As part of our ‘Best of 2020 Acquirers Podcast Series’, earlier this year Tobias had a great interview with five members of the legendary value firm Tweedy Browne. These include Roger R. de Bree, Frank H. Hawrylak, Jay Hill, Thomas H. Shrager, and Robert Q. Wyckoff, Jr. These members of the investment committee have spent between 17 and 45 years (30 years on average) at Tweedy Browne. During the interview the Tweedy Browne team provided some great insights into:
- Value Investing Works Because It’s Painful And Very, Very Difficult
- Find Great Companies In Boring Industries
- Investors Should Buy Stocks Trading At Two Thirds Of Private Market Value
- Measuring Qualitative Factors In Investing Is Critically Important
- Value Companies Using Comparative M&A Deals In Similar Industries
- Understanding The ‘Mix Shift’ Within Companies
- Compare Companies Using The ‘Owner Earnings’ Yield
- Berkshire Hathaway Is A Bargain Right Now
- 100-Year Anniversary Of One Of The Most Storied Names In Value
- Some Of The Folks At Tweedy Browne Have Read Tobias’ Book
- An Investor’s Biggest Edge Is To Take A Long Term View
You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Full Transcript
Tobias Carlisle:
Let’s get going and then let’s talk about that.
Bob Wyckoff:
Good.
Tobias Carlisle:
Hi, I’m Tobias Carlisle. This is the Acquirers Podcast. I’m incredibly excited today to have five of eight managing directors of Tweedy Browne here to discuss value investing, the past, the future, how it evolves. We’ll be talking to them right after this.
Speaker 2:
Tobias Carlisle is the founder and principal of Acquirers Funds. The regulatory is he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliates. For more information visit Acquirersfunds.com.
Tobias Carlisle:
Hi gents, how are you?
Bob Wyckoff:
Terrific.
Frank Hawrylak:
Good.
Tom:
Tremendous.
Jay Hill:
Nice, right.
Tobias Carlisle:
So, I’ve never had a podcast with five folks on it before. So we’ll just have to grope our way forward here, but surely everybody who listens to this podcast knows who Tweedy Browne is. But I just thought I’d give a little, a brief potted history. Tweedy Browne famously was Graham’s broker, and has been managing money for outside investors since 1968, 1969 continuously since then. And that’s an important date because you also helped Warren Buffett get control of Berkshire Hathaway, absolutely storied name in the value community. So I guess the first question is, how have you maintained the culture of the firm and how have you kept that continuity of that very disciplined value approach? How have you sustained that over such a long period of time?
100-Year Anniversary Of One Of The Most Storied Names In Value
Bob Wyckoff:
Maybe I’ll start. My name is Bob Wyckoff. I’ve been here at Tweedy since 1991. So, I’ve been here 28 years and my associates here have been here for also very, very long periods of time. So I guess, Tobias the first thing I would say is value investing is in the blood here at Tweedy. We started in 1920 as a firm, Tweedy and company. This year, we’re celebrating our 100th anniversary as an organization. And in the first half of that period, we were a broker. And we started in 1920. It was founded by a fellow named Forest Tweedy and he was looking for a niche in the securities business and he fell upon the idea of making markets in inactively traded, closely held public companies. And these were companies that often were owned or controlled by families on occasion. There was very little public ownership but there was some public ownership, the stocks traded by appointment, you couldn’t go down to your local broker and buy the shares.
Bob Wyckoff:
And Tweedy developed a business around that market segment. And he would go to the annual meetings of companies every year. And he would copy down their shareholder list and he’d go back to his office, and he would crank out postcards, sending them out to all the shareholders in the company offering to make a market in the shares should they desire some liquidity. And by almost any definition of value, when those shares did trade because they were liquid, they often traded at substantial discounts from just about any measure of value you could come up with and that attracted the attention of Ben Graham, who you know whose big idea, big thesis is that there are an essence to prices for every share of stock, the price you see on the exchange at any given moment and the other price, the price that would accrue to the investor in the event the entire company was sold in an arm’s length negotiated transaction.
Bob Wyckoff:
And Graham referred to that price as intrinsic value and to Graham the essence of investing was exploiting big discrepancies between those two prices. So these inactive securities were interesting to Graham and a brokerage relationship developed so much so that we moved our offices down the hall from his at 52 Wall Street in the 1940s. He retired, as you may know, in the mid 1950s. And when he retired his star analyst Warren Buffett, he offered the business to Warren, Warren declined. Warren went back to Omaha, Nebraska, started the Buffett Partnership. We all know Warren’s history. But there was another young analyst that Graham knew him named Tom Knapp.
Bob Wyckoff:
And Tom left Ben Graham’s firm when he retired and walked down the hall and joined Tweedy Browne. And Tom is the person who really helped transition the firm from a broker in these inactive securities to now being an investor and initially in the late 1950s, it was the partners capital. And then you were correct in the late 1960s we got our first outside client, when a fellow named Ed Anderson joined Tweedy. And Ed came to Tweedy from Wheeler, Munger which was Charlie Munger’s firm out in Los Angeles. So, there’s a lot of rich history. You asked how do we maintain the culture? People have long tenures here, it’s kind of in the blood. We all know the stories even people who came later. So the value culture at Tweedy is extraordinarily strong.
Tobias Carlisle:
One of the things that I have observed over, particularly over the last five years and it feels funny to talk about a five year period when I’m speaking to a gentleman who are celebrating 100 years, but there’s been a gradual shift from… When Graham started out, it was net current asset value. And then as he evolved too he defined it differently. And Buffett clearly has a different definition too which is that compound style franchise looking for future growth and value of net appropriately. I think that we’ve now reached a point where it’s almost all growth value. And there are very few folks who are even looking at the balance sheet at all, which is funny, because that’s one of the complaints that Graham had, when he wrote Security Analysis. So, how does Tweedy Browne handle that? How do you deal with that evolution and where do you put yourselves along that continuum from the very deep value to the franchise value?
Investors Should Buy Stocks Trading At Two Thirds Of Private Market Value
Jay Hill:
Yeah. This is Jay Hill speaking, I would say that we’re one of the few firms that actually does both. So, we actually invest in better businesses that we think that they can compound over time, if we can buy them at two thirds of what we estimate the private market value of that business is. But we also are willing to buy very statistically cheap securities that we refer to as bobbers, where the valuation methodology is generally balance sheet derived. So this would be either classic Ben Graham, where you’re trying to buy companies at two thirds of net current asset value that’s less prevalent today. But it would also include trying to buy highly cyclical securities at a big discount to, let’s say, tangible book value.
Tom:
As long as the debt is low.
Jay Hill:
That’s right. As long as the debt is low, the balance sheet is strong and it’s a business that we think we have no concerns, or serious concerns that the business won’t get through the cycle. Because usually when you’re buying them right at a big discount to tangible book, the near term outlook is not pleasant.
Tobias Carlisle:
Right?
Jay Hill:
So we have this darn strong balance sheets in those situations but we’re willing to do both. And I think that is something that differentiates Tweedy Browne from other investors. And I would agree with you when I read Value Investor Insight and other publications that talk about value investing, it’s clear that the vast majority of value investors have moved towards the Buffett style definition of value and moved away from classic Graham cigar butts.
Tom:
But I would add to what Jay has said, during our process of analyzing a company, we spend an enormous amount of time studying the documents, studying the annual report. When I look at the company, I start by looking at the notes first. Then I go to think of statement balance sheet and cash flow statement and see how they tie together if the income is real, and the last thing I read is the chairman’s propaganda. But that’s just part of the process, and we’ll talk about that later.
Bob Wyckoff:
But a key characteristic Tobias, is price sensitivity. Tweedy is very price sensitive, as Jay said, willing to own a great business, an average business, a deeply cyclical business but all at a price. Usually that price is somewhere around two thirds of a conservative estimate of value or less. And as you know, private market values today have gone up and up as debt has become so cheap. So we have limits, right? We will step away from observed comparables in the market, what companies are paying in terms of enterprise value to EBIT or whatever metric you might be using, we may step off those multiples a bit in valuing a business, if we think those multiples aren’t sustainable. But then we want the business at two thirds of that estimated value. And I think that’s the characteristic that differentiates Tweedy from the better business value [inaudible 00:10:34].
Investors Need To Pay Higher Multiples In Growth Markets
Tom:
Let me give you a little bit of background over the last 40 years. When I joined in 1989, we were valuing businesses if it was an earnings based valuation. We were valuing businesses at eight times and buying them at five times EBIT.
Tobias Carlisle:
Right.
Tom:
During the 90s and early 2000s, we moved to this valuation of 10, maybe 11 times and buying them at seven. Now we are in a range where we’re comfortable valuing businesses at 10 to maybe 13 times for an exceptional business and then buying them at a 33% discount. So that’s how we avoid. There are not enough current assets to fill a portfolio now. There are not enough stocks to trade at a significant discount [inaudible 00:11:22], they’ve been already charged out. There are not enough book value stocks, but when we find them as Jay has said, if they’re very little debt, then we’ll go.
Bob Wyckoff:
And the evolution of those multiples relates directly to the decline in interest rates that we’ve seen over time. When I first came to New York, it was 1980. And I wasn’t at Tweedy at that point. But I showed up in New York to start my career in the investment business. And Paul Volcker, the year before had been named head of the Federal Reserve really tightened money to try to bring inflation under control and interest rates were at sky high levels. And just look at what’s happened since 1980, 40 years of a decline from those multiples now down to the zero to negative rates we have today.
Tobias Carlisle:
You anticipated my next question, which was, what causes the increase in the multiples? Bob, I know that you were at JD. So, how did you transition from JD to the investment world?
Bob Wyckoff:
Well, it was interesting. When I was an undergraduate in college, I took an investment course, my senior year and I really enjoyed it and my dad was an investor. And when I was a kid, in my early teens, he bought me some stocks and back in the late 1960s, mid 1960s, you’d open up the newspaper to look for the price of your stock, right? I used to do that all the time at home. So, I was deeply interested in the stock market but I couldn’t decide whether I wanted to go down a legal path or a business path. I knew if I went down the legal path I could do, either. So I went down the legal path. I practiced law for a couple of years but I had interviewed at an investment firm, and I got a call from that firm two years into my legal practice and decided to take that job. And that brought me to New York. And I’ve been in the business ever since.
Tobias Carlisle:
When Tweedy Browne implements this philosophy, and I think that you’re probably the purest expression of gray and although I acknowledge that you’ve evolved as you’ve gone along, how does that manifest? I know that you run some funds and Bob you might want to read your disclaimer before you answer that.
Bob Wyckoff:
Okay. So, I will. If we talk about our funds there’s a little disclaimer investors. Anyone watching the podcast should consider the funds that we may mention their investment objectives, risks, charges and expenses carefully before investing. Prospectus containing this and other information about the funds is available on our website at www.tweedy.com. Investors should read that prospectus carefully before investing and of course, past performance does not guarantee future results. With that in mind, we do one thing here and it’s only value investing. And we do it only in equities and we do it in global, international, and we have what we call global high dividend portfolios, which is really undervalued securities with an above average dividend yield.
Bob Wyckoff:
And those are the three things we do and we have different vehicles in each one of those categories. Commingled vehicles together with a separate account capability, and even an offshore capability for non-US investors. So the business is pretty simple. In essence, we’re running three portfolios for the most part here at the firm. But we have lots of different ways you can participate in those portfolios.
Tobias Carlisle:
When you thinking about composition for those portfolios, how do you think about diversification? How do you think about concentration? Do you like to hold more and better ideas at equal weight? What’s the process for that?
Diversification Gives Investors Downside Protection
Tom:
I think one of the most important things that I’ve learned in my over 30 years at Tweedy is, how much of a humbling business this is. You think you know, you look at the company, it looks great, you get excited and then it doesn’t work out. So, over the years we have been highly diversified. The analogy I would bring to you is if you only underwrite Suburbans as a car insurance company, and the kids are under 16 and the father has a stable job, all that kind of stuff. You underwrite the portfolio of securities like this, you’re probably going to make money if you price it right. The diversification gives you a downside protection. I recognize the fact that if you own five stocks and those five stocks go through the roof, your performance is going to be extremely good, but you have to be right. And Bob has spoken in the past about the period of the Nifty 50s and how that turned out when people were investing in one-decision stocks. That’s all you had to do. And then the Camille pants that came in 1973.
Bob Wyckoff:
I would just add to what Tom said. Ben Graham believed in great diversification, what he called the law of large numbers. And as Tom said, he almost brought an insurance underwriting idea to the process of investing. And so our portfolios are diversified by issue, by industry, by country and by market capitalization. So, we’re willing to own market caps all the way down to a couple of hundred million and all the way up to several hundred billion, et cetera. And we really live with only three constraints, we try to limit our exposure to a particular industry group of somewhere not more than about 15 to 20% in a particular industry, no more than three to 4% at cost when we’re buying an initial security, and typically no more than 20 to 25% will invest in a single country. And those are our constraints. Setting those aside, the portfolios breakdown wherever we’re finding undervalued securities, and they don’t look anything like indexes so your viewers shouldn’t confuse diversification with a portfolio that looks like a market portfolio because it tends to look very different. Our country rates, our industry rates are often radically different from what you see in an index.
Tobias Carlisle:
How do you allocate responsibility for… Are there industry specialists? Is everybody a generalist? Does somebody take on a company and follow that company individually? How do you deal with those issues?
Roger:
We all screen and we screen a lot. And then what we aim for is that everybody is a generalist. The way human beings work is such that some people are more attracted to certain businesses than other people. But in principle, we are all generalists. We have some soft specializations. We have one analyst that tends to spend more time looking at the Far East, but there he will look at any type of company of course, right? So, that’s the way we come at it. I think it’s best if you… I used to always say that, let’s say you had a job working for a Bulge Bracket asset manager that runs 200 billion annuity, chemical analyst for Scandinavia, and there are no cheap stocks. Right? This is not good for anything, not for your career. I mean, this is a terrible situation to be in. And then maybe the portfolio manager likes you a little bit so he buys the cheapest of all the expensive stokes in chemicals in Scandinavia, right? So we don’t have that.
Roger:
Our aim is to all be generalists, our aim is to all be, have a similar gene set that takes you a while to get into the gene set, we are time moves a little bit differently because we’re long term slow investors. And so we’re replaceable, there are no stars. But we have different temperaments, different atom like [inaudible 00:20:30] and I call him my resident doctor. Yeah. But that’s how it goes.
Tom:
He likes [inaudible 00:20:40].
Roger:
I like [inaudible 00:20:41]. But anyway, so that’s more or less how that cookie crumbles? So you work on what comes out of your screens, you have that freedom, right? And you check it with the other people, are we not working on the same stock? But that’s how we go about it.
Tobias Carlisle:
Could you take me through the way that an idea is generated through to it being added to a portfolio?
Jay Hill:
Yeah, so, and by the way, Tobias, I read your book, was a huge fan of your book.
Bob Wyckoff:
Me too.
Jay Hill:
And I think our philosophies are actually very similar.
Tobias Carlisle:
I’m happy to hear that. Thank you so much.
Jay Hill:
But look, what we’re trying to do as Bob mentioned earlier, we’re trying to buy companies at two thirds or less of a conservative estimate of private market value. With private market value being defined is what would the business be worth if the CFO of the company that you’re looking at picked up the phone and put the company up for auction tomorrow? Right? So we really estimate value by studying M&A deals in different industries. To use an analogy that I think everyone can understand, if you’re looking to buy a home, or if you’re looking to sell a home, right, one of the most important things that you would want to know is what have similar homes sold for recently? Right, similar square footage on the same street, similar lot sizes, and are there opportunities to purchase a home, right, at a substantial discount to observes transactions. And that’s really what we’re trying to do.
Value Companies Using Comparative M&A Deals In Similar Industries
Jay Hill:
So one of the things that I think people find interesting about our process is that the analysts here probably spend anywhere from 20 to 30% of their time just tracking M&A deals in different industries, and trying to build a frame of reference for what buyers in different industries, what types of multiples they’re willing to pay. And I would say in general, multiples tend to be highly influenced by the organic growth prospects of the business, the returns on invested capital of the business, the stability of earnings, particularly through recessions. And if there’s a fourth criteria, it would be synergy potential. There are certain industries where a buyer can pay what looks like a really high multiple to the seller. But in fact, it’s a one win win for both the buyer and the seller, because the cost synergies are so large that it can actually make sense for the buyer as well.
Jay Hill:
I can tell you that we apply this same theoretical private market value framework to both large-cap companies like a Nestle, let’s say where the prospects of a deal are highly unlikely just due to the size of the company. We also apply this to small-caps and mid-caps where a deal is a very real possibility. Another thing that it’s probably important to understand is that we make sure that every new idea passes a two part test. So the first part is what I just mentioned, is the stock trading at a substantial discount to our conservative estimate of intrinsic value based upon M&A deals. Right? And the second criteria is, is the stock just cheap on a standalone absolute basis, without looking at the M&A deals, right? And the reason that we have that second criteria is because we’ve realized that sometimes buyers overpay. And we don’t want to extrapolate what we believe are unsustainable purchase price multiples on businesses that we’re studying. So that’s really the underlying criteria. I can tell in terms of how do we identify new stocks?
Frank Hawrylak:
Can I just add-
Jay Hill:
Sure.
Frank Hawrylak:
-one thing? This is Frank Hawrylak, to what he said. It sort of implied in what he said, but I’d like to state it explicitly is, the valuations have to have some sort of cash flow support. Because there are plenty of areas where you can find deals or values based on some metric that isn’t related to earnings or operating income some other metric-
Tobias Carlisle:
Eyeballs that used to be very popular.
Tom:
Yeah, eyeballs.
Frank Hawrylak:
Yeah, you’ve got it. So this idea of having cash flow support and not necessarily looking too far out in terms of making judgments, how far out to go in assuming that the current earnings are going to continue. We try to think more here and now earnings, maybe look out a little bit but not out, years and years or decades. We do think a lot, especially about the better businesses about the economics, the competitive environment, whether these returns are sustainable, but in terms of guessing future earnings or discounting them back, we rely more on deal multiples instead of some discounted cash flow model. Go ahead.
Compare Companies Using The ‘Owner Earnings’ Yield
Jay Hill:
Yeah. And I guess the next part of the process is how do we identify new ideas, right? And I would say probably 80 to 90% of the new ideas that I’ve come up with over the years have come from quantitative screens. There’s no one quantitative Tweedy screen that we us. Each analyst is free to use their own methodologies. But in general, I would say that our screens tend to rhyme. So we’re generally looking for companies with a market cap in excess of $200 million USD. So, we’ll go down into small-cap territory. We’re looking for companies that have an enterprise value to EBIT of less than 10, generally speaking. There’s a new metric that we’re using, that we refer to as owner earnings yield, and that probably deserves a little bit of an explanation.
Jay Hill:
Tax rates have been coming down around the world, right? And it’s our view that if you had two companies, each trading, let’s say, at an enterprise value to EBIT of 10, but one company had a 40% tax rate, and the other company had a 20% tax rate, we believe that the company with a lower tax rate is worth more. And so one of the metrics that we’ve come up to adjust for that and to adjust for the fact that tax rates have been coming down around the world, is to look at what we call the owner earnings yield. And to define that explicitly, the owner earnings yield is, the numerator is net operating profit after tax. Another way to say that would be EBIT times one minus the tax rate.
Tobias Carlisle:
Got it.
Jay Hill:
That’s the numerator and the denominator is enterprise value. The way you would traditionally calculate it. And generally speaking for new ideas, we’re looking for companies that have an owner earnings yield of 8% or higher. And then we also have a metric and I know you’re a big fan of this as well. I read about it in your book that we’re pretty risk averse when it comes to leverage. And so generally speaking, our screens have maximum net debt-to-EBITDA of two and a half times or less. That number is not set in stone, we realize some businesses have greater visibility than others. And so there are instances where we will buy a business that has higher leverage than that.
Tom:
But lower is better.
Jay Hill:
But lower is better. Absolutely. And then I would say look, we also look at our competitors of businesses that we’ve studied. That’s been a source of new ideas over time. We look at 52 week low lists, insider buying, we’re big believers in the efficacy of combining cheap quantitative criteria with insider buying. And so that’s another, I guess, metric or tool that we use to uncover new ideas. Once we’ve identified a cheap stock, then really the real work begins and that’s when the analyst is going to go and read the most recent 10K, 10Q, read relevant sell side research, reports, read company presentations or analysts days, develop a financial model going back oftentimes 10 or 15 years in time to study the long term underlying trends in the business. I think we spend a lot of time studying the margin history of a business over time and trying to understand why margins have either increased or decreased.
Jay Hill:
What we want to really avoid, right, is valuing a company off of peak margins, that you’re putting a multiple on a company that’s earning peak earnings and overvaluing the business or the opposite, putting a multiple on trough earnings, right? So in many instances, we’re trying to estimate what’s normalized earnings over a cycle. We’re also big believers in free cash flow quality or free cash flow conversion, we defined that as does the company do a good job of converting that net income number on the income statement that has all types of accruals? Does the company actually convert that number at a high rate into free cash flow? And so we’ll look at let’s say a five year period or a 10 year period, free cash flow can be highly volatile, right? Even more volatile than earnings, but over an extended period of time does the company convert its net income into a high level of free cash flow and if it does, that gives us comfort that the earnings quality is high. And then really the final job of the analyst is to obviously identify the attractive attributes or characteristics of a business, but also identify the risks.
The Primary Job Of The Analyst Is To Identify Serious Risks
Jay Hill:
And I can tell you, Tobias that any of the stocks that meet the quantitative criteria that excite us, right, get us trembling with greed. The near term news flow and the near term outlook is likely very bad, right? And so the primary job of the analyst is to identify the risks, the most serious risks and make judgments on whether or not we think those risks are cyclical, meaning IE temporary, or are they more permanent in nature in structural. If we ultimately can convince ourselves that the risks are more temporary then the analyst will often write up a full report, send it to the rest of the investment group. And then a discussion ensues on whether or not we should purchase the stock.
Tom:
And the discussion if you were the proverbial fly on the wall, at the Tweedy Browne meeting 90% of the questions that are thrown at the analyst in a nice way, deal with what’s the downside? Because if you understand the downside, the stock is cheap, then the probabilities are in your favor. And this is a game of probabilities. How can you improve your odds for making a good decision?
Bob Wyckoff:
And Tobias I would follow up with one final thought. Frank mentioned we don’t like to predict earnings way out and that’s absolutely correct. But we are trying to try to get a hold on what we think the earnings power of the business model is and the sustainability of that earnings power over time. And we’re willing to be incredibly patient as investors. We’re not looking for catalysts for value recognition, which is kind of a thing some people do these days.
Tom:
We hope they will come.
An Investor’s Biggest Edge Is To Take A Long Term View
Bob Wyckoff:
We would love to have catalyst. But usually if those are observable, it’s in the price. So we’re looking for those deep discounts and we’re willing to be very, very patient and feel absolutely, strongly about the notion that we have less competition. If we’re looking at something and we’re willing to think or wait much further out for our returns. More often than not that return comes in sooner than we would have anticipated but we’re willing to be patient and in this day and age where information is a commodity and it comes at you so quickly and investors have so much information. I think one of our biggest edges is, well, it’s judgment and temperament but it’s also this longer term perspective, because most people are telegraphed on the next six to 18 months. And if they’re not going to get value recognition during that period, they don’t want to own this stock. We’re willing to look much further out.
Measuring Qualitative Factors In Investing Is Critically Important
Tobias Carlisle:
This is the last question on the process and then I’d like to ask you about what you’re seeing in today’s markets. But when I first started investing, I read Buffett’s letters then I read Security Analysis and some of Graham… And The Intelligent Investor. Then one of the very early documents that I read was What Has Worked in Investing, the very famous Tweedy Browne document from, I’m not even sure of the date but it could be 20 years old at this stage. Maybe it’s older than that.
Bob Wyckoff:
It’s back about ’91, ’92.
Tobias Carlisle:
Is it as old as that?
Bob Wyckoff:
Yeah.
Tobias Carlisle:
That talks about quantitative factors that have done very well in the markets at that time, but you’ve make it explicit in many of your public statements that you do think very deeply about the qualitative factors as well. So what are you thinking about in that process? What are you looking for? How does that manifest?
Roger:
If I may, I would say that you, especially if you go into balance sheet type of valuations, there’s a lot of traps out there. And if you play the game for a while you learn about traps, individual companies being traps and an unreliable majority shareholder who was trying to enrich himself or was only [inaudible 00:34:36], the company quoted for reasons other than trying to grow wealth over long periods. So if you look at the long term economic history of a business that can help you a little bit because if there’s no progress, that’s not a good sign. So it then needs to be cheaper the discount that you need to pay needs to be bigger. So you ask yourself questions like, would I like to compete with this company? Would I like to try and push it out of business? And now you’re going into the direct terrain of what’s the strength of their franchise, and some truly local and small companies you wouldn’t want to compete with because they dominate, let’s say, little rocks or like a gravel pit or something, it’s a very difficult business to compete with very locally.
Roger:
So it can be anything, but you have to think about factors like that. So you can’t just say, “Well, the numbers are low.” Because before you know it you own all the steel companies of the world, and now it’s two times EBIT. This is not a good… And that’s a business that is always thirsty for cash over long periods of time. So you have to watch out for these kinds of things. So you have to think industrially, you have to think competitively, and those are the kind of qualitative things that are in our minds. Earnings based valuation or balance sheet type of valuation, we think about these things aggressively. You can say, “Well, the debt situation now of airline x, y, z is good. If things go sour, their ratios really, really quickly.” So you have to think about operational leverage in the business. If you have operational leverage on top of financial leverage it becomes a little bit more tricky, right? So those are the kinds of factors that are in our head.
Bob Wyckoff:
I want to make one point. The qualitative is critically important in addition to the quantitative. And we spend a lot of time and there’s a lot of institutional memory here that goes way back. A good understanding of business models and the sustainability of business models obviously, in a world today that’s being disrupted, right left all the time. I think back on something Munger said years and years ago, he said, “If it can be quantified, it will be emphasized.” Right? And he said, “It’s often the softer stuff that is the most important in the decision making process.” So when we can find a business and this would fall into the Buffett kind of category with a durable competitive advantage, a business model that we think is sustainable, with a durable, competitive advantage over time, we spend a lot of time looking for that. It’s not a characteristic of every stock we own. But we do spend some time looking for that.
Jay Hill:
Yes, but what I would add is, look, I think you can look at a company’s history and see that there’s quantitative evidence of a move, right? High margins and high returns on invested capital. And then you want to understand the qualitative reasons behind that move, right, to help you better understand is it sustainable, and I’m a big fan of Pat Dorsey’s book. I can’t remember the name of it right now. I think it was The Little Book That Builds Wealth. But it’s a book that’s basically describes competitive advantage. And he basically breaks down moats into four sources. So the first one is intangible assets. These are things like brands, patents, attributes that bring with them pricing power. And we own companies like Nestle, Diageo and Roche that I think fit into that camp. High switching costs, right. We own a business called Safran that makes jet engines. Once Boeing decides to use the leap engine which Safran makes for Boeing, it’s very difficult for Boeing to switch that decision.
Jay Hill:
We look for businesses that have network effects. That’s a very powerful one. It’s more difficult, I think, for us to identify at the quantitative prices, right that are attractive to us. But we’ve owned businesses like Google and MasterCard over time that we believe benefit from network effects. And then low cost producers. We look for that as well. We own a company called Antofagasta that makes copper that we believe is a low cost producer. We’ve owned Cisco, the food distributor in the US in the past that because of their scale advantages have much lower costs and better margins than their competitors. And other things that I look for. Look, I love fewer competitors in an industry, I love oligopolies and duopolies much more than industries that are highly fragmented.
Understanding The ‘Mix Shift’ Within Companies
Jay Hill:
I think stability of market share over a long period of time is another very important quality characteristic. If a company’s got stable market shares or an industry has stable market shares over time, to me that’s strongly suggests the evidence of a competitive advantage. We also look for things like mix shifts in a business that may positively impact the company over time. Another-
Tobias Carlisle:
Mix shift? Can you just explain that?
Jay Hill:
Yeah. Where a company perhaps has a couple of different segments, but the piece that has higher margins and higher returns on invested capital is growing faster than the rest of the business.
Tom:
So for example, Johnnie Walker black versus Johnnie Walker red. The EBIT margin is at least two and a half higher. So you can’t look at the company and just look at the number of bottles they sell. You have to figure out what is the mix and that itself. But what I would add to what Jay has said, you shouldn’t think about us as being geniuses. We make mistakes. There is we bought [inaudible 00:40:35] that is down, we bought WPP that is also, it’s… But we are diversified. We-
Bob Wyckoff:
And our council wants me to explain that, we as individuals at Tweedy, also own these stocks that we’re talking about. And as investors that’s another characteristic of our firm Tobias. We’ve got over a billion dollars of our own capital. That’s the partners, our families, retired partners and our employees all invested in the commingled vehicles that we manage here at the firm, separate accounts, et cetera. And we own the stocks Jay just mentioned. So we just want to make that clear, as well as individuals. We think of it as a community of interest, not a conflict.
Value Investing Works Because It’s Painful And Very, Very Difficult
Tobias Carlisle:
Let me ask you, given the very long history of Tweedy and the enormous combined experience in the room, when you look at today’s market, are there any obvious analogues from historical markets or do you think that this is unique in some way?
Tom:
[inaudible 00:41:55].
Bob Wyckoff:
Well, yeah, nothing. What did Mark Twain say history repeats-
Tobias Carlisle:
Rhymes.
Bob Wyckoff:
…That rhymes, it doesn’t necessarily repeat itself. I think that’s absolutely true. Tom mentioned something earlier that, and of course, it’s different today. It’s not 100% like this, but I couldn’t help but think about parallels back to that Nifty 50 era when I think about the FANG stocks today and that era between 1965 and mid 1973 was an era where a group of securities performed extraordinarily well. Ended up trading at more than double the market multiple and the market multiple was high during that period, and these were the technology stocks of the day back in those days. It was companies like IBM, Hewlett-Packard, Digital Equipment, the Texas Instruments-
Tom:
Eastman Kodak.
Bob Wyckoff:
The Eastman Kodak.
Tom:
Polaroid.
Bob Wyckoff:
Polaroid, and of course, you can add Philip Morris, Avon, Walmart-
Tom:
Disney.
Bob Wyckoff:
Disney. All these stocks were part of the Nifty 50. And I think people would be shocked to know that in late 1973 and 1974, these stocks absolutely collapsed. Disney was down over 80%. Hard to imagine that kind of thing happening. But it reminds me today a little bit of the feeling we have about these dominant technology stocks and full disclosure we own shares of Google, which we bought many years ago at a point in time when we thought the stock was cheap, but many of the others we don’t own. And of course, that’s where the action has been of late as you know. And those stocks are group. You’ve probably heard Rob Arnott presentations where he talks about the valuations of these companies. I seem to recall he said, “As a group they’re worth four to $5 trillion which is greater than the annual GDP of most developed countries except Japan and the United States or something.”
Bob Wyckoff:
I mean, truly dominant companies growing quickly, no doubt, and will continue, obviously, to be good businesses, but maybe priced for perfection, hard to know. But the Nifty 50, that era reminds me a little bit of that aspect of today. And another thing I think back on I think the Barton Biggs, who was the strategist at Morgan Stanley years ago, I want to say in early March of 2000, wrote a piece called Even Monkeys Fall From Trees. And the piece was about value investing was once again being declared dead. And Barton had great courage. Came out in a piece, talked about this is no time to be abandoning value. You should actually be thinking about putting money in that era. The dot-coms were in ascendancy. And within three weeks of writing that piece, the technology bubble burst, and these stocks came tumbling down. So that’s another thing that comes to mind in the press lately, particularly in the last year, value is no longer relevant. It’s dead. It’s dying, I could give you a pile of press-
Tobias Carlisle:
I have it, don’t worry.
Bob Wyckoff:
You know it. And I just think it’s… I can tell you, my career, I got here in 1991 and values been declared dead three times in my career. This is the third time and I suspect it’ll be declared again down the road, right? And value is the most, Jay likes to talk about the reason why value works is it painful at times and psychologically very, very difficult for people to practice because almost a condition proceeding to value success are these sometimes unbearably long periods of underperformance and we’re obviously in one of those. There’s one thing you can count on at Tweedy, we don’t change our stripes. And we think we’ll come out of this. But it’s been a tough time.
Tobias Carlisle:
I don’t know if you saw Cliff Asness published a piece saying he advocates for… He says it’s very hard to time when any strategy will start working. So when will value start working? Nobody really knows. But he says, “When the opportunity gets stretched as it has been, it’s time to sin a little.” And he advocated for allocating a little bit more to value than you may ordinarily allocate. And then he had to follow it up six weeks later with another piece that he called, Never Has a Venial Sin Been Punished So Quickly, also [inaudible 00:47:36]. Because it was the worst six weeks in what has been a very tough decade. But I saw something very encouraging the other day. I look at the French data, Ken French’s website, he has all of the factor data. Ken French of Fama French.
Jay Hill:
Yeah.
Tobias Carlisle:
And I looked at price to cash flow I saw that you can divide it into all the deciles. And I looked at the cheapest decile against its own long run main. And it is since 2019, for the first time in a very long time, it’s actually cheap to its long run main. And the only other two times where that’s happened in recent memory was 1998 to 2000. And then 2009 right at the bottom, both of which were very good times to get started as a value investor, and the performance thereafter was quite good. So how do you feel? Like without really looking at the data anecdotally, how do you feel about the prospects for value at this point in the cycle? Looking at your own portfolio, how do you feel?
Bob Wyckoff:
I would mention one thing. I sense a certain fragility in markets over the last couple of years. There have been pockets of volatility. They last very briefly, and as Cliff said, you get punished very quickly as stock prices come back. But we have had pockets of volatility and I think that is a reflection on the fact that we have very high valuations. And facing a lot of macroeconomic issues all over the world, I think back to the Nifty 50 era and what… It’s hard to know exactly what brings stocks down and what causes a correction. But I remember back in that era, it was the oil embargo played a big role.
Tobias Carlisle:
As the supply shrunk.
Bob Wyckoff:
Saudis embargoed oil. Oil prices quadrupled in the United States, prospects for recession were knocking on the door and we got a big decline in stocks. It’s hard to know what’s going to cause that. Is it going to be a virus? Is it going to be any trust scrutiny of technology stocks and some disappointments there? Is it going to be simply the fact that at some point people begin to think about low interest rates, rather than being a catalyst for market performance, maybe indicating something else.
Tom:
It’s a symptom, maybe.
Tobias Carlisle:
Yeah.
Bob Wyckoff:
Something that could be an indicator of bigger problems. So who knows? We don’t know. But because of this fragility and the pockets of volatility that we’ve been seeing, I sense we’re closer to that time. And it’s probably as Cliff would say it’s, we probably should be sinning a little right now.
Tobias Carlisle:
I think that the Nifty 50 is a very good analogue for today. And I agree with you because when I look at the companies that do have the highest valuations, they do tend to be the better companies that are growing very rapidly, throwing off lots of free cash flow. It’s just that I think that they’re extremely expensive when you look at Microsoft at one stage got to a 2.8% free cash flow yield. No question that Microsoft is a fantastic business with incredibly high margins and likely expanding margins and growing at a very high rate. It’s just that at 2.8% it’s getting to that point where it doesn’t have anywhere to go and if it backs off a little bit from there, it’s still not really cheap at three and a half percent. So that’s why I agree with you completely that that year was a good one… Is a good analogue. What happens there after? Do you avoid value in the interim while the volatility in the markets takes over or do you remain steadfast? Do you hold a bit more cash in the portfolio? How do you deal with that?
Tom:
We’ve don’t know how to do anything else except we value investors. We have a little bit more cash than the normal. We are above 10% I believe we are around 12 or 13.
Bob Wyckoff:
Mm-hmm (affirmative).
Tom:
But we’re still looking for value. That’s the only thing we know how to do.
Tobias Carlisle:
So you could be fully invested in short or if the opportunities presented themselves?
Tom:
Right, right.
Roger:
Maybe in a volatile environment you look for the better businesses rather than the ones that are likely to get it on the chin if the heavy weather continues, right? So we prefer to do that. So the rougher the environment you’re in the higher the odds you buy better businesses at decent prices, and then those are the ones that can compound that you can hold for a while.
Tom:
But only if they fit.
Roger:
Yeah sure that’s all we do.
Tom:
[crosstalk 00:52:38].
Roger:
That’s all. [crosstalk 00:52:41] going to pay up for anything. We do the same thing, I mean, we just get a little bit more excited that we can buy better businesses when markets fall.
Find Great Companies In Boring Industries
Tobias Carlisle:
Are any industries or countries looking particularly enticing?
Jay Hill:
Yeah, well, I mean, I could say not necessarily more recently. But over the last summer of 2019, when it was clear that the leading economic indicators in the industrial sector of the economy like PMIs, and industrial production indexes, were coming down substantially, right? This summer, it became consensus that manufacturing around the world was entering a recession. And so there were lots of stocks that sold off significantly due to expected near term weakness in earnings. Right? And so, we did have the opportunity to buy a few stocks in 2019, that met our criteria. One business that we were able to buy was a business by the name of Trelleborg. It’s a company that’s based in Sweden. Again, this is a stock that we were able to buy at roughly nine and a half times enterprise value to EBIT plus merger amortization. So EBITDA around 12 times after tax earnings, it had a 3.6% dividend yield. And it was trading at a substantial discount to similar companies that have been acquired in M&A deals.
Jay Hill:
And there was also substantial insider buying by insiders at the company about three and a half million dollars worth at a price of around 170. And just to give you a little bit of background Trelleborg is a company that makes industrial polymers. So they make essentially products made of plastic and rubber. And 75% of this company’s earnings comes from two segments. There’s multiple segments, but there’s really two segments that matters. The first segment is a business called Sealing Solutions. And the Sealing Solutions segment represents about 55% of operating profit.
Tom:
That’s a seal.
Jay Hill:
It’s a… Yeah, this is called a wiper seal and I’ll explain to you the significance-
Roger:
We played mini basketball in the office.
Jay Hill:
I’ll explain to you the significance of this in a minute. But this is a business that over the last decade has grown organically about 4%. And it’s got for this seal, right 23% EBIT margins. So, high margin product seals are used in virtually everything but you know, John Deere tractors, caterpillar, construction equipment, they’re used in aeroplanes. They’re used in electronics, so wide variety of uses. Seals, protect equipment, they protect environment and they protect people. Generally speaking, you’re trying to keep a liquid in or keep a liquid out in an application or you’re trying to keep dirt out. And the key characteristic, and this gets back to the qualitative question you answered earlier, the key characteristic is that the cost to produce this seal is relatively low, relative to the value that it protects. It’s considered a low cost, but high failure consequence product. And for that reason customers will pay more for it. Really the key in this industry is to convince a customer that, “Look, this seal doesn’t cost a lot of money. But if it fails, right, you could be potentially looking at a product recall, an environmental fine, equipment downtime, and in some cases, human safety, right?”
Jay Hill:
If the seal on the landing gear of an airplane fails, it’s possible that you don’t have a safe landing. And so because it’s a low cost, high failure consequence product, you have pricing power. And so this seal right here, it’s called a wiper seal. It costs five bucks for the customer. The price of this is five bucks. It’s used in industrial cylinder applications and an industrial cylinder might cost $100. And that industrial cylinder goes into let’s say, a John Deere combine, and the John Deere combine, right, costs $500,000. And so that characteristic is absolutely key, right? Low cost, but high failure consequences.
Bob Wyckoff:
Good business model.
Jay Hill:
Also, if you look at similar businesses to Trelleborg Sealing Solutions, there’s some good M&A comp so Michelin, right? The tire company based out of France, bought a company by the name of Fenner in the last couple of years and paid 18 times EBITDA for that business. Parker-Hannifin company hat we know very well in the US bought a private company that competed with Trelleborg’s Sealing Solutions. This private company was named Lord Corporation. Parker-Hannifin paid 18 times EBITDA for that business. We valued Trelleborg’s Sealing Solutions business at 13 times EBITDA. So a pretty big discount relative to observed M&A Comps.
Bob Wyckoff:
But we paid little lower than that.
Jay Hill:
Nine and a half times. Right.
Bob Wyckoff:
Nine and a half.
Jay Hill:
Nine and a half times EBIT. Another 25% of this company’s earnings come from wheels. This company is a big producer of agricultural wheels, and that also wheels and tires for forklifts. But it’s a similar situation where it’s a pretty good business over the long term. If you look at M&A Comps, Michelin paid 17 times for a business called Camso that also made agricultural tires. And then there’s another deal where Yokohama.
Tom:
[inaudible 00:58:33].
Jay Hill:
Yokohama, bought a business called Alliance Tire Group for 15 times EBIT. So-
Bob Wyckoff:
I will just add. This is just one of the niche manufacturing businesses where value has been showing up because of the bad macro data the middle of last year. There are others and this is not a big company, this is a-
Jay Hill:
Right. This is a $4 billion US market cap.
Bob Wyckoff:
-$4 billion company. So there are other niche manufacturers like this that we’ve been able to pick up and what we think are very attractive valuations because of that poor industry growth area. And a lot of these businesses, we find outside the United States, the US equity market, as we all know, has been the strongest equity market in the world. It’s more than double the returns of non-US equities. And I would say today, one of the interesting things about Tweedy, when I first came to the firm and in 1991, we were largely a US equity manager. We had invested anecdotally from time to time in non-US securities, but since then, we have become much more of an international investor than we have a domestic investor. And this is simply a function of where value has shown up in the world for us. And I think part of that has to do, Tobias with the fact that equity cultures outside the United States are not quite as advanced as we’ve been here in the United States.
Bob Wyckoff:
And so, over time, we’ve got more inefficient pricing. When I first came to Tweedy, Frank, who spent a lot of time looking at US names, it was very difficult for him to get a US name through in our research process. Tom here who was looking at a lot of the international names, we were buying these things right and left. And so when you look across the board at Tweedy today, I think today we’re managing about $14 billion. You can’t hold me to this, I think about 70% of our money is invested outside the United States.
Tom:
But to answer your question a little bit more specifically, value investing to give you an analogy is like duck hunting. You sit in a blind and the guy goes with a whistle and course the ducks and if the ducks come you shoot. So it’s whatever opportunities Mr. Market is offering you. And at this point we find value without mentioning names is in some European chemical companies, some Japanese chemical companies, we are buying a German industrial company.
Bob Wyckoff:
Farm equipment company.
Tom:
Farm equipment company, so there are pockets of clear undervaluation I would say. But they’re just pockets.
Bob Wyckoff:
Yeah, anything of quality is pretty expensive, pretty fully valued.
Tom:
So, these are more cyclical businesses.
Berkshire Hathaway Is A Bargain Right Now
Tobias Carlisle:
Gents. Final question just to bring it full circle. I’ve noticed recently that I think Berkshire Hathaway has become extremely undervalued and I didn’t ever think that I’d see it as cheap as this in my career. Do you have any views on it? What do you think about it?
Bob Wyckoff:
Frank’s our veteran Buffet watcher so-
Frank Hawrylak:
Well, I think you’re absolutely right it touched on the a shire 300,000 the other day. And I would agree with you, I think the values on that name are in the 375 to $400,000 range and you kind of hope at some point that Buffett’s going to be able to put the hundred plus billion, 120 billion he’s got into something that compounds. But I think you do have a high quality set of businesses, great capital allocation, problem is a big company but I think is a nice value with Berkshire down there at 300,000 was quite good.
Bob Wyckoff:
And you get the chance to buy it right alongside Warren.
Frank Hawrylak:
Right.
Bob Wyckoff:
Who’s been buying it of late, so-
Frank Hawrylak:
So, we noticed what you noticed.
Tobias Carlisle:
I’m happy to hear that. Frank, Tom, Bob, Jay, Roger. It’s been an absolute thrill on a privilege. Tweedy Browne, if folks want to get in contact with you, how do they go about doing that?
Bob Wyckoff:
Maybe the easiest way is to visit our website www.Tweedy.com. But we’re located in Stamford, Connecticut and we’re accessible. It’s our only office and has 48 of us working hard every day here. So-
Tobias Carlisle:
Well, thank you very much, gents.
Tom:
Thank you.
Frank Hawrylak:
Thank you.
Jay Hill:
Thank you.
Bob Wyckoff:
Thank you Tobias.
Roger:
Take care.
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