Cliff Sosin - Investing in Carvana - [Invest Like the Best, EP.421]
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Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. If you enjoy these conversations and want to go deeper, check out Colossus Review, our quarterly publication with in-depth profiles of the people shaping business and investing. You can find Colossus Review along with all of our podcasts at joincolossus.com.

Patrick O'Shaughnessy is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To

To learn more, visit psum.vc. My guest today is Cliff Sosin. Cliff is the founder of CAS Investment Partners, a fund he started with $5 million in 2012 that's now $1.7 billion. This conversation is different from our typical episodes. We start by talking about Cliff's investment philosophy, but the bulk of this long discussion is a case study into his remarkable investment in Carvana.

Cliff is one of the biggest investors in the business, which had a market cap of over $60 billion in 2021, then fell 99%, survived, and now has a market cap approaching $50 billion again. While I hosted Carvana's CEO, Ernie Garcia, last year to get the inside perspective on managing through such turbulence, today we hear the investor side of this extraordinary story.

It is a singular episode and a rare opportunity to hear a major investor describe his decision-making process at every stage of a volatile journey. Please enjoy my great conversation with Cliff Sosin. Cliff, I'm so excited to be able to do this with you. I've been asking you to do this for at least three to four years, something like that. So I don't know what made you capitulate, but it's an excuse to talk to you about investing in general and some very interesting specific episodes that you've been involved with specifically.

And I think we got to start broad because I want to set the context for everyone that doesn't know who you are or what your setup has been. Maybe just give us like a history of how you started the firm. What was it, 2012, something like that? Why you started the firm and kind of what it's been since. 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, you know, an Edison in my mind or something. But

But when I went to school and I studied engineering, you know, a lot of inventing is kind of obsessively debugging like real things. And nature is pretty unforgiving. And so what I learned about myself was that I didn't love that process. It just wasn't as fun for me. And so I was sort of casting him out for what I wanted to do. And I ended up doing an internship at a big private equity firm. And I just thought it was really neat that I could use. And I discovered I could use a lot of these tools.

things I'd been learning in school, like game theory, apply them to these situations. And that brought novel insights that these people who've done this for so long weren't using. And I was hooked. The idea of 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. 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 Hooligan Loki, which is a leader in financial restructuring. And I did that for a time. I still wanted to get to the buy side. So I went to a place called Silver Point 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. 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 one LP.

And it did a lot of the sort of traditional things that I think a lot of hedge funds do. There was a lot of focus on short-term performance. There was a sort of desire to have, yes, we want things to sort of 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 as I was involved in that, there was sort of an effort to teach me how to do it. And I...

I didn't like it. I sort of discovered that, you know, they would sort of say, well, 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 the three beta. Why do I have to, why do I need to short $3 of S&P for every dollar, you know, of stocks we're going to buy here? That doesn't make any sense. 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, right? Yeah.

And I just hounded them about it. And eventually this debate went on and on. And it became pretty clear to me that, like, I was right. Like, you know, 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. 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.

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. 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, three, five, 10-year feedback loops that are incredibly noisy, and they just don't lend themselves to it. And if you think about it practically, let's say that I meet with someone from an institution and

And, you know, first of all, you know, and I convinced them that like, I've got that they're gonna say, like, how do you pick stocks? I'm gonna say, well, I think really hard. You know, and they're gonna be like, okay, cool. Like, I'm convinced Cliff thinks really hard. He's good at this. But then they have to go back to their committee.

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. 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, you know, when I started this, I wasn't fully aware of quite how challenging it would be. 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 running 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. 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. So what did you tell your original investors? Because

Some people gave you money, including some well-known institutions. What did you tell them and why were their decision-making processes different? And how much did you start with? 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, you know, at the end you always ask people who they're most grateful to. He's, 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, 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 going to give you my dollars. No problem. And I was like, wow, this is going to go great. The next time I saw a check like that, you know, it was years. 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

I 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.

But I definitely wouldn't have raised any money. So there's also a meaningful component of luck. And where does that bring us today? So how many investors do you have? What's kind of the capital base? Like, how do you think about the firm today? 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. What is your view of investing and markets? Like, describe how you think it is supposed to be done in some detail. The premise was always...

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. 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. And then you get real world data and you can compare the real world data 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. 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. It's a pretty sort of lethargic pace of turnover. It's this idea that businesses compete and win in certain ways. There's sort of a minority of businesses that once you sort of figure them out, you can just tell they're going to be very successful relative to other similarly priced businesses.

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 my ways of understanding a really complicated world and sort of trying to find a few things that work. - Yeah, so I guess like the obvious and very simple but very big question is like, what is a good business? Like what is that taxonomy? Maybe this is the time to talk about one of my favorite ideas of yours that you like businesses you described as contained. I've always liked that description when we've talked about companies.

Yeah. Give us your kind of view on what makes a good business. 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, you know, competitive forces can't drive, you know, economic profits to zero. And those reasons, I mean, there's sort of a lot of them. 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. 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

multi-threaded advantages, a lot of things working for you that are very hard for your competitors to replicate. You want to bring a lot of value to your consumers. You want the things that are working for you to be generally invariant with time as society evolves and changes. And when you kind of have all those things lined up,

You should be able to, you know, have higher 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, it's the emperor. I think investing is the emperor of activities in the sense 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. 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 a deep understanding of why meat prices are what they are.

But in investing, you know, it is wildly accountable. 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. 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. Say why you like this idea, what a contained business means and what an uncontained business is and why you like to avoid them. 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. 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's 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. Once you sort of understand everything immediately around that, other changes outside of the – that are sort of happening feel less relevant. Would like software tooling be a good example? Yeah, that would be a great example, right? So, you know, I –

Who knows how people are going to write software in 10 years? Like for what? For quantum computers? And it's just like you might have a business today. It's like building a castle on sand, right? Like 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. 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. But like 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. And so, again, investing is this incredibly challenging endeavor where you're dancing on the knife set. You're looking for these things that, you know, like 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. Give us an example of the process you go through to explore a contained system. You're coming across a new company for the first time. You

you want to start to learn everything. What is your method for doing that? And I recognize that like to some degree, this is like an obvious answer. You talk to people, you read stuff, you think about it. I always love these moments where you get like some new click of understanding and maybe you could tell the story of one of those clicks of understanding or something from the investing history. 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 Cournot 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. 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. 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, 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 of the time.

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. 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 asked myself the question, should I make one more cookie? 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, uh,

all of my cookies at a slightly lower price. 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, I lower the price for me. I also lower the price for my competitor. I don't internalize the effect on my competitor. 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 will solve our differential equations at the same time. We get to an equilibrium and lo and behold, we end up, we both end up making profits. Okay, this is all very theoretical. So you start studying the cruise line industry. Okay, 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. 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 a 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, OK, this is a business where –

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? 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

of are you in equilibrium or did people accidentally bring too few let's say let's say you show up at the fair and you brought a tray of cookies and it rains well now cookies price of cookies plunges and you lose money right 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 premium so you know are you at equilibrium is another you know good question but it turns out that like a lot of travel businesses are you know a corno oligopolies um

You know, rental cars, air travel, cruises. 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 corno oligopoly. 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 corno oligopoly. And it's also a good one because elasticity of demand is... Demand is very inelastic. Turns out nobody said like,

You know, I see the price of man lifts is down a hundred 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 a hundred bucks this month. I hope that got to your question. 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. 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. And so you're looking for, you know, relatively sort of technological change invariant advantages and layered and interwoven that kind of give you the business. And then from there, you know, I have a friend who jokes that...

a good value investors 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?

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. If I was thinking about how you would spend your time, it would seem to be incredibly valuable to collect models like this over time. Do you find your way to most of them through a specific business? Which comes first, the business or the mental model? 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, you know, I hired a Stanford professor to assemble all of the economics modules.

models in all of the courses in Stanford and then just like walk me through all of them to make sure I hadn't missed any. And I picked up a few that I'd like, you know, missed or forgotten about. I would try to read broadly, like, you know, then of course you study companies and one after the other and for in various companies, it'll sort of like click for you. That's something, you know, that's something that's happening. To drive home the point, can you do one more like the Cornell Oligopoly just to give us like a flavored sense of like another thing that you've used in the past? Secondary reinforcers.

So this is just a different place. This is out of psychology. It turns out that there's like 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, you know, mammals something that stimulates their reward systems, um,

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 what makes that interesting is that it turns out that the strength of these secondary reinforcers is proportionate to the

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 you do the pleasure sensors get stimulated. So, you know, 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, you know, 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 can create these associations 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 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, you know, Coca-Cola.

And then you'd probably have coffee. And then you'd probably somewhere have like candy. And then you'd have like sugary sweets, like, 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 the pleasure people's like, you know, pleasure systems?

Well, in the case of nicotine, you know, 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. Not only, I mean, if you ever watch smokers, they're not only smoking the same brand, they're smoking at the same time, in the same place, like 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. 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.

you know, soda has sugar and caffeine. It goes through your stomach, so it's slower, but it still creates a fair bit of, um,

you know, the association isn't that far, isn't that far apart as you work. You know, then you get to things like cookies there, the cookies mixed with fat and stuff. So it slows it down. The sugar is mixed with fat and stuff. So it slows it down even more, but it's still pretty potent. It's a, it's obviously a sweet, um, you're working way farther down. You get to your savories or whatever here, you know, yes, these are things people really like, but like the, the sort of stimulation is much weaker. Uh, it's more time lagged. Um,

And as a consequence, people, they have a preferred tomato sauce, but in the end, there's much less brand loyalty than, say, a cigarette. Obviously, water, other than if you think about brands that are more status-focused. But if you think about just a bottle of water, I don't think in the end anyone's that

uh, picky. And I guess the valuable thing in markets would then be that markets don't properly value that insight. Like if you look at Philip Morris, at one point it was the best performing stock in us history or something like that for like decades and decades. So it would like corroborate this idea that it's probably like a valuable insight, but at some point it gets priced, like, like insights all get priced. And so maybe that's what you're talking about earlier, which is you need a confluence of these things to,

in an area that's been neglected to find an interesting opportunity, something like that? Yeah, you need something that scares people away. You know, I think the, you know, the example I gave it, 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. They just have observed that in practice, these are very brand little businesses. Um, however, you know, sometimes things come up and, you know, there, there were, um, I was involved in a, in a nicotine vaping company, um, which was reasonably successful and ultimately acquired by a large, um,

tobacco company. In the early days, it was not, you didn't have necessarily all this evidence that these were going to be really great businesses. 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. And there's opportunity costs 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, you know,

like intellectual construct gave them a sense that like that zinn was going to have a lot of brand loyalty um you know where at that time you know it was sort of unproven um

And Zin, of course, has been proliferated and there's a lot of brand loyalty. But that wasn't obvious. At least it wasn't in the historical data until – so these were – all of these tricks, they're not useful until they are, I guess, would be kind of the way to think about it. If you think about the classical ways of –

finding edge in markets. It would be informational, which seems kind of gone. Analytical, which is a lot of what we're talking about. And then I'll call the last bucket like structural or behavioral or something like that. What do you think about ESG? It comes to mind because of the nicotine examples where there's just a class of investor that's not allowed to own it, which creates like a weird impact on markets, especially if those asset owners are very large. What do you think about ESG?

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. 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. 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. That's a really fraught thing because like what, you know, sort of what gives you this deep understanding

wisdom about what's right and what's wrong that is better than the collective will and unjudgment of society. And by the way, maybe you'd say, okay, fine, I'm not going to use my judgment. I'm going to use my investor's judgment. But then the question becomes, okay, well, but which investor? And how do you weight them? Equally? Is it by AUM? What if it's an institution? Do you poll the underlying people at the institution? This is a wild thing. I think

I think a much better approach is to just say that the goal is to maximize returns. And obviously, in doing that, companies have to comply by the law, you have to comply with the law, and you have taken the change in norms into account.

But laying any sort of further ethics onto that. And then, of course, you maximize your trends. People can, of course, take that money and give it to whatever charity, you know, they feel that they want to. And I think that that's sort of the only solution. It's like a

The only solution that I think kind of resolves this problem that isn't fraught. I've noticed in my career that, you know, people in investing circles, they talk a lot about like panics, right? 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. And, you know, you can buy into moral panics much the way you can buy into economic panics. And, yeah.

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 or rulemaking change that can hurt the company. 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. 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. But, you know, electricity is pretty good. 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 sort of elasticity of price concept. And I'm not that, I think the literature on this kind of agrees with me, but I don't think that like

groups of investors deciding to forego certain asset classes like oil companies necessarily cause them to be like 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 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 skinned. It's more of a panic people get scared like oh no You know this company is gonna get shut down because you know this group this group of people view it as terrible and they're gonna try to kill it I think now's a great time to tell devote a long block of time to your investment in Carvana. I

I think people that know you and your firm's history will certainly associate you with the position. It's been an enormous position for you over time. You're one of the biggest investors in the business. And for me, one of the reasons I've asked you so many times to do this is that let's say dating back five or six years now,

I've had the chance to talk to you about this company through its many ups and downs. And it's been one of the most interesting educations that I've received from another investor on investing, just talking to you every so often about this company and what you're thinking about it.

And so I've been lucky to enjoy that, you know, the audience of one. And I thought it would be an amazing opportunity to hear you tell the story, which is very complicated. It's a complicated business story. It's a complicated investment story. Your own story about how you were going through it all is interesting and complicated. There's all sorts of dimensionality to it. You were joking that it's like five rivers coming together. You kind of have to explain each river, but we have the luxury of time here. So I don't know how best to start

with which river maybe you can pick. But I wanted to devote like a lot of time and I'll have lots of follow-up questions because I just think like you can go look at the Carvana price chart. You can listen to my two conversations with Ernie. Like there's lots of, there's lots of stuff out there about Carvana. But the thing that I find interesting is the investor's perspective as the person that probably had the biggest position held onto it, bought more has been with it the longest and,

You sort of had the most holistic perspective on it. And I want everyone to benefit from what it's like to own and live through one of those episodes. Sure. And part of the reason I actually that almost all the reason I said yes, more than all the reason I said yes to coming on is that it is 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, I

that it would get forgotten. And it is such an interesting story. I think it deserves to be memorialized. I also think it's sort of wildly misunderstood in terms of what happened to Carvana in 2022 and 2023 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...

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. 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. 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...

Especially now that we've laid the groundwork for how you sort of apply ways of thinking to understanding a new company. And so maybe even make it specific to you. Like how did you encounter it? What were some of the models that, you know, felt relevant to you as you tried to learn about the business and use that as a way to introduce like how the business works? 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.

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. And I'm going to own a lot of this, provided like 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 when you're in my business, you you're waiting for your stocks to go up. 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. I'd also looked, obviously, who hasn't studied Amazon and read the Everything Store. I'd also studied logistics companies. And I'd also looked at manufacturing companies and all the rest and software companies. And so it turns out that Carvana is all of these things. As they were explaining the business, it was clear to me that the

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. And by being great at all of these things, 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, 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. 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 to have someone pick up the car or you can for a small fee or you can drop it off at one of their hubs and, you know, get your money. And the transaction takes no time. Everyone gives them five stars. Doing that's hard.

Right. Like 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 like 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 build

figure out what you want to offer in order to maximize the profits from this lead and to do it all for every car on the road all the time across the country. It's 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. 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

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. 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. The sort of insight there, which Ernie had, was if you want it 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. Mobile. Mobile, Alabama. It's just no volume.

And so the car 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.

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 are moving, can move continuously between these spots. And what that does is, you know, if a truck travels, you know, 40 miles an hour on average and, you know, costs like $3 a mile to travel, then you can work out what the costs 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. 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 as a bunch of different stations that do a bunch of different work that's relatively homogenous. 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 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. Sure. Right? So the car will go from the IRC it's at to the IRC closest to the customer along basically the rails.

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,

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. 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 like no one else is. And it's also very hard to get into these businesses as well. There's title and registration. 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 Claire Vonet.

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. That's kind of how the system works. Now, in that whole system, like let's identify some economies of like scale. Inventory. Turns out selection matters. Matters a lot. And inventory.

If you think about all the makes, models, trims, years of cars, as well as mileage, the selection space is massive. And Carvana's coverage, even at its size, is still relatively small. And so as a consequence, conversions go up as selection goes up. So selection is like big economy scale. Everything's dark. Yeah. Logistics. The cost of running a logistics system, you can think about moving these trucks as a fixed cost. Yeah.

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. 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 does all the, one guy or gal does all the repairs. 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. 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 like an expensive place. And so you have less overhead. So like these are just examples of places, but there's economies of scale to doing that as well as enormous like 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. Title and registration, there's software that's built to run all this. So there's enormous economies of scale and skill in terms of being able to do all these things. And then 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 an act of trust. We can talk about how Carvana grows. 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. 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

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? So 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. And, you know, this is, it's this combination of things. And if anything I've said sounds easy, it's because I haven't described it right. Like, it's so hard. And so that's why everyone who's tried to build this business besides Carvana has failed. And that's why it's taken Carvana, you know, over 10 years and $10 billion to

to get where it is. And outside the US, there were other people trying to copy Carvana in other markets.

You know, 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. Just to pause on the, on just like the concept of combining skill, scope, trust, you know, traditional economies of scale of different types. Is there another business that comes to mind? Maybe it's Amazon that you think,

all these same things that has interested you through time just to like draw a comparative point for people. I actually love the comparison to Amazon. There's a famous, there's a video I saw once, I don't know if it's famous, 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, and, um,

And people can pay for the books. Well, imagine if... 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. 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 know, 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 like accept MasterCard, right? You had to build a financing platform. And Lord knows you can't just sell the person the book. You have to do title and registration, right? And all that.

And, you know, 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, you know, they're disappointed, but it's okay. Car is the second largest purchase of your life. And so you can imagine how, like, that is also really challenging. And so in the sort of fulfillment sense of it, I think, you know, used vehicles are probably the hardest purchase.

uh thing um to build in uh but the analogy to amazon actually i think is uh is apt i've interviewed ernie a few times i'll you know my bias is that i i think very highly of ernie and he's a much maligned figure because of everything that's going on with carvana and it's just it's so fascinating to me to hear all the different like rashomon style parts of the story

So I'll put out there that I think very highly of Ernie based on what I've known. I haven't studied the business like you at all. I don't own Carvana. Like I don't have a dog in this hunt financially, but I think it's important to say a little bit about management. And maybe it's also an excuse since I haven't asked you yet to talk about how you think about management as it relates to certain businesses.

And where you fall on the spectrum of like leadership is everything to like the Buffett ham sandwich, you know, concept of a business that's so good that a ham sandwich could run it because someday someone will or one will. So talk about Ernie, the management team behind the team behind Carvana and kind of your philosophy on management and investing. 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, okay, Cliff, I get it. You don't care, but like rank them anyway. And I'd rank them.

the teams that I was involved with, I would like my, that ranking would have perfectly predicted how, how like things did relative to my expectations at the time. So what I learned there was two things. One 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. Like that is in the end, the right thing, a great team with a terrible business is, is going to be a channel. It's going to be a slog. There's just no two ways about it. Um,

By the way, just to go back to your contained versus uncontained point, that's another idea. 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. So you want businesses, so a contained one would be one where once it's, set it and forget it's the wrong term, but there's 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. I don't care that this is a business that will perpetually throw up hard problems. I'll buy it anyway. Okay.

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. It turns out all the people who become CEOs figured out how to sound great. You know, I learn a little bit. And 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. 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, you know, a company which spits off people who worked there for 10 years, left on good terms, who you're just like, I don't get it. Like, this guy's an idiot. Yeah.

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 talk to – go talk to 10 former employees who spent at least five years at Capital One. They'll blow your mind. That tells you something about what's going on at Capital One. And so I find that that's really the best approach. As to earning, 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. There's a reason why they've succeeded where, you know, nobody else in the world has been able to, um, you know, succeed. And I'll also add that, like, I I'm aware obviously of his dad's history, you know, with the savings and loan crisis. And, um, you know, this is, um,

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. It's just, it is wild to me that people then take- What, his dad? Yeah, people take that fact. They're like, therefore, this company is a fraud. And it's like, oh my God, this is the guy who was a billionaire. What was his plan? To make a few billion more but send everyone he loves to prison? This makes no sense to me. 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 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 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

He's assembled a 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. 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

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, which

And he's very deliberate about things like that. All right. Now we get to talk about the tough part of the whole story and experience. What went wrong with the business? Just tell us the whole story. Like what it was like to be one of the larger investors in the business as this was going wrong. What did you do? How did you second guess yourself? What was the psychology like? Like I'm interested in all aspects of it. 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. 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 like it didn't, you know, we couldn't see it like 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%, you know, percent-ish and rising. And they'll probably get to the 13, 14-ish percent range based on what they've said. And there's no reason to doubt it. And the average car dealership's about 4.5%. So they make of the order of 2.5, 3x the margins of their competitors. And we track every car that they sell and we compare it.

It's a similar car sold by CarMax, we also compare it to other market indices. And we believe that they sell cars of the order of sort of $500, $600 cheaper doing that. 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. 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, right? 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. 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 is like 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. Right. Right. 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. 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. 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. 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. 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

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. 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 just do internal operational stuff. It's interesting. The company had been growing year after year.

Circa 100%. 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 looked at the overall rate, star ratings, they had great reviews. It was like, well, you know, it's a big organization. They're growing really fast.

To think about it, if you're doubling every year, less than half of your employees on average have been with you for less than a year. This is wild. They also had deliberately prioritized speed and growth over necessarily slowing down and really hardening their processes.

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. 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? 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 is like – it's not like walking down the street and getting a car, right? Yeah.

you know, all of these 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 know, 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. And the software system tells you, like, 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, right? And this is how you do this. And it turns out that this set of protocols...

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. That software had never been written, right? Because this was just not a function that someone had ever bought. Because think about how hard, that's in and of itself what I just described is a fairly meaningful 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 public. And this has been a wildly successful thing. 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 of 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. 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. And so now suddenly they had this shift in the logistics system, sort of reduced the flip the direction of that 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.

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 a car as like a series of events that have to happen one after the other.

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, how does that truck route continue? Okay, so now you have nine cars that just got stranded somewhere. How do you get those cars moving again? And now this happens all the time. But if this happens a lot...

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. 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 you're buying cars, you're accumulating the system, and you don't have your flows through your logistic system anymore.

haven't been optimized for this. So the cars are piling up everywhere. You're sort of shuttling, you're shuttling cars. And 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 it took them 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. And it meant that they were still behaving in February 2020.

Like demand was as it had been in September, even though by that point, in retrospect, demand had materially declined. They bought Edessa using debt. Edessa was, just describe what Edessa was. Sure. So Edessa is a traditional auction business. So I think a large lot, people bring...

Car dealerships, fleets, they bring cars and they hold in-person auctions. You drive 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. 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, 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 their commercial real estate. 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. 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.

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. 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. 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, 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. 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. Mm-hmm.

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. 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. 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 like a few months. And then it was sort of down, like back up to like low double digits. CarMax's comp store sales were down 20% for the whole year in 2022. And they, by the way, like still haven't recovered. I think they've sort of clawed half that back. The reason was in part because cars are more expensive and interest rates also made the cars more expensive. And the other thing was this weird effect where franchise dealerships were being unusually competitive, you know,

because they had access to this unusual source of cheap supply. 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. 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, right? Okay, so interest rates will rise. That could affect the overall market a little bit. It will probably affect car prices a bit, sort of the depreciation curve of a car. But in the end, people's propensity to sort of swap cars shouldn't change that much. And yes, to Carvana's financing business, you know, they just finance a spread off of rates. So whether rates are, you know, one or four sort of 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

This is where the 99% part comes from. 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. 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-year is a reasonable proxy for the appropriate kind of risk-free benchmark. 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. And I remember there was a long period of time where Navy Federal was offering car loans at a discount to the Treasury over 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. 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. 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. And then we try not to raise rates more than like 25 bips 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. It's kind of like when oil goes negative. Like this is not supposed to happen. 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. Carvana was not in that position, right? Like we, you know, the company needed the money. So Carvana had to price to reality. And, yeah.

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. They saw their auto originations fall 50, 5-0 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.

And this is one of these, 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. Carvana, you know, if you think about a market like Connecticut, Carvana has, I don't know exactly how big Connecticut's, you know, 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. Because they probably have, I don't know, Connecticut sales out of my head, but like 1%, 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's shipping fees, there's delays, like let's only look at cars that are nearby. And so you cut that inventory down,

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. The number is gradually falling, 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? 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

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.

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, you know, like, did you get a recommendation from a friend or family member? How important was it? 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, you know, once I saw that, that got me thinking, like, I wonder what's going on with this third of people, you know, who are buying without the recommendation. So that convinced me there's virality, right? Like, you know, 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, like, Bitcoin? Right?

You know, do you do online grocery shopping? 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-garvanavirus. 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 adopterish you are, the less nudging you need from relations to do it. And that's what drives the growth curve. 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. 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. 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. 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. 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

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, like I sort of, but you, turns out they're all now. Yeah.

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. 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 like stuff, that all runs against you.

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. And look, the reality is like...

the sort of 10,000-foot telling of the story was they were okay getting more efficient between March and November of 2022, and they got really amazing at it after November of '22. It took them six months to figure it out. That's fine. So I lived through those six months.

It did not feel like I just described it. It felt like a very long time. And for context, it's by far your biggest position. Absolutely. By far, it's my biggest position. And, you know, it didn't help that nothing else seemed to be doing well at the time either. You know, by the time you get to the fall of 22, demand just keeps going away. And...

they hadn't by that point caught up on costs to like fix it. 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 there isn't, they can't do it. If they keep cutting costs, they can't. They said, okay, in May, this operational plan is like, okay, so I'm going to re-underwrite everything. And it's like, I think they can do this. This makes sense to me. 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? He's like, well, no, I don't think so. You know, like, I don't think so. I think they're going to fix it. I think the unit economics work. And by the way, this crazy thing with the credit markets is going to end at some point. And like, I'm sure Navy Federal isn't going to give away free money forever. And

But then you'd say, yeah, but of course, I never thought Navy Federal would be giving away free money for like, you know, nine months. Like I thought it was going to be like a few weeks, right, before they noticed that interest rates had changed. I never thought it would take them this long, you know, 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, like you did have to put on the table, like Ernie would say, look, we're cutting costs and we're burning cash.

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. And sometime instead of January, February of '23, instead of chasing demand, it looked like they were restraining it. And you can sort of see that because if you think about delivery lead times on the website as like a line, you can sort of see how long the line is to get a car. And you could see that like the units were steady, but the lines were longer, if that makes any sense. Yeah.

And then rates fixed themselves and the industry is seen as car prices, manufacturing improved car prices, ground lower. And over time, unit volumes have improved industry-wide a bit, although they're still pretty low. And they succeeded in cutting a lot of costs and got to the place they are today, which is that everything worked.

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. 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.

And so they ended up negotiating this new secured loan structure and people converted their debt into new debt, which is safer, more higher priority at a discount. And that whole exchange happened in the summer of 23. And a lot of sort of the retelling of the story is, 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. 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. But yeah,

It was not by any stretch the thing that turned the business. Can you talk about your investing decisions? Because during that period, like every day is kind of a decision, like not selling is a big decision as the information comes online. What did you do? Like, did you buy more? Were there constraints on how much you could buy? Would you have done anything differently in hindsight? Like what were the frictions that obviously wouldn't buy more in hindsight?

Stupid question. I would have sold all of it at the peak and bought all of it. Very stupid question. I think you know what I mean. Like, what were like the real, walk us through like the psychology, the barriers, the like, you know, the real hard stuff. 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? Why are they not selling any units? 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 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, you know, like 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 then something was off. So I kind of didn't buy a lot. And then they came out with this like operational plan and it did issuance at $80,000.

And I thought, okay, like this is the fix. This is it. So I bought a bunch more. And then the stock went all the way down to $1.

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 and they're going to sort it out.

Um, and, and so, um, but I realized that that point that, um, there were more kind of deep operational fixes in the business. Um,

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. 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, um,

And so we're like, okay, we're going to just go, like, we're going to instrument the heck out of this in a way. Like, we already were instrumenting it somewhat, but, like, we're really going to turn our attention, like, 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, you know, we're going to know, and maybe we'll pay a little bit more, but we're going to get – that's when we buy the second half of the stock. And that was May. So I bought the first half, and I think –

um instead of in the mid-20s was where i ended up getting kind of most of it and so i bought some at 80 some in the mid-20s um and uh just mentioned like 180 in the mid-20s and then um and then we we started instrumenting and we start waiting

And like things just get worse and worse and worse. It's like every marginal data point was like worse. I remember I, you know, 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 like just didn't. It was just like, what the heck? Yeah.

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. 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, and if there's too much turnover amongst the 5% holders, then they would have destroyed the value of those NOLs. Because 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 turnover, so there was a risk they were going to cross some threshold. 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 to be honest, my initial reaction was like, well, that's annoying. But I wasn't planning to buy any right now anyway. Right. But then as fate would have it, six weeks, eight weeks later, I'm looking at all of my data and it's all green shoots. And I'm like, darn. That wasn't what I said. It was a different word. Yeah.

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. 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. So 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. And...

So say a little bit about the range of psychology and maybe like how close you got to thinking, you know, just really deeply questioning yourself. Like you're one of these investors that typically knows when I've talked to you about companies, you've known more about the company than anyone else I've talked to about that same company. And that's always been the case with Carvana. Yeah.

I think that was true prior to the 99 decline. It's probably true today. But even despite that, even though you knew so much, it's sort of like the Navy Federal Credit Union X factor thing. Like, how are you wired? Like, how distraught did you get? I'll talk about how it was super miserable. And like, it's pretty easy to imagine how it was super miserable. Yeah.

But it is worth just making a point. Like we were not fighting the Japanese in the Pacific. Like it sucked, you know, but right 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. 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. 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 fret and berate myself. And it's super hard to live like that. But again, it didn't have terminal cancer. I wasn't fighting the Japanese in the Pacific. It was within the realm of human experience. But it is super difficult. And you have 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? Like, your view of the world is that maybe you haven't let them down. It's just like, this is, you know, just a very big wave. But like, then your partners would, you know, some, like, you've got different responses. You know, I had some smaller partners who are no longer partners who, you know, were mean. But like, I had other, you know, partners who would very sensibly and totally appropriately, like, want to grill me about it. But you, but that grilling didn't,

It wasn't like mean. It was totally reasonable. But it didn't come from a place of confidence, right? We'll eventually get to people I'm grateful for. But there was one partner who drove a long distance 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. And we're just 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, you know, we're we're Team Cliff. And like, I didn't cry, but I was like, wow, what a thing. And he's like, look, we're here for lunch. I drove here just to meet with you. We can talk about investing. Yeah, we can talk about everything. But like, this is what we're doing. And I was just like, it was 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. 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, when you want to stock this down 30%, you know, okay, here's what's wrong. Here's what we're going to fix it. Right, 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. 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. Okay.

And you can see how that makes you seem like you've lost the plot. Yeah. And there isn't a good way to say that that doesn't make you seem totally nuts. 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 a hundred, like this is like, I couldn't be like, yes, yes, we're fine. It was like, look, things are way off course, right? 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

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%, right? And you're going to the gym and you're like, particularly, whatever. 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. I'm so glad we did the long version of the story because...

whether or not people care about this specific stock. I just think like as an investing and business story, it is very singular. I said this on the Ernie episode,

We looked because he gave me that stat about going down 90% is like going down 20%, 20 times or something like that. And each one's painful. There really is not another example of a company that was that big by market cap or something that went down 99% that survived and like wasn't a fraud. Like it, it, it, like it doesn't, that's an N of one. It doesn't exist in the record. And so it's so cool to hear its major investor talk through the entire thing from soup to nuts.

And I guess in conclusion, I'm curious how you think you will most approach future investment opportunities differently as a result of having had this specific experience personally. 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. Another is that in general...

I have a new and deeper appreciation for how much harder it is in reality to go from profitable – from unprofitable to profitable than it is on paper. And like, you know, everyone like – I feel like that's kind of trite. But like 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 willingness to underwrite to that is just adjusted. There's like a base rate adjustment that I'm that's more salient for me than it was before. I have like less of an interest, I should say, in investing in businesses that have narrower capital.

Because like life will throw massive curveballs at you. 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. Right. Like the world threw like three like 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 like, you know, whatever at the same time. And they did it. Like 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 there?

If this business all grown up and super great was a 5% margin business and not a 13% or 14% margin business, I'm not sure they'd have had the wherewithal to make it. So I have a greater... Sort of just my reaction to companies where, yeah, it works, but the consumer surplus isn't that much and the advantage isn't that big, but pencils, it's just kind of like, move on. Has it made you think any differently about...

your appetite for concentration. Just like I think of that old quote, like the only rational deployment of our ignorance is diversification. Yeah. And that like, it's not ignorance so much. It's just like the Navy Federal Credit Union factor, like that stuff happens in the world and a simple way to protect against that, you know, the idiosyncratic math of like, whatever, at 15 positions, the risks all gone. And like, why not have 15 positions instead of five? Like, has it made you re-question

that stuff? Obviously, your portfolio is the answer to this question. So maybe the answer is no. But curious what you think. 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. On the margin, I think there's probably room to be a little more diversified. But we've had a lot of success over the whole history of the fund up to through and including this period. That success was because of how we did things. And if I were to

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, like 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 like stout, but

But a teaspoon of medicine, not the whole bottle. Well, it's an incredible story. I'd love to take our remaining time and talk about the world and the future and investing kind of writ more large. One of the things I think we're allowed to talk about IQ again, which is why I'll frame the question this way. If you think about like the world's stock of processing power in human brains, right?

some measure of the number of people with a certain amount of processing power, plus how efficiently they use that, or if they use it productively, or if they just play video games or something.

And then we think about the introduction. There's a question about the introduction of artificial intelligence into the world, which I'm curious for your take on generally, but I'm also more specifically curious for your take on the introduction of intelligence and processing power into the job of investing, of like ingesting information, looking for stuff that overlaps, training on past pattern recognition and what's worked in businesses historically.

And if we fast forward 10 years or something, what it's going to be like for even a very smart human to

to invest in a world that is full of artificial intelligence. And I'm just curious, I haven't talked to you about this before in such specific terms. I'm just curious for your take on the whole thing, how you've processed watching it unfold in the last couple of years and how you think it'll affect this job. 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 will be super helpful. I use various AIs every day. 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 need, you could fill a room with the materials that are on the internet and you can't possibly read all of it. And most of it's kind of boring anyway. Um, but you know, the, the, the, these things can. And so then you can ask it questions like, okay, like who, who won, you know, the RFPs, uh,

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. And that's a ton of work and, you know, it takes two seconds with an AI. So the, I have, I think that in the playing field of life, it advantages someone like me who works, you know, fairly independently. I don't have like a giant team in investing. Yeah.

You know, as to whether these... Like right now, an enormous amount of information is not in the internet, right? 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. This interview will get in there, but most of what I know about Carvana, 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, you know, these, like if you spend a bunch of time trying to learn about Carvana from an AI, I don't think you'd get very far. That being said, you know, over time, maybe they have agents that are able to gather information, put it into the internet. Maybe the internet, this bulb corpus information, 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.

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 they would require doing. It's kind of like asking about singularity. It's like, eh, you know. I sometimes am grateful that I've had a chance to sort of do well before all this happened because, you know, it might be hard to do well after all this happens. If I reflect on...

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, I am fully confident that my great grandchildren will marvel at my poverty. Um,

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? Because the ability to create synthetic data with real-world simulations using quantum simulators and then to train the AIs on that seems like a wildly interesting opportunity.

Your portfolio is, I don't know if it's entirely, but it's been historically mostly US companies. If I think about the US, you've got all these incredible advantages. We're the home of innovation. We've got this incredible geographic isolation and abundance here domestically. Our currency has been the reserve currency of the world. We sort of control our own destiny in those ways.

Any observations just about like the U.S. as the what historically has been the most fertile soil for finding great investment opportunities and kind of the modern era and whether or not that is changing one way or the other? You know, the U.S. is an amazing system. I think there's a lot of reasons for that. I mean, I tend to think about the idea that, you know,

there was meaningful selection effects in the people who chose to migrate to the U.S. versus the people who chose to stay behind. And that probably led to us having, you know, the U.S. 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, you know, 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, you know, changing in any deep way. But I don't necessarily think I've invested in the U.S. because it's such a great

I think I've mostly invested in the US because, you know, I always use the following example. You talk to some investor and they're telling you about their like British, you know, restaurant investment or something. And you say, that's so cool. It sounds like you really know England really well. 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. Right.

And so it's not that I could never invest outside the US. 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 UK. And so I just think that like the US is an enormous market. There's lots of interesting things to do. And, you know, someone will pitch me some like, you know, Chinese stock. And I say, that's fascinating. I'm sure it's going to be great. I'm going to put it on the bottom of my list right after all the American stocks. Yeah.

That served me well. I'm sure I miss all kinds of stuff, but we got to pick our lanes. I think it's so interesting and funny that lots of the big investors out there have gotten to the position they're in owning Microsoft and Amazon and these exciting big, like no one gets faulted for this. And we're talking about used cars and subprime lending and things like this. I used to own multi-level marketers too. All right, of course.

And it's just so interesting how many different ways there are to do really well in investing. And maybe the last question I'll ask before my traditional closing one is,

It's just how you process the really big, like I'm sure you think Microsoft is a great business, like objectively it's just a great business. How do you process those ones that are so dominant in the market that are such a huge percent of the market's market cap or whatever? How do you think about for your own money? I know you're a huge investor in your own funds, your own fund.

Do you want exposure to those things? What do you think about market exposure for the average person? It seems like a very sensible thing for the average investor.

Do you ever feel strange that there are these like massive, incredible, what seem like enduring businesses that you have nothing to do with? I have a fairly boring view like everyone else. I think for the average investor, you know, 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. Yeah.

You know, I've certainly thought at times that they represented like good to even superior, you know, returns. It's just never, they've never kind of, 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.

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, there's Google sitting there, looking all cheap.

And, you know, he was right. But thank goodness I didn't buy it because I think the things I owned, you know, did better, but 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. If I ever, you know, retire, I imagine I'll stop thinking about stocks and diversify and I'd own them. And if I had someone who wasn't, you know, if my mother wasn't invested in my fund, I'd, you know, tell her to, you

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, you know, 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. Whenever we talk time flies by, there's 20 things I could ask you about. Maybe I'll convince you to do this another five years. We could talk about those then, but for now I have to ask my traditional closing question. What's the kindest thing that anyone's ever done for you? So I had the two that I mentioned earlier. Um, one was, um, the guy, uh, who, you know, right when I was starting my fund, um, invested, uh, you know, in it and, um,

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. And then the other one was in 2022, that partner who

went out of his way to just come and basically buck me up over lunch. Didn't have to do it. What a kind thing to do. And you think about how I'd lost the guy to fortune, right? At least on paper, right? 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.

you know, 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? 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. It's great. Beautiful stories. Cliff, thanks for finally doing this with me. Thanks for your time.

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