In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:
- Heico Corp Has Increased It’s Share Price By Five Times More Than Berkshire
- The Stretched Rubber Band Between Growth And Value
- The Price That You Pay Erodes All Of The Intelligence You Had On Making An Investing Decision
- Anti-FOMO Starter Size Rules
- Warren Buffett – The Macro Investor
- Is It Possible To Short Apple Stock?
- The Problem With The Equity Risk Premium
- How Real Is Flight Shaming – ‘The Greta Effect’
- Jake Is Going Down To Compound Town
Here’s an excerpt from the episode:
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Jake Taylor: Welcome back to Value After Hours. I’m your host Jake Taylor and I’m joined by my usual suspects, Bill Brewster and Tobi Carlisle. What are you guys going to be talking about today for your segments? Go ahead Tobias you first.
Tobias Carlisle: I’m talking about Heico. They’ve returned 47500% since a father and two sons took it over in 1990 they did 1270% over the last decade too, which is five X the S&P, five times Berkshires. Pretty good effort.
Jake Taylor: Mr. Brewster.
Bill Brewster: I’m going to talk about revisiting a previous answer that I had and a potential error of commission that I made. I wish it was more exciting as Toby’s. That’s quite an intro, Toby.
Jake Taylor: And I’m going to be covering a little bit of nuance between this idea of the stretched rubber band between value and glamour, and then we also have a couple of good mailbag questions so we’ll be back right after this.
Speaker 4: Tobias Carlisle is the founder and principal of Acquirer’s Funds for regulatory reasons he will not discuss any of the Acquires funds on this podcast. All opinions expressed by the podcast participants are solely their own and do not reflect the opinions of Acquires funds or affiliates. For more information, visit Acquiresfunds.com
Tobias Carlisle: should we kick off the topics?
Jake Taylor: Sure. Do it.
Tobias Carlisle: Should I take it away with Heico? Great article. So I was sort of talking about that a little bit last week that it’s the father Larry who’s 81, and he was an Arthur Anderson accountant. And then the two sons, Eric and Victor who are in their 54, 51 so they approached him, they approached dad in 1990 to say let’s do an LBO because it was still just after the LBO craze had kind of peaked with the barbarians at the gate.
Tobias Carlisle: So they find Heico which basically had one product it was an engine combustion chamber, whatever that is made by Pratt and Whitney and they’d spun it out. So they got control of it for three million dollars. It was half equity, half debt in 1990. Since then there are 47500%, and over the last decade they’ve done 1270% which is five X the S&P and more than five X Berkshire just for kind of context because they’ve both done around 250% which is still not bad of that period of time. So now two point one billion profit 328 million. They’ve acquired 78 companies. Basically what they do is they try to buy something that’s got very fat margins and some of competitive advantage and then they just reduce the margins to price and properly. So they sell 100,000 parts.
Tobias Carlisle: Their target, which I found was kind of interesting, they look for $10 billion in profit margins over 20% and then they try to buy 80% because they want existing management to remain incentivized, and they’ve done about nine acquisitions in the last year, which is sort of a little bit more than they have in the past. But basically the entire engine of growth of this thing is the ability of these guys to acquire companies that do continue to grow and make money over time. So they are really, really good investors. Buying cheaply. And that’s sort of the analysis that’s as simple as it gets.
Jake Taylor: Do you know what their typical multiple is that they pay on that 10 million-ish?
Tobias Carlisle: I don’t.
Bill Brewster: For the acquisition?
Jake Taylor: Yeah.
Bill Brewster: I think it’s roughly eight times EBITDA. is what they target. Interestingly in their 10K they have, you know how Bezos has the cashflow statement upfront. They have on I think pretty prominently on page two disciplined acquisition strategy. Some of these businesses I do think that when you open up the 10K and you just read it, it’s like, oh, these guys know what they’re doing.
Tobias Carlisle: They’re talking about it all the time.
Bill Brewster: That’s right, and they put it in a way that is easy to digest. I read their fourth quarter earnings call and I read the 10K and I read a scuttleblurb his right up on Heico and TransDigm shout out to scuttleblurb.
Tobias Carlisle: Is that public?
Bill Brewster: TransDigm?
Tobias Carlisle: The scuttleblurb.
Bill Brewster: No, it’s behind a paywall but it’s worth paying for if you’re interested in this stuff. He’s a solid resource. So anyway, it’s just interesting. So there was TransDigm who sort of runs like a levered acquisition strategy and then hikes price and maybe it goes a little bit more aggressive. And then scuttleblurb says something along the lines of like, I love Heico, you love Heico, we all love Heico, it’s a family run company. They do things the right way. They’re trying to save engine or the airlines cost, right? They’re not about pushing price. They actually comment in one of their, I don’t know if it was the earnings call or what, but they say something like, PEs got raise the price because they carry so much debt. Our net debt to EBITDA is under a turn. Like we can play the long game.
Bill Brewster: So I for the longest time had closed my eyes to the name because the multiple and turns out maybe that was dumb.
Tobias Carlisle: How do you value it?
Bill Brewster: I think you’ve got to look at it on free cash flow and then sort of embed some acquisitions in there.
Tobias Carlisle: What sort of yield are you getting at this level? Do you know?
Bill Brewster: Well your entry is only about what? So it’s trading at roughly 35 times free cash flow. So two point eight, two point nine percent out of the gate.
Tobias Carlisle: That used to be expensive.
Bill Brewster: It did used to be expensive.
Jake Taylor: Yeah, that used to be like a puckering number. Now it just seems like-
Tobias Carlisle: That’s half price now. 60 times is the market, 35 is like half price.
Bill Brewster: To be fair. Something that I had been thinking about, and actually I’ve got a mailbag question on this a little bit, is what is an asset like this? What’s your downside risk really in that multiple, because an asset like this in most realistic scenarios that you can underwrite as today’s world exists probably isn’t going to trade at less than 20 times free cash flow.
Tobias Carlisle: I’ll remind you of that sometime over the next five or 10 years.
Bill Brewster: We’ll see.
Jake Taylor: Was that a bag holder quote right there?
Bill Brewster: It could be.
Tobias Carlisle: You don’t think so if your end user is airlines and I know I own one so they are cyclical. They’re still cyclical. You don’t think that the suppliers are a little bit cyclical too?
Bill Brewster: Well they’re going to be a little bit, but even after 911 and in the great depression or the great recession, average seat miles are flown or available seat miles actually didn’t decline that much. We’ll see what goes on with all this flight shaming and whatnot, but-
Tobias Carlisle: Not much is my prediction for what it’s worth.
Bill Brewster: Yeah, I think so too.
Tobias Carlisle: Nobody flies because they want to, you’re basically flying because you’ve got somewhere you have to be and there’s no other way to get there.
Bill Brewster: That’s fair.
Tobias Carlisle: Flying’s terrible.
Jake Taylor: Yeah, but it’s better than all the other forms of transportation.
Tobias Carlisle: It’s better than driving there.
Jake Taylor: That’s right.
Bill Brewster: Where was I going? I’m thinking of flight shaming and how much I’m about to travel over the next three months. I should be shamed-
Tobias Carlisle: Can’t you just buy some carbon credits and offset it? Just tick the box.
Bill Brewster: No, no. That’s somebody else’s problem. Anyway. Heico gets to do the replacement parts. So as long as there’s planes flying in the sky, you’re not going to be able to defer your maintenance. So I don’t disagree that there will be peaks and troughs, but I don’t know I think maybe we’ll see if it ever trades South or higher than five percent free cash flow. I’ll probably be a buyer.
Jake Taylor: Isn’t that kind of the argument though for those, you almost want volatility in the industry because when you have a good acquirer that becomes opportunity for them. Right? So you worry about them being disrupted but maybe more so you want that for them to throw off opportunities for more acquisitions for the weaker hands to get forced out.
Bill Brewster: Yeah. Because they’re in theory going to get much stronger over that. Right. And if PE has too much debt on some of these companies and they have to end up selling these guys could be the buyer. So it’s one-
Jake Taylor: I think cap allocator is an anti fragile strategy I think.
Bill Brewster: Yeah.
Tobias Carlisle: What about the level where they’re shopping, the level where they’re fishing $10 million as profit, that’s a pretty small company?
Bill Brewster: Yeah. They are tiny.
Tobias Carlisle: I think that’s smart. Like there’s probably not a lot of professional private equity hunting at that level. Maybe I’m wrong. I don’t know. But that seems low to me.
Bill Brewster: Yeah. I’m not certain about that. I agree with you though on what two billion of sales, your acquisition target can’t be a massive portion of what your business is if you’re hunting in that size, incentives would matter a ton. Right? So you would want to make sure the two sons understand that like the father does.
Tobias Carlisle: Well they’ve been running it since 1990 right?
Bill Brewster: Yeah.
Tobias Carlisle: It was kind of their idea.
Bill Brewster: Yeah-
Jake Taylor: I got the sense that there’s kind of a Costco element to it as well where it was like didn’t they do a flat markup of cost basically for and then pass that along?
Tobias Carlisle: Yeah, they were 15%, I didn’t read closely enough, it was net margin of 15% I think Costco targets gross margin of 15%, right?
Jake Taylor: Something like that, 15 or 17. But yeah, it’s a fixed amount.
Tobias Carlisle: What are you netting out between gross and net margin? What are they including in that to get to the 15?
Bill Brewster: Well you’ve got-
Tobias Carlisle: SGNA.
Bill Brewster: Yeah, you’ve got SGNA and there’s a little bit of R and D. they’re not a particularly a heavy R and D organization from what I can tell.
Tobias Carlisle: I think they’re trying to buy it in, I bet that’s what they’re trying to do. An R and D through acquisition, but they’re not stopping at either they seem to try to continue on with it once they buy it.
Bill Brewster: Yeah. Like part of my hesitation with paying up for some of these growth companies is, where will it be in the future? And I do think Heico’s one of those that if you can listen to how they talk about their employees, how everybody’s invested in success, the secretaries, retiring millionaires, it’s not a flashy way to talk and I almost think it’s like a very targeted Berkshire, in that if the culture remains, I don’t know that you have huge business risk, if that makes sense.
Tobias Carlisle: I always get a little bit nervous these days when I hear everybody in the firm’s buying stock and everybody’s doing really well. I think Enron.
Bill Brewster: Cycle.
Tobias Carlisle: Enron just destroyed so many people, Meb Feiba would make this argument where he says, you’ve already got exposure to that company because you work there, and then to further invest in it, you’re doubling up on your exposure. Maybe you should be diversified. Then if inside and you know that it’s a really good one, you want to be exposed to it, don’t you? That’s how you get really wealthy.
Bill Brewster: Yeah, yeah. I think so. That said, this is not financial advice and you should talk to a retirement advisor. But yeah, I mean sometimes you really do know something and having the ability to understand what the culture is from the inside. That said, sometimes I don’t even know how much the employees know. I mean at Bemo I would have miss assessed a lot of the stuff that was going on in the organization. So I don’t know. What do you actually know?
Tobias Carlisle: I’ve sat in on board meetings and just been kind of astonished at like how little outside directors, how little everybody knows about what’s going on. I don’t think I know anything these days. I’d love to know what it feels like to know something.
Bill Brewster: Yeah. Well, I think knowing that you don’t know anything is probably knowing something. That may be a little circular, but yeah.
Jake Taylor: Galaxy mind right there.
Bill Brewster: That’s great. Well, there’s not false precision in it.
Jake Taylor: True.
Bill Brewster: The scuttleblurb thing real quick about TransDigm and Heico, I like what he said, he said, both companies are decomposed into small autonomous business units with their own P and L is giving rise to a culture of accountability that is often lost down in top down bureaucratic stray structures. We were talking last week about what might IAC and Heico and these other companies that you’re going to go down, what might that have in common and that may be part of the clue.
Tobias Carlisle: Yeah. Decentralization.
Jake Taylor: Don’t have any scale though on like some costs of, I don’t know, even like accounting and backend and things like that or are they fully decentralized?
Bill Brewster: I don’t know enough to answer that. I’m sure there’s some synergies that go on, right? I mean with your accounting system or something like that.
Jake Taylor: I kind of hope so. Right?
Tobias Carlisle: Berkshire doesn’t do any of that or do they, they just,
Bill Brewster: No. That’s why they have a 50,000 page tax return, you know?
Tobias Carlisle: All right. Next, topic. What have we got?
Bill Brewster: Jake, you want to go?
Jake Taylor: Sure. I thought it would be maybe fun or instructive for us to try to add a little bit of nuance around this stretch rubber band idea between value and growth. All the value investors have seen this, all these charts that come around about how much growth has outperformed value. And I thought it’d be interesting to see if we might be able to back into what are the implicit bets that we’re making and are we really even cognizant of them if we are more of a quantitatively driven sort of like we’re going to buy the cheapest basket of value right now.
Jake Taylor: Maybe it doesn’t apply if you’re a among our three stock portfolio guy. But if you’re a more 50 plus and you’re just trying to approximate values, outcomes historically with your current portfolio, what’s the implicit bets that you’re making? So more specifically, I thought it’d be interesting to decompose really, what are the factors that you’re trying to figure out here and specifically the multiple that people are willing to pay for glamour versus value and the underlying fundamental business changes that may happen in between those two companies. You guys have any initial thoughts at this point before I try to drill even deeper into that?
Tobias Carlisle: I would just say that I think that… have done a few good pieces and the lightest letter also deals with this, but basically value is doing what it has always done, to the extent that it’s not been rewarded, its multiple expansion has not occurred. There’s been the reverse there’s been some contraction in it, where traditionally what happens with the growth companies is that they do see that very high growth in the earnings, but they see a little bit of multiple contraction. They’ve seen the expansion. So it’s just been that is unusual. Maybe that is the brave new world, I don’t know. But it’s still unusual. We don’t have enough data to sort of say that the world I think has flipped, but maybe you’ve got to start thinking that that’s a possibility. I don’t, but you know, got to start thinking for the luck.
Jake Taylor: Yeah.
Bill Brewster: Jake, what are you asking specifically? Are you saying like the underlying business risk, what would be some of the commonalities that we’re betting on or are you just saying like from a factor perspective?
Jake Taylor: Kind of more a factor like so if you’re buying value today, are you buying it because you believe that multiples will expand in value or do you believe that growth multiples will contract? Do you think that the business for whatever reason of glamour will maybe slow down a little because it has been a really good year or a good decade for growth companies, their underlying businesses have done better than historically? Or is it a matter of is it possible that the multiples will come down for both glamour and value from here? These are, I think actually pretty important things to untangle if you are going to be making a value basket type of bet.
Bill Brewster: Yeah, so I just off my like gun, I would say that value is more likely to continue to perform like it has, but glamour is likely to potentially hit a hiccup. I don’t know if I hedged my words carefully enough, but specifically with SAS I went out with scuttleblurb this weekend and we were talking about how in technology the nature of technology is that there’s a winner and then a bunch of other companies sort of build their ecosystem around the winner. And right now a lot of the SAS names are priced as if they’re all going to be the winner that everyone else comes around.
Bill Brewster: And by definition there can only be a few of those. So that’s why I always say if you really know what you’re doing in that space, it’s probably a good space to play in. But I think a lot of people are going to end up not, they’re going to own something that they didn’t think they were buying. So I have a feeling that there are pockets that people are going to get really crushed in. And I would think generally speaking, value doesn’t have the same stretch to it that sort of gives people that-
Tobias Carlisle: Not the same stretch but I do think that it is like, it’s upsetting to say it, but value is probably 50% rich to its long run mean or maybe not quite 50% it might be 30% now or something like that. Growth is multiples of where it should be, so growth can come back a lot. But it could easily be, it’s not going to be a scenario like 2000 where the market collapses. The dotcoms are down 80 or 90 or 95% and value’s up. I don’t think that’s going to happen. I don’t think it’s a 2007, 2009 type scenario either where value gets absolutely taken to the woodshed. I think it’s somewhere in the middle where value is probably going to do a little bit better than the market, but it’s still going to get hurt. Growth-
Jake Taylor: Is that a positive or negative expected outcome bet set today on the value basket?
Tobias Carlisle: Probably still it’s hard so…
Jake Taylor: Pick the timeframe too like…
Tobias Carlisle: I still think that there’s positive. I think the only place you can get positive absolute returns at the moment is in value. Even though I think in the interim with volatility in a crash, who knows what’s going to happen it’ll probably go down, but I think that everything else is priced for perfection and must sort of come back to a long run meanwhile whereas I think value probably won’t do that as much, but I still think realistically in a crash it’s going to go down. It’s just not going to go down as much as the market. I think the SAS names and a lot of those things are going to get absolutely cut to smithereens.
Jake Taylor: How about fundamental… any reason to think that the kind of winner take all phenomenon that we’ve seen or at least that’s been, it seemed to have been the last 10 years that maybe that will, whether it’s antitrust comes up more or whether it’s competition comes, is there any reason to think that fundamentally speaking that a basket of the cheapest 10% might have better business results?
Jake Taylor: Maybe like a lot of weekends get forced out and maybe the more expensive stuff will have a reversion to the mean and business results as well?
Tobias Carlisle: Yeah, that’s a good question. I don’t know. I think there’s so many influencers that it’s impossible to see what the impact is going to be. Other more expensive names taking business away from the cheaper names or are they’re taking funding away from the cheap names. I don’t know.
Bill Brewster: Yeah, I don’t have a good sense either. I would say that in a lot of the stuff that I have seen the deep value pitch on, my biggest concern is agency cost and I brought this up last week, but I do think that, and… or Dan had a good point on Toby’s recent podcast with him where he said, he thought the agency costs were more aligned in some of these compounder type names relative to the deep value, sort of like liquidation slice at least, which I thought was interesting. I happen to agree with it, which is probably why I liked it.
Tobias Carlisle: In practical terms, what does that mean? Does it mean that they are paid to sort of keep on growing?
Bill Brewster: Well, if you’re long game stop right now, I’m pretty sure that CEO, part of his compensation is operating income growth. In my opinion, his entire compensation should be total shareholder return over the next three years. Because a lot of that is a cigar, butt that you’re hoping to get the money back from, I don’t actually want him re-investing if I’m buying today. I don’t want him to try to grow operating income, especially not on an absolute basis. I mean maybe if you want to go per share or per store or something like that, fine. But like I don’t want this guy trying to think about how to grow the company, but that’s me. Right? But I don’t think a lot of deep value guys that are like, oh, how are we going to turn GameStop into a compounder? Right? So get the guys incentives aligned with sort of your incentives.
Jake Taylor: Right, with the corporate strategy that you would like to see.
Bill Brewster: That’s right. Yeah.
Jake Taylor: Well I think it’s a tough question because there are so many variables, whether it’s technology, government interaction, investor sentiment, but I do think maybe a lot of times we don’t think enough about, if we’re going to win, why is it that we’re going to be winning? Is it fundamental based is it multiple based? And I think a lot of times maybe we don’t always strategize enough about those kinds of things.
Tobias Carlisle: I just wonder if the counterpart to that is sometimes Buffet clearly is smart enough to figure out macro, right? Well if anybody is he is and he says I don’t do it because it’s too and maybe just says that and he actually does do it. I’ve got no idea. But it seems to me that it’s so hard that you’ve got to get the sequence of things right and any single thing in a sequence that you get wrong invalidates the whole thesis.
Jake Taylor: I will push back a little bit on that in just looking at his actions and-
Tobias Carlisle: Do you think that he’s more macro?
Jake Taylor: Well by borrowing a billion in Euro denominated specifically, that’s kind of a macro bet to me. Holding 130 billion of cash is a bit of a macro bet to me. And he’s like gotten rid of all interest rate risk like he has no long duration interest rate risk really, like that’s kind of a macro bet. I mean his actions Telegraph a little bit of some macro thinking I think.
Tobias Carlisle: But not some of those ad hoc decisions that you can make on a case by case basis that you don’t necessarily have to make a prediction you just sort of look at where you are in the cycle.
Jake Taylor: Well, I mean aren’t you making a prediction though that what you’re doing is going to work out better than if you didn’t do that? Isn’t that implicitly baked into the decision?
Tobias Carlisle: But then you’ve got this, I guess they’re micro decisions they’re not sort of like some grand macro thesis there. Each one is its own, even if it does reveal, you know, so he’s interviewed-
Jake Taylor: I agree with that.
Tobias Carlisle: He was interviewed sometime this year. I saw this in a recent article where he said he thinks, oh sorry, it was earlier 2019 he said, he thinks if you look at where interest rates are, stocks look really cheap. And then he was given credit for like the big run up in equities last year, which as we’ve discussed before-
Tobias Carlisle: But he always says that, he said that at the top in 2007.
Bill Brewster: Yeah.
Tobias Carlisle: But he’s also implicitly relying on the equity risk premium to say that which as we know it doesn’t work.
Jake Taylor: Yeah. The fed model.
Tobias Carlisle: How could it be otherwise? That’s the bizarre thing about that particular model that I like the logic of it. Logically it must be the case because your alternatives are stick it into cash or stick it into some bonds or something like that or stick it into an operating business. And if you’re getting a better return seeking in the operating business, isn’t that how you make the decision? So how does that thing not work? It just doesn’t, absolute return. The absolute yield on the equities is the better determinant of future returns than the return relative to the interest rates.
Jake Taylor: It is surprising that it doesn’t have contained more signal in that noise, but I don’t know, maybe it’s probably that it’s such a confluence of factors that it just gets kind of washed out by so many other things. Whereas for whatever reason valuation becomes a stronger signal.
Tobias Carlisle: Well, that’s my thought is that you have the fed there as well sitting in the interest rates. So they’re sort of putting their finger on the scale a little bit. So when you’re looking at the relative attractiveness of one or the other, you’ve got to add in the fact that their interest rates aren’t static and they’re going all over the place too.
Jake Taylor: Tin foil hat alert. We’ve got to…
Tobias Carlisle: But I mean that’s their job, there’s nothing conspiracy theorist about that.
Bill Brewster: I think Buffet does do a lot more macro thinking that he leads on. I just also think that his brain does like automatic decision trees and I think that when you get into macro, there’s just so many permutations that he’s sort of like, I don’t think anyone can be involved in finance and not at least find macro like mental porn a little bit. I mean, it’s fun to think about but I just think-
Tobias Carlisle: And macro got some smarter too.
Jake Taylor: Oh man it’s so smart.
Bill Brewster: Yeah, and it’s super fun to put it together and it’s like, Oh, this is going to happen. And it’s in the world. And it’s going to impact you. It’s a lot-
Tobias Carlisle: Talk about Euro dollar bond volatility.
Bill Brewster: That’s right. Yeah. And I just think Buffet’s probably like I could have that conversation with you, but I don’t think it’s worth the time of doing it.
Jake Taylor: I think it probably is a matter of an inversion where he says, would I loan someone else these billion Euros today at like a quarter of a percent? No. All right, well maybe I’m going to borrow them then instead, because that might make sense.
Bill Brewster: Well there’s also not much downside. I mean if rates continue to go down, you just refile them at negative five. And then issue all the debt.
Tobias Carlisle: Why is macro so hard? Because interest rates can go negative it turns out there’s no hard dick there.
Bill Brewster: That’s right. Because all of our assumptions actually may not be correct, but-
Jake Taylor: We want to treat it like it’s a physics problem and that you dropped the ball and it’s going to fall towards some center of mass, but it turns out it’s probably not like physics at all and anyone who comes at it from a first principles kind of physics standpoint is going to probably lead themselves into a blind alley.
Tobias Carlisle: So how do you approach it? What’s a better model than a physics model?
Bill Brewster: I think that trying to figure out a specific industry and the strategies that the players are taking within the industry and getting some insight into that. Like the people that made a lot of money or, well, not the only people, but people that did make a lot were people that followed Schwab, understood that Schwab makes less from trading fees than TD Ameritrade and Fidelity did. They cut all their fees, the stock sold off hard and the people that were ready and there with the analysis that said like, no, this is longterm good for them because it’s going to cripple their competitors were able to buy in a period when spooked people were selling the stock that didn’t really understand. So that’s how I think you can make money.
Bill Brewster: Other than that I really don’t know. Unless you are doing some sort of factor analysis and you’re betting on the factor working, that makes sense to me, but I don’t know any other way. I would’ve gotten every major macro call wrong over the last probably five years minimum. So what good is my thinking on it? Almost none.
Tobias Carlisle: You need to… yourself.
Bill Brewster: Yeah. Yeah. I mean-
Tobias Carlisle: Because… a macro.
Jake Taylor: Contra bill.
Bill Brewster: Yeah. Well I don’t think I’m a moron or anything like that. I don’t understand how the fed works. I did not foresee Trump getting elected, which would lead to deregulation. There’s a lot of things I didn’t see so-
Tobias Carlisle: It’s not that you’re a moron, I’m sorry I stopped there. It’s not that-
Bill Brewster: The insults are going to fl into me.
Tobias Carlisle: The point is that everybody basically thinks the same way, everybody can do the analysis to get to that point and then it’s like going to the parade and everybody’s standing up on their toes. Like nobody’s better off for everybody having done that analysis, you have to do the analysis where you work out the consequence of everybody else doing that analysis.
Jake Taylor: But then what if they’re also working that out and then they pick a different analysis to-
Tobias Carlisle: Now you John Maynard Keynes, beauty contest. So then you’re back to first principles and you’re only swinging at something that makes sense on a first principles basis.
Jake Taylor: It’s so recursive.
Tobias Carlisle: It is.
Jake Taylor: I don’t know how you get out of that.
Tobias Carlisle: Well that’s why deep value hasn’t worked for 10 years.
Bill Brewster: They’ve talked about before. Like tell me that 10 years ago you could have said we’re going to be running these deficits. Interest rates are going to be here and-
Jake Taylor: And no one cares.
Bill Brewster: … cycle and the dollar is strong.
Tobias Carlisle: Zero people picked that. Zero people picked that. Nobody expected that.
Jake Taylor: No.
Bill Brewster: So I don’t know what good is. I can’t do that game.
Jake Taylor: It does seem like one of those things though where if you could figure it out the rest of the game gets very easy. Like you just know where all the tailwinds are.
Tobias Carlisle: But guys figure that stuff out all the time and they’re wrong.
Jake Taylor: Well they didn’t figure it out.
Tobias Carlisle: But they think that they did so that’s the great danger. Basically, that you’re a conspiracy theorist and you figure out this is the consequence of all of these things happening. Long gold and then gold gets crushed or whatever. That’s the devilment of it. That’s what makes it so hard.
Bill Brewster: Well, the problem is the system isn’t static, right? So you may have figured it out for a day, but everything changes tomorrow. I mean, maybe not that quick. Right? But you can’t. It’s like anything, I mean everything. I don’t know.
Tobias Carlisle: It takes you back to macro.
Jake Taylor: It is the ultimate kind of narrative fallacy thing. No. Where when you look back at it and hear the explanation, it seems so obvious you could… thinking.
Tobias Carlisle: You just slowed down a little bit there Jake-
Bill Brewster: You did.
Jake Taylor: Oh, sorry.
Bill Brewster: The matrix.
Jake Taylor: Yeah. I think they didn’t want me to tell you what I was about to say. No, I just said it suffers from the narrative fallacy. Where it seems very obvious in hindsight when you hear the story put together of what happened that it sucks you into thinking that you’ll be able to figure it out the next time.
Tobias Carlisle: Predicting the future, yeah.
Jake Taylor: Yeah. Just that case.
Tobias Carlisle: Good questions. Good thoughts.
Jake Taylor: Toby what’s…
Bill Brewster: So I was talking with somebody that listens to the podcast and he was commenting on how weak my answers sounded to the, why don’t I run outside capital question. And I felt like I probably owe it to the listening base. Hello. I think we’re up to 10 so hello to all 10 of you. But to be honest about it, right? And I thought about my answer and I thought it was actually a pretty weak answer. And I guess that part of the issue is I’m still not a hundred percent sure of the strategy that I want to take to the world. Like I’m really struggling with sort of where I came from in the beginning, which was the Buffet and Graham thing and the way that they look at the world to these, why not buy better businesses at some reasonable prices. And the current, what?
Jake Taylor: Reasonable.
Bill Brewster: Yeah. Well look, I mean this is an art, right? I don’t know how you define that, but it’s like any other asset I guess. And then the behavioral problem that I have made more likely doing counter with the strategy that I’m running, looking for mispricings is, I actually think that who I am gets a little bit of FOMO if I’m doing work on a company that I think could be a good value. I get worried that the market’s going to realize it so quickly and I think it almost-
Tobias Carlisle: By a half point.
Bill Brewster: Yeah. Well I think I need to work on sort of thinking that way. Like who cares if it goes up a half point, right?
Tobias Carlisle: By a half point. So what I’m saying is like, just like sit down and work out a structure. So having done this much work, I’m allowed to buy this much, this much work I’m allowed to buy this much. And so on. So like when you first see it seal the ratio, it looks really good, read a few 10K’s and Q’s and whatever that allows you to buy whatever, half one. And then as you keep on going in, you’re like, actually there’s more to this than I realize I’m allowed to take this position up until you get whatever your inception limit is, three, four, five, 10 whatever.
Jake Taylor: 75%.
Bill Brewster: All on it.
Tobias Carlisle: 125%.
Bill Brewster: No, I think that’s a really good answer. So working through some of that stuff before I have all that ironed down. I mean you’ve got to have that. I think you have to have that system before you take something to market. I don’t think those are the type of questions that you take something to market unproven. Right? And I think that what you said makes a lot of sense. It’s actually what I did with that company that I just wrote up. Ali’s was, I did some work on it and it has a lot of what I really like in a story. So you have the founder that died, you have-
Tobias Carlisle: That’s what I always look forward to.
Bill Brewster: To be fair I worded that improperly. They missed on a quarter, sold off hard. The founder died. I think there’s a lot of reasons that we cans would be selling the stock now. As I sort of had it written out on a piece of paper. Right? And then as I started to pen the longer article and I started to actually write what do you have to believe for this to make sense and what’s the actual upside downside. I got to the point where I said somewhere in the article I said something like, you need to have a 43% chance of having the current management be able to run the business. That’s like sort of silly, but that’s how the numbers that I was working with worked. And I asked myself like what makes me the person that’s able to make that bet? And I don’t have a good answer to that other than time. So I don’t know, it’s just one of those things that-
Tobias Carlisle: It’s funny you could go through an analysis, any analysis and you could holding all the other inputs the same, and you could figure out what probability each of the inputs that you have has to be to get. I can see how I can understand how you’ve got to that point. Like I can see how, what does this whole thing turn on if I keep all of these other ones static for this one to succeed, this thing working. I think if you did that, like that might almost paralyze you.
Bill Brewster: I know it’s kind of terrifying to do, but I do think that like for that particular entity, in my mind, the bet is, was this thing dependent on one guy? Can the current management execute the plan? And then I guess the second question is, can they get to their store count? But thus far they’ve been able to execute their entire plan, so I’m not sure that the store count question really matters yet. I don’t know that that matters for another six years or so if they have proven it now.
Bill Brewster: Now there’s a short thesis going around that might allege that they’re doing fraudulent things to the inventory. That’s a whole nother basket of worms. Right? But for these purposes, assume it’s not a fraud. Maybe that’s-
Tobias Carlisle: Since the new management came in?
Bill Brewster: Well, yeah, they’ve only held one call and they haven’t executed at all.
Tobias Carlisle: Okay. I mean this is a perfect opportunity for them to clear that out. Blame it on the big guy.
Jake Taylor: Yeah, that’s a big bath accounting time.
Tobias Carlisle: That’s what I’d do.
Bill Brewster: He was a charismatic founder. Everybody loved him. So we’ll see. I don’t know. It’s an interesting setup, but it was one of those that I felt like I took a small position because I felt like I had done the work that I needed to do, but then actually sitting down and writing I was like, I don’t know, maybe this is an error commission here and one that’s an error that is-
Tobias Carlisle: There are no errors of commission anymore.
Bill Brewster: No.
Jake Taylor: Just not buying.
Tobias Carlisle: The only error is not buying. Yeah.
Jake Taylor: Let me ask you this Bill. If you, let’s say that 100% or a hundred is your perfect, like you know that you have the best process that you are capable of doing in the investing world of analyzing and controlling for biases, all those kinds of things.
Jake Taylor: What number do you think you need? What threshold do you need to get over to feel comfortable managing other people’s money, right? Because you’re theoretically always going to be learning and getting better. Right? And hopefully your process is getting better as well. But what’s kind of that minimum number in your head that you would need to get over to take outside money?
Bill Brewster: I don’t know that I have a good answer for that. I would need to have an answer as to what kind of companies am I going to target, that I think is something that people probably want to know, and two, I would need to make sure that I had a process where I wasn’t making early errors of commission, because I think those are probably my biggest personal risk. So if I could have a system in place that sort of, maybe it’s a guy stereotype system where I say the day that I decided to buy, I’m not buying for a week. Right? Because who cares?
Jake Taylor: The countdown starts. Yeah.
Bill Brewster: That’s right. And just sort of a blockade, that may be sufficient, but I-
Jake Taylor: You know what you need to carry yourself of that little FOMO bug is just to watch prices go down every day in a grinding bear market where you buy and you’re like, oh my God, I can’t believe I bought already. And it just keeps grinding on you. That might cure you. Because that hurts.
Bill Brewster: Yeah. Well, I do think that this is late cycle FOMO and it goes back to when I said earlier to you guys, how many people have really managed through pain? Extended pain is going to be a much different feeling for a lot of managers out there.
Tobias Carlisle: Being a deep value investor for a decade. I can run a thesis on it at this point.
Jake Taylor: On pain.
Bill Brewster: Well you have you, oh, just the pain. I was going to say you’ve written a fair amount of books on deep value.
Tobias Carlisle: I buy something undervalued. It goes down further. It’s still undervalued and I’ve got to sell it out because there’s other more cheaper stuff around.
Bill Brewster: Yeah. Well for a while everything I bought would go down a fair amount-
Tobias Carlisle: In a rising market?
Bill Brewster: Yeah. And people ask like what’s it like to be down 20 or 30% on a stock? And I go no, that’s Monday.
Jake Taylor: Yeah. That’s the first two weeks of ownership.
Bill Brewster: Yeah. Well that’s what happened to me on Ryanair. I mean I bought Ryanair and that thing was just nobody wanted it. And then I just kept buying more, which worked out. But that one, I think I was right for the right reasons.
Tobias Carlisle: Do you have a mail bag question Bill?
Bill Brewster: I’ve got two, two mail bags. One I think this person could use our advice and the answer can just be no, but I’m going to ask him or ask for him. It’s at investing chef, thinks Apple’s stretched, wants to short it and doesn’t know how. Is there a simple strategy to short Apple into this strength?
Tobias Carlisle: Buy it. Buy a put. Buy a little put. That’s the only thing you can do there.
Bill Brewster: You’re probably still paying a bunch in Valdo-
Tobias Carlisle: Yeah but you know how much you’re going to lose.
Bill Brewster: Rather. Yeah, I don’t know.
Tobias Carlisle: This is not financial advice.
Bill Brewster: That’s right.
Tobias Carlisle: If you have to express the view, make sure that you know how much you’re going to lose, which is what buying a put is. Buy it so you’ve got a year or so to run on it. So it’s not a short term thing. I don’t know how much your portfolio but you know it’d be not half a point or a point and something like that and just know that you’re probably going to be wrong because the market tends to go up.
Jake Taylor: I think for me, every single one of those, anytime you want to try to win when something’s going down, it requires a timing element to be right and that I believe is incredibly difficult. So difficult. I think you can know probably when something is overvalued and you can know even like fraudulent things, you just don’t know how long it’s going to last, and to win then you have to get the timing right as well. So I personally if you like Apple but you don’t like Apple’s price, I would rather hold cash, which I look at as a call option on it that it has no expiration and buy it when you like it again instead of trying to win going down as well, but you have to get the timing right.
Bill Brewster: Yeah. And I would say if you’re going to play this game, which I don’t think is a very smart game, wait until momentum turns over on it because I just think you’re bound to get destroyed by inputs or even selling call spreads. I just don’t-
Jake Taylor: Don’t you think that the cost of the insurance though moves up also once kind of the cat’s out of the bag and the momentum, right? And everybody’s like, all right, well it’s going the other way now and I’m going to charge to allow you to take the other side of that.
Tobias Carlisle: Definitely.
Bill Brewster: For sure. But I suspect that the benefit from the Delta that you pick up is bigger than the cost of the premium that you have to pay. I I think shorting strength like that is not a very smart strategy, especially if it’s short term.
Tobias Carlisle: You got two problems. It’s a very good business and it’s got momentum at the moment. Even if the valuation is getting stretched, which you know, there’s probably a few compound guys around here can tell us how cheap it’s still is, but it might still be, I’m being flippant there, but I don’t know. I haven’t done enough work on it. It’s very, very hard to short particularly something like that. I mean, even shorting frauds is hard. Like they’re definitionally trading way, way over what they’re worth and there’s no reason why as David Einhorn says, two times over value is silly, but three times over valued is not more silly. It’s still silly. 10 times over valued is still silly.
Bill Brewster: I like what Dan said to you on your podcast where he said, we don’t short frauds because by definition they’re very good at being frauds, right? Like if you have a two billion dollar market cap and nothing, you’re really, really good at being a fraud. I thought that was pretty insightful. Anyway, so that’s question one. Question two, is from our buddy at Paul H four, two, two, four, hope to see you at Berkshire again this year. He said, why do value groupies with longterm mindsets in their life all get attracted to value strategies, which inherently are short term, meaning less than two year holds and contradicted belief that equity ownership creates value over the long term?
Tobias Carlisle: I don’t fully understand the question. What do you mean by short term strategies?
Bill Brewster: So I think what he’s saying is if you are playing a game where you’re buying something cheap, expecting the multiple to rerate, that’s not the same game as owning equity for the longterm, and those those two are disconnected theoretically. I think that’s his question.
Jake Taylor: I think he’s right. Yeah, I think that’s true. I think there are different ways to express value and whether it’s different time horizons, different setups, as far as business quality versus just pure asset amount and what you’re willing to pay for a different thresholds. A lot of different ways for it to make sense. I think you just have to make sure that you understand which of those that you’re doing. Which one appeals to you more? I think there are seasons for different ones. I think we’re in the middle of a more growthy compounder one the last 10 years. I wouldn’t be surprised if maybe the price-to-book as a signal maybe starts to work again.
Bill Brewster: Oh my goodness. How’d you do that? You just said that out loud.
Tobias Carlisle: I think it was the best before. Like I saw it before Cliff Asness shuffled off the immortal Twitter quote he pointed out that price-to-book had been the best performed value metric for like nine months over the last year.
Jake Taylor: Well that makes sense. Like everything moves in cycles. Like I’ve been reading Merger Masters, which was a Gabelli and Kate Wellings book about all these different guys that did merger ARB. You know, mostly through the 80s when it was a hot period and the smart ones realized that it got crowded, that the spreads were tightened up and that you just couldn’t make money at it anymore and they started doing other things. And I think the flavors of value go through similar seasons and just knowing when it’s your season and having the conviction to go do it again when everyone else is kind of saying that that doesn’t work anymore. I think that’s a perfectly valid strategy if it makes sense to you.
Tobias Carlisle: Yeah. This is not really answering the question but I want to keep on going with what Jake said.
Jake Taylor: I didn’t answer the question. I get it.
Tobias Carlisle: Jake economic shout out to Jake. I know he listens to it. He pointed out that in 2007 eight, nine somewhere around that period, the growth strategies got cheap relative to value strategies. So value, for like a very brief period there was actually more expensive than growth, which makes no sense. And as Jake Farnham, Jake and I have talked about in the past, there’s a possibility that we’re like momentum value guys because we sort of got on the value bandwagon after working really well, which is the wrong time to do it.
Tobias Carlisle: That means that I think that at some stage it’ll make sense again, to become a growth investor. I don’t think that now is the time to be a growth investor. I think you want to be a value guy. When I say growth, I’m using, that’s my shorthand for saying buying better companies growing at a higher rate, still paying a sense of price for them. I don’t think that’s now, but I do think that this value cycle is going to play out more. It’s going to be a better decade for value, I think, than it is going to be a decade for growth. Maybe in about a decade. You want to be buying those compounders at low prices.
Jake Taylor: I’m probably going to get hate mail for this, but I’m going to say it anyway. I sometimes wonder about the willingness to pay kind of whatever multiple for a great business today if it doesn’t kind of remind me of the.com timeframe where you could really make the argument that a lot of those companies were, they had a better business model, they had a better mouse trap, they were going to have lower costs because they didn’t have as much brick and mortar. Like there were a lot of really logical things that you could be saying why you should pay up for this. Like the world kind of had changed. It was just going to take longer, and I can’t help but wonder if sometimes now the multiples being paid, we’re not kind of replaying that same thing where yeah, you’re right and you’re smart. However, the price that you’re paying basically erodes all of that intelligence that you have on this decision.
Bill Brewster: Well I know who’s getting the insults this week. Compound town send them to Jake.
Jake Taylor: I’ll take them. I mean you guys are, listen, it’s-
Tobias Carlisle: Going to take you down to compound town and compound-
Bill Brewster: Toby and I are long Heico everyone. No I’m kidding it’s okay.
Jake Taylor: Do you agree with that or not? Or I mean you guys think I’m a idiot?
Bill Brewster: I think you’re totally right. I mean that’s the whole question. It’s the whole fucking horse thing that Charlie Monger always says, right? Like yes, it’s the best horse, the question is the odds offered. You can’t look at a two or three and probably a five year period’s enough, I don’t know. But you can’t look at a short term horizon and say, this is the answer. I do think that where I have aired, so why have I prayed at that altar? One is my own version of hyperbolic discounting, which is being so worried that the multiple is going to rerate hard on me right away.
Tobias Carlisle: Up or down?
Bill Brewster: Down is why I have historically avoided the sexier companies. Two has been a real concern about not being able to predict the future. I’m starting to think that that is a valid concern, but also maybe I am under weighting my ability to observe the present a little bit.
Jake Taylor: What attention that is to when you really think about it, to try to untangle.
Bill Brewster: Yeah, I mean it’s tough. If I just put this in a real estate context, I don’t want to be a slumlord buying slums cheap. That’s not really the game I want to play. I also don’t really want to own class A real estate where pension funds and all these endowments are going to pay whatever just to own that building. So I think probably where my sweet spot is, is the financial equivalent of class B real estate that has some sort of… Scuttleblurb. I’m throwing out his name a ton, but like he said it to me in a way that made a lot of sense. We were talking about small caps versus large caps and he said, I think that’s the wrong mentality because there’s sharks all over small cap world.
Bill Brewster: He’s like, I like to think about it as the proportion of dumb money to float. And that I thought was really, really smart, because that’s where I think I want to play, where there are scenarios where retail or some hot money gets scared, but the business is pretty good and I can sort of provide the liquidity at that time, that would be where I think I’m going with this. But historically it’s been a fear of multiple re-rating and a lack of confidence in predicting the future.
Jake Taylor: So he’s saying that the larger cap space is actually more inefficient than smaller cap space effectively?
Bill Brewster: Yeah. I don’t know that he would say large cap necessarily, but so an example of something that I think he would be comfortable with me quoting is he said like there’s a lot of people that are in trade desk today that don’t understand what they really own. Right. And that could be a scenario where you get a short term move when people are paying so much for the equity, something that really doesn’t impact the business could cause a huge sell-off I think is sort of what he’s thinking. But I like that way of thinking of things.
Jake Taylor: That is an interesting multiple or ratio I should say.
Bill Brewster: Yeah, because you look at some of these-
Tobias Carlisle: Do they publish that on like Morningstar or something like that?
Bill Brewster: They should.
Jake Taylor: Dump money.
Bill Brewster: Small cap names like, I’m sorry. Matt Clarkin that guy that writes Clark Street Value, that guy’s one of the smartest investors I’ve ever met. I mean every time I talk to him, I think he’s the smartest guy in the room. I don’t want to play a game against him. And he messes around in short, small cap, special situation stuff. There’s a lot of sharp money in that space. And I think a lot of people do a mental shortcut where they say it’s small therefore there’s a lot of dumb money. I don’t think that that’s true at all.
Jake Taylor: That’s an interesting question.
Tobias Carlisle: I think we’re coming up on time fellows. If folks are looking to get contact with you, how do they do that.
Bill Brewster: Jake?
Jake Taylor: Yeah. Send all your hate mail to just-
Tobias Carlisle: I’ll probably do, send it to me.
Jake Taylor: Tag your hate tweets. You can tag me and I’ll cry and pretend that it doesn’t bother me.
Bill Brewster: He’s @farnamjake1 on the Twitter machine. I’m @BillBrewsterSCG.
Tobias Carlisle: And I’m Greenbackd G-R-E-N-B-I-C-K-D. Thanks very much for listening folks. It’s a lot of fun. As always, we’ll catch you next week.
Jake Taylor: See you next week.
Bill Brewster: Take care folks.
Bill Brewster: (music)
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