Finding Intrinsic Value, With Randall Watsek

Most financial advisors are happy to outsource stock selection, or to use portfolios consisting entirely of ETFs or mutual funds.

Randy Watsek joins Michael to discuss his process for researching individual securities for client portfolios, as well as best practices for business owner clients.

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Episode Highlights

  • Lessons learned from managing money for more than 25 years, including multiple bear markets.
  • Building a diversified portfolio that includes individual stocks through personal investment research.
  • Differences between the CFA and CFP designations.
  • The two basic questions that Randy seeks to answer through his research.
  • Best practices for business owners to maximize value of their assets.
  • Perspectives on the current stock market, including lingering geopolitical risk.
  • Guest, where can our audience of High Net Worth investors to go to learn more about COMPANY?

Today’s Guest: Randall Watsek, The Birch Lane Group

About The Uncommon Advisor Podcast

The Uncommon Advisor podcast features insights from advisors who are embracing a modern and holistic approach to wealth management. Learn how the most creative minds in the industry are innovating their practices to deliver superior client results, generate new business, and maximize retention.


Michael: Welcome to the show. I’m Michael Johnston. Joining me today is Randy Watson. Randy is a financial advisor with the Birch Lane Group of Raymond James. Randy, thanks for coming on here.

Randy: Oh, thank you for having me, Michael.

Michael: So I love talking on the show about what makes financial advisors a little bit unique, what they do that’s a little bit different than than maybe other folks in the industry. I’d like to start Randy talking about you’ve you’ve been managing money for for a little while. You got maybe maybe a couple of gray hairs there. You started in the late 1990s. So you’ve been through that, that boom and that bust, and then the subsequent boom and or bust in 2008. What have you learned from going through a couple of full market cycles? And particularly, I’m guessing the more valuable lessons are learned on the way down during those those busts?

Randy: Yeah, I think the interesting thing is when I first started managing money, it was in the 1990s and that’s really when boom came to be. And I had coworkers who were just buying stocks off of whatever tips they saw for CNBC. And they made a lot of money with without doing any research. Basically just whatever was hot. They bought it, it went up. And I even had a coworker who bought a Mercedes with with that. But things like that that happen, like, you do have occasional bubbles, and we’ve had bubbles since then in various things, but ultimately they’re not sustainable. And and Boom. Eventually went to a bust and 90% of the companies went went bankrupt to zero. And you even had the case of a billionaire who had built his fortune off of backing dot com startups and everything. He actually lost the entire billion dollars and ended up in debt because he had borrowed some money off of off of it. And then when the asset prices went down 90%, he was underwater. And so that’s the really the that lesson really stood out to me is it’s one thing to make money on a temporary basis while you’re riding a boom. It’s another thing to preserve and grow it. To do that, you really need to understand what’s the underlying value of things, not just whatever people will pay more for at the current time, but what’s really the intrinsic source of value for these investments.

Randy: And I had already been of that mindset I had. I started in credit. And as you know, in credit, it’s all about can they pay? Can they pay you back? And so you’re looking very heavily at cash flow and things like that. And I sort of applied that as I went into money management with equities as well. And then after the recovery from bust, you had a few good years. And then there was the great financial crisis in 2008, 2009. And you saw a lot of securities being sold by Wall Street related to mortgage backed securities and having derivatives of derivatives and things like that, that just playing shell games so that they could get an investment grade credit rating. But in reality, there was nothing backing it. And the investors and those sorts of things suffered huge losses after the financial crisis and those sort of sorts of lessons sort of reinforced to me that it’s always important to do your own research. You don’t just like, trust whatever, like a ratings reports or whatever that, that people are publishing.

Randy: You always have to look at the investment yourself and determine for yourself is there a real business there? Is there an underlying source of value that’s going to grow over time? And so that’s that’s really informed my decision. I and as you mentioned, some of the things that make me unique as an advisor, I don’t just use whatever the firm’s cookie cutter approach is, where they typically at any wealth management firm, I, they have sort of a standard menu of options. If the client is conservative, you click conservative and they give you the conservative funds. If the clients aggressive you that you click the aggressive one, they give you the aggressive funds. I just don’t think that serves people very well. I think it’s more important to look at the investments yourself, determine what whether there’s value there, and determine whether the risk and growth opportunities are appropriate for the client. And so I do pick individual securities, I pick individual stocks treasury bills, CDs, things like that, rather than just using a variety of fund options. And I think that serves investors very well both from knowing that the value and risk is appropriate from the investor. And also there’s tax advantages to doing it that way and greater customization.

Michael: Yeah, absolutely. So that’s that’s great. There’s there’s a lot to dive in there. To dive into there I want to I want to start with, I think what you said about, you know, kind of making sure that there’s that intrinsic value there you know, it makes a lot of sense in kind of this but, but it’s easy to get kind of caught up, like, it must be hard to see, you know, folks essentially throwing darts at a dart board and and hitting new Mercedes. Right. When, when everything’s going up. Or conversely, you know, in the 2008, 2009 time frame to say, be thinking like this doesn’t make sense. You know, something’s got to give here eventually, but it doesn’t always happen, like, right away. Right? Sometimes these bubbles last a lot longer than than we think they’re going to. And that’s got to be challenging in your, you know, in your position when you’re saying, you know this doesn’t make sense. There’s not intrinsic value here. But you sometimes have to have to ride it out. Am I thinking about that the right way that, you know, it’s kind of easier said than done sometimes.

Randy: And that that’s the real challenge. And I think it’s important to have the right kind of clients with the right kind of mindset, too, because there will be people saying, oh, I, I’ve talked to so and so neighbor. They made 100% on some random crypto investment or something. And I just can’t recommend that because I can’t figure out any intrinsic source of value for for crypto. Crypto’s done very well. I can’t argue with the with the performance of it, but there’s no actual underlying value that I can see to it. So you do miss out on things like that. And, and I, I remember I was talking with a 20 something year old a person who does invest in crypto. And he was telling me, oh, all you financial advisors are screwed because you can’t invest in crypto. And that’s that’s what I that’s where all the money is going to be made. It you just you, you know, it’s a different mindset. You can’t really argue with people like that. I haven’t found that I could ever persuade someone of that mindset who’s just sort of attracted to the latest flashy object. But there is a market, too, for people who want to see that there’s underlying value for for their investments that will hold up.

Randy: Regardless of the market conditions, and that are not just dependent on the bubble, like expanding and expanding, because at some point, and you’re right, it might might take years, but at some point it they do tend to pop. And when something is down 90% or it could wipe out years of gains like you could, you could go up 50%, one year, 50%, another year, 100% after that. And then all of a sudden you’re down 90% and you’ve just wiped out all those years of gains. And that’s why you typically find during these, these bubbles. So if you’re. I mean, it’s one thing if you’re a you’re a traitor type of person, if you’re like, well, look, I don’t care what the intrinsic source of value is, I’m just going to bet on the direction and then I’ll try to get out before everybody else. I get screwed with that. That’s one mindset. But if you’re looking to build built wealth over a lifetime the more important thing is to think, what will this wealth compound over time, regardless of the, the market conditions? So that’s that’s the sort of mindset that I’m looking for.

Michael: Yeah, I think I’ve, I’ve heard it, you know, I’ve heard the I think it’s called the Castle in the Sky theory or the greater fool theory. Sometimes like sometimes that works, right? If there’s a bubble, but someone comes in after you and visit a buy an even higher, sometimes, you know for a while that ends up that that ends up working. But.

Randy: I will note that that coworker who I mentioned who bought a Mercedes did end up crashing at a couple weeks later, literally crashed it.

Michael: Literally crashing.

Randy: That’s probably a reason to go sometimes.

Michael: Yeah, that’s that’s probably a a pretty good analogy there. Very, very apt. So, so Randy, let’s let’s talk a little bit about you mentioned you do quite a bit of personal research into more than just funds and individual positions. What’s your what’s your research process. And maybe give folks a your, kind of your, your background. I believe you’ve got a CFA and a CFP and an MBA from, from the University of Chicago. So you’ve got you’ve put in your dues to kind of learn to, to analytically value individual securities. But what’s your what’s your process like?

Randy: Yeah, I, I, I’ll say that’s probably what makes me different from probably 99% of other advisors. And it, it really does relate, relate to my background. When I was at University of Chicago, I, I took a lot of classes on, on quantitative analysis, and that led to me doing a lot of quantitative work in my subsequent career beginning in 2002 in addition to fundamental analysis. So my process has always been a combination of quantitative analysis on the front end and fundamental research, reading the annual reports and conference calls and etc. on the back end. So basically my process is I’ve developed models over time that ranks the the value of stocks across the universe. And I focus on basically the top 25% of stocks, according to to my model, in each of the different industries, I try to be well diversified, to have only one stock per industry and 2,025% of stocks per sector. And So I start off there and all the model really does is tell me what’s more likely to work than not. I based off of historical evidence, but that’s that’s just the starting point. After that, then I read the annual report, the 10-K. I read the quarterly reports. I listen to the earnings call. And really through all of that, I’m just trying to answer two basic questions. The first basic question is, is this a good, solid business that’s going to grow over time? And if it is, then the next question is, is the valuation reasonable given the quality of the business? And if I can answer those two questions positively, it has to be a good quality business that’s growing, and then it has to be at a reasonable valuation. If I can answer those two questions and it fits into a diversified portfolio, then that’s when I would buy the stock.

Michael: Yeah, great.

Randy: It sounds more complicated than it is. Probably. With all the quantitative models and all that. But those two basic questions is really what it’s all about. That’s what you’re trying to answer.

Michael: I love that. I love it when we can make things, when we can make things that simple. Now obviously answering those questions is, is is not always simple. But that’s a good starting point. So can you talk a little bit about the the CFA designation? I think a lot of folks are familiar with CFP. A lot of financial advisors have done the CFP. Cfa is a little bit of a different animal. And I’m a CFA charterholder, too. So I know kind of from experience how grueling and brutal that can be. But I think that that a lot of folks are not as familiar with that, but it’s kind of relevant to what you just talked to, that kind of detailed analysis.

Randy: Yeah. So most people are familiar with the CFP because that’s focused on financial planning. And that’s sort of the gold standard for financial advisors and financial planners when they’re helping investors formulate their financial plans, meet their life goals, target their risk profile, and etc.. The CFA, like you mentioned, is a bit of a different animal. It’s focused on investment analysis. So it’s it’s the CFP is focused on your personal financial situation. The CFA is focused on researching investments and uncovering what the value of those investments are. And so on the institutional side, which is where I started my career, where you’re an equity analyst or portfolio manager. The CFA is held in much higher regard because the focus is on portfolio management and investment research. So basically, I bring that background to the personal financial planning space as well, where I combine the two. I do the financial planning to figure out the person’s needs and goals and risk profile. But then I use the CFA background to choose the best investments for that profile. Whereas most people, they do the financial plan than they hire outside money managers to to choose the actual investments for clients.

Michael: Sure. Or just or just throw everything into a diversified mutual fund or ETF and call it a day. Right? Right. Yeah. And the other the other thing about the CFA, if your experience was anything like mine, is it’s a lot of work to study for, and you’re usually cramming on Memorial Day when all your friends are out barbecuing and having fun and you’re sitting in your apartment or in a library somewhere poring through formulas and really trying to cram it in there. That was my that’s my memory, at least.

Randy: I remember, like, I took the advice of people who had passed the CFA literally, and they said, you have to study 250 hours per year to pass the test. And there’s three years that you have to do this. And so I did that. I did the 250 hours. I basically had no social life because I was working. And then at night I would study several hours for the CFA. And so I was very glad with the process was over with but then pretty much right after that, then I went off to business school. So I had after my undergraduate, I had a lot of years of no social life, so that’s what I remember from it. But it was very valuable. I, I can say like having done business school after the CFA the CFA is just as good as any standard MBA finance curriculum. So I would say, like in the standard MBA finance classes, even at Chicago, one of the greatest business schools it didn’t really add a lot that the CFA didn’t already cover. Where I had value at Chicago was taking the PhD level classes, like with Eugene Fama, where they really go into intensive statistical analysis. And I learned tools that I would have never learned otherwise. So that’s what I got out of the Chicago curriculum. But the CFA, actually, I would say, is just as good as any top level business school finance education.

Michael: I would agree with that. And now it makes me enjoy Memorial Day a little bit more every year that I’m not studying, and that I can can be out enjoying it with with friends and family. So let’s let’s switch gears a little bit here. I want to talk to you about ways that advisors can add value beyond asset allocation. And there come to be some there can be some. I call them the high leverage moments of life when you’re kind of deciding one of those is for a lot of folks, is selling a business. If they’re looking at at selling a business. And this is maybe not what people think when they think of the value that a financial advisor can add. But but this is potentially, again, a very high leverage moment. It can like you said, a lot of value is kind of made slowly over time. But you do occasionally come to these points where the decision that you make, the route that you go can, can kind of have a very big impact on where you end up financially. So. So how do you work? Just talk at a high level. How you work with folks who are are thinking about selling a business and how you can can add value or help them through that process?

Randy: Sure. Well, this journey started with me mainly because a lot of my clients are business owners or executives at firms of private equity backed firms. And that at some point they are thinking of having a liquidity event of exiting their business. And so that sort of started me on this route to think, how can I help them as a financial advisor? And that, on the other hand, I a lot of my business and our clients, they’re very hard charging type of folks. They want to work forever. They can’t fathom retirement or anything like that. But the reality is 50% of business owners are forced to sell at some point involuntarily. It could be health reasons, it could be divorce, it could be disagreements with partners or whatnot. There’s a variety of reasons and if you are in that situation where you’re forced to sell before you’re ready to, to sell it’s very sad. But you often see the case where the businesses are sold out of fire sale price and much less than the full value that they could have got if the executives are prepared for the business sale. So what? I always try to talk to my clients about even if they’re not contemplating selling in the next year. But especially if they are is how to position the business in a way that can achieve maximum value whether you’re planning on selling it or in the eventuality that something happens where you’re forced to sell it. And so there’s a number of, of key things that I work with them on. Of course, I at Raymond James, there’s the relationship with the investment bankers for the larger middle market businesses that are in the 10 to $500 million revenue range.

Randy: But but even with smaller businesses, I have relationships with business brokers and things like that that that can help them out. But before you get to that stage, you do want to position yourself in a way where you maximize value. So one of those is and this is actually a key thing that a lot of people don’t think about because they’re running they’re running the business is having clean financials for 3 to 5 years. A lot of people, even fairly sizable businesses that are private they they don’t even have reviewed statements or audited statements. It’s kind of informally done. You if you’re going to have a buyer come in there and have confidence in the numbers and the value that you have to have cleaned financials. So you want to you want to clean that up, preferably have 3 to 5 years of, of clean financials. And then the the other key thing is and this this can be a hard psychological break for some people is they’re so intertwined in their business. It’s almost a part of them. But if you want to maximize sale value, that business has to be able to run without you. So you want to structure it in a way that you have you’ve delegated responsibility that you could easily hand it off to somebody else and you’ll get a much higher multiple if if I basically a buyer can come in, pay for the business and then it’s theirs versus if they’re still dependent on you then it’s almost like they’re buying you.

Randy: If if you’re doing that and you can’t really exit the business that way. So you have to start thinking about how you can transition different responsibilities to different people, documenting all the different processes that all the key employees have things like that. And then lastly, but very importantly is you have to start thinking about how you can improve margins to some degree or improve growth, growth prospects. And that can be hard from a strategic level if you’re putting out fires day to day with all the problems that come up with any business. But if you think of it like this every dollar of, of EBITDA that you can create. By tightening things up or growing a market can translate into somewhere between 4 to $12 of of multiple value that that you get. So if you’re able to increase EBITDA by, say, $1 million, that’s an extra 4 to $12 million for you when you sell the business. And so you have to start thinking about it from the perspective of a buyer. What would the buyer pay for your business then? They’re typically going to pay a multiple of EBITDA that that multiple depends on the type of business and how clean the financials are and how easy it is for them to take it over. But those are some of the key things that I start talking to them about. And then once they’re ready, then I introduce them to either to the investment bankers or to business brokers, depending on what’s appropriate for their business.

Michael: Yeah, I love that. First of all, that’s an incredible statistic. About 50% are kind of forced to sell involuntarily, I believe it it makes sense. But it’s it’s incredible. And it kind of you know, I was talking about this a high leverage as it has a potential to to make you or lose you a lot of money. But it’s kind of a different concept of leverage there, too. If you’re being forced to sell, you kind of lose all leverage. And and that becomes a buyer’s market and not a seller’s market. So that’s an incredible statistic. I have to imagine that, you know, in this position, it’s a lot of times you’re you’re kind of like telling them to to eat their vegetables. Right? Like nobody really loves setting up QuickBooks and getting clean financials and thinking about how things are going to run without you and improving margins. And like you said, a lot of times entrepreneurs or business owners are putting out fires all day and and that kind of the squeaky wheel gets the grease. And, you know, setting up a chart of accounts in QuickBooks it feels less urgent than, you know, whatever whatever crisis or whatever opportunity has come up that day. But but I think I think that’s all that’s all really sound advice. And I imagine that when, when folks listen to you, they’re, they’re usually pretty glad that they did.

Randy: And you’re right. It is to some degree. And and eat your vegetables type of type of thing. And you do find that business owners who are actively thinking of selling in the next few years tend to focus more on eating their vegetables than ones who don’t have any immediate plans, tend not to worry about it as much. But, you know, my duty as a financial advisor is to try to help my clients realize their maximum value, so I. I’ll I’ll tell them to eat their vegetables. And it it’s up to them whether they do or not. But I it’s always my duty to tell them what I think they can do to help themselves.

Michael: So I get I get two more questions for you here. Randy, you talked about your process. I guess I would describe it as kind of more of a bottom up approach. Looking at individual companies. If we’re looking top down, though, do you have any any thoughts on this current market, anything that you see as a big opportunity or that that keeps you up at night? Any, any storm clouds you see forming?

Randy: So so in terms of the current market, I would say I if you’re just looking at indexes like the S&P 500 or whatever, anything capitalization weighted the market looks frothy. It looks quite expensive from a multiple basis versus history. But if you sort of dive deeper into it and see what’s getting those valuations it’s really it’s all on the big tech side. Anything related to artificial intelligence? All those types of things are getting enormous multiples right now. And because the indexes are weighted by market capitalization, those things get an inordinate influence on, on indexes. But if you sort of look at the rest of the market, the less sexy types of things, their multiples are sort of in line with, with historical averages. So I would say in this market, it you do run a risk of a mini bubble to some degree in the big tech area. But you can still find lots of attractively valued companies in a variety of industries, if you’re willing to sort of dig deeper and go broader. In terms of, like, what keeps me up at night. Nothing keeps me up at night because I I’ll tell you, even if the market’s down 3% in a day or 5% in a day, like going back to the financial crisis or Covid, like you would see some daily movements that are huge.

Randy: That stuff never bothers me. It’s just maybe a quirk of my personality that even when the market was down 50% and the financial crisis, that didn’t bother me a bit. And the reason is because and it goes back to the core thing that I was saying earlier, is I’m always focused on intrinsic value. If if it’s a company that has very little debt, that’s producing lots of cash flow and profitability. Even if the market’s down 50%, I as long as I’m confident that that company will survive and not go bankrupt or anything, then it becomes more attractive to me. It becomes a very attractive valuation. The only caveat there is if it is a leveraged company, if if their cash flow is sensitive to economic times and they start having negative cash flow, then then you do worry about that, that they might go bankrupt or whatever. But those are not the type of companies that I invest in anyway. So I never worry about normal market fluctuations or even like extreme market fluctuations. But what does worry me is more geopolitical types of things, really just one geo geopolitical type of thing. But the war in Ukraine doesn’t worry me. The war in Israel doesn’t worry me. Those are our human catastrophes there. But in terms of what affects us economically, it hardly has any effect on us.

Randy: What would worry me is if China invaded Taiwan at some point, I, I still don’t think they will just because it’s would be so harmful to them, economically speaking. But you just never know what these sorts of things. If but if they did invade Taiwan, so much of our technology and manufacturing infrastructure is related to China that it would be a very negative effect on the stock market. Like, take the stock market, darling. Right now, Nvidia all of their chip manufacturing or most of it anyway, is, is in Taiwan. They, they use Taiwan Semiconductor for, for their chip manufacturing. So what Nvidia does is they do the designs and then they, they actually outsource the manufacturing to Taiwan Semiconductor. So if China invaded Taiwan that that would be a huge negative for, for Nvidia. And then even companies like Apple and different ones do a lot of manufacturing in China. So that would be the number one thing that would worry me. I don’t think that’s going to happen in the next year. And it may never happen, but if it did happen, it would be a very big negative. But in terms of just normal stuff like recession and things like that, the economy looks like it’s in okay shape right now.

Randy: I want to I don’t really see a recession on the horizon. It if it did, it would be a fairly minor one. I would think you never know what these sorts of things, but I, I’m just not seeing any indications of it, that when I look at company profits, they look pretty good. You look at unemployment, it looks pretty good. Inflation is still high. And and it people think that the rates rates will go down in the second half of the year, and they might. But just looking at the inflation report, they haven’t really improved in the last year. I mean if you look at the top line inflation it has improved because of oil prices and things have come down. But if you look at the core inflation, that’s been pretty steady at around the 4% level which is much higher than the Federal Reserve wants to keep it. So unless inflation actually starts. It’s coming down. Core inflation starts coming down. There’s a risk that the Federal Reserve will not cut interest rates. And there’s also a risk that long term rates will have to go up, which would be bad for bonds. On top of that, the federal budget deficits are so high, and they have to issue so much debt. And there’s always a risk that the Federal Reserve will feel political pressure at some point to, to buy some of that debt, given that it’s hard to find buyers for it.

Randy: They’ll always deny that. But I think there’s there’s a reality there that that’s a risk. So so that’s kind of my thoughts on the current market. But and yeah, in my view, I sort of ignore my own forecast to some degree. You can’t help but make a forecast, but I think it’s more important for value creation. Just to find good, good growing businesses that are trading at an attractive valuation. And in most scenarios, you’ll be better off 5 or 10 years from now just by buying those that rather than trying to time the market or jumping in and out based off of various worries that you have. So I pretty much I just always buy the good quality businesses at an attractive valuation. And to the degree that it’s in fixed income and everything that’s based more on your personal situation than the market. So if you need liquidity over the next five years, then you buy a more short, short term bonds, you buy treasury bills, CDs, etc. if you have a lower risk tolerance, you buy those so that that sort of asset allocation decision is not really related to the markets. It’s more related to the personal situation.

Michael: Sure, I love that. I love the perspective of when when the markets do go down and they’ve gone down before and they will go down again. You almost look at it as well. This is on sale now right? Like I like this stock yesterday and today it’s on sale or this week or this month it’s on sale from where it was a few months ago. And if you’re confident in where it’s going to be over the long term, and if you have that patient capital and that long term perspective, you you want to see those things, right? You almost you almost cheer those things. Especially if you’re if you’re a younger investor with a, with a long term time horizon a chance to have some.

Michael: So, Randy, my last question for you. Where can folks go if they want to learn more about you and your group?

Randy: Sure. Really two places. One is you can find my profile on LinkedIn that has a good background. And then if you just search for the Birch Lane group of Raymond James, there’s a web page about that. I also have a monthly newsletter. So anyone who wants to subscribe to that, you can just email me at Randall at Raymond and I’ll add you to the newsletter list.

Michael: Okay. Perfect. And we will make sure. And by the way, it is a great newsletter. I get it every month. I look forward to it every month. Randy does a great job with it. We’ll make sure all those links are in the show notes for this episode. Randy Wasek, thanks so much for coming on. I really enjoyed this.

Randy: Thank you for having me. It was a pleasure.

Michael Johnston, CFA
Michael Johnston, CFA

Michael Johnston, CFA is the co-founder and President at WealthChannel, and host of WealthChannel Academy.

Michael previously founded ETF Database, the leading independent authority on exchange-traded fund investing.

Michael's professional experience includes positions in corporate finance and investment banking, as well as entrepreneurial experience as a co-founder and early employee in multiple high growth, venture-backed companies.

Michael graduated from the University of Notre Dame with a degree in Finance. He lives in Oregon with his wife and son.