Cliff Sosin
Appearances
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's the emperor, I think investing is the emperor of intellectual activities in the sense that in academia, people write papers. They're wrong, they're right, eventually they die with a bunch of ideas. Most of them are wrong. In politics, people have views and they're definitely wrong, unlike a lot of them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And in business, people, they have this narrow world and they kind of have to be really good about executing in their narrow world, but they don't necessarily need a deep understanding. You can run a deli. without necessarily having like a deep understanding of like why meat prices are what they are. But in investing, you know, it is wildly accountable.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You're making predictions about which businesses are going to win and which are going to lose, which, you know, to understand businesses are sort of complex social structures embedded in our society, which is a complex social structure. So what do you need to understand how a business's success or failure over time? It's like you kind of need to know everything.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So it's, and unlike all these other pursuits, this one's like highly accountable. So- I think it's the emperor of intellectual pursuits. I think that there's no arena to train people better about understanding the world. And I think if you're just curious about the world, there's nothing more interesting than to study business.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I generally think of a contained business as one where when you're trying to understand a company... If you find that it's just, the problem starts to feel intractable in the sense that it's very hard to think about how changes in, there's many things that could change in society that are changing that could cause your view of what the business could be to change over time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
That is just a tough problem to live with. you know, if because it's just, you know, it's very susceptible, like as the world evolves, like you don't know where the company is going to go. Whereas a business where the thing that makes it work or things that make it work are relatively narrow and in a sort of part of our lives that isn't evolving that much. That would be, you know, very contained.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Once you sort of understand everything immediately around that, other changes outside of the, that they're sort of happening, feel less relevant.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Yeah, that'd be a great example, right? So, you know, I, Who knows how people are going to write software in 10 years? For what? For quantum computers? You might have a business today. It's like building a castle on sand. It's just very, very hard to make predictions. But on the other hand, You know, like the cigarette business, right? Like people, nicotine's habit forming.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's this phenomenon called secondary reinforcers, which is a psychological phenomenon that you can, you know, put into Chachi Petit. I'll explain it to you. And, you know, but basically it makes people incredibly brand loyal to things that like stimulate the reward systems. And then there's also distribution economics.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But that is just not an area where there's a lot of dynamic change happening. It's also not an area where I need to think about 15 different moving parts to sort of have a general sense as to what's going to happen. Of course, the problem with these contained things is that If they're easy to understand, then everyone understands them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so, again, investing is this incredibly challenging endeavor where you're dancing on the knife's edge. You're looking for these things that, on the one hand, they're simple to understand so you can understand them. On the other hand, they're challenging to understand so everyone else misses it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I have in my head a number of different frameworks for how a company can make money over time in a competitive world. And a simple example from microeconomics would be that of a Corno oligopoly. And just for those who maybe forgot their game theory from college, there are... Two broad types of oligopoly in the economics literature. One is Cournot. The other is Bertrand.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The key difference between them is that in a Cournot oligopoly, the competitors choose the quantity of things they're going to sell first. and the price falls out. It's the thing that moves. In a Bertrand oligopoly, the competitors choose the price that they're going to sell at, and then the quantity falls out, and it's the thing that moves.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And this seems like a subtle change, but it results in a pretty big difference in the competitive equilibrium. So in a Bertrand oligopoly that's non-cooperative, that is to say that people aren't figuring out a way to signal and to sort of cooperate.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Then what happens typically if you imagine, like let's say I'm selling cookies at the state fair and there's me and there's another competitor and there's two spots to sell cookies and we both can manufacture all the cookies we want in a truck next to the fair. And let's say people only buy cookies based on price and they're right next to each other and perfect competition, all the rest.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So what happens is, you know, let's say each cookie costs a dollar to make. Well, I start out, maybe I started selling them for $2. I want to make a dollar a cookie. But my competitor realizes that if they charge $1.99, they can get all the sales. And so they charge $1.99 and then I charge $1.98. And before we know it, we're both down to a dollar and we're making no money per cookie.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that's the equilibrium. That's the non-cooperative equilibrium. We make no money. But now... Let's imagine instead that I had to bring a tray with a fixed number of cookies and I can't make more. Well, what happens is that morning I'm trying to figure out how many cookies I'm going to make. And I ask myself the question, should I make one more cookie?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And if I make one more cookie, it'll have two effects. One is I'll get to send extra cookie and I'll make whatever the profit on the cookies are times that cookie. But the other is it will increase the number of cookies in the market, which will drive down the price of cookies. And this will cause me to sell all of my cookies at a slightly lower price.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so as I'm making this decision, you can see how there would be a natural maximization point where I maximize profits. Now, in this case, there's two competitors. So when I add an extra cookie to the market, the price for me, I also lower the price for my competitor. I don't internalize the effect on my competitor.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I end up behaving like a monopolist, but a monopolist who only absorbs half of their price impact in the marketplace. In other words, one who faces more elastic demand. But I still behave like a monopolist, just with one facing more elastic demand. So there's still monopoly profits to be had. So the equilibrium gets worked. We both solve our differential equations at the same time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
We get to an equilibrium. And lo and behold, we both end up making profits. OK, this is all very theoretical. So you start studying the cruise line industry. OK, just to pick an example of an industry, I'm not that. I've never owned a cruise line business, but I've been around it. It turns out that if they want more cruise ships, they can't just snap their fingers and have more cruise ships.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The number of cruise ships for a good long while is essentially fixed. And so what they do is, this is a perfect example of corno oligopoly. The number of cruise ships is fixed in the short to medium term. So they maximize yield, which basically means they're adjusting price. That leads you down a path of, okay, this is a business where
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Just from that perspective, there's lots of other things to think about. There's brand, there's distribution, there's a zillion things. But from that perspective, now you have a sense as to how this is a business where there should be some monopoly profits. But what will mediate how much economic profits there are is how many competitors there are, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And also how much elasticity of demand there is. And then, of course, other factors. And then, of course, there's also the question of Are you in equilibrium, or did people accidentally bring too few? Let's say you show up at the fair, and you brought your tray of cookies, and it rains. Well, now the price of cookies plunges, and you lose money, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Or let's say you show up, and for whatever reason, a famous singer shows up, and there's a gazillion people, and now you sell the cookies at a premium. So are you at equilibrium is another good question. But it turns out that a lot of travel businesses are coronal oligopolies. you know, rental cars, air travel, cruises.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So this is an example of using a mental model that allows you to understand like certain types of businesses in a somewhat systematic way. One of the investments I sort of cut my teeth the most on where I first had a lot of success was in the construction equipment rental business. And that is also It is a Corneau oligopoly.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, in any market, there's a sort of fixed number of rental companies and they own a certain amount of equipment and their ability to change that in the short term is constrained. And therefore, you know, it's a Corneau oligopoly. And it's also a good one because elasticity of demand is demand is very inelastic. Turns out nobody said like.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, I see the price of man lifts is down 100 bucks this week. I'm going to rent one. And at the same time, nobody ever said like, I'm not going to build my building because the price of man lifts is up 100 bucks this month. I hope that got to your question.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But basically, you can think about there being many of these things, like these concepts that you can then kind of follow to their conclusions. And of course, life is complicated. And every company has like often a whole confluence of these things. And what you're really looking for is a business where you have a sort of a bunch of these things that are working together.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
With the cruise ship industry, like the idea that it takes a long time to build a cruise ship and you can't just snap your fingers and have another cruise ship is fairly invariant to technological change in society. I guess maybe there's some future state where we can like, you know... Print them out. Print them out. But like for now and for the foreseeable future, this is going to be fixed.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so... you're looking for relatively sort of technological change in variant advantages and layered and interwoven that kind of give you the business. And then from there, I have a friend who jokes that... A good value investors, you know, memo is like 20 pages about the business and one page on the valuation. So like from then from there, it's like, I don't know, like, is it cheap?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Does it make a lot of money relative to the price? Is it going to grow a lot relative to the price? You know, these are pretty trivial calculations.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Oh, so you're asking how do you find the gold on the ground? The answer is yes. It's hard. There's nothing, I keep coming back to that, but there's nothing about investing that's not hard. We look for, I hired a Stanford professor to assemble all of the economics models in all of the courses in Stanford and then just walk me through all of them to make sure I hadn't missed any.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I picked up a few that I'd missed or forgotten about. I would try to read broadly. Then, of course, you study companies one after the other. And in various companies, it'll sort of click for you that something is happening.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So this is just a different place. This is out of psychology. It turns out that there's a meaningful psychology literature that's been built up in animal studies and people and all the rest, which basically says this idea that when you give...
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
you know, mammals, something that stimulates their reward systems, your brain, for lack of a better term, sort of captures the context in which it was received. And then, you know, if it likes it, tries to replicate that context. And you can, the sort of evolutionary reason why this makes sense is self-evident. And
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
What makes that interesting is that it turns out that the strength of these secondary reinforcers is proportionate to the power of the stimulus, as well as it's proportionate to the... inversely proportionate to the time lag between when the stimulus comes and when the pleasure sensors get stimulated.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So if something makes you feel good three hours after you got it, your brain kind of doesn't know where it came from. If something makes you feel good within a moment of when you got it, then your brain knows exactly. And what's interesting about that is this is called secondary reinforcers because you create these associations
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
between the stimulus and other things that are in the context that it was received. So you can make rats prefer cocaine that's given to them with a certain color light. They'll continue to seek out that light even when you deprive them of the cocaine. Okay, cool. That's a neat thing to know about the human brain. Where do I see that applied? Well, if I were to rank
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
by margins, the consumer packaged goods industries, I think the ranking might look something like this. You'd have the nicotine cigarettes at the top, and then you'd have like dip, and then you'd probably have Coca-Cola, and then you'd probably have coffee, and then you'd probably somewhere have like
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
candy and then you'd have like sugary sweets like um uh you know cookies and stuff like that and then you'd have like tomato sauce and bread and then you'd have i don't know water right something like that it's probably a rough like ranking well it turns out that if you go down that same list and you ask, what is stimulating people's pleasure systems?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Well, in the case of nicotine inhaled through a cigarette or a vaping product, nicotine is incredibly powerful. And the respiratory system is a very fast delivery mechanism. So you get this very rapid stimulation of people's pleasure sensors. And lo and behold, it creates these very strong secondary reinforcers, which make people very brand low.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If you ever watch smokers, they're not only smoking the same brand, they're smoking at the same time in the same place every day. It also helps that nicotine is addictive, which creates a trigger for a habit, which is a whole other brain function piece where you're kind of making and following habits.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, if you go down the list, caffeine is a good stimulator, but, you know, it's not as potent necessarily as nicotine. More importantly, you're taking it through your stomach. And by the way, dip goes through your lips. So it's pretty fast, but not as fast as cigarettes. Caffeine soda has sugar and caffeine.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It goes through your stomach, so it's slower, but it still creates a fair bit of, the association isn't that far apart. Then you get to things like cookies. The cookies mix with fat and stuff, so it slows it down. The sugar's mixed with fat and stuff, so it slows it down even more, but it's still pretty potent. It's obviously a sweet.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You work your way farther down, you get to your savories or whatever. Here, yes, these are things people really like, but the sort of stimulation is much weaker. It's more time lagged. And as a consequence, people, they have a preferred tomato sauce, but in the end, it's much less brand loyalty than, say, a cigarette.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Obviously, water, other than if you think about brands that are more status-oriented, focused. But like if you think about just sort of like a bottle of water, I don't think in the end anyone's that picky.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, I think the, you know, the example I gave, like, I don't think it's a mystery to most people that, like, Coca-Cola is a good business, right? I'm not totally convinced that, like, what I just laid out is, like, going to make you a lot of money in the public markets anymore because I think it's priced in. I'm not totally convinced that the people who own these things understand it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They just have observed that, in practice, these are very brand-new businesses. However, sometimes things come up. I was involved in a nicotine vaping company, which was reasonably successful and ultimately acquired by a large tobacco company. In the early days, you didn't have necessarily all this evidence that these were gonna be really great businesses.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But the theoretical construct that I just laid out to you was an important sort of guiding factor in giving me confidence that this was a business. There's a lot of other factors, but this is a business that, you know, would ultimately be successful. Or, you know, I have friends who I didn't do it because I thought they were right, but I thought I had other things that were better.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And there's opportunity cost to consider. But I have friends who were successful investors in Philip Morris International. They were observing Zin. And, you know, a lot of this... like intellectual construct, gave them a sense that like, that Zin was going to have a lot of brand loyalty, you know, where at that time, you know, it was sort of unproven. And Zin, of course, is... Quite a big one.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Has been proliferated and there's a lot of brand loyalty. But that wasn't obvious, you know, at least it wasn't in the historical data until, you know, so these were, you know, All of these tricks, they're not useful until they are, I guess would be kind of the way to think about it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I think that if you manage money for other people, you're deeply arrogant if you are going to apply your ethical framework onto the way that you invest. Society in aggregate comes to a collective view of what's allowed and what's not allowed. And we call that the law. And if a business is violating the law, you know, that's often a bad investment because, you know, obvious.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If society is evolving and the law is likely to change, that is a risk that one needs to factor into an investment. And you'd be sort of silly not to think about that.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But if something is just disliked by a group of people, but they haven't built up the critical mass necessary to change the law in this country, and you don't think the risk of that happening is particularly high, but you decide that you're going to apply some moral framework and not make them money to do it, not make money for your partners to do it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
That's a really fraught thing because like what – sort of what gives you this deep wisdom about what's right and what's wrong that is better than like the collective will and judgment of society? And by the way, maybe you'd say, OK, fine. I'm not going to use my judgment. I'm going to use my investor's judgment. But – Then the question becomes, OK, well, but which investor?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And how do you weight them? Like, equally? Is it by AUM? What if it's an institution? Do you poll the underlying people at the institution? Like, this is a wild thing. I think a much better approach is to just say that the goal is to maximize And obviously, in doing that, companies have to comply by the law. You have to comply by the law. And you have to take the change in norms into account.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But laying any sort of further ethics onto that. And then, of course, if you maximize returns, people can, of course, take that money and give it to whatever charity they feel that they want to. And I think that that's sort of the only solution. It's like the only solution that I think kind of resolves this problem that isn't fraught
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I've noticed in my career that people in investing circles, they talk a lot about panics, this idea that you want to buy when things are bad. I have noticed that there are certainly economic panics that have happened in my career. I've also noticed there's sort of moral panics that have happened.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
you know, you can buy into moral panics much the way you can buy into economic panics and you can do well. Now, economic panics bring with them the risk that things could get worse and the business might not survive the challenges that lay ahead. Moral panics bring with them the risk that You could bring about legislative or regulatory rulemaking change that can hurt the company.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so you need to take these things into account. But I think that it's reasonable as an investor to look to areas that are viewed as sort of bad but are not illegal. Right. And for what it's worth, when I've dug into most things like this, I've always discovered that these things are far more complicated than the sort of naive, you know, coal is bad. Okay, well, sure.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But, you know, electricity is pretty good. Yeah. You know, so it's complicated. I'll add one other thing, which is this idea that I think you mentioned, which is funds that can't invest or whatever. You know, there's an implicit point that you're sort of saying, which is an elasticity of price concept.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I'm not that... I think the literature on this kind of agrees with me, but I don't think that groups of investors deciding to forego certain asset classes like oil companies necessarily cause them to be super cheap. I do think that there can be sort of more broad based things where people kind of don't want to own something for some reason.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that can, you know, and if it's really broad, it can have some effect. But I think mostly what happens is people just kind of get scared. It's more of a panic. People get scared, like, oh, no, you know, this company is going to get shut down because, you know, this group of people view it as terrible and they're going to try to kill it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Sure, and part of the reason, actually almost all the reason, I said yes, more than all the reason, I said yes to coming on. is that it has been such a wild episode in business history. And I sort of worried that if I didn't try to memorialize it to some extent, that it would get forgotten. And it is such an interesting story. I think it deserves to be memorialized.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I also think it's sort of wildly misunderstood in terms of what happened to Carvana in 2022 and And 23 and beyond. So, yeah, I guess maybe a place to start just to level set for people who don't know it so well. Carvana is an online retailer of used cars. It was founded in 2013 by Ernie Garcia, who you've had on.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And if you were to broadly describe the company's history from 2013 to 2021, it was up and to the right. The business grew every year. Its margins improved every year. And it grew really fast. It was doubling often every year. Slid a little bit, but that was kind of roughly the pace. You know, if you'd spoken to me in 2021, I roughly would have expected a continuation of that trend.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And, of course, what happened was the business... It slowed. It lost tons of money. The stock went down 99%, which is more than... Pretty bad. Which is pretty bad. And then, you know, to ruin the story, which I think most people realize, you know, it turns out that was all a mistake. The company's fine. It's right back.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's a little behind where I sort of thought it would be, but it's actually more profitable and it's back on track and the stock's mostly recovered and all the rest. So that's kind of the broad arc.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I first encountered Carvana in 2018. And they used to have a video up on their site, they might still, that kind of describes the business. It was a pre-IPO video, one of these things you put up or whatever. Yeah. And I remember sort of watching that video, basically realizing this is an amazing business that's going to do great. And it's incredibly underpriced.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I'm going to own a lot of this, provided everything they just said is true. But obviously, that's not how reality works in the sense that the reason why I felt like that was years and years and years of context. And so to go further back, over the prior years for, you know, like when you're in my business, you're waiting for your stocks to go up.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
In the meantime, you're sort of looking at other things. And so I had spent time studying CarMax and I had spent time studying car dealerships. So I was sort of reasonably fluent in kind of how the auto retailing business works. I'd also been involved in the auto lending business. I'd been involved in credit acceptance, which is a one on auto lender.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I'd also, you know, looked obviously who hasn't like studied Amazon and like read the everything store. I'd also studied logistics companies. And I'd also looked at, you know, manufacturing companies and all the rest and software companies. And so it turns out that Carvana is like all of these things. As they were explaining the business, it was clear to me that the
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The economic advantages that allow someone to build a successful distribution company or a successful retailer or a successful lender, all of them have economies of scale, skill, and trust. And what Carvana was building was going to involve all of the advantages from all of these different businesses that they're effectively in at the same time. And this is called economies of scope.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And by being great at all of these things, it was going to produce this very – it could produce this very big moat. What I didn't believe necessarily until I saw that video was that anyone would buy a car on the internet because that was just common wisdom. And at the time, this is a while ago. This is before it was obvious. But they just had some cohort curves. And I was like, well –
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
People clearly love this. And so at that point, it was kind of like love at first sight. Maybe to sort of explain a bit about the business and why I think it's so... The things I identified turned into the tremendous advantages it has today. and are kind of the moat. So let me just spend a few minutes. So at the core, the way the Carvana system works, it will follow a car.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Carvana buy cars mostly from the public. You take a picture of your license plate and you enter a few things and it's like four questions and they'll give you a price. You can exercise it or not, you have seven days. Once you do that, you can arrange for someone to pick up the car for a small fee, or you can drop it off at one of their hubs and get your money. And the transaction takes no time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Everyone gives them five stars. Doing that's hard.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
What I just said, it sounds so simple, but actually being able to take a license plate, to map it to a VIN, to map all the features of the car's VIN, to then be able to figure out what you think you're going to be able to sell that car for, how much it's going to cost to ship it, how much it's going to cost to recondition it, and be able to work out from all that, therefore, what you think you're going to be able to make on the car, and then to figure out what you want to offer in order to maximize the profits from this lead.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And to do it all for every car on the road all the time across the country is wild. Then Carvana owns a real estate footprint. That real estate footprint consists of larger inspection reconditioning centers. These are, I think, very big facilities that can recondition up to 40,000 cars a year with 6,000, 7,000, 8,000 cars in the parking lot, which is a lot of cars.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Then there's local points of presence that they call hubs. And those hubs would be, there's one in Fairfield, Connecticut. small facilities that originally were sort of purely non-consumer facing. Now they've modified them to be somewhat consumer facing, but they're, you know, they're Not very big. And so the car's at the hub. The hub is connected to the IRC. Let's say you have the car picked up.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
One of their nifty little single-car haulers will come out. They'll pick the car up. They'll bring it back to the hub. From there, that hub is connected to the IRC via logistics on a nine-car hauler. Those IRCs are then connected to each other via logistics on nine-car haulers. And what that does... is it's built a hub-and-spoke logistics system. It's like FedEx or something.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The sort of insight there, which Ernie had, was historically, if you wanted to ship cars, it was very slow and expensive. And the reason is that sort of the amount of car shipping happening between... Fairfield, Connecticut and, you know, Alabama and someplace in Alabama, I don't know.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Mobile, Alabama. It's just no volume. And so the car, your point-to-point system doesn't work. So what they've done in their hub and spoke system is they've collapsed down all this volume onto relatively narrow routes. Most of the shipping is happening between IRCs. There's a relatively small number of them, and they're sort of sparsely connected.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And what that allows them to do is to move trucks continuously back and forth, loaded with cars between these IRCs. And you can think about them as train tracks, where the vehicles can move continuously between these spots.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And what that does is if a truck travels 40 miles an hour on average and costs like $3 a mile to travel, then you can work out what the cost on a nine-car haul or how fast cars can travel and what the cost is. And it's actually not that high. And so... But running a hub-and-spoke network like this, one, it's hard. Building a logistic system requires a lot of density, requires a lot of scale.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's also a lot of technology to it, recruiting drivers, there's a lot. But that's the next piece of the system. With that, come to an IRC. And at that IRC, it'll get reconditioned. And reconditioning a car in an IRC is a challenging thing. Which dents do you repair? How do you repair it? And you can think about a reconditioning center
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
has a bunch of different stations that do a bunch of different work that's relatively homogeneous. So changing tires, changing oil, inspecting, paintless dent repair, painting, whatever the thing may be. A car starts out with a mix of work that has to be done to it. That has to be ascertained in an inspection. And then the car is going to be routed
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
through the IRC to different stations, and then come out and be imaged and put on the website. Some time later, it sells. They take the car, nine-car hauler, to the hub. Now, you'll see this is beautifully balanced. The cars are coming back from the hub. They're also going out to the hub, right? So the car will go from the IRC it's at to the IRC closest to the customer along basically the rails.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then it will go from the IRC to the hub. And then from the hub, it'll be delivered on the single car hauler or picked up by the consumer. That's the physical system. There's also finance. If you go on their site and you enter your information, instead of searching by price, you can search every car by payment. So you can adjust the number of the months, your down payment.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And you can see each payment for each car to the penny based on your individual credit score. And this isn't an estimate. This is exactly what it is. In order to do this, Carvana has a fully vertically integrated financing stack. So they're essentially underwriting you for every loan combination for every car in real time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then they're taking that and they're making it available to you through this cool widget. To this day, as far as I'm aware, no one's replicated this capability. In order to do it, you need to be vertically integrated into prime lending, subprime lending. It just turns out that no one else is, and it's also very hard to get into these businesses as well. There's title and registration.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Obviously, you've got customer service. The thing about this business, you have to remember that, like, this is all great, but things go wrong. Then you have to deal with, like, all the many, many corner cases that can come up. If you want to entertain yourself, like, go read the one-star reviews at Carvan.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's like, well, I was moving, and I ordered the car when I lived in Florida, but I needed it delivered to North Carolina. And, you know, then, like, there was a hurricane, and as a consequence, it was late. But then, like, there was a problem with the title, and you're like, oh, my God. Yeah. That's kind of how the system works.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Now, in that whole system, like, let's identify some economies of, like, scale. Inventory. Turns out selection matters. Matters a lot. And there's, if you think about all the makes, models, trims, years of cars, as well as mileage, like, the selection space is massive. And Carvana's coverage, even at its size, is still relatively small.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so, as a consequence, conversions go up as selection goes up. And so, selection is, like, big economy scale.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Yeah. Logistics. The cost of running a logistics system, you know, you can think about moving these trucks as like a fixed cost. And if you want to provide complete connectivity and move cars quickly, it turns out conversion speeds matter a lot. And by the way, when you think about the inventory space, inventory nearer to customers increases conversion because you can get to them faster.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Then you can think about these IRCs. These are very large facilities. It turns out that run well, you can recondition cars for a lot less money and time because cars are depreciating assets if you have like a big facility. So like if I have a traditional dealership, the car comes in and like one guy or gal does all the repairs.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But the problem is that person isn't necessarily the right level of, like they're overqualified for a lot of the things they're going to do on the car. And they have to change tasks. And that slows you down. If you're at Carvana, you can have people who are very entry level to do the cleaning and the oil changes and the tire changes.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And you can have advanced mechanics do just like a very narrow subset of stuff. And you can have people at like specialized stations where like this is what they're doing. And so they can be more efficient. Now to do that, though, you have to efficiently route the cars through the system and all the rest. Also, the dealership is in an expensive place, and so you have less overhead.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So these are just examples of places, but there's economies of scale to doing that, as well as enormous process power, like economies of scale. Underwriting loans is obviously an endeavor where you learn The way to do this over time, you connect all these data sources, you learn how to predict defaults, you then get data over years that cycles back into it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Title and registration, like there's software that's built to run all this. So this is like there's enormous economies of scale and skill in terms of like being able to do all these things. And then, you know, I... would be really remiss if I didn't mention trust. Consumers, when they buy a car, it's an active, a sight unseen in the air, it's active trust. We can talk about how Carvana grows.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And it was one of the things that kind of went wrong in 2022, but like getting Carvana is able to get people to buy cars because there's been an enormous amount of word of mouth built up over many years of delivering great experiences. And You know, you can't buy that. You have to build it up over time. That's trust on the buying side. There's also trust on the selling side, although less.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's also trust in the financing business, right? You make these loans, then you sell them. And the people who buy these loans have to trust that you're making these loans to spec and that the loans are going to perform kind of as advertised. You're a great originator, yeah. Subject to economic conditions. The other thing about this business is if you think about a car transaction, it's a...
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's a whole series of things that have to go right. And if you get any one of them wrong, you're going to lose money on the transaction and your customers are miserable. And this is economies of scope, right? This is the idea that you have to put this whole portfolio of things together and you have to get them all right, and you have to get them all right every time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And this is this combination of things. And if anything I've said sounds easy, it's because I haven't described it right. It's so hard. That's why everyone who's tried to build this business besides Carvana has failed, and that's why it's taken Carvana over 10 years and $10 billion to get where it is. Outside the US, there were other people trying to copy Carvana in other markets.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Some of them are doing okay. A lot of them have failed, but none of them are doing really great. And just the bottom line is that it is so hard.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I actually love the comparison to Amazon. There's a video I saw once, I don't know how famous it is, but I love it, where Jeff Bezos is describing why books is the first best place for an internet business. And he talks about how the selection matters so much, and then he talks about how you can get the books and you can ship the books, and people can pay for the books.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Well, I actually think that from a consumer's perspective, used cars is just as great as books. The selection space is infinite. Selection matters an enormous amount. Also, what I described with Carvana system is a lower cost to operate system than the traditional dealership system. It's a better experience. But the thing about books is it's really easy to do.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Imagine if you had to start Amazon, but you couldn't just call up the manufacturer and get books. You had to manufacture them. And imagine if you couldn't just call FedEx and have them ship the books. You had to build basically FedEx. And imagine if you couldn't just accept MasterCard. You had to build a financing platform. And Lord knows you can't just sell the person the book.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You have to do title and registration and all that. And with books, the stakes really just aren't that high. And so people are willing to try it. And if it doesn't go so well, they're disappointed, but it's OK. A car is the second largest purchase of your life. And so you can imagine how that is also really challenging.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so in the sort of fulfillment sense of it, I think used vehicles are probably the hardest thing to build. But the analogy to Amazon actually, I think, is apt.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If you'd asked me five years ago, I would have put myself firmly in the let's focus on the business. I don't think I bring much advantage to understanding management. It's been an exciting five years. And in that time, one of the things that's come out is the businesses where if you'd ask me, OK, if I get it, you don't care, but like rank them anyway. And I'd rank them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
the teams that I was involved with, that ranking would have perfectly predicted how things did relative to my expectations at the time. So what I learned there was two things. One, it matters. I knew it mattered. But more importantly, I think I can judge it. And so now I fall into the, obviously, I care predominantly about the business and the price. That is, in the end, the right thing.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
A great team with a terrible business is going to be a slug. There's just no two ways about it. By the way, just to go back to your contained versus uncontained point, like that's another idea. It's like there are businesses where there's a new problem to solve every six to 12 months. And it throws up a never-ending series of hard problems.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If you'd gone all the way back to when I was in high school, I thought I would have been an inventor. I sort of modeled myself as an Edison in my mind or something. But when I went to school and I studied engineering, a lot of inventing is kind of obsessively debugging real things. And nature is pretty unforgiving. And so what I learned about myself was that I didn't love that process.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, so you want businesses, so a contained one would be one where like once it's, set it and forget it's the wrong term, but there's like an obvious, like, would you like to sell more cars? Yes, yes, I'd like to. Okay, so now going back to management. So I don't necessarily think I'm going to ever get to a point where I'm like, this team is great.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I don't care that this is a business that will perpetually throw up hard problems. I'll buy it anyway. But I do think that I've now come to understand that I can judge it and that management matters a lot. So it gets weighted into my thinking in a way it wasn't before. For what it's worth, I'll add to you how I judge it. Meeting with a management team is great.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It turns out all the people who become CEOs figured out how to sound great. You know, I learn a little bit, but I certainly listen to them talk in public. And you can definitely pick up over time who kind of is making what seem like sound business judgments and giving good reasons for them and people who, you know, aren't.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
That being said, the really good way to do it, I find, is I talk to former employees. And I'm certainly interested. I'm using that to learn about the company, learn about how it works, how do you buy things, how do you sell things, blah, blah, blah. But I'm also just assessing them. And a company which spits off
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
People who worked there for 10 years, left on good terms, who you're just like, I don't get it. This guy's an idiot. That says something about the caliber of people in the organization. And the human capital exhaust is kind of indicative of what's inside. And conversely, when you find yourself, go talk to 10 former employees who spent at least five years at Capital One. They'll blow your mind.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
That tells you something about what's going on in Capital One. And so I find that that's really the best approach. As to Ernie, I think, you know, at the risk of inflating his ego, I think that someday people will compare Jeff Bezos to Ernie Garcia, not the other way around. He's extraordinary, right? This business is... incredibly difficult, as I've tried to emphasize so many times.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's a reason why they've succeeded where nobody else in the world has been able to succeed. And I'll also add that I'm aware, obviously, of his dad's history with the savings and loan crisis. And This is – I think it was either a $20 or $50 fine that he paid as like a late 20-something. And this is, by the way, his dad, not him. And this is 50 years ago or 40 years ago.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's just – it is wild to me that people then take – What his dad did. Yeah, people take that fact. They're like, therefore, this company, you know, is a fraud. And it's like, oh, my God. Like, this is the, you know, the guy was a billionaire. What was his plan? To, like, make a few billion more but send everyone he loves to prison? Like, this makes no sense to me.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If you just spend any time dealing with talking to people who've dealt with the Garcias over... the 35 years that, you know, since the, you know, guy, you know, made a mistake, which, you know, if you actually go through the details of it, it's not obvious he did anything super wrong, but like whatever, he got caught up in stuff. Everyone speaks incredibly highly of them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It just wasn't as fun for me. Um, and so I was sort of casting him up for what I wanted to do. And I ended up doing an internship at a big private equity firm. And, and I just thought it was really neat that I could use. And I discovered I could use a lot of these things I'd been learning in school, like game theory, apply them to these situations.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They've done nothing but behave totally ethically. If you go through the experience the company had in 2022 or whatever, like there were plenty of opportunities for them to hurt us as third party shareholders. And they haven't. And, you know, so I mean, Ernie does a great job of just tuning all that nonsense out as to like what he does. Well, he's incredibly smart.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
He's assembled the team around him that are incredibly smart. And he does a great job of thinking about things in a variety of perspectives that are very, you know, wise. So on the one hand, he'll analytically explain to you how, as an outside investor, you could look at CarMax and try to make a sensible guess at what Carvana sees as its price elasticity demand, which is a fairly analytical thing.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then, you know, if we were to ask him a question about, you know, once upon a time, I sort of said, why don't you adjust your pricing to kind of like compete more aggressively with Vroom? And he basically sort of described how
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
if he made competing with Vroom something that mattered, then suddenly, instead of focusing on the customer, everyone in the organization would be sort of, when Vroom wins, we lose. When Vroom loses, we win. We're not focusing on the customer anymore. And he was thinking about the second and third order social effects on his culture. And he's very deliberate about things like that. All right.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's worth pointing out where the company is today because through most of the company's history, it was obvious that Carvana could grow. Margins, however, were improving, but there was always debate around the economics of the business. And I said earlier that this is a more efficient system. And for a long time, that was a matter of conjecture.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I could sort of work out unit economics and how much does it cost to ship a car a mile and blah, blah, blah. But we couldn't see it on the press release. As of now... the company's margins, EBITDA margins, and they have very little stock-based comp and relatively little capex, are 10.5%-ish and rising. And they'll probably get to the 13, 14-ish percent range based on what they've said.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And there's no reason to doubt it. And the average car dealership's about four and a half. So they make of the order of two and a half, three acts, the margins of their competitors. And we track every car that they sell, and we compare it to similar cars sold by CarMax. We also compare it to other market indices. And we believe that they sell cars of the order of $500, $600 cheaper doing that.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Now, in fairness, they charge a bit more on financing, but it's still cheaper overall. And they offer, obviously, a far superior experience, far superior selection. And they're growing. There's high-frequency data that's published. And so recently, they've been sort of growing 45% to 50% year over year.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that, that brought novel insights that these people who've done this for so long weren't using. And I was hooked, like the idea of like, you know, being able to do that. From there, I was trying to kind of get into investing. I thought I was going to do private equity.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so the idea that they're putting all of these things together, at this point, you no longer need to speculate about the... power of the model. It's also a model that gets better as it gets bigger. So as time goes on, the selection gets better. And so I should make a note here. A traditional car dealership is a monolithic unit, a certain number of cars.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Even if you think about like CarGurus, it's a certain number of dealerships in your area that collectively have some number of cars. Carvana's pooled national inventory There are more cars available on Carvana's website right now than there are for us right now sitting here in the entire state of Connecticut from all the other dealerships.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that's only going to improve brand, also process efficiency. They still have a long ways to go in terms of... Fixed cost leverage is a long ways to go. So this is a business that gets better as it gets bigger, and it's already so much better than its rivals. And its rivals, of course, it's very challenging to meaningfully update the processes in a car dealership.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's just not a very skilled organization. How much technology can they really bring to pair? All the rest. I thought I'd just finish that story. The company grows. The company had enormous amounts of demand in 2021. Just put a car on the site, car disappeared. And they were trying to overcome the challenges of the pandemic, to build supply, to grow tremendously into 2022.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They sold something on the order of 425,000 cars in 2021. They had ambitions of doubling or more in 2022. To do that over the course of all 21, they were hiring and hiring. As it would work out, demand collapsed. And they discovered all manner of operational problems that they were having. And it made 2022 really challenging.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I knew the path into private equity was through a banking analyst program, but I didn't want to do a traditional sell-side analyst program. So I ended up going into financial restructuring because I didn't want to do as much marketing. So I worked at a place called Houlihan Loki, which is a leader in financial restructuring, and I did that for a time. I still wanted to get to the buy side.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
When you tell a story like this, you have the benefit of everything you learned during the whole period and everything you learned after and all the time to synthesize it and sit calmly later on and figure it all out. All of this happened in a cloud of dust with incomplete data. So it's all going to sound so neat and put together and understood.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And there were definitely pieces of this that I had nailed and there were pieces of it that I learned later. But I just want to, you know, this was real life. What happened was, at least my understanding of it now, was a few things. One is they had a bunch of latent operational issues we can walk through. Another was that
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There was just a very unusual used vehicle market, which led to the used vehicle market being significantly smaller than normal in 22. And it still hasn't fully recovered. It's only partially recovered. In particular, it was bad for independence. And we'll talk about that. Another was the vehicle financing market did totally strange things, which made life absolutely miserable for them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then, of course, because things had to be the way they were, they bought Odessa. They added a bunch of debt. The capital markets were close to them, all the rest, which is another set of external facts. So let's just in terms of let's do internal operational stuff. It's interesting. The company had been growing year after year. Circa 100%.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And when you're doing something as complicated as what Carvana is doing and growing as fast as Carvana is growing, things were always going wrong. And I would always hear kind of some horror story or another out of some part of the organization. But, you know, you looked at the overall star ratings. They had great reviews. It was like, well, you know, it's a big organization.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They're growing really fast. To think about it, like if you're doubling every year, less than half of your employees on average have been with you for like less than a year, right? This is wild. They also had deliberately prioritized speed and growth over necessarily slowing down and, like, really hardening their processes.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the reason for this was that they viewed, you know, this is a scale business, and there was risk that if they weren't first to scale, that they would be disadvantaged over time. And at the time, their competitors hadn't failed yet. They grew a lot of their operations were more mediated by, like, I'd call it tribal knowledge and culture. And so, silly example, but a real one.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's a role at the IRC inspection and reconditioning center for receiving trucks, taking the cars off the trucks, putting different cars on the trucks and sending the trucks on their merry way. This sounds simple enough, but it's a lot of trucks and it's a lot of cars. And there's this question of where do you put the cars and what order do you put them on the trucks in?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And by the way, if one of them doesn't start, what do you do? And how do you staff this operation? Because it turns out fetching a car in a 6,000 car parking lot, it's not like walking down the street and getting a car, right? And all of these...
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
things and you know if someone's done it well and sort of smart they can kind of figure it out and they can do a pretty decent job um but as you scale you're putting people into roles who you know may not be as good at this and um in 2021 in retrospect for the first time the business kind of in part because of covid in part because of the growth the businesses kind of reach outstripped its grasp from a process maturity perspective now in 2022 there's a software system
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I went to a place called Silverpoint for a year. And then from there, I went to UBS, where I spent five years before I started my business. And while I was there, that was really where I think I did a lot of my maturing. And I thought a lot about, I'd come from a lending and finance background. And at UBS, I was involved in trading, investing in stocks, trading in stocks.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the software system tells you, this is how many people you need at these times of the day. And this is where you're going to put the cars. And here's your protocols. You're going to have a starter, like a jumper. You're going to keep it here. And this is how you do this. And it turns out that this set of protocols
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
locally and globally optimizes better than even the best people, but also makes sure that everybody, so it takes the best people, makes them better, and then takes everyone else and makes them almost as good as the best, right? That software had never been written, right? Because this was just not a function that someone had ever bought.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Because think about how hard, that's in and of itself what I just described is a fairly meaningful like project, right? Before 2018, before 2019, I should say, the company bought almost all of its cars at auction. So the flow of cars was auction to IRC to customers. Starting in 2019, the company began buying cars in the public. And this has been a wildly successful thing.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They make a lot more money doing this. But it turns out that when you do that, you create the potential that if you buy more cars than your... If you have a node in your system, an IRC, it's possible, unless you've thought about this, for cars to accumulate at a node. You can be buying more cars than are leaving that system, or more cars can be transiting in than are leaving.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And if you have finite amounts of parking, this can create congestion, right? And what had happened, what interestingly what happened for the first time in 2021 or so was the buying cars process became really successful. And they were buying more cars. For the first time they were buying.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so now suddenly they had this shift in the logistics system, sort of reduce the, flip the direction of net flow. This is fine. You just need to build a bunch of things to change it. But like this is an example of the sort of thing that was happening all at the same time. A lot of this was covered up in 21 because they were hiring to beat the band.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so when you have excess staffing, it kind of covers up a lot of blemishes. As you get into the end of 21, the first indication that something was wrong was, you know, slightly weak November. And then Omicron happened. Their whole system became a disaster. And the reason is that if you think about cars like a series of events that have to happen one after the other.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
if let's say you have a truck and the truck goes out 250 miles, switches with the driver and comes back. Well, if that driver calls in sick, like how does that truck route continue? Okay, so now you have nine cars that just got stranded somewhere, right? How do you get those cars moving again? And now this happens all the time, but like if this happens a lot,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
you overwhelm your ability to clear these things. And now you have cars piling up in basically giant traffic jams throughout their whole system. And then your delivery times that you're promising on your website have to get way extended because you just can't. So your sales come way down.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Which, if you haven't had a system before where you could accidentally buy more cars than you're selling because that's never come up, Now suddenly you have a problem where like you're buying cars, they're accumulating the system, you know, and you don't have your flows to your logistic system haven't been optimized for this. So the cars are piling up everywhere. You're sort of shuttling cars.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
This is what the system looked like in January of 2022. It was total wreck. And they were trying to fix it. And, you know, it took them a few months to do it, like three, six months or whatever to fix this. But the important fact is that it obscured demand, which was falling off a cliff. Underlying demand was falling off a cliff.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And it meant that they were still behaving in February like demand was as it had been in September, even though by that point, in retrospect, demand had materially declined. Yeah. they bought Odessa using tech. Odessa was, just describe what Odessa was. Sure. So Odessa is a traditional auction business.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
UBS at the time, it was their proprietary investing business. It was the bank's own capital. Think of it as a hedge fund with 1LP. And it did a lot of the traditional things that I think a lot of hedge funds do. There was a lot of focus on short-term performance.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I think a large lot, people bring car dealerships, fleets, they bring cars, and they hold in-person auctions. You drive them down a lane, people bid. The in-person auction business will have a long tail to it, but it's eventually a decaying business over time.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But what they got with Odessa is 54, I believe, very large, centrally located properties on which they can build IRCs and store facilities. One of the challenges in their business had been that it turns out they worked out that it is better for them to have large IRCs located relatively close to the customer, because fast delivery speeds are good. Access to labor pools is good.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And those are more important than the benefits of being far away. But it turns out that getting 200 acres zoned for auto industrial within 10 miles of downtown Boston is difficult, to say the least. It turns out this is the sort of property that Odessa had. And so they basically bought it for the commercial real estate.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It came with the auction business, which has a lot of benefits to them as well. And makes all the sense in the world. In retrospect, it's been a huge home run. But they bought it with all that. They bought it in February of 22 after, if you read the proxy or whatever, they've been talking for years. It just happened the timing was bad.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So what happens is you get to March and they sort of realize that they have a demand problem. And I haven't really addressed what was going on that caused the demand problem. So there were, as far as I, my best understanding is there were three things. Although at the time I pretty much only sort of knew about two of them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And it's worth pointing out that all of these things, they kind of got worse and worse and worse and worse and worse over time. So you thought you'd identified it. And then like six months later, it was like worse. So the first, there were chip shortages. during 2020 and 21, which caused manufacturing shortages and caused used car prices to rise.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There was a desire to have, yes, we want things to be misvalued, but we want to have a bunch of catalysts that are going to cause the price to go up. There was a lot of trading around events. There was a lot of hedging. And Um, as I was involved in that, there was sort of an effort to teach me how to do it. And it, I, I didn't like it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You think about the used car business as facilitating people swapping cars. But what happens oftentimes when people are swapping cars is they're upgrading. And so if prices are higher, the cost of upgrading is greater. And that tends to reduce people's propensity to swap cars. As a consequence of that, the used car industry, which is typically about 40 to 42 million cars a year,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
it was about 39 and change in 2021, fell to about 36 million cars or 34 million cars. I think it got as low as 34 annualized and sort of did 36 for the year or something like that. I might have my stats slightly off, but it fell.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And this doesn't seem like a huge negative effect, but it was bigger than you might realize because what happened was franchise dealerships, I think you're Ford or Toyota dealership, when a lease vehicle is returned, unless the customer exercises their buyout, the landing dealership, the one you return it to, gets the car at a price that's been set at the time the lease was created.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so when car prices rise, if the... lease returning person, of course dealership has no incentive to tell them that they have the right to buy the car, doesn't know this, which many people haven't read the fine print of their leases, and they return the car. The dealership gets basically a really cheap car. What this turns into is a big subsidy for franchise dealerships.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And those dealerships would then turn around and sell this car. It would look to them like a big profit, but was actually really cheap relative to wholesale prices. But what that's doing is putting enormous pressure on non-franchise dealerships who don't have access to the super cheap inventory. Oh, by the way, that's us. We're a non-franchise dealership.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so the best example to understand the magnitude of this is CarMax. So if CarMax... In the Great Recession, CarMax briefly saw nearly a 20% decline in comp store sales for a few months. And then it was back up to low double digits. CarMax's comp store sales were down 20% for the whole year in 2022. And they, by the way, still haven't recovered. I think they've clawed half that back.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The reason was in part because cars are more expensive, and interest rates also made cars more expensive. And the other thing was this weird effect where franchise dealerships were being unusually competitive because they had access to this unusual source of cheap supply.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So as a starting point, you had the biggest decline since the Great Recession, including the Great Recession, bigger than the Great Recession, in the number of used transactions at an independent dealership, which is a rough place to start. To make matters worse, that was the used vehicle market. Carvana was facing that.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The second thing that happened, when interest rates rose, the sort of naive thing you would think, which is certainly what I thought, was it wouldn't matter all that much to Carvana. OK, so interest rates will rise. That could affect the overall market a little bit. It will probably affect car prices a bit, so the depreciation curve of a car.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But in the end, people's propensity to swap cars shouldn't change that much. And yes, to Carvana's financing business, they just finance spread off of rates. So whether rates are 1 or 4 shouldn't really matter that much. And that's totally correct. And that's exactly where we got to. But there was a catch. You see, what I didn't know.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You see, what I didn't know was that when rates would go up, so the auto finance markets made up of a bunch of credit unions and small banks and then a bunch of larger banks who compete and then independents like Carvana who compete. The credit unions price their loans, I mean, it depends on the credit union, but like off of deposit rates or off of Fed funds or off of a, you know, a napkin.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I sort of discovered that, you know, they would sort of say, well, we should, we should do this and do this. And I'd sort of say, well, why? And that doesn't make sense. And, you know, I don't know why this stock has a three beta. Why do I have to, why do I need to short $3 of S and P for every dollar, you know, of stocks we're going to buy here? That doesn't make any sense.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The two-year went up and Fed funds were low and deposit rates were low. And the credit unions, and when I say the two-year, it's worth pointing out that the average duration of a pool of auto loans, including prepayments and defaults, is about two years. So the two years are a reasonable proxy for the appropriate kind of risk-free benchmark.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So in late 21, as the two-year goes racing up, as people expect Fed funds to rise, all these competitors just didn't raise rates because they didn't. There's no academic reason why they shouldn't have. They just sort of didn't. And then even as Fed funds began to rise, they were super slow.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, I remember there was a long period of time where like Navy Federal was offering car loans at a discount to the treasury of the comparable duration. And this is a big problem for us. This is funny, except for the fact that we have to compete with this every day.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Industry-wide, auto loan spreads by late 2022 were at the lowest levels in the whole time series I have, going back to before the crisis, before the financial crisis in 2008. And it was a wild time for that to be the case because every other consumer credit spread was wide for a whole bunch of really good reasons. And the underlying auto collateral was the most kind of overpriced it would ever be.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So auto loans should have been really expensive on a spread basis. But instead, they were at their all-time tights. And the reason was that there was just all these dumb competitors. And then you'd call these – we did research into what was going on. And you'd be like, well – Our asset liability management committee meets like once a quarter.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then we try not to raise rates more than like 25 bps at a time. And then it takes us 60 days to implement the rate changes because our systems, blah, blah, blah. And you're just like, but guys, like...
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Right. This is definitely not in the textbook. But so the problem, so CarMax, they just ate it. They just originated at low spreads. And then the next year, and even to somewhat, it's getting better now. But if you look at their financials, you can see they paid for it a year or two later, but they ate it at the time. They sacrificed a bit of the future for the present.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Carvana was not in that position, right? Like we, you know, the company needed the money. So Carvana had to price to reality. And That meant that Carvana was in the market with loans that were like meaningfully more expensive than competitors, which did not help. And to just put this in context, Capital One also pressed to reality because they're smart.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They saw their auto originations fall 50, five zero percent. So Carvana is dealing with both of those things. The other thing, which I think is more subtle, but I also think is true, has to do with early adopters. And to explain this, I need to go back and explain a little about how Carvana grows.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And this led to like a really vigorous debate. between me and some of my former colleagues there. And to their credit, I mean, I was young and incredibly difficult to have as someone working for you. And I just hounded them about it. And eventually this debate went on and on and it became pretty clear to me that I was right.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And this is the part that I was least aware of at the time, but I've done more work on and I've come to understand a lot better.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Carvana, if you think about a market like Connecticut, Carvana has, I don't know exactly how big Connecticut's fleet total used vehicle inventory is, but let's say that Carvana has something like three quarters of all the inventory, including Carvana's inventory in the state of Connecticut, just to make up a number. One might ask why we don't have like three-quarters of the sales.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Because they probably have, I don't know, Connecticut sales out of my head with like 100%, something like that. And so, you know, the first thing you might do is throw out, okay, well, there are some cars that are there in California. There are shipping fees. There's delays. Like, let's only look at cars that are nearby. And so you cut that inventory down.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then you might say, well, let's throw out people who haven't heard of Carvana. It turns out they have like 80% awareness, but we'll throw out some people. Okay, let's reduce some half of people say they don't want to buy a car online right now, although the number is gradually falling.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But like, let's throw out, you know, that half, you're still left with a number that's way higher than where they are. So like, where are the sales? And also weird is, okay, you go into a market, you have all this huge inventory, this great product. Why does it take all, you know, why do sales kind of ramp like this as opposed to just like step function? Like what is delaying people adopting this?
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I didn't have a great answer for that for a long time, but I kind of thought it was word of mouth. I was kind of like, you know, I think it just takes time, word of mouth. And my evidence for that was that if you surveyed
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
people who bought from Carvan asked if they recommended it to people I think it's something like four they would recommend it to four people on average which is an enormous like you know number viral thing yeah and so that's where I'd left it but as you know in the sort of wreckage of trying to figure all this stuff out you know I started thinking harder about this
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And it occurred to me that I'd never done two things which seem obvious in retrospect. One was I'd never asked people how important this word of mouth was to their decision to buy from Carvana. So we added to the survey something to the effect of, did you get a recommendation from a friend or family member? How important was it?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And we found that 70% of people said that it was either somewhat or very important in their choice to buy from Carvana. Therefore, only a third of people were buying from Carvana without the recommendation of a friend or family member. And once I saw that, that got me thinking, I wonder what's going on with this third of people who are buying without the recommendation.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So that convinced me there's virality. But what's going on with these people who are buying without the recommendation of a friendly family member? And my theory was, well, they're early adopters. So we survey people who bought from Carvana. We ask them questions like, do you have a Robinhood account? Have you ever owned Bitcoin? You know, do you do online grocery shopping?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the answer is like, of course I do all these things. Like, you know, all yes, yes, yes. They're way higher than non-carbonavirus. So now I can say, look, many people won't do it unless someone says, okay, some people will just give it a plunge, right? And in general, the more early adopter-ish you are, the less nudging you need from relations to do it. And that's what drives the growth curve.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It also gets us back to 2022. You see, back in 21, Let's say that you were the sort of person who had a Robinhood account. And you might have speculated in some SPACs and some cryptocurrencies. You might have had a windfall. And you might have thought, you know, look, this isn't like billions of dollars. This is thousands of dollars, tens of thousands of dollars maybe.
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Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You might have thought that given your windfall, you were going to go buy a car. And you might have thought to yourself, since you're the sort of person who owns like SPACs and cryptocurrencies and shops online, obviously the place you were going to buy a car was Carvana.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I was naive enough to think I would just explain to them that I was right and they would just do it differently. Further occurred to me that they couldn't change. And they couldn't change because they had a principal agent problem. The problem was that they had to deliver steady profits to the bank. And if they had big drawdowns, that they would lose their money.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Now, you may or may not have actually bought that car at Carvana because Carvana was sold out and they might not have got what you wanted. You might have gone somewhere else. But here's the deal. you pulled your demand forward. So from Carvana's perspective, even if this is, like Carvana in 2021 had like 1% share.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So even if this 0.3% of the market, this does not have to be a lot of the market for Carvana to feel this enormous demand pull, which they definitely saw. And it also means that you roll forward a year and all these people are in the exact opposite position. They've just had the opposite of a windfall, whatever you call that, sort of unexpected loss. Decimation. Yes.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the year before, they all just bought a car. So turns out from Carvana's perspective, although none of us sort of realized it at the time, this isn't great. So I think that was the third contributor that was unique to Carvana. So you have these three, you've got the overall market is down more than the great recession. You've got the tightest auto credit spreads ever and you can't match.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And you have this unique thing where you kind of all of your sort of bleeding edge customers bought last year. And you just bought this big asset with a bunch of debt. And you just bought this big asset with a bunch of debt. And it turns out that you're learning that like a bunch of your processes. Like eventually, I always sort of thought that Carvana would have bumps in the road operationally.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But it turns out they're all now.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And none of that was totally obvious at the time. There were bits and pieces. You're kind of learning as you go. The rate stuff was pretty clear. The market stuff was pretty clear. The stuff I described, but all this data comes at a lag. It was all in a cloud of uncertainty. And then you do what Carvana has to do, which is you start cutting.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And one of the things that's glorious about this business is that as it gets bigger, it gets better. And size begets size. It's just a virtuous cycle. But here's the thing. When you cut that a lot because of all this stuff, that all runs against you.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So you slash advertising, you slash inventory, and then external demand gets even worse, and you've reduced things that drive down demand further, and they were like chasing a ball down a hill all year long. And Ernie told you the story on your podcast about kind of how they got better organizationally at focusing on efficiency and how they kind of learned their way into it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And look, the reality is, is like, The sort of 10,000-foot telling of the story was they were OK getting more efficient between March and November of 2022, and they got really amazing at it after November of 2022. It took them six months to figure it out. That's fine. So I lived through those six months.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
like i just described it um it felt like a very long time and for context it's by far your biggest position you know absolutely by far it's my biggest position and you know didn't help that nothing else i don't seem to be doing well at the time either you know by the time you get to the fall of 22 um demand just keeps going away. And they hadn't, by that point, caught up on costs to fix it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so, you know, I started poking around quietly looking for another place to work. And I realized that so did all the other firms. in the industry had the same problem. In fact, it's endemic. Basically, one might naively think that the investing business is about maximizing performance, but it's not. It's about maximizing marketability.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So everyone at this point, not everyone, but there was a narrative out there, look, the problem is it doesn't work. The problem is they're trying to get the profitability, but they can't do it. If they keep cutting costs, they can't. They said, okay, in May, there's operational plans. Okay, so I'm gonna re-underwrite everything. And it's like, I think they can do this. This makes sense to me.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And they have a lot of liquidity to make this work. Fast forward six months, they've burned a lot of liquidity. They're way behind, right? And now at that point, you're like, well, if next year looks like this year, we're going to run out of money kind of in 13, 14 months. You'd ask, well, is that going to happen? You'd say, well. No, I don't think so. I don't think so.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I think they're going to fix it. I think the union economics work. And by the way, this crazy thing with the credit markets is going to end at some point. And I'm sure Navy Federal isn't going to give away free money forever. But then you'd say, yeah, but of course, I never thought Navy Federal would be giving away free money for nine months.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I thought it was going to be a few weeks before they noticed that interest rates had changed. I never thought that they'd have so much trouble chasing demand this far down. And so At that point, that was when it was the most challenging part of the investment. Because at that point, you did have to put on the table. Ernie would say, look, we're cutting costs and we're burning cash.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And as our costs go down, eventually we'll be profitable. But as to the pace of that versus the cash burn, reasonable people could disagree as to whether we'll get there in time, which is super reassuring. And then what happened was they got much faster at cutting costs. the banking system discovered that interest rates had gone up. And that really helped.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And sometime instead of January, February of 23, instead of chasing demand, it looked like they were restraining it. And you can see that because if you think about delivery lead times on the website as a line. you can see how long the line is to get a car. You could see that the units were steady, but the lines were longer, if that makes any sense. Then rates,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
fixed themselves and the industry is seen, you know, as car prices, manufacturing improved, car prices ground lower and over time, you know, unit volumes have improved, you know, industry-wide a bit, although they're still pretty low. And they succeeded in cutting a lot of costs and, you know, and got to the place they are today, which is, you know, that everything worked.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And performance is a component of marketability, but really what you're trying to do is signal talent. And the way you do that is by finding things with short feedback loops, with low amounts of noise, so that you can sort of show people, look, we did this and it worked, and we did this and it worked, and we did this and it didn't work, but on average, we win.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Oh, I forgot to mention, because everyone thinks the whole story is they got this deal with Apollo. Yeah, so basically, along the way, one of the levers they had to pull was putting their lenders in a prisoner's dilemma. So you have bondholders, and you basically say, look, we might not be able to pay any of you. But the first person who accepts less gets paid first.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And if your documents are written, you can do that the right way. If it's written the right way, you can do that. And they were. Um, and so they ended up negotiating this new secured loan structure and people converted their debt into new debt, which is safer, uh, more higher priority at a discount.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Um, and that whole exchange happened in the, in the summer of 23 and a lot of sort of the retelling of the stories. And by virtue of that exchange, they like saved the business. By that point, the data I was looking at said that everything was great. Um, that was just kind of like... you know, the cherry on top because that saved them a ton of money in terms of interest expense and debt.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But it was not by any stretch the thing that turned the business.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There are stupid questions. I would have sold all of it at the peak and bought all of it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I knew the issues they were having logistically in Q1. Like I could see it. And when I say I could see it, like we look at a lot of data on the website. So I knew that Omicron was an issue. And so the disappointing surprise was that as Omicron kind of cleared up, you know, it was like I was waiting for like some units to come out of the system. I was like, why are they not selling any units?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It was kind of clear there was a problem, but then the stock had thirted. And it went down, the first sort of most of that thirting was because things were really bad during Omicron. But until you realize that there was a deep demand problem, that seemed like the sort of thing that happens in markets when you have a short-term operational hiccup. And it was only once demand didn't
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
kind of recover, that you're like, uh-oh, something's wrong. But by then, prices go down so much, you're kind of like, well. I didn't actually buy any the whole way down to there. And the reason was just, it was a big position, and I generally don't buy more of things that are over a certain amount of the fund. And I was sort of waiting.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the type of investing I was thinking about, basically buying a piece of a company through the stock market and owning it for a long time, these are multi-year, 3-, 5-, 10-year feedback loops that are incredibly noisy, and they just don't lend themselves to it. And if you think about it practically,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It was kind of like, well, if it gets below that, I'll buy more. If it doesn't, it's fine. And then I bought a bit more after that. But by then, something was off, so I kind of didn't buy a lot. And then they came out with this operational plan and they did this issuance at 80. And I thought, okay, they'll fix this. This is it. So I bought a bunch more.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then the stock went all the way down to 20. And in that intervening period, I'd gone out to visit them again and I'd gone through the whole operational plan with them and tried to basically do a blank sheet of paper underwriting. And I convinced myself that this would work. No, Clifford, you weren't a moron. Yes, the stock was down 95%. But this was okay and they'll be fine.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
They're going to sort it out. But I realized at that point that... There were more kind of deep operational fixes in the business than I'd realized. And so my thinking at the time was like, they should be fine. I'll buy half now and I'll buy half when I can see it turn.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And in order to see it turn, what I'm going to do is we work with a third party consulting firm that basically does like analytics, like, you know, web scraping and database, you know, go get credit card data and match it and blah, blah, blah. And so we're like, okay, we're going to just go, we're going to instrument the heck out of this in a way.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
We already were instrumenting it somewhat, but we're really going to turn our attention to focusing on instrumenting this. And we're going to focus on the things we think we're going to see first when we see the turn. And when we see the turn, we're going to know, and maybe we'll have to pay a little bit more, but that's when we buy the second half of the stock. And that was May.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I bought the first half. And I think it was sort of in the mid-20s was where I ended up getting kind of most of it. And so I bought some in the 80s, some in the mid-20s. And just mentioned like 100 in the 80s and mid-20s. And then we started instrumenting and we started writing. And things just get worse and worse and worse. It's like every marginal data point was worse.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I remember the week after Thanksgiving, sales always fall off on Thanksgiving, and then they always come back the week after. It's always a little lower because of seasonality. And it was like sales fell off during Thanksgiving, and then they just didn't.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And like, you know, you're living this in real time, right? You're just like, what the heck? And so I was really glad I hadn't bought the second half. But at this point we had things pretty well instrumented. And, you know, we had all this rate data, which I hadn't had in the beginning of this process. We had just a lot, like a lot of ways to capture how cars move. There's just a lot.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So then, you know, the year ends. They put out this poison pill. And... The poison pill basically said that anyone who owns over 5%, which was like me and like two other people, can't buy more stock. And they had very good reason to do this. The reason is they had big NOLs. And there's IRS rules having to do a turnover.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Let's say that I meet with someone from an institution, and first of all, and I convince them that I've got this. They're gonna say, how do you pick stocks? I'm gonna say, well, I think really hard. And they're gonna be like, okay, cool. I'm convinced Cliff thinks really hard. He's good at this. But then they have to go back to their committee.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And if there'd be too much turnover amongst the 5% holders, then they would have destroyed the value of those NOLs. the way they repriced it. If a certain amount of turnover happens, they repriced the NOLs based on your market cap. So the market cap was super low, and the NOLs could turnover, and there'd been a bunch of turnovers, so there was a risk they were gonna cross some threshold.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so they put this poison pill in, which made all the sense in the world for them, but it was not particularly helpful for me. But, you know, to be honest, my initial reaction was like, well, that's annoying. But I wasn't planning to buy any right now anyway. Right.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But then as fate would have it, you know, six weeks, eight weeks later, I'm looking at all of my data and like it's all green shoots. And I'm like, darn. That wasn't what I said. It was a different word. And so I tried to reach out to see if they could make an exception. But, of course, you know, they can't, all that stuff. So we ended up not being able to buy anymore.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Now, I should say when I made the decision to buy half now and half later, I promised myself that I wouldn't beat myself up. I said, listen, Cliff, you will be a happy, successful person if you write about this, whether you buy this other half or not. So it's all good. And so I'm still telling myself that.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I'll talk about how it was super miserable, and it's pretty easy to imagine how it was super miserable. But it is worth just making a point. We were not fighting the Japanese in the Pacific. It sucked, but in the realm of human experience, I've lived a blessed life. I would say one way to think about it is there were two versions of me.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There was the me who you spoke to, who I think would sort of cogently say, well... There's this weird thing going on with rates and it can't last forever. And when it gets better, I think this will get better. And there was the me who was laying awake at night at 1 a.m. who was just kind of like, you know, my inner voice was not being kind to me. And I've always thought of myself as a person.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I think I am sort of naturally one of these people who has pretty good control over his inner monologue. And it was the first and only time in my life where I like lost control of my inner monologue. Like I, you know, would lay awake at night. I never lose sleep over monologues. things. I sleep and I would lay awake at night and I would, you know, fret and berate myself.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And it's super hard to live like that. But, you know, like again, it didn't have terminal cancer. I wasn't fighting the Japanese in the Pacific. Like it was, you know, within the realm of human experience. But like it is super difficult. And, you know, you've partners that you've let down. Right. And I mean, I say you've let them down as though you've let them down. Like, have you let them down?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And the committee's going to be like, well, how does Cliff pick stocks? And he's like, well, he thinks really hard. And they're going to be like, well, you know, that's not very credible. And then even if they do make the investment, now, you know, they're going to own it. And so invariably, we're up, we're down, we're up, we're down. I look smart, I look dumb.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Like, your view of the world is that maybe you haven't let them down. It's just like, this is just a very big wave. But, like, then your partners would, you know, some, like, you got different responses. You know, I had some smaller partners who are no longer partners who, you know, were mean.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But, like, I had other, you know, partners who would very sensibly and totally appropriately, like, want to grill me about it. But that grilling didn't, wasn't, like, mean. It was totally reasonable. But, like, it didn't come from a place of confidence, right? You know, we'll eventually get to people I'm grateful for. But there was one partner who drove, you know, a long distance.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
to have lunch with me. And it turns out that was the only reason they drove this long distance. And we get to lunch and it's like, this is not going to go great. These meetings haven't been going my way recently. And we sit down and he goes, Cliff, I'm just here to express my and everyone I work with's view that you're awesome. And, you know, you're going through a lot.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I'm just here to say, like, you're great. We support you. Let us know if we can be helpful. But, like, we're Team Cliff. And I didn't cry, but I was like, wow. What a thing. And he's like, Neil, look, we're here for lunch. I drove here just to meet with you. We can talk about investing. Yeah, we can talk about other things. I don't really care. But this is what we're doing.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I was just like, wow. And so that would be the other thing. To that day, and I think it makes me a better person because I remember how that affected me. Like the other day, there's a CEO in a company I'm involved in. He's wrongly getting a lot of crap. from really dumb investors. So I wrote him like, I sent him like a hug. Like I sent him like a nice, like a really nice email, I think.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
As nice as I could write it. But I think it makes me a better person to be on that side and to hear it and remember. So in terms of other things I'm grateful for, that would be another one. But you've let people down and you internalize that. And there's also this weird thing that happens where like,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
When you own a stock that's down 30%, you know, okay, here's what's wrong, here's what we're going to fix it, blah, blah, blah. When it's down 99%, like, so, you know, someone meets you and says, like, what's up with Carvana? And you're like, well, I'm aware that last year I thought they were going to sell 800,000 cars, and they're on track to sell 300.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And along the way, they're going to be like, why did we do this? And by the way, we have a board that we're reporting to. And like, we're down this quarter because Cliff thinks really hard, apparently. This is just a really challenging setup. What this means is that When I started this, I wasn't fully aware of quite how challenging it would be.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I'm also aware that last year I thought they'd make positive EBITDA this year, and they're on track to lose $2 billion. And I'm also aware that the stock is down 99%. But what I'm about to say is I think things are going to be okay. And you can see how that makes you seem like you've lost the plot. And there isn't a good way to say that that doesn't make you seem totally nuts.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Because basically, you say all that and they're like, oh, you denial bull market baby. And so that was another real tricky thing. There was no good way to... And there was, at some level, deep uncertainty because things had gotten bad enough where I couldn't be like, look, I'm 100. I couldn't be like, yes, yes, we're fine. I was like, look, things are way off course, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And for reasons I never would have predicted. And so how do you have that meeting, right? And then how do you have the 30th version of that meeting, right? Because you do these over and over, right? And then, of course, you leave that meeting and you've sort of done it. And then you drive and the stock's down another 8%. And you're going to the gym and you're like, particularly, whatever.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You sort of try to manage yourself and then you can't sleep. It was really hard. I'd rather not go through it again.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But the premise was that I would start a business based on really focusing on long-term compounding, finding a relatively small number of stocks, treating it like owning a piece of a business, dealing with the volatility that comes with it. And I figured it would be maximally optimized around returns and minimally optimized around marketability.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
One thing I mentioned earlier was the importance of management teams. Like if I rank things instead of how they ultimately turned out over the full span, the management teams were wildly predictive of outcomes versus my expectations. So that's like a practical learning.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Another is that in general, I have a new and deeper appreciation for how much harder it is in reality to go from unprofitable to profitable.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
than it is on paper and like i that you know i everyone like i feel like that's kind of trite but like this the thing is you do this analysis you're like okay this is you know the margins and blah blah blah and like it all makes sense but like now i've seen this like play out like up close over and it's hard like it's so hard it's so much harder than it looks and so i think my it's not that i won't invest in loss making companies but like my
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
willingness to underwrite to that is just adjusted. There's like a base rate adjustment that's more salient for me than it was before. I have less of an interest, I should say, in investing in businesses that have narrower Because like life will throw massive curveballs at you.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And like, you know, there's sort of an interesting point, which is like if you'd asked me why I owned so much Carvana back when it traded for like 300 back in 2021, I would have said this is an incredibly stout business. People do not appreciate how stout this business is. And in retrospect, I was right.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The world threw three once-in-a-generation curveballs at these guys at the same time while they were having all kinds of internal problems that don't happen that often. And they added debt and whatever at the same time. And they did it. They got through it. So it turns out it really was that stout. But had it not been that stout, had these sort of advantages been –
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If this business all grown up and super great was a 5% margin business and not like a 13 or 14% margin business, I'm not sure they'd have had the wherewithal to make it. So I have a greater, like my sort of just my reaction to companies where, yeah, like it works, but there's just consumer surplus isn't that much and the advantage isn't that big, but like pencils, it's just kind of like move on.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Yeah.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And I think certainly on the marketability side, we nailed it. And so that's where we are. But I wouldn't change a thing. It's how I'm built. So that's how I am.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's made me re-question that. Well, I think on the one hand, you know, one of the things that I have said to people who've asked me about this is sort of like the lessons from this period are... important, but it's a teaspoon of medicine, not the whole bottle. So on the margin, I'm less interested in loss-making companies, but I'm not excluding them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
On the margin, I think there's probably room to be a little more diversified. But, you know, like we've had a lot of success over the whole history of the fund up to through and including, you know, this period, that success was because of how we did things. And if I were to
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
have thrown out the concentration over the whole life, I think we come out in a worse place, albeit maybe with less volatility. And so the lesson is, yeah, on the margin, there's room to be more diversified probably, especially if you factor in the idea that you might have some companies that are less stout. But a teaspoon of medicine, not the whole bottle.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Yeah, you should ask someone really smart about that. And here we are. I'll tell you a few thoughts on artificial intelligence that are super narrow because, you know, some world is big and complicated. And, you know, I think maybe one of the lessons of 2022 is that you don't know a lot. I find this super helpful. I use various AIs every day.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, in particular for businesses where there's a lot of information on the Internet. Right. So if you're studying Medicare Advantage or Medicaid managed care companies, you know, let's take Medicaid managed care. There's think tanks and government reports and RFPs. And you could fill a room with the materials that are on the internet and you can't possibly read all of it.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And most of it's kind of boring anyway. But these things can. And so then you can ask it questions like, okay, who won... you know, the RFPs, did the incumbent win or did the entrant win for Medicaid RFPs in the last 50 RFPs by state? And like, what were the major qualitative factors identified in the, you know, decision that like drove each one, make me a table, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that's a ton of work and, you know, it takes two seconds with an AI. So I think that in the playing field of life, it advantages someone like me who works, you you know, fairly independently. I don't have like a giant team in investing. Um, you know, as to whether these, like right now, an enormous amount of information is not in the internet, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So if I were to grill an AI about all things like Medicare, Medicaid, managed care, it knows a lot. If I grill it about Carvana, we pretty quickly run out of stuff. Like this interview will get in there, but, you know, most of what I know about Carvana
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I've learned from a lot of thinking, a lot of talking to people who used to work there, a lot of data scraping and other things that just aren't in the internet yet. And so the tools, if you spent a bunch of time trying to learn about Carvana from an AI, I don't think you'd get very far.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
That being said, over time, maybe they have agents that are able to gather information, put it into the internet. Maybe the internet, this bulk corpus information in the internet gets bigger because more stuff is put in there in other ways. And of course, these tools are only going to get better.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I launched with $5.2 million. The old-fashioned way. It was $2 million from me because I'd been successful at UBS and they'd paid me. I like to joke it was a lot for post-crisis, not a lot pre-crisis. And I also got $2 million from my mom. She was a sympathetic audience. I had one million from a friend and it was, at the end you always ask people who they're most grateful to.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
When AIs get to the point where they can make investing decisions, there's probably not a lot that's pretty far down the spectrum, I think, of things that they would require doing.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
um it gets it's kind of like asking about the singularity it's like yeah you know i sometimes i'm grateful that i've had a chance to sort of do well you know before um before all this happened because um you know it might be hard to do well after all this happens if i reflect on um the future sort of big picture i mean i people used to ask me what my macro opinion was and they always meant like interest rates and gdp growth and i always always give them some version of something like look i
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I'm fully confident that my great grandchildren will marvel at my poverty. Unless they're all dead, but hopefully they won't be. I think these tools make it all the clearer how we're going to get there, especially if quantum computing happens, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The ability to create synthetic data with real world simulations using quantum simulators and then to train the eyes on that seems like a wildly interesting tool.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, the US is an amazing system. I think there's a lot of reasons for that. I mean, I tend to think about the idea that there was meaningful selection effects in the people who chose to migrate to the US versus the people who chose to stay behind.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And that probably led to us having, you know, the US having a gene pool that, you know, an aggregate is selected for people, the sorts of people who will create businesses and be sort of independent minded and get on a ship and travel to an unknown land across the other side of the sea for a better life. I don't see that changing in any deep way.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But I don't necessarily think I've invested in the US because it's such a great place, per se. I think I've mostly invested in the US because I always use the following example. You talk to some investor, and they're telling you about their British restaurant investment or something. And you say, that's so cool. It sounds like you really know England really well.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Why don't you tell me three places you could buy a power drill in the UK? And they sort of, like, realize that they don't know, right? And there's just an enormous amount that you learn about a place by being there. And so it's not that I could never invest outside the U.S.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's just that, like, I'm keenly aware that, like, overcoming a certain degree of naivete is very, very hard, even for some places seemingly close as, like, the U.K. And... And so I just think that the US is an enormous market. There's lots of interesting things to do. And someone will pitch me some Chinese stock. And I say, that's fascinating. I'm sure it's going to be great.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I'm going to put it on the bottom of my list right after all the American stocks. That served me well. I'm sure I missed all kinds of stuff, but we got to pick our lanes.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I had two in mind and he's one of them. I'd known him for years and we talked and he's a very successful person and I had this meeting, it was like my second marketing meeting ever and I sit down and he basically is like, I'm absolutely gonna give you my dollars, no problem. And I was like, wow, this is gonna go great. The next time I saw a check like that, you know, it was years.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I have a fairly boring view like everyone else. I think for the average investor, an S&P 500 ETF is a great way to go. Maybe an all-market ETF or whatever. But I've certainly looked at all these big companies. They are great for a reason. I've certainly thought at times that they represented good to even superior returns. It's just they've never kind of...
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
I mean, one of the hardest parts about my job is, like, I sit around and I study all these things, and I find plenty of things where, you know, I said a joke, in the $100 billion portfolio, there's definitely room for that. But we don't, you know, we're not managing $100 billion. And as it is, you know, the opportunity cost of selling A to buy B doesn't work.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So the hardest part about this, one of the harder parts about my business, about my day to day, is spending a lot of time on something, getting to know it really well, concluding that it's a great investment, but just not quite as great as the other thing. That's frustrating. And there have been times, I remember back in 2010, a friend of mine put it really well.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
There's Google sitting there, looking all cheap.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
right and you know he was right uh but thank goodness i didn't buy it because i think the things i owned you know did better but um not all of them so you know i wish i could have picked the worst thing i had but like that's not how life works these are great businesses um if i ever you know retire um i imagine i'll like i'll stop thinking about stocks and diversify and i'd own them and if i had a someone who wasn't you know if my mother wasn't invested in my fund i'd you know tell her to
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
you know, buy that. But, you know, there's a lot of businesses I don't own. The key isn't to understand everything or to pick the even to pick the very best one. The key is to pick a bunch of things, a handful of things that you know well and, you know, are going to do well and watch them closely and don't worry too much about all the other stuff.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I had the two that I mentioned earlier. One was the guy who, right when I was starting my fund, invested in it. And I didn't quite appreciate at the moment just how rare that was. But it turned out to be a major kind of event that played a big role in me ultimately having some success.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then the other one was, you know, in 2022, that partner who went out of his way to just come and, you know, basically buck me up over lunch, you know, didn't have to do it. What a kind thing to do. I mean, and you think about how, I mean, I'd lost the guy to fortune. Right? At least on paper, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And not only did it make me feel better at the time, but I think it's made me a better person because I can reflect on that now and try to make sure that you've got a management team. Things are not going well. like, what are you going to do? On the one hand, you have an obligation to understand, so you have to ask questions. But on the other hand, like, they're trying, right?
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
Even if they're idiots, they're trying, right? And so, you know, it's important to sort of remember how I felt then and how I was treated by different people and like how I want to treat people. And so maybe a better person.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then it was a couple hundred thousand from some other people that I knew. Started with that. And, you know, over the years was sort of able to kind of steadily bring in a little bit of money here and there and compound and was fortunate. You know, I've had up years, I'd have down years. If you changed the order of the years, get to the same place.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
But I definitely wouldn't have raised any money. So there's also a meaningful component of luck.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
So I don't remember exactly how many investors we have. It's sort of between one and 200 across a few different vehicles. And the firm moves around every day, but sort of between a billion and a half, too.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
The premise was always... You know, let's find a handful of businesses that are publicly traded where I can buy a piece of that business in the markets and own it with a premise of owning it forever. And then own it until basically I find something that I can upgrade that I think is even better. Or I discover that I've misunderstood the business in the first place.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so there's two ways out of the portfolio. One is that the gap between what I think – I find something better so I can upgrade. Or the other one is that I have some view as to what makes a business successful. You can think about like a mental model of kind of how the business is competing and winning in the ecosystem. And that makes predictions about the world.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then you get real-world data and you can compare the real-world data to – to what your predictions of your mental models are. And if you discover that your predictions aren't lining up, then you need to update your role to model. And it might be that you need to throw it out. And at some point you sort of realize you don't know which way is up anymore.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And then that would be an investment that you would jettison because you just no longer know. Over time, We've sort of had kind of between like, we'll call it four and eight. It might have been as many as 10 at one point, but that's kind of the number of investments. We tend to, over the course of time I've been investing, I think on average, I've sort of bought and or sold one thing a year.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
It's a pretty sort of lethargic pace of turnover. It's this idea that like businesses compete and win in certain ways. There's sort of a minority of investors. businesses that, you know, once you sort of figure them out, like you can just tell, like they're going to be very successful relative to other similarly priced businesses.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so, and we can talk, there's a lot of like mental models and stuff, like ways that I think businesses can be sort of a taxonomy of businesses that I've sort of think about. But those are just, you know, my ways of understanding a really complicated world and sort of trying to find a few things that work.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
If you think about it, in most markets, you shouldn't have a lot of profits, right? Like profits are kind of a fluke of some sort of something about the setup that makes it so that some reason why competitive forces can't drive economic profits to zero. And those reasons, I mean, there's sort of a lot of them.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And in terms of how to think about them, I gather different examples from sort of microeconomics, from psychology, from business history, to try to understand different ways that companies have carved out a piece of the world where they are advantaged. And then they can, you know, you can think about a company's profitability over time as kind of its market opportunity times its advantage.
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
And so the, what, you know, I mean, I don't think there's anything particularly exciting about like what makes a great business. It's you generally want to have,
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
um you know multi-threaded advantages a lot of things working for you that are very hard for your competitors to replicate um you know you want to bring a lot of value to your consumers you want to you know um you want the things that are working for you to be generally invariant um with time as tech as society evolves and changes and when you kind of have all those things lined up um you should be able to
Invest Like the Best with Patrick O'Shaughnessy
Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
You know, have high returns on capital, reasonably good margins, you know, all those things that grow, all those things people look for. You know, of course, everyone knows everything I just said. And so, you know, the whole game is to identify the ones that other people, you know, have missed for one reason or another. And, you know, it's really important.