probably heard these quotes before, and if you stopped your portfolio-construction research there you may put your money into 6 stocks and call it a day, after all, that is what some of the best investors recommend.

The common belief is that an intelligent investor should concentrate their money into a few of their best ideas. When diversification is brought up proponents will cite the quotes above and argue:

• “Why put money into your 7th best idea”

• “Diversification will water down your returns”

• “No one can follow 30 companies closely enough to know them inside and out”

• “You will only find 1 or 2 good opportunities each year”

In what follows, I will take one out of Rob Vinall’s playbook and challenge the widely held belief, a tenet of value investing, that a concentrated portfolio is superior to a more diversified portfolio.

For the purposes of this post I will define a ‘concentrated’ portfolio as one with less than 10 stocks and greater than 70% in the top 5 holdings. A more ‘diversified’ portfolio is one with between 10 to 30 stocks and less than 75% in the top 10.

Personally, I haven’t put more than 10% (by cost) into any one position, although I will allow them to grow past that.

For the record, I believe you can achieve exceptional returns with a concentrated portfolio OR a more diversified portfolio. Many strategies can work in investing and you’ll want to choose a strategy that aligns with your personality and temperament.

Arguments for Diversification

I have attempted to rank order these from most beneficial to least:

1. Optionality to buy companies with perceived risks;

2. Increase your odds of holding right-tail outcomes;

3. Timing problem;

4. Optionality to reweight between undervalued and overvalued holdings; and,

5. Risk (probability of loss) mitigation

Benefit #1 — Optionality to buy companies with perceived risks

If you only have 6 companies in your portfolio you really need to focus on the downside with every investment. Unfortunately, some of the biggest winners will have hair on them when you first find them.

Payfare, Zedcor, and TSSI are all companies I’ve bought that had/have significant customer concentration risk. Payfare lost their biggest customer this year and the stock fell 75%. On the other hand, TSSI and Zedcor gained enough in the year (each on their own) to offset all of my losses combined, including Payfare.

Consider $HIMS and $LMND → yes there is a chance Amazon wins telehealth e-commerce or that Lemonade incurs catastrophic insured losses but the upside in the most right-tail outcome is >100x and thus I think both opportunities present favourable Expected Values (asymmetry).

I would not have been able to hold any of these stocks in a concentrated 6-company portfolio (although some investors may).

One final example from popular portfolio manager Mohnish Pabrai: Due to its structure, his new mutual fund holds more positions than his partnership and as a result he can hold investments with perceived risk. One investment he made was the arbitrage play on Spirit Airlines (which didn’t work out). He could not invest in this arbitrage as part of his partnership because the portfolio’s concentration necessitates higher holding percentages.

Source: Pabrai Wagon’s Fund Semi-Annual Report (as of June 30, 2024)

No one should fill a portfolio with these types of investments, but having a diversified portfolio allows you to include the best ones when you might otherwise have to forgo them.

Benefit #2 — Increase your odds of holding right tail outcomes

What does right tail mean? In investing the right tail represents the most extreme positive outcomes and highest returns, referring to the far right of a distribution.

Per the study below, few companies (~7%) drive positive stock market returns. The right tail is the companies circled on the right side of the chart.

Credit: JP Morgan and Brian Feroldi (who I first saw present it)

Having more companies in your portfolio increases the chance of finding and holding one of these outliers → 4 times more likely with a 20-company portfolio vs a 5-company portfolio.

You don’t have to be right on every pick, what matters is how much you make when you’re right and how much you lose when you’re wrong.

Benefit #3 — Timing problem

If you aren’t an investor with a large following or avenues for promotion it can take longer for your companies to be discovered. Think about what happens when Warren Buffet buys a company: (1) he buys a new “cheap” company; (2) his 13F comes out after quarter-end; (3) the market researches the company; and (4) it will be discovered. You don’t even need a following as big as Buffett’s to have the same effect, especially in smaller market caps.

If you’re like me and don’t have a large following, you can invest in a company, write a post about it, but who knows when the general market will notice.

I hold about 25 companies that I think are undervalued, but I have no confidence in timing/guessing when the market will agree with me. So instead I hold them all and have the option to reallocate from names that are quickly discovered to ones yet to be discovered.

Benefit #4 — Optionality to reweight between undervalued and overvalued holdings

In general, I try to weight my companies by my conviction in each name. When a holding like Zedcor or TSSI double → triple → quadruple in a short period, and I think the company fundamentals could take time to catch up to the valuation, I have the option to reallocate funds to other companies. When you hold 25 companies and follow them closely, you will inevitably have some companies that look especially undervalued.

Having more options to put your cash to work also helps when making deposits to your portfolio.

A watchlist can be used similarly, but most don’t follow their watchlist as closely as the companies in their portfolio.

If you’re looking for extra reading on this topic, here is a great article by Turtle Creek who employ a similar approach of reweighting current holdings and have achieved >20% returns for over 20 years:
https://www.turtlecreek.ca/wp-content/uploads/2020/09/TCAM-Thought-Piece-Edge-3-Portfolio-Construction-Apr-2013.pdf

Benefit #5 — Risk (probability of loss) mitigation

This is the first benefit people think of when you mention diversification, but I included this one last because (1) the additional risk mitigation you get going from 10 uncorrelated ideas to 30 isn’t huge; and (2) I do believe you can adequately manage risk with less than 10 companies so long as you focus on the downside of each investment.

Having more companies at lower weightings can mitigate the impact of losses from any one holding. For example, in 2024 one of my holdings Payfare dropped sharply after a negative press release, but since it was only a 7% position it didn’t really affect my annual results. Even if it went to $0 it would have only affected my portfolio a little over 7%.

This can be especially valuable for a new investor buying companies for the long-term because it takes time to build comfort that you know what you’re doing.

Arguments Against Diversification

Drawback #1 — “Why put money into your 7th best idea”

Because I don’t know which my top 6 ideas are and I especially don’t know the timing of when or if they’ll appreciate. Companies and their management are too complex and markets are too nuanced to precisely rank ideas.

Some of my biggest winners started in the bottom half of my portfolio.

Drawback #2 —“Diversification will water down your returns”

The more companies you hold the less impact each will have on your portfolio, so at some point you are diluting the quality of your ideas. I actually agree with this one to a point.

While it is difficult to pick an exact number for “how many companies is too many,” I think a good rule is that if you hold more than 30 companies you should be weighting new additions towards the long-term compounder category — the 7% right-tail type of companies where a small position can turn into a much larger one. To identify companies like these, I like to think to myself “is it plausible this company could 10x in the next 10 years?”

If you’re holding a portfolio of 100 “cheap” companies where the best outcome is a double, I think you will end up disappointed with your results.

Also, the more companies you hold the more important it is to focus on watering the flowers and trimming the weeds i.e. don’t average down as much as you average up.

Some examples of successful investors that hold a lot of companies are Peter Lynch (often mentioned when the topic of diversification is brought up), he is an extreme example and held hundreds of stocks with an annualized return of 29.2%. Francois Rochon, Brian Feroldi, and David Gardner are others.

Anecdotally, holding 25 companies hasn’t watered down my returns (yet).

Drawback #3 — “No one can follow 30 companies closely enough to know them inside and out”

You don’t need to follow them all as closely because the downside risk in any one name won’t ruin you. Do you really need to be the most knowledgeable person in the world on a 1% holding?

On the other hand, if you hold 6 companies you really need to hold them tight and maybe you should be talking to management for every holding.

One tip to optimize your time spent on research and analysis is ‘cloning.’ See the relevant excerpt below from a previous post of mine:

Explicit analysis = Fundamental/financial analysis and looking for red flags (table stakes, every investor must do this well to succeed)

Implicit analysis = Analysis of business quality, management, and industry/market (harder to teach and convey, I think this is where good investors can develop a sustainable edge)

In investment terms, "cloning" refers to the strategy of reviewing portfolios of successful investors or investment managers for ideas. Cloning is helpful because you can find managers whom (1) you trust are good analysts and (2) have some confidence that they put investments rigorously through their explicit filter.

Through cloning good investors we know that it is likely an investment will pass through our own explicit filter so we can focus more time on implicit analysis (intuition of quality).

Since explicit filtering takes longer than implicit, cloning is especially advantageous for a part-time investor because it saves time. However, even for a full-time investor the time savings increases the number of investable opportunities you are looking at and, since investing is really a game of opportunity cost, the more viable opportunities to compare against the better.

It is important to note that before making any investment it is still required to do a fulsome fundamental analysis yourself, cloning just lets you know which companies are likely to pass.

Drawback #4 — “You will only find 1 or 2 good opportunities each year”

Maybe this is true if you are limiting your search to large caps in the S&P 500/Nasdaq, but I disagree when we include all public companies. I see enough potential opportunities in micro and small-caps that I find ranking opportunities to the top ~25 has been a bigger problem than finding new ones (so far).

Conclusion

You don’t have to be right on every pick, what matters is (1) how much you make when you’re right and (2) how much you lose when you’re wrong. I believe a diversified portfolio helps in both of these respects.

$BUKS was a successful pick for me returning 130% since my original post almost 2 years ago. Substantially all of this increase has come in the last year → even though I identified the company as cheap, the market can take time to recognize it.

Reasoning for Sale

They just released their FY25Q2 earnings which were quite solid: good growth in Aerospace & operating profitability, near all-time highs Aerospace backlog, and the company has been buying back shares. However, I feel the price is close enough to intrinsic value for me to re-deploy the funds to other opportunities. The stock could continue to rise with momentum on its side (or it could drop from here); I never expect to time the exact top on a sale.

1. FCF conversion

Although the company is cheap on a P/E ratio (~8 P/E) the company will always require re-investment in the form of maintenance capital expenditures (CapEx).

The company recently expanded their operations to a new hangar, new office, and has been buying planes (likely for resale) which has limited the amount of income being converted to free-cash-flow in recent years. Some of this spend leads to revenue growth which is great, but it is hard for me to determine how much income will convert to cash in the future.

2. Casino Business Model

The aerospace business is still growing at a good rate and their backlog is at all time highs, this appears to be a quality business.

However we’re also paying for a casino which requires significant capital reinvestment with little growth. This was ok when the company was cheap and actually gave us a strong floor in the stock, but now will act as a drag on the ROIC of the overall business.

3. Opportunity Cost

After the recent run up in price I feel that there are better investment opportunities for my money. I could be wrong, but time will tell.

4. Other

My general strategy is becoming more focused → instead of finding something optically cheap and waiting for the market to recognize it, I am trying to focus on what I perceive as “quality” companies. I still try to buy these quality companies cheap, but often the discount to intrinsic value is much harder for the market to calculate and perceive.

I won’t rule out buying these optically cheap companies in the future and I still consider being able to identify them a valuable tool in my toolkit.

Big thanks to Daniel Zeff, from whom I originally found the idea.

Kits reported Q3 earnings today and their press release can be found here: https://ir.kits.com/news/news-details/2024/KITS-Eyecare-Reports-Record-Third-Quarter-2024-Financial-Results/default.aspx

This was another great quarter with 34% YoY revenue growth and they guided for an even stronger 39% YoY revenue growth in Q4 (at the mid-point).

In my first post on Kits (Mar 4, 2023), I pointed out that “as eyeglasses make up a larger portion of revenue, overall revenue growth % could accelerate” and I believe we are starting to see a bit of that, but I don’t want to minimize the incredible growth in contact lenses either (33% growth YoY). Kits’ marketing strategy is obviously working and the company continues to exhibit operating leverage as they grow.

It feels like I go into every quarterly earnings thinking there won't be much new going on, I think to myself "this is a simple recurring revenue business," and the team surprises me again and again. Here are a few of the new products they've released in the last few months:

1. Coloured contact lenses: Founder Joe Thompson says they are "off to a strong start."

2. Kits PIXA personalized glasses: think Crox Jibbitz for glasses.

3. Pangolin smart glasses: sold out in one quarter - no idea on volume.

4. Kits+ Subscription Membership: Joe says off to a "blazing start."

The one I'm most interested in is the Kits+ $50 annual membership. When I thought about a subscription membership to an eyeglass store that won't be deductible under insurance I was initially skeptical. However, the more I think about it, the more I like it:

1. This will entice members to shop with Kits exclusively when they may shop around otherwise.

2. There is an obvious initial value proposition with up to $100 in savings off the first offer and savings of 40% on lens upgrades, offsetting the entire cost of the first years' membership. 

   • The membership is a no brainer for someone without insurance coverage, although I'm not sure if the 50% discount on the first order will be renewed every year.

   • For someone with insurance like me -> typically glasses cost me $0 a year because I can claim them. With this membership my annual glasses cost will be $50, but I will get considerably more value with my insurance dollars. I think the benefits they've included are enough to make the purchase worthwhile.

   • Overall, I have a good feeling about membership adoption rates.

3. This seems like a low risk bet with potential for a big payoff if it gains traction. 

Regardless of the actual performance of any of these products, none of them required significant upfront investment. This is a strategy out of Amazon's playbook (albeit on a more narrow vertical) -> try a bunch of initiatives that require little upfront investment and see what works. These are asymmetric bets and investors can view these products/services as free options.

Thoughts on Recurring Revenue

Most wouldn’t consider a company selling eyeglasses a recurring revenue model. Most recurring revenue models are subscription or license-based with annual contract terms. So it makes sense companies measure their net revenue retention on a year-over-year basis, if a customer cancels (churns) then they are unlikely to provide revenue to the company in the future.

If you look at Kits’ 12-months retention of approximately 50% you may not be impressed, but unlike subscription/licensing revenue, there is no annual contract with customers → customers can come back and spend after 1 year, 2 years, and so on. Per the slide below, customers are spending >100% of their initial purchase by 36 months post-sale. These numbers are impressive and give the company more predictability than the average retailer.

Paper-napkin Valuation

Some of the analysts on the call were most concerned with updating the next two quarters in their models rather than inquiring about the subscription membership. Instead of building a complex model which will inherently require a lot of assumptions anyways, I have provided a high-level valuation model below.

Assumptions:

1. Estimated FCF margin at maturity = 10% (this estimate has been provided in the past and makes sense for a company focusing on a low-cost competitive advantage. Note that subscription revenues typically attract higher margins)

2. Estimated valuation in 10 years: 15 times FCF (average)

3. TTM Revenue = $146M

4. Current Market Cap = $309M

5. Minimal dilution

In order for us to achieve a 15% return based on the above assumptions, the company would have to grow revenue by 19% on average over the next 10 years (calculation below).

• $309M * (1 + 15%) ^ 10 = $1,250M market cap in Year 10

• $1,250M / 15 FCF multiple / 10% FCF margin = $833M Revenue in Year 10

• ($833M / $146M) ^ (1/10) - 1 = 19% required revenue growth

If FCF margins are higher at maturity; if the market applies a higher multiple of FCF; or if revenue growth is higher than 19% then our return could be even higher than 15%. Of course the inverse would lead to a lower return so it is up to you to decide if these assumptions are aggressive or conservative.

One thing I’ve noticed is that disruptors tend to surprise to the upside. So I’ve bought more shares and Kits now makes up approximately 10% of my portfolio.

Disclosure: As of November 7, 2024, I am a shareholder of Kits Eyecare Ltd at an average cost base of $4.40. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings.

Read disclaimer here: Disclaimer & Process​

Story-time

On March 10, 2023, the S&P and Nasdaq markets had fallen by -20% and -30%, respectively, from their peaks in 2021, after steadily declining throughout 2022. Large-cap tech stocks had been hit particularly hard as interest rates rose (I know because my portfolio at the time was made up of mostly large-cap tech stocks). Market participants were selling their positions, the market sentiment was driven by fear, and here I was thinking: “this looks like a great time to pick up some deals.”

I was at my in-laws enjoying my mother-in-law’s delicious hamburgers when my father-in-law asked me about his GIC portfolio, which had been earning between 1% to 3% over the last few years and was now offering 5% for the coming year after interest rates had risen.

One thing led to another and I was pitching him on the idea of giving me a very small portion of his net worth ($30K) to invest in stocks so I could show him what kind of returns you can get with equities vs GIC’s. I wanted to keep the amount small so that it would be low risk and also keep it to an amount I could pay back if I was wrong on my picks. He declined and I was fine with that.

Later that week, I was journaling at home and started thinking about what stocks I would purchase if he had decided to go through with it. I thought we would want companies that I wouldn’t have to trade in and out of — companies we could buy and hold for years to keep it simple. I knew I wanted to diversify, but (1) with a sum of $30K I didn’t want to spread the bets too thin and (2) since it would have been a small portion of his net worth then diversification for the purpose of risk mitigation is less relevant. So I eventually landed on 5 companies.

I also thought to myself “he could still see the potential of equity returns even if it is a mock portfolio,” so I created a Google spreadsheet and e-mailed him the list I had put together. The e-mail is below:

Here is a screenshot of that spreadsheet today (Oct 20, 2024) including the picks and their respective values:

(Click here for link to live version with current prices as of today)

The original investment has almost tripled in 1.6 years, a +$51K gain on $30K.

Spotify, Amazon, Netflix, and Meta are long-term compounders which I’ve owned at different times in the past and Butler National Corp is a company I’ve written about on my blog (BUKS costed $0.67 when I made my original post and has since more than doubled).

It took this portfolio 1.6 years to reach $51K in unrealized gains. Here’s how long it would have taken to achieve the same returns with GICs:

• 2% annual return = 49 years

• 3% annual return = 33 years

• 4% annual return = 24 years

• 5% annual return = 20 years

Now I’m not suggesting that a 170% return in 1.6 years is normal and repeatable. One reason for these outsized returns is because the market was near a cyclical low and investors were capitulating i.e. a portion of the outperformance can be attributed to “timing.” But in general, I believe equities will outperform GICs over most periods greater than 3 years and especially 5 to 10+ years (this statement is not regarded as controversial).

You could invest in a cheap (low-fee) index fund and out-earn GICs which is what I would recommend to most who are interested in equity-like returns. But to substantially outperform you will need to spend a lot of time researching and investing in individual equities.

Why don’t I have these companies in my current portfolio?

I did hold all of the stocks above throughout different periods, but the only one I still own is Butler National Corp. The others, Spotify, Amazon, Netflix, and Meta are all companies I would categorize as large-cap ‘Long-term Compounders’, here is my definition:

Long-term Compounders: an investment with a 5 to 10+ year time horizon. Plausible to hold 10+ years. Only sell if thesis is busted or there is opportunity cost to hold (much better investment elsewhere). High-level to detailed review of financial statements/KPIs each quarter. Less reliance on margin of safety than for Core investments as there is more reliance on qualitative (implicit) factors like destination analysis. A good sanity test for a compounder is that it is plausible (not necessarily probable) that the company could 5x to 10x in the next 10 years. These companies will have strong business models and could have large total addressable markets (TAM), strong management teams, and some of the strongest moats i.e. network effects, switching costs, and scale-economies-shared (low-cost) to support long-term compounding.

Even though I originally started my investment journey looking for large-cap compounders, I now focus most of my time on small and micro-caps for a few reasons:

1. With larger-cap compounder companies I am aiming for a 15 to 20% return per year which is great, but I believe I can consistently get higher returns in small & micro-cap. I think I have more edge (or advantage) in small and micro-caps due to less people looking at them and I believe it is easier to grow a small company than a large one.

   1. Here is a quick example to illustrate the last point: You could add an entire car division to Apple and it may increase the market cap by $250B or +7%. Now take a $25M market cap company, it is plausible you could add one product or big contract and double the market cap (+100%).

2. I believe the current valuation multiples of large-cap companies are quite high (28 P/E currently). While some argue that these higher multiples are justified due to the companies' quality, I see potential for a downward re-rating in the future (no guess on the timing). Regardless of a re-rating (short-term correction), I think the great companies will do fine over longer periods.

With all that said, I do own a few companies in my portfolio that I would categorize as long-term compounders — designated as ‘LT’ under the ‘Type’ column. Two examples I like are Hims ($22), Lemonade ($18), and Trustpilot (243 GBX) (click for my original Trustpilot blog post). When I imagine the world 10 years from now, I can envision these companies being significantly larger than they are today.

Identifying companies that will grow substantially over the next 10 years is heavily reliant on making qualitative judgments of business quality (micro) and business opportunity (macro). For further reading on what implicit factors I consider, you can read my article here: https://curiousinvesting.substack.com/p/conviction-and-quality-by-josh-tarasoff

BONUS: Savvy Trader Public Portfolio

I started a couple portfolios on Savvy Trader in January of this year. I wanted to see what would happen if instead of my micro & small-cap strategy, I focused only on long-term compounders. So far I’m up 37% YTD (since Jan 20th), which is worse than I’ve done with my current micro & small-cap strategy, but one benefit of this portfolio is that it should require less activity.

Here is the link (you can view the actual positions with a free account, including buys & sells): https://savvytrader.com/ReadThinkWrite/lt-compounders

A couple caveats to keep in mind:

1. I don’t put as much explicit research into these companies as I do my primary Google Sheets portfolio;

2. Re-iterating the point I made above — I believe the multiples on large-cap companies are susceptible to re-rating lower; and,

3. Savvy Trader doesn’t let you invest in Over-the-Counter (OTC) or international companies. So I cannot invest in companies like Trustpilot as it trades on the London Stock Exchange.

Disclosure: As of today approximately 7% of my portfolio is in Payfare.

The investment case for Payfare Inc was short-lived as the following material news released after hours on Payfare today: https://www.newswire.ca/news-releases/payfare-and-doordash-to-not-renew-agreement-832185782.html

After Lyft and Payfare announced a “long-term extension” of their agreement 2 months ago, now DoorDash has announced they are not renewing with Payfare and their contract expires in early 2025. This is a big deal because DoorDash is Payfare’s largest customer and is responsible for a substantial portion (most?) of their revenue.

They mention that growth in other programs (Uber, Lyft, and ADP?) could mitigate the impact of the non-renewal, but even if that’s true I think it will take a long time before Payfare recoups the lost revenue and returns to growth.

Losing a big customer was the first big risk I called out in the original post, but I obviously didn't think it would happen so soon. I also mentioned in the same post that “There is also some hair, like with a lot of small caps, and I can justify the risks all I want but there is real downside here.”

This is just me “softening the blow” by noting that I called out the potential of them losing a big customer, in the end I allocated 7% of my capital to Payfare, making it one of my largest positions.

Customer concentration risk is something we consider with every investment, it won’t always bite you, but sometimes it will. Customer concentration is a risk I face with TSSI as well (currently my largest position and up 4X). I thought the upside in Payfare’s case outweighed the risk of them losing their biggest customer (positive EV) and whether my calculations were right or not, just because the risk came to fruition I can't judge my decision based on the result.

This situation also highlights the importance of portfolio diversification as since I kept the position to 7%, even if it falls in half tomorrow (or goes to 0) I would still be up over 50% year-to-date; nevertheless, it will be a setback.

I’m not sure what the price will do tomorrow or what I will do tomorrow, I lean towards selling, but it may depend on the price action. I am guessing there will be an over-swing to the downside as investors rush for the exits, but I may still want to cut my losses and reinvest elsewhere instead of waiting for them to replace DoorDash’s revenue and return to growth (not to mention the possibility of them losing another big customer). I do believe in their other programs and think the recently released Uber Canada card is doing well, but not enough to offset the losses in DoorDash and there is now a lot more uncertainty surrounding the company now.

I will post in my Substack chatroom within a day if I do end up selling. (Update Sept 30/24: I’ve decided to keep my shares; see the chatroom for full details.)

It doesn’t look like there will be a great outcome with Payfare, but we can only hope to be right 3 out of 5 times (60%). The asymmetry of investing, where you can only lose up to 100%, but can gain multiples of invested capital, allows us the chance to only hit 60% of the time and have a few winners drive portfolio returns.

Disclosure: As of September 26th, I am a shareholder of Payfare Inc at an average cost base of $6.28. I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

Here is a link to the quarterly earnings press release:  https://www.sec.gov/Archives/edgar/data/15847/000143774924029094/ex_692434.htm

Butler National released their Q1 earnings on Friday and, as expected, this was another good one. Historically Q1 has been their weakest quarter earnings wise so it was nice to see a tripling of their earnings this quarter, but don’t expect such an increase every quarter.

**Please take a second to like this post**

Here are a few highlights from the report:

1. Aerospace revenue grew 30%, this revenue can be lumpy but has grown consistently over the last 10+ years.

2. Overall revenue grew 15%, dampened by the cash-cow casino which isn't growing as fast (excl. sportsbook which still shows signs of growth to $1M rev - 42% YoY) Sportsbook revenue is still a small portion of casino revenue however I believe revenues collected from DraftKings are high-margin due to their turn-key solution.

3. Backlog grew from $28.6M to $38.2M as of July 31, 2024, which is 34% in 12 days. There must have been a big order near quarter-end.

   • In last quarters' press release they stated the backlog was at $28.6M as of July 19, 2024:

     

   • This could be a bullish signal for continued aerospace growth.

   • As aerospace makes up more and more of revenue, overall revenue growth could continue to accelerate.

4. Continued to pay down debt.

5. 312% increase in earnings to $2.2M. P/E should be down to around 6 now which seems cheap for a profitable and growing company with considerable tangible assets/book value ($18M cash, $10M inventory, $22M PP&E (net of mortgage) which includes land, buildings, equipment, and airplanes).

6. 80% of net income converted to FCF which (I think) could be a reasonable go-forward assumption.

   • Purchases and gains on sale of airplanes skew their FCF somewhat, but as far as I can tell there were none of these accretive transactions this quarter.

Disclaimer: As of September 15, 2024, I am a shareholder of Butler National Corporation. I am not an investment or financial advisor. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 60% (3 out of 5) of investments I make; this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

We believe the greatest investments of our time are companies that we call "Rule Breakers," because they break the rules of the business status quo. Rule Breakers bring a disruptive technology, diabolically clever marketing, or a totally new business model into the world, and they rattle our capitalistic foundations. In so doing, they can create serious profits for the opportunistic investors who find them early on.

— Motley Fool (David Gardner)

I have been posting about Zedcor on MicroCapClub, a private investment group, and I want to summarize my thoughts here as well.

Note: I have also started sharing some of my other MicroCapClub forum posts in the Curious Investing blog’s chat if I don’t feel it warrants an article of it’s own.

Zedcor price today (Jul 28, 2024): $1.52 CAD
My cost basis: $0.52 CAD
Market cap: $130.24M CAD

Zedcor is one of the larger investments in my portfolio at 7%. The stock has almost tripled since my original posts in December, but I still believe in the long-term investment case.

What does Zedcor do?

Zedcor Inc., formerly known as Zedcor Energy Inc, is a Canadian company that provides security and surveillance solutions. They specialize in offering mobile surveillance units and security services to various industries. Their solutions are designed to protect assets, deter crime, and ensure safety on job sites.

This is a simple business — they set up towers with motion sensors and remotely monitor them at a central location. They can speak through the towers to deter would-be thieves and call the police. You may have seen some of theirs, or competitors’, security towers in parking lots. They look like this:

Business Highlights

1. They are experiencing rapid growth — with 70 towers in operation at the end of 2021, approximately 950 towers in operation as of March 31, 2024 and 1,300 to 1,500 expected by the end of 2024. So far the towers have greater than 90% utilization rates.

2. Zedcor is active with offices across Canada and recently entered into the US, initially in Texas with plans to expand to more states. Colorado has now been announced as well.

3. They earn revenue through monitoring services. Zedcor owns the tower, sets it up on customer sites, and then charges a recurring monitoring fee (high margin).

4. They have announced projects with Home Depot (started with 10 locations and recently expanded to 23 stores / distribution centres + 13 projects under construction) and the “largest homebuilder in North America” (I’m assuming this is DR Horton per Google search).

5. They have started manufacturing their own towers in Houston, lowering their cost per tower.

6. Zedcor is working on wall or pole mounted cameras, currently in beta, and they already have an order for 100 units. These should be less capital intensive and hopefully also come with a monitoring (high-margin) contract attached.

Competitive Advantages of Towers vs Traditional On-site Security

This is a new way of doing security that I think has structural advantages over typical security (having a guard on site) – it is cheaper, scalable, and able to more efficiently / safely monitor sites. It is difficult to tell when a new way of doing things will truly disrupt and it can take a long time in capital intensive businesses, but if the cost of the remote monitoring for a customer is less than the cost of shrinkage and on-site security, then the market should continue to grow.

On-site security guards also come with liability to the employer — this is one reason security guards are asked not to intervene when someone is stealing something (so the employer isn't sued if they get hurt).

The capital intensive nature of the business gives competition more time to enter the market, but also keeps out new competition once the business is mature and has scale (Zedcor isn't close to scale yet). 

Some signs of security towers being a disruptive technology:

• Per management, they opened operations in eastern Canada 2 years ago and it already makes up 33% of their revenue;

• Zedcor has mostly maintained revenue while Transmountain (previously their largest customer) has wound down from 190 towers to 30 towers (160 towers is 17% of their 950 fleet); and,

• Their high utilization rates (greater than 90%) indicate they are putting every tower they get their hands on into the field.

Security Tower Unit Economics

Zedcor is a simple business at its core, buy or produce a security tower and rent it to someone with a monitoring service contract. But we still need to determine if each incremental tower bought/produced provides a sufficient return on investment.

Here are my rough assumptions:

1. During my initial research, in an older YouTube interview, their CFO didn’t directly state their margins, but implies the recurring revenues are highly profitable (>50%). And per their FY23 and FY24Q1 financials, they had > 60% gross margin (excluding tower depreciation).

2. In their most recent financing we can calculate their estimated cost per tower at $31K ($4,495,000 / 145)

   

3. In their latest presentation they quoted $30K revenue per tower per year ($2,500 per month), but larger companies may be able to negotiate lower rates. Let’s assume 90% utilization.

4. Tower useful life of 10 years and disposal value of $0 (guesses on my part, somewhat informed by depreciation rates).

Here are two simple calculations:

Based on these calculations Zedcor’s tower unit economics appear quite strong (40% IRR) → this implies that Zedcor will earn a 40% return less their cost of capital (cost of debt or equity) on every dollar invested.

Even in a much more conservative scenario with $20K annual revenue per tower, 80% utilization and 50% margin, the company would still be making money (15% IRR) although the returns wouldn’t be as jaw-dropping.

Competition will put downward pressure on Zedcor’s margins, but we should also see some scale benefits as they grow e.g. if they can reduce manufacturing costs or extend the useful life of a tower.

Here are management estimates of unit economics from the following Smallcap Discoveries presentation:

I'm having trouble reconciling their numbers because a 24 month payback period implies higher than 24% ROIC to me; someone let me know if I'm missing something. 

Valuation Based on Q1 and Today’s Price

The company has run up since my original purchase, but the calculations below have been updated for today’s prices.

I’ve put together a model for fun using very high level assumptions. These numbers illustrate a scenario in which the company could be undervalued today — a sanity check — but won't come close to actual results. I've included my assumptions so you can assess yourself whether they are too aggressive or conservative.

Note: Most of the estimated intrinsic value is driven by the terminal value in year 10. It is difficult to accurately forecast 1 or 2 years in the future, let alone 10, that is why we can only use models like this as a sanity check.

Risks

(1) Competition with Other Security Tower Providers (Moat): Even if we think security towers are better than on-site security there isn’t much stopping other companies from entering the sector other than capital constraints, as there is nothing proprietary about these towers. So their direct competition with other security tower providers is likely the biggest risk to this investment. However, I like that:

1. Zedcor is public, which allows more flexibility for funding;

2. The biggest competitors are primarily focused on remote monitoring & towers — they may have their focus split between different types of security offerings, including on-site security guards. These competitors would have to cannibalize their sales in one offering to make the switch — a tough proposition for a public company (innovators’ dilemma).

3. Zedcor is starting to vertically integrate by manufacturing their own towers. "On January 9, 2024, the Corporation announced that Zedcor Manufacturing (USA) completed design work on its 2024 Solar MobileyeZ model ... The Corporation is now in full production of the 2024 model and is able to currently produce 30 to 40 MobileyeZ a month at its Houston facility with the intention to ramp up production to 100 security towers a month by Q3 2024"

   • It is impressive how quickly they got manufacturing operations up and running, already producing 30 - 40 per month, but this also means a competitor could quickly ramp up production as well.

4. I don’t think that Zedcor needs to be a first mover to capture enough growth to be a good investment and, anecdotally, I think the remote monitoring sector will have tailwinds (growth) for years to come.

(2) Insiders: The largest insider Dean Swanberg (Board Member with 21.6% ownership) is selling shares — there are many reasons an insider can sell shares, sometimes neutral and sometimes bad, but never good.

The second largest insider is the CEO Todd Ziniuk with approx. 2% ownership.

One thing to look out for companies with low management ownership is agency issues i.e. when management enriches themselves over shareholders — I don’t see anything concerning in this area for Zedcor.

(3) Financing/Equity Offerings: Zedcor recently issued $15M worth of shares at $1.00 share. If Zedcor wants to grow to meet demand they will need financing through debt or equity. The market generally doesn’t like financing, but based on Zedcor’s unit economics it could be a good long-term decision for the company. However, if the terms of the financing are unfavourable i.e. with warrants attached or equity raises at unfavourable prices, this could turn into a long-term risk.

Zedcor’s current financings appear to be under reasonable terms, so hopefully they can obtain similar going forward.

(4) Dilution: Related to the above two points, there has been significant dilution over the last few years as Zedcor has transitioned from energy services to security. They have raised funds for growth and granted significant option and RSU packages.

We should hope that dilution slows down going forward (excluding equity raises specific to building additional towers when the stock price is “expensive”, and ideally with no warrants & minimal transaction fees).

As little dilution as possible, or even a reduction in share count, is always good for shareholders.

(5) Related party transactions: I don’t think there is anything here to be alarmed about, but something to keep an eye on (the $3.3M note has since been paid back):

(6) Demand dries up: Zedcor has plans to build manufacturing capacity for up to 100 towers a month by FY24Q3, which equates to 1,200 per year. As of FY24Q1 they had a fleet of 950.

Can they generate enough demand for that many towers?

• If the project with Home Depot continues to go well, Home Depot has 182 locations across Canada, 184 locations in Texas (where ZDC is operating in 2024), and ~2,300 stores in the US (side note: the scale of US vs Canada is incredible — one state has more locations than all of Canada).

• They mentioned in a press release they are working with the largest homebuilder in North America (D.R. Horton?) so if you believe home building is going to have strong tailwinds over the next decade, which I do, that is a good thing.

• Just these two companies could keep Zedcor busy, but Zedcor’s sales team will keep working on signing new customers along the way.

Summary

You won't find many microcaps in large-market industries with ironclad competitive advantages (because by the time it is obvious the company will be much larger), but you also don't need one to get a more than acceptable return.

If my thesis is right (it may not be) — that these remotely monitored security towers disrupt on-site security due to being cheaper, a better deterrent, and/or less liability — then growth & adoption could follow an s-curve with the total addressable market for on-site security shrinking while the market for remotely monitored towers increases. Zedcor only needs to capture a small portion of this growth to be a good investment.

Disclaimer: As of July 28, 2024, I am a shareholder of Zedcor Inc. at an average cost base of $0.52. I am not an investment or financial advisor. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data, findings, and calculations. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

Here is a link to the press release: https://butlernational.com/fy-2024-q4/

Current Price: $0.90 USD
My cost: $0.76 USD
Market Cap: $61.78M

For a refresher and to summarize my previous posts, here are the improvements BUKS has made over the last 3 to 4 years which I think should drive a higher earnings multiple than the company has historically traded at:

1. Purchased the land and building of the casino in 2020 (no more lease payments and have been paying down their debt at a good clip).

2. ~2021 they purchased 100% of the economics/earnings of the casino, prior to that they only collected 60% of the earnings and 40% went to a minority partner.

3. in FY23Q2, they added a (1) turn-key online sportsbook with DraftKings (BUKS earns commission on Draft Kings' KC customers), as well as (2) an in-person DraftKings branded sportsbook to their casino. Revenues appear to be growing nicely, although still too early to draw any conclusions:

   

4. Removed the CEO, his son, and a son-in-law (architect) from the payroll who were earning higher than market salaries, saving roughly $1M+ in operating costs annually. The COO, Christopher Reedy, has now taken over the CEO role without a huge pay increase. 

5. Repurchased $5M stock (on a ~$60M market cap company) - mostly from the outgoing CEO and son.

6. Completely new insider — Joseph Daly (founder/CEO of Essig Research which has been around over 30 years and provides high-tech engineering and manufacturing services. One of his areas of expertise is aviation / aerospace) — has bought ~12% of the company in the open market, sits on the board, and is now the largest shareholder.

7. Completed construction of a new hangar in 2023, and purchased KC machine (asset and skilled labour purchase - almost no goodwill), to expand capacity and address their record backlog.

8. Just completed their move to a larger HQ and sold their last HQ.

With today's results BUKS is trading around a 7 EV/E, although that includes some gains on sales of airplanes and a building. If we look at EBITDA excluding the gains they trade at a 4.4 EV/EBITDA, but this doesn't exclude maintenance CapEx. Neither metric is perfect, but the company looks cheap to me and both those multiples include a mediocre Q1 in Trailing Twelve Months (TTM) results. The company also has considerable book value of ($40M+).

Note: Q1 appears to typically be their worst quarter, but I'm hoping for YoY improvement when they report in September based on the reasons above.

Additional Notes

Since they don't break out Q4 in the earnings report here are the amounts:

Very good: (1) increase in aerospace revenue; (2) increase in operating income; and (3) decrease in G&A.

On the other hand free cash-flow (FCF) doesn't look as great this year:

My thoughts on FCF:

1. There were significant swings in current assets and liabilities which inflated cash-flow in 2023 and swung back in 2024 i.e. accrued liabilities changes were the largest and contributed to a $9.6M difference.

2. They purchase airplanes and re-sell them for a profit, I am thinking this helps them use up capacity and recently has earned them nice gains/profits. However, since these are recorded as capital assets and other income, the gains are removed from operating cash-flow, but the airplane purchases are kept in Capital expenditures (either both should be removed or included if we consider it part of their normal business).

3. They have been spending significantly on capital projects (CapEx) and there isn't an exact breakdown of the CapEx spend for 2024 that I could find, but see excerpt below for 2025 where they expect to spend $13M on CapEx:

I think the only thing we should be deducting from FCF is maintenance CapEx since growth CapEx is intended to drive revenue growth, but it is hard to differentiate between growth and maintenance for BUKS.

1. $6.0M of airplanes I would argue should be more like inventory and not CapEx, but as long as they continue to sell for a profit I think we can conclude that airplanes are growth CapEx.

2. $2.5M of STC's are the approvals they get for new modifications on airplanes which they can market/sell to customers. I think this would be growth, but to-date we haven't seen huge increases in revenue resulting from these new STC approvals. I am hoping we see more significant revenue growth in aerospace now that capacity has been added.

3. The $3.0M equipment and $1.5M on buildings and improvements is likely primarily maintenance CapEx and should be deducted from FCF. Regarding building improvements, as part of a contract with a government to run a casino you are required to invest a certain $ amount in improvements over the life of the contract.

Where do we go from here?

We'll see how the market reacts to the results today, but short-term moves often don’t mean much anyway. I expect (and hope) Butler National will continue to perform and the market will start to recognize the company as under-priced. One way to unlock further shareholder value, in the future, would be if we saw a sale of the casino so they can focus on the growing Aerospace business. Typically the market doesn’t like two unrelated businesses under the same umbrella and the casino, while being a cash-cow, isn’t growing much outside of the Sportsbook.

Disclaimer: As of July 24, 2024, I am a shareholder of Butler National Corporation at an average cost base of $0.76. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

Here are a couple notes I thought were interesting from the news release and earnings call:

1. Kits had a customer post a review on TikTok which garnered a lot of attention and co-founder Joseph Thompson mentioned, at the recent Needham conference, that this TikTok post drove significant sales. Since then, Kits has been investing in influencer marketing which I think is a great strategy -> (1) a lot of youth use social media; and (2) since glasses are recurring purchases, the younger you obtain a customer the better.

2. Glasses still make up a small portion of total revenue vs contact lenses, but if eyeglass growth continues to outpace contacts, and eventually becomes a bigger proportion of sales, this could lead to higher overall revenue growth rates. It is also possible that growth could eventually slow for glasses due to the law of large numbers which suggests it is harder to grow as the revenue base gets larger. Regardless, the below growth rates are great for both contacts and eyeglasses.

3. [Correction July 3/24: this bullet point originally said “35% YoY growth at the midpoint” instead of 25%, but I incorrectly used March instead of June for comparison; all other amounts in the post remain unchanged] Kits gave guidance for the first time this quarter and next quarter (Q2) they're expecting ~25% YoY growth at the midpoint (great - strong revenue growth) and a doubling of their EBITDA % margin quarter-over-quarter to ~4% at the midpoint (great - operating leverage). I'm typically not a fan of guidance because I feel it draws focus from how the company is doing to how the company will do next quarter/year — pulling forward sentiment (good or bad) and satisfying investors with shorter time frames (often analysts). However, one quarter guidance is better than full-year and it's not a big consideration for me generally. I am hopeful Kits will be accurate to conservative in their guidance.  

4. Co-founders Roger and Joseph provided comments on competition during the earnings call. As I have mentioned in previous posts, other companies will have trouble competing with Kits due to their cost structure - Kits provides the highest value proposition through scale economies shared, as the low cost provider.

• Roger: "This quarter, we experienced declining competition across many areas of our business, where we saw competitors withdraw from situations where their cost structure simply could not rival our lower cost direct distribution model."

• Joseph: "Outside of [Black Friday / Cyber Monday] we've seen less promotional intensity. And that's really been the case in Q1 and it has continued in Q2. For many in the industry as this category moves online at an increasing level, it's a challenge if you have a big network of brick-and-mortar overhead. And it's a challenge if you outsource design and manufacturing or have a big head office. And so for us, our heads are down. We're focused on providing category-leading value and greater selection every quarter and the highest quality with delivering in 1 to 2 days. And as we do, we find it's just -- it's more and more difficult for the legacy industry to compete with that. And that definitely has been what we've seen play out so far in 2024."

• Roger: "Our value proposition is cutting through the noise. And so that's why we see -- I think that's why we see a more efficient yield on our marketing spend. I think that others if their offering is weaker [less value offered] will have to spend more. And over time, they'll be inclined to spend less or not really compete with us. And so I think that's kind of what we've seen. We did mention a couple -- to us, it's become clear that there's a few people falling out of the sort of lead and there will probably be others that continue to fall away. Our model really is just getting started."

5. Kits highlighted the growing use of their try-on software, and subsequently released that virtual shopping in the first quarter surpassed 1 million sessions. They have recently made significant improvements to their try-on software — now you can easily filter try-on glasses only and, more importantly, quickly switch between different glasses. I think this makes the online shopping experience even better as you can virtually try on many different types of glasses more quickly and efficiently than in person.

   I’m glad Kits and FITTINGBOX (licensor) are improving this feature as this is what I had highlighted could help accelerate the transition from in-person to online eyeglass shopping in my initial post on Kits in March of last year:

   I think the “try-on” feature is one of the bigger value-add experiences as it allows customers to get an in-store experience digitally, and they can see how the glasses look on their face. I haven’t seen any digital eyeglass retailers that have a seamless, and feature rich, “try-on” user interface yet.

   It could improve the customer experience if Kits adds a sorting filter to see “try-on” glasses only, then allows you to quickly switch between, and favourite, different eyeglass frames inside the software. This experience would be more convenient than in-store shopping as I don’t know any stores where you can quickly try on 50 pairs of glasses in 15 minutes and easily keep track of your favourites.

https://ir.kits.com/news/news-details/2024/KITS-Eyecare-Reports-Record-First-Quarter-2024-Results/default.aspx

News release excerpt below:

• Revenue increased by 26% to a record $34.8 million compared to $27.7 million

• Gross margin was $11.2 million or 32.1% of revenues, compared to $9.1 million or 33.0% of revenues

• Marketing expenses as a percentage of revenue improved by 150 basis points to 13.0% compared to 14.5%

• Fulfillment expenses as a percentage of revenue improved by 60 basis points to 11.9% compared to 12.5%

• General and administrative expenses as a percentage of revenue improved 10 basis points to 6.9% compared to 7.0%

• EBITDA improved by $1.2 million to $1.2 million compared to $(0.05) million

• Adjusted EBITDA improved by 100% to $0.6 million compared to $0.3 million

• Net income was $0.1 million compared to a net loss of $1.0 million

• More than 75,000 pairs of glasses delivered in the quarter compared to 67,000 pairs of glasses

• Over 1.35 million glasses were tried on using our Virtual Try-On compared to 0.65 million glasses

Second Quarter 2024 Outlook

For the second quarter of 2024, KITS management expects revenue to be in the range of $36 million to $38 million, with Adjusted EBITDA as a percentage of revenue between 3% and 5%

Disclosure: As of May 25, 2024, I am a shareholder of Kits Eyecare Ltd at an average cost base of $3.34. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings.

Read disclaimer here: Disclaimer & Process

I have been thinking about this company a lot this week and I really like what I see, with a few significant risks to call out as well.

Similar to Trustpilot, another company I wrote an investment case for, Payfare came public at the height of the recent tech boom on March 19, 2021. After an initial rally to $12.69, the share price subsequently fell by almost half to its current price of $6.62.

Key Points:

1. Payfare (TSE: PAY) is a fintech company providing Earned Wage Access (EWA). Earned Wage Access is a no-cost to the employer solution that provides workers with on-demand access to earned but unpaid wages before payday.

2. Valuation of 13.5 EV / AEBITDA (excl. SBC add-back) as of December 31, 2023 (unaudited) with a strong balance sheet.

3. The company has inflected on profitability and has shown impressive revenue growth and scalability since the company was founded in 2016.

4. Payfare's highly scalable business model, with minimal capital expenditures and low customer acquisition costs, is supported by its software-based operations and leverage of large customers for top of funnel marketing.

5. Payfare has strong growth prospects, including potential expansion to new countries, new customers, and optionality of additional features or products.

6. 15% insider ownership, with recent insider selling observed. The company took advantage of low share prices to opportunistically buy back shares, which appears to have been a good move by management.

7. The company faces risks such as reliance on a few large customers, accounting issues, regulation, and potential disruption from technology advancements (e.g. autonomous vehicles reducing the need for delivery drivers).

8. Despite risks, Payfare's strong revenue growth, low capital intensity, low customer acquisition costs, and expanding margins make it an attractive investment opportunity. I am starting with a modest position based on the risk/reward profile.

What does Payfare do?

Payfare is a financial technology (fintech) company that specializes in providing payment solutions for gig economy workers. They offer services such as instant payouts, financial wellness tools, and prepaid cards tailored to the needs of workers in the gig economy. Payfare's platform allows gig workers to access their earnings quickly and conveniently, helping them manage their finances more effectively. They plan to diversify their offering to include full-time workers as well.

Payfare currently holds contracts with much larger companies — Uber, Lyft, DoorDash, and ADP — although their contracts are limited to specific countries for now.

Payfare generates 70% - 80% of their revenue from network interchange fees from payment networks and 20% - 30% from user banking fees such as ATM withdrawals, money transfers, and foreign exchange.

I will briefly discuss the quantitative aspects of the investment case before delving more deeply into the qualitative aspects, as I think that's where we stock-pickers gain more of an edge (see my post on conviction and quality for more on this).

Valuation

Last week Payfare released their unaudited Q4 earnings in a press release. The figures are unaudited due to an outstanding vendor report (discussed in the risk section), but they do not expect the published results to change.

Payfare Announces Unaudited Fourth Quarter and Full Year 2023 Financial Results

In the press release, Payfare guides (estimates) 2024 revenue of $235M to $245M (~29% YoY) and $30M to $35M in Adjusted EBITDA (51% YoY). Side note: Earnings growing faster than revenue is a positive sign and indicates that they are in the operating leverage stage, which I will discuss later.

Current market cap:        $317.41 million
Cash and equivalents:     ($78.2) million (no debt)
Enterprise value (EV):            $239.21 million

If we assume their intangible spending is on growth initiatives, such as onboarding integrations and adding new features such as overdraft, then EBITDA is an acceptable earnings metric to use because the company has little to no maintenance capital expenditures.

$239.21M EV / 2023 AEBITDA (excl. SBC add-back) of $17.7M = 13.5 EV / AEBITDA
$239.21M EV / 2024 AEBITDA of ~$32.5M = 7.4 EV / AEBITDA

In my opinion, the back-of-the-envelope calculation indicates to me that the current price is fair for a company with Payfare's business quality.

If you’re wondering how reliable Payfare’s forward estimates are, based on the company’s slide below, Payfare achieved its guidance in 2023 which is a good sign. They also added two significant customers post year-end (Uber Canada and ADP Canada).

Business model

Payfare is highly scalable — as a software company, they have little to no capital expenditures. So they must be bottlenecked by customer acquisition costs like a typical software company right? Wrong, their customer acquisition costs were ~2% of revenue in 2023 and ~5% in 2022, this is due to Payfare’s model of signing on large customers (Uber, Lyft, DoorDash, ADP) and using their customers' funnel to acquire users. These large customers handle the bulk of Payfare’s marketing.

The cherry on top is that all of their processing is handled by a vendor, so staff costs do not increase linearly with Gross Dollar Volume (GDV).

This scalability is evidenced in their historical metrics below and I don’t know many business models that can achieve such rapid revenue growth with such modest increases in operating expenses.

Payfare inflected on profitability in Q4 2022 and is currently undergoing operating leverage where earnings will rise faster than revenue, as incremental revenue is spread over fixed operating costs.

Another point to note is their gross margin expansion. This is partly due to volume discounts as they scale, see the following question and answer from their Q3 2023 earnings call:

Customers and Growth Prospects

A couple charts on GDV and user growth from Payfare:

Although still experiencing strong revenue growth (~30% expected in 2024), growth has started to slow in recent quarters, primarily due to the law of large numbers — it becomes increasingly challenging to double revenues as the revenue base grows. However, I still see opportunities for Payfare to grow: (1) they currently have access to limited countries for each customer, providing opportunities for future expansion and growth to new countries; (2) they recently signed on two new customers at the beginning of 2024, with more hopefully in the pipeline; and (3) Payfare has optionality; they have 1.4 million (33% YoY) active users, as of Q4 2024, to whom they can sell new products and features.

Another aspect I like to see is small-cap companies with relatively large customers. This is one thing I liked about Civitanavi who signed an agreement with Honeywell (and was ultimately acquired by Honeywell).

Some of their large customers include:

• Uber ($143.73B market cap); Payfare already works with them, but signed an additional contract in Q1 2024 to serve Canada.

• ADP ($99.85B market cap); Payfare signed a contract with them to serve Canada in Q1 2024, with revenues and profits expected in 2025.

• DoorDash ($53.37B market cap)

• Lyft ($6.54B market cap)

ADP is an especially interesting customer to me because it diversifies Payfare beyond the gig worker economy and expands their total addressable market (TAM) to full-time workers. Imagine any worker getting access to money daily instead of every two weeks. ADP processes payroll for more than 1M clients worldwide, ranging from small businesses to global enterprise, however Payfare will only have access to Canada to start.

In general, I think it is a good strategy for Payfare to go through these large providers, such as ADP, instead of trying to market to individual businesses - imagine the customer acquisition costs if they went that route.

Now let’s talk about some of the risks.

Discussion on Risks (speculative)

I’ve included some of the bigger risks I can think of below:

1. The company has a few large customers, if any of them didn’t renew their contract it could dramatically impact revenues. Some mitigating factors:

   • Switching costs, it takes time to create a white-label solution and integrate the software with customers. Payfare starts with a smaller cohort of customers to test and then rolls it out to the rest of the user base. Once a customer becomes familiar with the app, there could be change management required to switch to a new offering.

   • The longer Payfare remains the chosen provider, the more their product improves through updates. Payfare gets the advantage of ironing out the quirks of what is essentially a new, currently non-commoditized, SaaS offering.

   • They don’t seem to be gouging customers - the fees and cash-back offerings look on par with good consumer credit cards and they don’t charge fees for some of their add-on services i.e. their back-up balance feature (up to $50 with no cost / interest).

   • Payfare white labels their offering (e.g. Uber or DoorDash branded card & app), perhaps this provides less incentive for a company to bring development in-house.

2. Accounting issues and reporting delays:

   • Looking through their historical financial statements I’ve seen a few restatements, however the ones I’ve seen don’t seem to affect the income statement materially. It isn’t ideal that their reports are delayed, but they have only been public for 3 years and accounting for a fintech company growing this fast could be tricky. I’m hoping there are less of these issues going forward.

3. Disruption / competition - any company that is as scalable as Payfare (from $1M in revenue to $186M in 7 years) is also disruptable; since they don’t need to reinvest a lot to grow, neither does the competition.

4. Payfare is currently heavily reliant on delivery drivers and if autonomous driving eventually works out maybe there would be less delivery drivers (maybe Payfare will be diversified by that time if this is far in the future?).

5. Regulation - I found this bill that could affect what fees Payfare can charge and there could be additional restrictive regulation passed relating to Earned Wage Access in the future.

6. Regarding insider selling, I reviewed the market buys and sells since the IPO in 2021. Due to never knowing for sure why anyone is selling, this section is highly speculative:

   • Kingsferry Capital Management Group Limited is the largest shareholder and appears to have been an early investor in Payfare. The group was heavily buying after the IPO, in 2021 and 2022, possibly expecting a significant increase in the share price as the company grew revenues by over 200% in both 2021 and 2022. Unfortunately in 2022 unprofitable tech names and microcaps took a large hit and not many companies were spared. In 2023, Kingsferry started heavily selling shares and now owns around the same amount as at IPO. There is always the possibility of increases in interest rates putting pressure on any borrowed shares. We will have to wait and see if they continue selling.

   • Co-founders, Marco Margiotta and Ryan Deslippe both also bought shares in 2021 after the IPO, and throughout 2023 have been participating in planned selling. Maybe they need the money or maybe they think the shares are going to fall – we can only guess.

     • Marco has slightly more shares than he did in the prospectus due to his sales being offset by market buys, options, and RSUs.

     • Founder, Ryan Deslippe, has about 20% less shares than in the prospectus.

     

     Note: Kingsferry was a significant seller when the stock dropped 40% in Sept 2023.

• Insider/founder ownership is 15% overall (24% including Kingsferry) which is good, and most insiders have not sold significant shares, including Keith McKenzie, the co-founder with the largest shareholding. The company also took advantage of low share prices to opportunistically buy back shares, which appears to have been a good move by management.

Summary

Payfare Inc is profitable with expanding margins, strong revenue growth, low capital intensity, and low customer acquisition costs — all at what I think is a fair price — there is a lot to like here. There is also some hair, like with a lot of small caps, and I can justify the risks all I want but there is real downside here. My current strategy involves a max initial allocation of 10% to any position (if it grows beyond 10% that’s fine) and Payfare currently sits at ~7% of my portfolio.

2024 Q1 earnings will be released next week, around May 8th. Although the new products with ADP Canada and Uber Canada were signed in Q1 2024, we shouldn’t expect to see significant revenues or profits until later in 2024 or 2025.

Disclosure: As of Apr 28, 2024, I am a shareholder of Payfare Inc at an average cost base of $6.24. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

Rather than dissecting the entire article, I will summarize some ideas and thoughts the article brought up for me.

Implicit and Explicit Information/Conviction

The core of Josh’s article revolves around two types of information that we base our conviction on: implicit and explicit.

So explicit information includes tangible, measurable factors, such as:

1. Analysing a company’s financial statements, valuation, and growth; and,

2. Information that may disqualify a company right when you see it → red flags like poor capital allocation, low insider ownership, high debt, over-reliance on a single customer or vendor, and legal issues.

I believe explicit analysis is table stakes at this point and every investor must do this well to succeed.

Implicit information, on the other hand, relies on gut feelings and intuition, covering areas like:

1. Management and governance;

2. Culture;

3. Business Model; and,

4. Industry and Market, including competition and total addressable market (TAM)

Implicit analysis is harder to teach & convey and, as a result, I think this is where good investors can develop a sustainable edge.

The lists above are not exhaustive, but these are some of the main factors many investors, myself included, consider before investing in any business.

My Takeaways and Learnings

With these concepts in mind, here are my primary takeaways from Josh’s article, particularly related to the “Quality” section:

1. Many companies pass my explicit filter (solid fundamentals and minimal red flags) and many companies pass my implicit filter (intuition of quality), but few will pass through both filters. This is because cheap companies tend to have worse quality and high quality businesses tend to be expensive.

2. I have companies in my portfolio that pass my explicit filter only (cheap), but the vast majority have both aspects. It is harder to know when the market will agree with you for a company that is just cheap -- especially if you're a smaller investor with limited avenues for promotion. However, quality companies grow revenue and earnings, which the market is more likely to eventually recognize.

3. One of my favourite parts of the article was this:

   “Well-honed intuition does what analysis cannot by perceiving Quality directly, as opposed to through an intellectual process. What I suspect is happening in the direct perception of Quality is subconscious pattern recognition, based upon a dynamic, holistic experience of the thing in question.”

   • Implicit conviction and intuition are much harder to teach and communicate to others, as Josh mentions. It explains why two investors might evaluate the same company but arrive at completely different conclusions.

4. If investment decisions were split evenly between explicit and implicit factors, the time spent on each wouldn’t be equal. I think explicit analysis/filtering (fundamental analysis and looking for red flags) takes much more time than implicit analysis/filtering (intuition of quality).

   This leads to another thought related to cloning: In investment terms, "cloning" refers to the strategy of reviewing portfolios of successful investors or investment managers for ideas. Cloning is helpful because you can find managers whom (1) you trust are good analysts and (2) have some confidence that they put investments rigorously through their explicit filter.

   Through cloning good investors we know that it is likely an investment will pass through our own explicit filter so we can focus more time on implicit analysis (intuition of quality).

   Since explicit filtering takes longer than implicit, cloning is especially advantageous for a part-time investor because it saves time. However, even for a full-time investor the time savings increases the number of investable opportunities you are looking at and, since investing is really a game of opportunity cost, the more viable opportunities to compare against the better.

   It is important to note that before making any investment it is still required to do a fulsome fundamental analysis yourself, cloning just lets you know which companies are likely to pass.

5. When Josh talks about implicit (intuition on quality) information he really focuses on the microeconomic aspects of companies. Look at the selection of indicators in his list and the chart at the bottom of this article, all but perhaps #2 are about what the company is doing internally and its culture.

   • I think implicit information also applies to macroeconomic aspects and the business model, as I listed above, both especially relevant for investments with longer time frames: 

     • Consider these implicit questions we ask ourselves: What will this company look like in 10 years; Do I foresee a bigger total addressable market than other investors do (macro)?; Are there tailwinds (macro)?; Are there positively reinforcing attributes e.g. flywheels or network effects (business model)?; Is the product or service something customers will want more of in the future, or less of (for a dying industry), e.g. will people watch less cable TV in the future (business model)?

     • These are all intuitions we implicitly make when assessing where, and how big, the company will be in the future.

Excerpts from Josh’s post:

See the link below for a story about when I gave stock picks to my father-in-law:

Here is the link to the fund where this information and more can be retrieved: Pabrai Wagons Fund

Here are the holdings from his recently released semi-annual report: 

There’s very little additional discussion on Tiny in the report, and it’s a short read, so I’ve included the letter below:

For Tiny, I think as fundamentals start to line up with the story the market could change its view.

My current plan is to take a David Gardner approach with these types of companies (great story & destination, without an obvious margin of safety) -- start with a small allocation and see what happens; if they perform add up and if they don't, do nothing.

Note: I also cloned a couple of Mohnish’s metallurgical coal investments as they are aggressively buying back shares at a low earnings multiples (uber cannibals). Mohnish originally cloned the CEIX idea from David Einhorn.

All of my posts on Tiny can be found here: https://curiousinvesting.substack.com/t/tiny-capital-ltd

Disclaimer: As of March 24, 2024, I am a shareholder of Tiny Ltd. at an average cost base of $2.61, but it is currently a very small allocation (1.1%). My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

These are some very interesting acquisitions, but what I'm realizing is that some of the most exciting ones to me (unique & with the highest upside) are purchased through the Tiny Fund I i.e. Letterboxd and the Huberman Yerba Mate beverages. So based on the information below, it looks like Tiny shareholders only own a 20% stake plus a 15% (50% of 30%) performance fee over an 8% hurdle.

In a more recent presentation we see the term of the fund is 10 years with an option to extend 1 year. (tiny-shareholder-presentation-february-2024.pdf (q4cdn.com))

They left it more ambiguous to the reader by removing the % investment in the LP which was 20% in the above image, but I’m assuming they still own that stake.

Why did they raise a fund in this way with this structure? A couple theories: they have only been a public company for a short time and perhaps (1) when they started the GP fund they didn't originally plan to go public so soon; or (2) they had good opportunities and wanted to raise cash without diluting.

The fund does contribute to investor confusion, and holding companies typically trade at a discount to their parts, so adding confusion only hurts the investment case.

Financials

The presentation also included financials, which I rearranged for the last 4 years so it is easier to compare:

In the recent trailing-twelve-months ended Sept 30, 2023 revenue appears to be stalling and after excluding the $42M one-time gain adjustment, they incurred a significant loss. Overall, the revenue and earnings appear to be lumpy/unpredictable since going public, a couple speculative theories for this could be:

1. The agency operation makes up a large portion of their business and these revenues are project based - not guaranteed or recurring. This can lead to lumpiness in earnings / revenue.

2. They moved (acquired or sold) companies in / out of the Tiny umbrella throughout the years and before going public. I know Andrew owns some businesses privately as he speaks about them on podcasts.

Summary

I will be keeping my tiny (1.1%) investment in Tiny and wait for more post-public financial results before investing further. Going back to what I said before, if they really are the Berkshire Hathaway of the internet, this will be a long journey and you will have many opportunities to purchase along the way with extraordinary results.

The two drivers of the thesis for me are the types of businesses they are focusing on and management:

1. I think Andrew and Chris are great capital allocators, proven by their track record, and I have seen a few of Andrew's interviews and I believe he is a rational thinker;

2. As Andrew says, this is a management team "I would trust with my kids";

3. They are highly aligned to creating shareholder value as they own a substantial portion of the shares; and,

4. Just as important, they have a long runway as they are relatively young.

A good track-record, ethical (as far as I can tell), aligned, and with a long runway - these are the kind of leaders I want to invest in.  I think there is a lot of potential here.

See the following link for my next post on Tiny: https://curiousinvesting.substack.com/p/tiny-and-the-pabrai-wagons-fund

All of my posts on Tiny can be found here: https://curiousinvesting.substack.com/t/tiny-capital-ltd

Disclaimer: As of March 24, 2024, I am a shareholder of Tiny Ltd. at an average cost base of $2.61, but it is currently a very small allocation (1.1%). My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

A few items of note:

1. Revenue decreased slightly in Q3 YoY, driven by Aerospace which tends to have lumpy revenue. Aerospace has grown consistently over the last 10 years and I expect it to keep growing when measured over longer time-frames, supported by their backlog totals:

   • Aerospace backlog has grown to $30.4M as of January 31, 2024 ($26.4M – April 30, 2023 & $22.1M – April 30, 2022).

2. Net income increased 20%.

3. Sports wagering earned $1.5M in Q3 – this is the highest quarter since launch which is a great sign. The KC Chiefs had a playoff run and won the Super Bowl so this likely led to higher betting volumes; however, since the Chiefs won the Super Bowl and beat the spread in every game, the sportsbook may not have fared as well on each bet if the locals were betting on KC.

   • Note the Superbowl occurred after quarter-end.

4. EV (price) should continue to go down approx. $4M every year as they continue to pay down their debt.

5. Free cash-flow (FCF) doesn’t look great YTD due to high capital expenditures (CapEx), and this quarter they noted they plan to spend $6.5M on airplanes, excerpt below. I haven't seen this mentioned before (usually CapEx consists primarily of STCs & equipment) and it could indicate they plan to buy airplanes and perform modifications with the eventual goal of re-selling for a gain (as evidenced in Q2 with a $3.9M gain on sale of airplanes). Historically they haven't had issues converting positive earnings into positive FCF although they will always have some level of maintenance CapEx.

Additional thoughts:

The company has beat prior year earnings handily over the last two quarters driven by the gain on sale of airplanes and the recent restructure of management with related cost savings. They have two “easy” comps coming up in the next two quarters: -$575K in Q4 (included significant one-time adjustments for re-org) and $719K in Q1. As a result, over the next couple of quarters, the company could look very cheap on a fundamental basis if the price stays around here. I have no guess on when or if the market will agree BUKS is undervalued, but I continue to hold that belief.

BUTLER NATIONAL CORPORATION ANNOUNCES THIRD QUARTER FISCAL YEAR 2024 FINANCIAL RESULTS (prnewswire.com)

Disclaimer: As of March 24, 2024, I am a shareholder of Butler National Corporation at an average cost base of $0.74. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings. Please also read my disclaimer and process here: Curious Investing Disclaimer and Process

In the quarter there was a year-over-year (YoY) slow-down in revenue growth to approximately 20% vs the 30%+ they had been achieving in the last few quarters; this could be why they didn’t release preliminary results like in prior quarters.

We continue to see operating leverage as fulfilment and G&A costs become lower proportions of revenue (Good).

Here is the segmented information for the year showing nice growth across all segments:

Working capital

Another interesting thing I noticed is Kits’ working capital management – their cash balance of $16M is completely offset by their accounts payable and accrued liabilities of $16M (with a similar offset in the prior year).

So even though it looks like they have a lot of cash on hand, really their significant cash balance is set aside for payments to vendors. By delaying payments to vendors it allows them to be more nimble with their cash planning.

On the other side of the equation, Kits’ receivables are collected instantly since customers pay directly for their glasses, with credit cards or PayPal, before they are ever made.

Collecting from customers right away and putting off payments to vendors leads to favourable working capital and cash flow.

Technically they could reinvest the $16M in something like additional marketing, and it might even be good ROI, but I agree with their finance team - it’s better to be resilient by keeping the cash on hand.

News release: KITS Eyecare Reports Fourth Quarter and Full Year 2023 Results (newswire.ca) 

Disclaimer: As of March 24, 2024, I am a shareholder of Kits Eyecare Ltd at an average cost base of $3.34. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings.

Current price: $5.82
Current market cap: $182.8M

I haven’t posted an update on Kits Eyecare in awhile because nothing unexpected has happened, they continue to execute - significantly growing revenues (>29% YoY last 4 quarters) and reducing their costs as a percentage of revenues.

Since my last post I visited the Kits Warehouse in person and the operations manager Craig showed me around and answered my questions for about an hour and a half. I also had a short chat with Joseph Thompson. Everyone I met was very friendly and knowledgeable. On the business side: I got to see their state of the art equipment in action; their operations looked lean with the warehouse organized for efficiency; and everyone appeared to be happy and engaged in their work - what a positive experience.

In the rest of the article I will go into some noteworthy items I’ve observed from Kits over the last few months.

Kits’ Competitive Advantage

The competitive advantage Kits is trying to build is being the low-cost provider with exceptional customer experiences (fast shipping, large variety, and great customer service) driving high Net Promoter Scores. This is similar to Amazon’s online retail strategy, which is no surprise because Kits' Founder/COO Joseph Thompson spent part of his career there.

Why do I think this is their strategy? Because they've mentioned it and since Black Friday they have been selling all Kits branded glasses, including a prescription lens, for $28 all-in (no lens upgrades) – I haven’t seen a value proposition like this ever in eyeglasses and I started buying glasses online over 10 years ago. Before online shopping I remember paying almost $400 in-store for one pair of glasses (lol).

I think it's plausible Kits could sustain these prices because:

1. They are already break-even / profitable with their largest segment by far to-date being lower margin contact lenses;

2. Their warehouse has capacity to approximately double their current production; and,

3. They up-sell various high-margin options (i.e. lens upgrades) throughout the customization process.

Don’t let the low price point put you off, I have ordered several pairs of glasses from Kits at different times and they have all been good quality. I know what you’re thinking, ‘this is his biggest holding - he’s biased’ and to that I would say: go buy a few pairs and see for yourself.

I’m curious to see going forward (1) if they keep up this significant discounting and (2) what happens to their margins and revenue growth as a result. As of today, Clearly and EyeBuyDirect do not appear to be competing at these prices.

Some eyeglass companies like to grow their revenue by opening up brick-and-mortar locations, especially public companies after their revenue starts to plateau. However, any company with a significant retail presence will not be able to compete at these price-points due to their higher overhead costs, which gives Kits a sustainable competitive advantage over them.

Recent Hire

Two of Kits’ main competitors in Canada are EyeBuyDirect and Clearly, whom are both owned by the $83B giant EssilorLuxottica.

Interestingly, Kits’ new hire, Jean Francois Jupille – Director of User Experience, was most recently head of marketing for Clearly.ca (for 3 years). And previous to Clearly.ca, Jean Francois led creative, design, and UX/UI for EyeBuyDirect.com (for 4 years), based in China. 

Sounds like valuable experience to me.

Side note: I would friendly-bet that he has a longer tenure at Kits due to their culture and mission.

Link: KITS - KITS Eyecare Welcomes Jean Francois Jupille as Director of User Experience

Team

I want to reiterate my favourite part of this investment idea isn't the "elegant and superior business model of being an online retailer selling prescription glasses." Although I do think the industry has some nice tailwinds and a large total addressable market, I wouldn't invest in Clearly, Warby Parker, or EyeBuyDirect even if they were all stand-alone public companies. My favourite part of the idea is the highly-aligned and qualified team - for example, Roger Hardy, one of the largest shareholders, sold Clearly (dba Coastal Contacts) in 2014 for ~$435M unadjusted for inflation (which is over a double from today’s prices) and I think the team at Kits can at least do that again. Roger Hardy was on a non-compete for 3 years after the sale and in the meantime he invested in, and sat on the board of, Prive Revaux (designer glasses company) before the company was subsequently sold to Safilo Group in 2020 – Roger knows the optical industry.

Benefit provider partnerships

I think it's interesting to see their partnerships with benefits providers in Canada as well. Here is an image I see on the homepage when I log into my benefits provider:

I don't see any other eyeglass companies there and, while I'm not sure if they have exclusive deals, I think benefits providers prefer to work with a home-grown Canadian-based company.

Needham Growth Conference (Jan 16th)

Link: https://wsw.com/webcast/needham134/kits.to/2746040

Joseph recently presented at the Needham Growth Conference and I’ve noted a few items I thought were interesting below.

My favourite part of the Q&A was in reference to online optical category tailwinds and their total addressable market (TAM). Joseph mentioned (I’m paraphrasing): Online categories are typically very slow to progress initially i.e. it takes time for online stores to take market share from brick-and-mortar stores, but online market share will accelerate once it hits a tipping point. For the optical category, it took a long time for online market share to get to where it is today, approximately 20 - 30% of optical sales, but he expects online market share to grow comparatively more quickly to 40%, then 50%, and beyond.

Every year the entire optical category (~$80B TAM) grows 3 to 5% and online sales grow a multiple of that, making it a very exciting category. I expect (and hope) Kits will continue to capture an expanding share of this growth.

One of the initiatives Kits is investing in is their try-on technology, which I think is a great move. I mentioned when I visited the warehouse that it would be great if the online experience could more closely match the in-store experience and for that to happen the try-on technology is lever to pull on. Additional features I think would help are:

1. Add a filter you can select to only show glasses with “try-on” functionality;

2. Seamlessly stay in the try-on software virtual window while browsing glasses;

3. Easily switch between glasses (i.e. hit an arrow and the next pair comes on) in the try-on software;

4. Seamlessly save pictures of yourself in different glasses which allows you to (1) compare old pictures to the current glasses you have on and (2) make it easier to share multiple pictures and get opinions from friends and family.

Online shopping for glasses already beats in-person in convenience, price, and selection. Improvements to the try-on software could improve the user experience enough that there is no reason to go in-store to shop; especially once online tools for determining vision prescriptions and pupillary distances reliably reduces the need for in-person optometrists.

Joseph also mentioned they are working on ways to recommend glasses that a user may be interested based on details like the shape of their face - one problem with so much choice/variety is that it’s hard to narrow down options in a short amount of time. In my post on Trustpilot I mentioned in the online age with consumers having an abundance of options, filters are increasingly important and they will continue to gain importance over time.

Finally, a book recommendation: ‘Same as Ever’ by Morgan Housel

Along the same vein as the quote from Jeff Bezos above, ‘Same as Ever’ presents an exploration of the recurring patterns in human behaviour and how they influence our lives. This is an easy ready similar to ‘The Psychology of Money’ which I also recommend and was written by Morgan Housel as well.

Disclaimer: As of February 6, 2024, I am a shareholder of Kits Eyecare Ltd at an average cost base of $3.25. My plan at the time of writing is to hold these shares long-term, but I may have sold my position by the time you’re reading this. This is not a purchase recommendation and I can only hope that I’m right on 3 out of 5 (60%) investments I make — this could be one I’m wrong on. Please do your own research and double-check my data & findings.

I am newish to investing and up to May of 2021 I was solely invested in index funds. In May 2021 I started stock-picking with “confidence,” focusing on the hot tech stocks. I quickly realized how little I knew and from May 2021 to December 2022 I had a lost money overall. I started this live mock portfolio project in December 2022, which closely approximates my real holdings, so I can track how I am doing in more detail. I have only shared this with a few friends up to this point, but I want to try sharing the link so anyone can follow along as I go through the ups and downs of learning how to consistently beat the market.

Here is a link to the (now MOCK) portfolio:
https://docs.google.com/spreadsheets/d/1CYey3rCG6-YsKtWJlGQQp_Ltlbatkr8q5WRwHRhpZAU/edit?usp=sharing

Here is a preview:

A few notes:

1. I am sharing this as an experiment for fun and I provide no guarantees on how long I will keep the link/portfolio active.

2. I use the S&P 500 as a benchmark because it is one of the most popular indexes for dollar cost averaging passively. Dollar cost averaging into an index is a great option for anyone who wants exposure to equities, but doesn’t want to spend time researching individual companies.

3. I have only met two management teams and I don’t reach out to management teams often. As mitigating factors, for almost all of the companies I have either watched recorded management interviews and/or cloned the original idea from investors I follow, after performing my own research and due diligence.

4. Not all investments are researched with the same vigor - I have spent dozens of hours researching some companies and others less than 10 hours.

5. I will post my buys and sells after the fact on the ‘Activity’ tab, often within a day or two, but no guarantees on timeliness as it depends on how busy I am.

6. Even if I invest in a company with the expectation of holding long-term, I could sell out at any time for any reason i.e. a change in my perception of the company, reallocating funds to a perceived better investment opportunity, cash requirements, or otherwise.

7. I am open to changing my mind as I learn more, but I will try to include the rationale for each move.

8. Even though I performed well in 2023 (+25% for the year), the general market did well too. This could have been luck driven and these results could be much worse going forward, although I do believe that small caps have been underperforming large caps as a whole which should help a portfolio like mine as market valuations between large-cap and small-cap companies converge. I couldn't confirm it was Warren Buffet that said this, but I think it's a good quote regardless:

   1. 

9. Macroeconomics don’t play a large part in my decision making and my hope is that the companies I have chosen outperform even if there is a general market downturn i.e. don’t go down as much as the rest.

10. I diversify for (1) risk mitigation; and more importantly (2) because I don’t know when market prices will converge with my assessed intrinsic value of each portfolio company, if ever.

11. If the portfolio does poorly that’s ok, I can re-brand with new picks in a few years and try again. :)

Instructions for the spreadsheet:

1. HOLDINGS tab displays the overall portfolio return metrics (est. CAGR & YTD), my summary thoughts, and the individual gain/loss % of each company.

2. HISTORICAL RESULTS tab tracks the historical performance vs the S&P 500 since detailed tracking started December 25, 2022.

3. ACTIVITY tab indicates all buys and sells starting in December 2023. The activity/history can be followed going forward.

4. PROCESS tab contains rough notes on my current strategy.

Feel free to follow along for fun and please ask questions if anything is unclear or provide suggestions if you have any. We’ll see how I do over the next few years.

Best wishes,
The Curious Investor

Disclaimer: This investment blog and mock portfolio share personal experiences of an amateur investor for educational and illustrative purposes only; the author is not a licensed investment professional. The content provides transparent insights into investing thoughts and performance, acknowledging the possibility of mistakes. Results are not guaranteed and readers are cautioned against blindly following recommendations. Before making financial decisions, readers are advised to consult with a qualified professional and tailor investments to their individual circumstances. The content should not be construed as financial advice or a solicitation to buy or sell securities. Investing carries risks, including the potential loss of principal. Past performance is not indicative of future results and the author is not responsible for any reader's investment actions.

The model is subject to ongoing development and may contain errors and/or invalid assumptions. Be aware that it is generally not practicable to test a computer spreadsheet to the extent whereby it can be assured that all errors have been detected.