This Shark Is Your Best Friend
Kevin O’Leary is a Canadian businessman, investor, writer, financial commentator, and television personality. He’s the co-founder and chairman of O’Leary Funds and the co-founder of software company SoftKey. Kevin is an investor on the ABC reality television series, Shark Tank, and was a venture-capitalist dragon on the CBC television show, Dragons’ Den.
In 1999, Kevin had acquired no less than 60 of SoftKey’s competitors and then sold the conglomerate to Mattel for a staggering $3.7 billion, one of the largest deals ever done in the consumer-software industry. To keep his money working hard, Kevin took control of his wealth from lackluster money managers and founded his own mutual-fund company, O’Leary Funds.
Kevin’s “get paid while you wait,” yield-oriented value-investing philosophy is something that should resonate with investors, so we’re glad he joined Investor Hour hosts Buck Sexton and Porter Stansberry for this exclusive interview…
Q: You’ve got a lot of irons in the fire. You’re turning into an entire media brand… What role do you think the “angry” persona played in the success of your show and of your personal brand?
Kevin O’Leary: I don’t think it’s angry. I think it’s differentiated between those that tell you the truth about business and those that don’t. People say I’m angry… I’m just telling people the truth about business, which is binary…
Either you make money or you lose it.
And I think it’s important in the context of people taking risks with their own money, particularly their family’s wealth, putting it into an idea that has no merit, that will eventually go bankrupt, and I tell them the truth… And they think that’s angry? Not at all. It’s the truth. And I think people appreciate that over time.
I’m a very conservative investor, and I try and help stop people from making disastrous mistakes. If you think I’m tough on Shark Tank, for example, wait until you see the real world… what that’s going to do to you.
I’m your best friend. I’m the only shark that tells you the truth.
Q: Can you think of a product on Shark Tank that you thought maybe was a little too niche, or a little too goofy, that ended up becoming a big success? Because one of the things that’s so interesting about business to me is it’s very hard to predict what will succeed and what won’t.
Kevin O’Leary: You’re right… You need diversification in your portfolio, and you certainly need it in venture investing. The one that I thought would never work that I ended up investing in was called Plated.
It was one of the first companies to say, “We’re going to send out meal kits with just one portion in a box so that people that live in condominiums in metropolitan areas can order it up, have it come to their door, and make one meal.”
I thought, “That’s crazy. Why would that work? That sounds so inefficient.”
And we just sold it to Albertsons last week for $300 million. It’s the biggest exit in Shark Tank history and a 1,300% return for me. That just goes to show that you never know what’s going to work.
Q: Yeah, that was a great deal. Congratulations. Speaking of deals, what do you think matters more over the long term, finding the right deal or having the right structure?
Kevin O’Leary: I think it’s a combination of both. I look at this in terms of when you put money at risk, when you put it in harm’s way – my mother used to have a saying: “Never spend the principal, just the interest.”
She was the same way on stocks. She wanted to get paid a dividend. Her whole premise was that when you invest in something, it has to provide an ongoing return in addition to potential capital gains over time, and I think that’s a very good philosophy.
So the structure of what I do when I do venture investing is very much venture debt. I often will loan the company half a million dollars, take 5% warrants in their equity, and have a royalty rate on all their sales to pay back my principal so that I have a structure in place that assures that I get my capital back most of the time. I’ve learned over time that getting your money back is more important – preservation sometimes is more important than performance. Getting capital back, protecting it so you can fight another day ends up being paramount.
Q: On the show, you’re a huge fan of getting royalties… The one thing that I really love about royalties is in commodity investments because the commodity markets are very tough businesses that require a lot of capital. And, of course, the price of the product fluctuates wildly. What other kinds of businesses do you focus on royalties with if you’re going to get involved?
Kevin O’Leary: Well, when I’m offered an opportunity to invest in a family business… Let me give you an example. Something as ubiquitous and non-proprietary as cupcakes, I own a cupcake company – or at least I have a royalty stream from one – called Wicked Good Cupcakes. It’s the No. 1 cupcake company in America. It FedExes high-quality cupcakes in mason jars as gifts, all across the country. Every time one of those is sold, I get $0.45.
I do not own equity in the company because it’s family-owned – it supports 42 family members. It makes millions of dollars a month, and we have a very comfortable relationship because our interests are aligned. I want them to sell more cupcakes, more pies, gluten-free cakes. I spend a fair amount of my time promoting their business online to help them get more customers because it’s in my economic interest.
So the point is you don’t have to be an equity owner to align your interests with an entrepreneur. A royalty stream can do that, too. They have total control over their business, but our interests are 100% aligned.
Q: Let’s talk for a minute about individual investors in the equity markets. I know that you have a big new business in exchange-traded funds (ETFs). How’d you get involved in ETFs and what are your goals in that business?
Kevin O’Leary: The reason I got involved in ETFs is I’m a big believer in active management. In other words, having somebody determine which stock to buy, how much to own, and when to sell it.
The trouble with an individual manager – and I’ve loved many of them and have worked with some of them for decades – is they tend to have what’s called style drift. That’s when they start with one strategy, and then years go by, and they move into something else. And it no longer works as well.
So I thought to myself, was there a way to take a great active manager – and I’ll give you an example. Let’s say you want to invest in the S&P 500. There’s many companies in there I don’t want to own, because my definition of quality is this: If a company is using sales accruals like WorldCom did, I don’t want to own it. I don’t care what sector it’s in. When you sell something and you don’t get cash, bad things happen. So that’s something I’ll never buy. That excludes a whole bunch of companies.
If a company is using debt to grow or maintain its dividend like many utilities do, I don’t want to own it because it’s not generating real cash. It’s borrowing money and paying that out as a dividend, and that’s going to end badly one day. That’s the second rule. And these are some of the rules that good active managers use all the time.
The third one that I really like is return on assets. If you have assets and you don’t make any money on them, that’s a bad business. So I like companies that have a high return on assets as opposed to ones that have a low return on assets, and if return on assets is slowing from quarter to quarter, that means bad things are going to happen… It means products aren’t selling. I don’t want to own it. I just described three rules that I want to live by.
And a fourth and final rule: I don’t like volatility because most of my capital is tied up in family, generation-skipping trusts, and I want that money to stay there. So I tend to not buy stocks that are volatile. Those are four rules.
What attracted me about ETFs – and I didn’t know this until about six years ago when I started working on it – there is a way to take an active manager and turn those into rules, like the four I just gave you, and create an index or an exchange-traded fund that follows those rules so there’s no style drift. There’s no one individual making those decisions. The rules are the rules. And that’s what I’ve created: a platform.
For the S&P 500, I use the O’Shares FTSE U.S. Quality Dividend Fund (OUSA), which means when you apply the rules to the 500 stocks in the S&P 500, only 150 make the cut. And I own those 150 for a year, and then we look at it again, and then we cast our net and we put the rules to it, and then another 150. They’re generally the higher quality, and what happens is they’re less volatile and they pay 40% more yield. The S&P is paying about 1.8%. OUSA pays 2.4%.
With the O’Shares FTSE Russell Small Cap Quality Dividend Fund (OUSM), I did the same thing for small-cap stocks, of which there’s 2,000 in the Russell 2000. Nobody can manage that, but if you apply the rules, you get 339, which yield 3.2%. And they’re the ones with good return on assets, average size, $4 billion.
Those are two exchange-traded, actively managed funds, OUSA and OUSM, and I own them because that’s how I can decide which stocks to own year in, year out. They’re the highest quality.
Q: You have your personal assets in those ETFs?
Kevin O’Leary: I look at it this way: How do I preserve my wealth?
I create my own indexes with people like FTSE Russell to maintain a 5%-plus distribution to my family and the charities I support and everything else. And I go to sleep at night not worrying about which stocks I own because they all have to pass the rules.
I have my family trust in them. I designed them for my family, and yes, I own the manager, that’s true, but I also eat my own cooking. That’s probably the best analogy.
I don’t pick stocks anymore. I let FTSE Russell decide every quarter what I’m going to own with these indexes because I know the rules were built to maintain and preserve my capital as best they can. So there’s no more individual stock picking for me.
Q: For people who either haven’t been successful managing their own money or who don’t want to be bothered with the hassle, I think those are two great alternatives. What are the fees with those funds, do you know?
Kevin O’Leary: Yeah, sure. They’re 48 basis points. So if you look at a mutual fund, they tend to be more expensive. That’s what I used to use. They’re generally 90 to 120 basis points and 1.2%. Forty-eight is sort of right in the middle of where actively managed exchange funds trade.
You can get a lot cheaper indexes, like you can buy SPDR S&P 500 Fund (SPY), which is only 11 basis points. The trouble is there are no rules. You just own all the stocks. And two-thirds of them, I don’t want to own. I much prefer an active-managed strategy, and I’m willing to pay a little bit more for it because the yield almost makes up for the difference.
Q: There’s one risk with all index-based ETFs, and I wanted to get your opinion on it. The component that makes me a little worried is the volatility component… Over the past five years, I’ve seen a wall of money that has been shifted from either active management like a mutual fund or passive management like just the plain S&P. Do you have any concerns about the amount of capital that is chasing low-volatility stocks?
Kevin O’Leary: Well, you make a good point and I agree with you. If you have a single factor like high yield or low volatility, that’s a problem. For example, take high yield. You could end up with a lot of broken stocks if their price has been cut in half and their dividend’s go from 3% to 6% or 7%. If all you cared about was high yield, you’d end up with a lot of bad stocks you wouldn’t want to own. I don’t like strategies that are single-factor because nobody buys a stock on a single factor like low volatility. I don’t agree with that, so in some ways, you’re absolutely right.
What I prefer is to do what managers do. They look at a whole range of things that matter. For example, the rules I gave you are what is designed by an active manager, someone that I used to work with for years that cared about the quality of a balance sheet, so she didn’t like to see debt being used to raise dividends. She didn’t like volatility. She didn’t like companies where asset returns were slowing, return on assets diminishing every quarter. That’s multi-factor, or basically how an active manager works.
When you look at an ETF, it’s not good enough just to say what are the factors or what are the rules. You have to understand what they own inside of them. If they own massive, large-cap, liquid stocks, you’re not going to have the same problem as an exchange-traded fund that’s very thin. In other words, one that just owns one specific vertical. There are all kinds of eclectic ETFs being built these days around whiskey and marijuana and hacking and all that kind of stuff. The trouble with that is sometimes the stocks that are held in there are very illiquid. So if you want to buy a lot of it or sell a lot of it, it’s volatile, and I don’t do that myself. And I’m very, very concerned about what’ll happen because the fastest-growing asset class, as you just pointed out, are ETFs.
But you have to understand what you own. I prefer large, liquid stocks. If I’m going to own Microsoft or Apple in an ETF and I want to put $100 million to work, it’s not a problem because I’m only buying 40,000 shares of a stock that trades hundreds of thousands of shares a week. So I’m okay with that.
Q: The Kevin O’Leary brand is blowing up all over the media and in lots of different ways. What’s next? Besides the ETF business and Shark Tank, what do you have in the works?
Kevin O’Leary: You know, I’m getting very involved in financial literacy. I like to talk to college students. In the last couple of months, I’ve been teaching at MIT, Notre Dame, Temple last week.
I’m trying to get kids in their early 20s to understand what it means to be an investor because think about this: The average salary in America is $52,000, and if you were to take 10% of your paycheck each week at the age of 21 and put it away and put it into the stock market and become an investor, the market gives you generally 6% or 7%, on average, over a long period of time per year, even on those up-and-down years.
But teaching people how to invest is not easy. But the point is, if they did, and they just put 10% away, they’d have $1.2 million or more when they’re 65, and so many of us don’t do that. And I just tell these kids, “Listen, there’s something you’re about to buy today that’s a piece of crap that you don’t need – another T-shirt, another pair of sneakers or running shoes – you don’t need it. Look at what you’ve got in your closet already. Instead, put that into the market.”
And then a few years ago, someone said to me, “Well, how can I do that, Kevin? If I only have $50 a week to invest and I want to buy Apple that’s $150 a share, how am I going to do that?” And then it hit me: If we could do fractional-share ownership, we could allow people to put $20 or $30 or $50 to work each week and buy a fraction of Apple, a fraction of Microsoft, a fraction of a company they like, and they’d own the stocks and watch them grow over time and mark-to-market. And they’d watch them going up and down every day on their cellphones, because that’s what those kids use.
I’ve done that with an app called Beanstox.
I partnered with DriveWealth, a dealer-broker. It’s become very popular in universities, and I say to the kids, “Put $5 to work this week. Put $10. Put $2. Put whatever you’ve got and start investing. There are 1,000 stocks on Beanstox, there are 200 ETFs. You can build an international portfolio $20 at a time.” That’s what I’m all about, and I tell these kids something else: “If you start thinking this way now, every month, put something away, you’ll be a millionaire when you retire. And that’s the best thing you can do for yourself.”
And one last thought for everybody… I tell everybody, “What matters in life, whether it’s your marriage or whether it’s your business partners or how you treat people, just tell the truth. Think about it in the context of this: You fall in love with your significant other. The first time you lie to them, you lose 50% of the equity in that relationship forever. Forever and ever and ever. You can never get it back to where it was. So why don’t you just tell the truth every day, no matter how hard it is to say that?” That’s what my brand is all about.
Celebrity entrepreneur and investor Kevin O’Leary from the hit ABC television show, Shark Tank, shares his tips and tribulations with a national television audience and turns Wall Street upside down in the process.
When he’s not squeezing the market from his office in West Palm Beach, he travels the world looking for new opportunities to deploy his capital. One of his latest projects is an app called Beanstox, which allows investors to build a portfolio of stocks $20 at a time.
Like American Consequences, it’s 100% free. Each week, you’ll receive new show updates, previews, and access to transcripts and show notes. Whether it’s about investing… business… politics… or a controversial social issue… you’ll get the unfiltered information from behind the scenes.