VALUE: After Hours (S03 E02): St Petersburg Paradox, JPM’s Wide Value Spread, Risk And Valuation

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In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:

  • The St. Petersburg Paradox
  • JPM’s Wide Value Spread
  • Risk And Valuation
  • Invincible Stocks & Fragile Businesses
  • Dotcom 1.0s Trading Cheap
  • $AZO & $ORLY Buybacks
  • $IBM Shrinking
  • $SPGI Capital Allocation
  • Low Interest Rates & Banks
  • Wealth Inequality
  • Ackman’s SPAC
  • President Kim Kardashian

You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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Full Transcript

Tobias: What’s up, ladies and gentlemen? It’s 10:30 AM on Tuesday. It’s 1:30 PM on the East Coast, 6:30 Australian Eastern Standard Time, 6:30 PM UTC. I’m coming to you from California. Bill is coming to you from Florida. JT, all the way from an undisclosed location in the Caribbean.

Jake: That’s right.

Tobias: Where are you, JT? What’s happened? What’s the news?

Jake: I just needed a little break, give the family a little mental health break, and found a pretty good deal on a place here. We’re going to be here for a little while, but we’ll be back eventually.

Tobias: In Skull Island, in your supervillain lair, in the Caribbean.

Jake: Yeah, exactly. With pool.

Tobias: With a pool. Nice. 10:30 PM, Dubai. That’s what I wanted to know.

Jake: That’s good.

Tobias: What about, Bill? Where are you? Flo-Rida?

Bill: Same place. Nothing has changed. The only thing that’s changed is, I’m drinking caffeinated water, so I’m going to talk real fast today.


Tobias: Madrid, what’s up? London, Ontario, how you doing? Chicago. Cool. Cyprus. I think that’s a first. Kraków, Poland.

Bill: I’m going to get this thing started off with a somewhat of a– not a retraction, but a bit of a correction. I somewhat misframed Chamath’s get the money comment. I agree that the way that I framed it was probably not exactly how he meant it. I would say though, IPO A, B, C, D, E, F, G, H, I, J, K, L, M, N, O, P have somewhat backed up my comment. However, I do agree that the quotation that I used was not appropriate given the context.

Jake: That’s fair. But also get that money.

Bill: That is my– What?

Jake: But also get that money.

Bill: Yeah, I mean, look, it’s lot of SPACs going on.

Tobias: What was the context that he actually diluted in?

Bill: What he was trying to tell people is he was saying like, “If you want to change the world, you need to get the money. So, get as much money as you can, to then use that to change the world.” Where I will give him credit is I do think that he probably thinks that he’s changing the world for the better with all these SPACs.

Tobias: That was a Mother Teresa quote, wasn’t it?

Bill: Yeah, I think it’s pretty close. It was him and Mother Teresa.

Tobias: That’s what she said. “If you want to change the world, get the money.”

Bill: That’s right. Shortly thereafter, she said, “Fuck you, Peter Schiff.”


Bill: It’s all just quoting her.

Tobias: Mate, if you can’t say fuck you, what’s the point of the billion dollars?

Bill: That’s right. Or, like my boy, Mike NonGAAP, he’s got that Substack money, he’s got the FU money, too, just a little bit different.

Tobias: Substack money, yeah, that’s where the real money is.

Bill: I’ll tell you what, folks, sign up for his Substack. I’m not here to pump them, but that’s good stuff. The dark arts of corporate governance is something that is underdiscussed and I think it’s actually pretty value add in the little community that we have. Mike, if you’re listening, shoutout to you.

Jake: Of course, he is.

Bill: This podcast is sponsored by the NonGAAP Substack.


Bill: Sure as hell isn’t sponsored by Google, not giving us any of the–

Tobias: [crosstalk] -$2.78 NonGAAP Mike. You can PayPal us the $2.78.

Bill: That’s right. Yeah, we don’t have a high enough take rate on this stuff.

Tobias: What topics are we discussing today, gents? Now that we’ve got the formalities out of the way, we can move on to the substance of the podcast. What do you got, JT?

Jake: I have a little segment prepared on the St. Petersburg Paradox.

Tobias: Ooh.

Jake: We’re getting statistical.

Tobias: You’re somewhere hot and you’re going to talk about something cold.

Jake: Yeah.

Bill: Toby, what are you going to talk about?

Tobias: A brand new topic, you guys have never heard me discuss this before. The value spread is wide. JP Morgan brought up this. I just tweeted it out. It’s really interesting looking chart just showing the top– I think it’s quintile versus the bottom quintile, spread is wide, market is expensive, median is expensive. The top part is very expensive, bottom part not so bad. Typically, that’s been good returns for value going forward. But that’s about all I have to say about it. I’ll say it again in just a little bit.

Jake: Stretch that out for 20 minutes.

Tobias: [laughs]

Bill: Good topic. This would be like writing a book where you have like a couple really good things to say, and then the publisher is like, “Okay, well, now you’ve got to fill it all out.”

Tobias: That’s how it works, stick in some pictures, let people color it in.

Bill: I don’t know what I’m going to talk about, but I’m going to figure it out while we’re talking. One thing I’ll tell you what I was really disappointed in myself, I was doing some– like a look back at last year, and I had a lot of activity last year. I want to do a lot less this year. I do not want to touch stuff nearly as much. I think I have the portfolio set up so it will require less touching.

Tobias: Yeah, [crosstalk] right.

Bill: March was forensic– frenetic, like I did too much in March, but, whatever. I’ll tell you what you didn’t want to do is do nothing if you were long banks and[?] airlines. That would have sucked. [crosstalk]

Tobias: Do you want to take it away, JT?

The St. Petersburg Paradox

Jake: Yeah, absolutely. Let’s do it. I’ve observed the poorest third of Americans buy more than half of the lottery tickets. I’ve always scoffed at that and been cynical that it’s this kind of preying on the ignorant and poor and it’s like a kind of a predatory tax on them. Everybody knows it’s a negative expected outcome bet. The odds of winning times your payout is negative, so you should never do it. But it turns out that it’s probably a little bit more complicated than that, and a little bit more nuanced, and I was probably ignorant and foolish myself.

To explain why a little bit, let’s play a little game here. I’m going to put $2 into a pot, and then you’re going to be able to flip a coin, and if it comes up heads, then I will double the amount of money and we’ll play again. But if it comes up tails, we stop, the game is over, and you get whatever’s in the pot. Okay, so first, let’s say it comes up heads first coin flip, then I’m going to put $4 in, comes up heads again, $8 are now in the pot, $16, $32, you get the idea. Well, if you were lucky enough to get up to 10 heads, it’d be a little over $1,000, but crazy enough, the way that compounding works, 40 heads in and you’re up to like a trillion dollars. But you know the odds of flipping heads 40 times in a row, relatively small.

Now, what’s interesting about this is that we can ask ourselves, what’s the average expected payout of this game, and the math is such that it’s basically like X equals 2 to the power of K, where K is the number of coin flips. If you multiply it out, it’s like you have a 50% chance of winning $2 plus a 25% chance of winning $4, plus about a 12-ish– sorry, about around a 12% chance of winning $8. It’s like one over that number times the payout. You keep each one of those turns into the number one basically. So, one-half times two, one-quarter times four, one-eight times eight. You keep adding them up, and it turns out that the answer is actually infinity because it’s just one plus one plus one plus one forever. The average expected payout in one way of calculating it is that it’s an infinite payout.

The next question then you ask yourself is, it seems very odd because your gut tells you, I’m expecting to probably lose within, I don’t know, two, three, four coin flips and therefore, I’m looking more at an $8 maybe outcome, maybe I’m not even going to be able to buy lunch with it. And yet, it’s telling me I have an infinite expected outcome. The question gets interesting when you ask, how much would you pay to play this game? If it’s a truly an infinite outcome, you should be willing to almost pay an infinite price. Your entire net worth, you should be willing to put up to play this game, even though $8 or $10 is maybe what you would hope or expect to end up with.

This oddity was a thought experiment that was developed in 1738 by this Swiss mathematician named Daniel Bernoulli. Bernoulli was living in St. Petersburg, Russia, at the time when he developed this, and that’s why it’s called the St. Petersburg Paradox. We all caught up to explain. By the way, this is the same Bernoulli who has the Bernoulli principle, which is what explains why an aircraft wing produces lift like that Bernoulli effect or principle is the same guy. Anyway, smart dude, obviously. How much would you guys pay to play this particular game knowing what we just set up?

Tobias: It’s a difficult one because if you do that calculation, your expected return is infinite, but it’s a vanishingly small number on a vanishingly big number. The likelihood is very low on a very large payout. That’s why you tend to be at the lower end rather than closer to infinity. So, yeah, I don’t want to give you much for it. I’ll give you 5 bucks, 10 bucks for it.

Jake: Yeah.

Bill: I’m right around the same.

Jake: [chuckles] Okay, so here’s where Bernoulli actually had a pretty interesting insight. He observed basically that there’s diminishing marginal utility to each dollar, similar to like what Buffett has said about why would you risk what you have in need for what you don’t have and don’t need. He came up with this idea of logarithmic utility, which then allows you to– basically, it discounts the numbers that are up way high and puts more weight on the front end of the payments. Using that, you would actually end up with a– if you had a $1 million net worth, you should be willing to wager around $20. And then, if you had $1,000 net worth, you should be willing to go up to around $11. Looking at this principle, all of a sudden, a lotto ticket, if wealth is truly logarithmic like that, which it probably is, then playing the lotto as a poor person or less privileged suddenly is actually sort of mathematically a viable thing to do. And maybe it isn’t as predatory and it isn’t as dumb as it sort of seems at first blush. I felt like, “Oh.” I was probably judgmental about that before and I shouldn’t have been.

Tobias: Bernoulli came up with an early version of the Kelly criterion. His statement of it is geometric return, but it’s a slightly– I forget what Kelly added to it to turn it into the Kelly criterion. Bernoulli got it in one specific instance, but it doesn’t apply to all instances of Kelly.

Jake: I think if I have it right, it’s the irreversibility of time is what Kelly added, but that’s okay.

Tobias: You have to run that one past me after the podcast is done.

Jake: Yeah. Well, to keep going on this– Well, go ahead, Toby, if you had some observation.

Tobias: The only point that I was going to make was, Kelly is the correct statement for playing the game, but I think it’s Paul Samuelson who wrote the single-word rebuttal. That only had the single syllable rebuttal, only had the one– the final word had more than one syllable in it. He points out that it’s not independent of your own wealth playing the game. I don’t know where the breakpoints are, but clearly there’s some point where once you’ve got all of your living expenses, and everything else covered, then you should be prepared to just about swing for Kelly, but up until that point, you probably– but then some people play it the other way around, if you get to like some very big number, whatever that might be $10 or $20 million of net worth plus, then you might–

Jake: It takes all the chips off the table.

Tobias: There have been practical–

Bill: Fuck no, dude, you go for your jet.

Tobias: Well, there are practical discussions of it right now on Twitter, because there are people who’ve got that kind of money in bitcoin and Tesla. They’re showing their accounts with $20 million of Tesla.

Bill: Oh, poor guy.

Tobias: It’s funny to watch the comments underneath where people are like, “Why don’t you just take off 19, then you get 19,” whatever, after-tax, let something ride on bitcoin or Tesla.

Bill: It’s all about step changes in lifestyle, man.

Tobias: But you don’t get to that point, if you’ve taken that–[crosstalk]

Jake: [crosstalk] -any kind of valuation. [laughs]

Tobias: You took that advice. Well, that kind of attitude doesn’t get you there in the first place. That’s the difficulty of this game.

Jake: Yeah. In researching this topic, I came across a post from Mostly Borrowed Ideas that he had last summer, and he referenced an article actually from 1957 by David Durand that’s called Growth Stocks and the St. Petersburg Paradox. In it, he basically draws the correlation between this infinite outcome potential, but vanishingly small odds of it, you actually being able to realize it. One of the quotes he has in there is like, “Is it possible the market may at times pay too much for growth?” Back in 1957, these conversations were happening. We’ve made almost no progress on this. That’s actually what Mostly Borrowed Ideas is talking about, is he says that it’s possible that some of the SaaS companies today may be like that 40 heads in a row flipping and so you would as a basket be willing to bet on them as one of those potential infinite outcomes.

He has a really nice quote in here. “The path dependency and optionality embedded in many of these SaaS or technology stocks may make it a durable mystery for any investor to come up with a valuation method to value these businesses.” The fact that it’s a paradox that’s a couple 100 years old, and we’re still talking about it, means that it’s really hard to value this type of situation. If growth stocks, in particular, some of these SaaS names really look a lot like that, no wonder using traditional things like DCF, it’s unlikely that we’re going to be able to have much penetrating insight into what’s going to happen.

Tobias: As somebody else pointed out in the comments and it’s regularly pointed out, every time somebody mentions Kelly, the average across every person who employs Kelly and every person who employs the strategies is different from your own personal outcome, which is highly dependent on your first few spins, particularly so on the Bernoulli example where if you lose on the first one, it’s all over. The average is–

Jake: Non-ergodic is the term.

Tobias: Yeah, the average is skewed by the big winners. It’s got a gigantic right tail distribution, and most of us are clustered well below the mean.

Jake: And yet, people are betting right now– well, at least in my estimation that there’s a lot more people who think they’re going to be catching this right tail, and they’re paying up to play this game.

Invincible Stocks & Fragile Businesses

Tobias: That’s the challenge. If you look at the big winners that we’ve had over the last– I guess Tesla’s not an example, because Tesla’s had a pretty big win over the last– I guess, bitcoin’s the same, they’re both roughly 10Xed or something over the last year or so. For more than 10X, funnily enough, you need to pay value prices for them to get the really big compounder and going.

Bill: Yeah, I don’t know that we have standing to really talk about this. When you’re saying, well, you’re only up 10x for the next 10x, you really got to pay right. I don’t know that we’re the guys to come to for that kind of advice, but that said, I don’t know how many people out there are truly playing an investment game versus playing a Momo game tied to low rates and thinking that they’re brilliant. I’m not sure. I’ve said in the past, I think it’s hard to figure out which ones. I know a couple of them that I have a lot of respect for, but a lot of the comments that I see maybe [crosstalk] wanting for more work.

Tobias: I thought I copped to it earlier when I said that the problem with the attitude that says, take the 19 off the table when you get to 20 is that you don’t get to 20 in the first place.

Bill: Yeah.

Tobias: To give Musk credit, the reason that Musk is the richest man in the world currently, or– I don’t know exactly where he is, but he’s right there. It’s because he’s left his entire net worth in Tesla, and he’s just ridden it, just let it ride, let it ride, let it ride, let it ride. You’ve got to respect that. He’s running it. He’s an owner-operator running the whole thing. I take my hat off to him. Let it ride.

Bill: Yeah, there is an element of truth to that statement. The other element of truth to that statement is if you are someone that has $20 million of stock in Tesla, and you are unlevered, and your entire life is dependent upon that one position, that’s quite a bit different from Elon Musk who has almost certainly all his travel expenses covered by the company, a salary covered by the company, got a ton of options in his plan, a huge other people money levered game. So, you’re not making the same bet. You may think it’s the same bet, but if you think it’s the same bet you don’t know what the hell you’re doing, in my opinion.

Tobias: He’s got lots of houses, but he’s got houses and things because he was into PayPal.

Bill: I’m not saying he’s pillaging Tesla for his houses. What I’m saying is, like, the reason he’s the richest man in the world is his stock has gone up a lot and people were willing to give him a lot of options. It’s not like he bought that stock and held it. The way that he has made it is not–

Tobias: Most of it is, isn’t it?

Bill: Look, yes, but other people’s money is a huge part of the reason why he’s so rich. It’s the part of the reason that everybody gets rich. It’s part of the reason that Buffett’s rich. My man didn’t do it through option grants, y’all.

Tobias: [chuckles] Yeah, that’s fair. How do you keep Musk interested at this kind of level? I don’t know that the big option grant does much anyway, but he needs some sort of recognition for getting the– when they wrote these option grants, and they were like, if he could get, like, imagine in this world where Tesla gets to, whatever it is now, a trillion dollars or whatever. Sure, Elon, if you can get the share price, that will sling your $100 billion.

Jake: Yeah, you can have that.

Bill: Yeah.

Tobias: Elon just heard that. Okay, I’ll just get the–

Jake: Results. See, that’s the amazing thing. It didn’t require much business results to get there.

Tobias: I mean, to get give him credit, they’re making more and more cars. The business is doing something. The business is producing more and more cars. People like those cars, people feel very strongly about Tesla. I’m starting to think that maybe the community around it makes it kind of– it’s sort of an invincible business. I don’t know if the stock is invincible. The stock can do whatever the stock’s going to do. Musk is–

Jake: Really? I was going to say it’s the other way around.

Bill: An invincible stock and a fragile business? It’s very possible.

Jake: Yeah.

Tobias: I don’t know.

Bill: Look, it’s a great product. It’s a product that’s ultimately going to change the world. That’s what I would say about Chamath too. If somebody really push me on it, I’d be like, you know what, I may not want things done in the same way. I may not go about things the same way. If he is successful in what he’s doing, we need people to take risks like that in order to push the world forward. Maybe in the same shoes, I would feel the same way.

Tobias: Serious question, not trying to be snarky, but what risks has Chamath taken?

Bill: I think he has used his profile in a way to elevate a lot of companies and raise a lot of money for things that he deems worthy of raising. If he is correct on that, I do think that there is– I think the argument of reflexivity and getting somebody like him to stamp your product and go out and pitch it can create a somewhat virtuous cycle where it gets heat going into the headlines, and then people want to join. I do think that stuff’s real. Whether or not I’m willing to pay for it is a completely different question. I don’t invest in it, but I also think that saying like, that’s not how the world works is not really living in reality.

Tobias: Does his billion come from space?

Bill: No, most of it comes from Facebook, right?

Tobias: Oh, okay.

Bill: That’s what I thought.

Tobias: I don’t know. I don’t know that much. I’m not–

President Kim Kardashian

Bill: Something that pisses me off about him is, I hear him in an interview say that we’re more likely to get Kim Kardashian as a president in the future than we are someone that’s steeped in policy, like it’d be nice–

Tobias: That might be true.

Bill: I’m sure it is. I’d like him to solve that problem rather than work on IPOF. If you want to save the world, how about we don’t go down the world of Kim Kardashian POTUS.

Tobias: I mean, she’s done some work trying to get wrongly incarcerated people out of jail.

Bill: Yeah, I’m not saying that Kim Kardashian can’t do good things for society. I’m saying that she doesn’t deserve to be president. That’s the difference.

Tobias: [laughs] When you put it like that, it sounds pretty reasonable actually.


Bill: Yeah, but whatever, man. He’s doing his thing, and Elon did his. Elon did change the world. So, I’m not going to shit on that. If you’re asking me for the stock, it’s not a stock I would buy. I’m also not changing the world. I have a hard enough time getting dressed in the morning.

Jake: [chuckles]

Tobias: Is there still more Bernoulli? More St. Petersburg Paradox to come?

Risk And Valuation

Bill: Oh, yo, wait, I had a follow-up on this. This reminds me of what I talked to Sean at Ensemble about, and how he was saying if you offered me two-to-one odds that the sun was going to come up, you bet that a lot harder than maybe a bet that has a higher theoretical expected value, but less probability of success. I have not said it that articulately, but that was one of the reasons that I was really table pounding on Qurate.

I thought that the valuation had gotten so low, that the probability of real permanent impairment was almost nil. Obviously, it could have happened, but that’s what I think Buffett is so good at waiting for. Toby, when you were talking about, I’m looking for maybe the invincible strategy returns less than the deep value strategy, but I view it as almost risk-free return. I understand it’s not risk-free return but that’s how I view it. That is what really waiting and being hyperdisciplined on business quality and valuation gets you, is it gets you the reduction of downside probability and a much tighter distribution of outcomes. So, you can bet that hard, if you’re really right, and you’re really patient.

Tobias: Chris Bloomstran did that with Berkshire. He put a lot of his funds into Berkshire when it got cheap, because Berkshire virtually no downside, pretty good upside, but the upside is pretty solid. You know what you’re getting there. The zero is off the table basically, that’s the time you bet hard.

Bill: This is a tangential thought, but it is related, and what I’ve been thinking about lately with some of these quality– and it’s actually is going to pair nicely with your idea about the spread. Maybe you don’t deserve a market– No, I understand this is silly, because these quality companies have outperformed the market so heavily, but maybe going forward, like you don’t deserve a market return for some of these quality names, because they are really de-risked. I think that to come out the other side of a pandemic and to have shown, like, “Hey, we can flex our muscle. We can get stronger through this.” Maybe that equity is not entitled to an S&P return. And maybe that’s not a bad risk-adjusted bet, either.

Tobias: Well, I think that’s a true statement. That’s literally what I think is going to happen, the lower-risk companies are going to have a low return. That was one of the arguments for why value works, that’s the efficient markets argument for value is that it’s a risk trade. You’re getting paid more because you’re taking on riskier positions. I personally do subscribe to that one, but we’re talking slightly different way. It’s not a direct application of Fama/French, but we’re talking the same idea in a sense that riskier stuff should trade at a discount, which should then generate a higher return if you hold it.

You should be sort of agnostic as to which basket you hold, there should– If you think about it some sort of Monte Carlo test, the two portfolios should deliver the same return. It’s just the one portfolio does it by the positions– some of the positions in it deliver a lot more return and some of the positions in it are donuts. And the other one, they deliver lower returns, but they’re more of them deliver the lower returns. So, across the two portfolios, your returns are identical, but that’s not the way the market works. The market gets them mispriced all the time and that’s kind of why this is a fun exercise.

Bill: Yeah, well, I think to your point on the efficient markets hypothesis, if that was truly correct, there would have been no way that Jake could have written a paper about this is value’s worst opportunity set. If only you had said this is the best opportunity set for growth, then we wouldn’t be sitting here on a podcast, we’d all be in the Caribbean with you, man.

Tobias: On JT’s yacht.

Bill: Yeah, no shit, we’d be flying private. Holla.

Tobias: On JT’s plane?

Bill: [crosstalk] –explaining the article wrong and ruining my life, Jake.

Jake: Just smart enough to get a tenth of that outcome.


Bill: What we were talking about the risk-adjusted returns potentially being lower, I guess that it would make sense to me that after a pandemic and after such a shock to the system, that these quality companies and the things that have less business risk are perceived as that much safer, and therefore the crowd bids the price up way too high, because, man, one, there really is no alternative. What are you going to do? You’re going to go to bonds to actually compound wealth? Not anymore. I sort of understand the run. I understand why we are where we are, but on a go-forward basis, I lean towards you guys, which is why we all see the world similarly.

Tobias: What are we talking about when we say risk? What’s our definition of risk here?

Bill: I think that the return that you get for the underlying business risk that you’re taking is how I would define it. Not like beta or anything like that.

Tobias: It’s twofold. What are the chances that the company can continue to execute? So, it’s a business risk that the business can continue to do what it does, compounding and growing. How much are you paying for the growth? How likely is the growth? Then there’s also balance sheet financing risk, how levered is this company? There’s two ways that you get into trouble as a business.

That’s the nice thing about the tech companies, most of them have got pretty good balance sheets. And those businesses are recurring revenue, where it’s all short– it’s got to pay month by month. Those are great business models, and they’re virtually– the marginal customer is basically cost-free. That’s a really great business. That’s why they trade so extensively. Then, you’ve got a valuation risk in there as well. I think that hasn’t been a factor for about five years now, but that has historically been a factor. I think it will be again. I don’t think we’d trade like this forever. I think we’re going to see a little bit more volatility.

Bill: Yeah. I think that’s probably right.

Tobias: I can see it when I do a market-level valuation, not that this is really relevant for anything because I’m not buying the market. None of you guys aren’t buying the market, but I do think it’s important to think about base rates, and I do think that where the market moves sometimes that impacts your portfolio, correlations. It’s an old saw, but it’s true, correlations really do go to one. At least it turns out if your value correlations go to 1.2. [laughs] They’ve got [crosstalk] more in the market.

Bill: The thing that’s nuts about where we’re trading, to me, is not just these SaaS names. I just pulled up American Airlines, this thing in 2017 had a $44.7 billion enterprise value. Today, it’s $42.1 billion. The equity–[crosstalk]

Tobias: Has the mix of debt and equity changed?

Bill: Yeah, the equity is compressed from $24 billion to 9 and the debts gone from 25 to 41. The idea that that equity– the free cash flow that’s going to come to that company is not coming to equity for a very long time. You can’t just continually raise debt on an airline and not pay it back. I don’t know, is that stock cheap?

Jake: Jay Poe says otherwise.

Bill: People might do well on it, and I understand, like, to your point, on the Jay Poe thing, you can carry more debt because interest rates appear to be lower for longer, but I’m not convinced that there’s not a lot of overvaluation everywhere. Now, you’re obviously work to avoid that, but not a lot of cheapness.

Jake: Let’s go back to the liquidity versus solvency. Sure, they’re liquid, they’re able to roll over their debt, keep the paying the bills, even though they’re not flying. But someday, you have to actually make some money for the equity side, don’t you? Or you’re always get to roll it over?

Tobias: See, that’s where you’ve gone wrong. That’s the error that you’ve been making.


Jake: Every time, it gets me.

Bill: Well, a lot of the times you do get to roll it. A lot of the times, the debt doesn’t get paid back. That’s where a lot of the equity returns out of a levered equity strategy come from, but you better have an organization that’s growing. I guess what I’m saying is, American Airlines like–

Jake: [crosstalk] –layup.

Bill: What?

Jake: Airlines, that’s a layup.

Bill: Yeah, right. Like, no, I don’t know. It’s just a different bet. So, they can do well.

JPM’s Wide Value Spread

Tobias: This is a nice segue into my topic. I said everything I was going to say the intro, I’ll rehash it again. Just [unintelligible [00:32:44] JP Morgan has this fun chart. I just really liked the chart. So, I tweeted it out a little bit earlier, but basically, it’s got– I think it’s about 25 years, it might be longer than that. Actually, I think it’s a lot longer than that, because 2000s about midway through. 2000, very widespread, we’ve talked about this a lot of times. JT wrote the article in real-time, in about 2014 I think it turns out and I retweeted on Greenbackd, which was my blog pre Acquirer’s Multiple.

When the spread gets very wide, that means the most value companies are very overvalued, the cheaper companies are cheaper relatively. Typically, that means basically returns follow the– they do eventually follow multiples. I know that that’s anathema. You don’t have to say that anymore, but that’s what the data shows. [laughs]

Jake: Wrong.

Tobias: Wrong, yeah. Expensive stuff is bad as expensive as it ever gets. The cheap stuff is not super, super cheap but it’s way, way cheaper than the expensive stuff. The spread is very, very wide. JT wrote a great article in 2014 in real-time saying that he thought the value spread was so tight that it portended bad returns for value coming forward. 10/10, you got that exactly right. You just didn’t tell us to go and buy growth at that time. So, only half marks for that. I read it and tweeted out and thing about–

Jake: Can I launch a small defense of that?

Tobias: Yeah.

Jake: At the time, that average that was tightly clustered was a relatively expensive average. I didn’t think that that offered a very good risk reward even on the growth side. I understand why it was relatively a better bet than value at that point. But I thought the whole thing was relatively expensive, and then it was more likely that everything would come back down to a cheaper level and that was where I was 100% wrong. We just got more expensive.

Tobias: Now, we’ve got a really wide spread and everything is going to come back down.

Jake: Value stayed where it was, everything else got more expensive, pulled the averages up, blew the spread out. So, I missed that upper half of the blowout.

Tobias: What happens now? We get the spread closing with value staying exactly where it is.

Jake: Well, here’s how I’ve been thinking about it lately, and it’s kind of scary. We’re walking this path where if we fall over to the left, we fall into a debt deflation. All this expensive stuff gets repriced because all of a sudden risk is back again, maybe the confidence in central bank omnipotence comes into question like it has in other times. Lots of different problems that we can all recognize right now start mattering again. Nothing matters at the moment, but all it takes is a little bit of shift in the sentiment and price change to all of a sudden, every data point is already there and lined up for it to matter. That’s like, okay, everything is catching down at that point.

Then, we have on the other side of this little trail that we’re walking, we have currency totally gets out of hand, melt-up, indexing Mike Green type arguments, where you don’t want to be in anything except equities in the longest duration that you can. You definitely don’t want to be in bonds or cash or maybe even like cheap stuff. Then against that, you have maybe some kind of value rotation as well on that side of the falling over. We’re walking along this path and every single stimi check that we send out, every single problem, gunshot wound that we band-aid over, is just narrowing this path further and further until we’re just on this tightrope where, at some point, we have to fall one way or another. I don’t really know which way we’re likely to fall.

Tobias: That sounds a little bit like Chris Cole’s– he likes vol because both tails are hedged in both of those scenarios. Vol hit just both those tails. Which one’s better for value? That’s all I want to know.

Jake: [laughs] Which one does value rip? Probably [crosstalk] melt away, if I had to guess.

Bill: I think value’s got shorter duration cash flows, more of the cash is upfront. If rates were to go up, all else equal, I would think that value is going to outperform quite a bit. I don’t know that for your particular strategy, you need values jaws to collapse. What you need is the businesses to continue on a similar path to what they’ve been doing. And then you need them to eat themselves, and they should do really well over time relative to more expensive stuff that is buying in shares at a less attractive return of capital. That said, that more expensive stuff probably has a more attractive reinvestment return on capital. So, it’s all about whether or not that’s priced correctly.

The thing is, if you have, I don’t know, 10 years, I guess I was just looking at the median P/Es, the median P/E on the S&P seems to be just by my eyeballs somewhere around like 17 historically until the 2000s, then it sort of went nuts.

Tobias: Single-year P/E?

Bill: Yeah, I don’t think that you can look at like this year’s and say, “Oh.” When you’re buying a PE this high, earnings are clearly depressed. So, you’ve got to be cognizant of the denominator.

Tobias: That’s why I don’t like the single year. That’s why I prefer the Shiller P/E. The average is a little bit more useful in that scenario. The Shiller P/E is at 35 at the moment.

Bill: Yeah, I guess all that I’m saying is, I don’t know how much valuation bleed you need to underwrite over 10 years in some names. I don’t know, but I do think there’s– the thing that I continue to come back to and I know that I cheerlead the melt-up and make jokes and stuff, but to me, the higher the market goes, the further away the American Dream gets for the person that needs to save their way up the ladder.

That really concerns me. If I am right on the melt-up, it’s going to be really bad societally, in my opinion. Then, if I’m not right, then you get all these pensions that are underfunded. So, that’s not great either. I don’t really know. I just think you’d try to find companies that are reasonably good bargains and you try to buy them, and you find stuff that you think is going to be bigger in the future than it is today or smaller, but knows how to return capital and just try to remain flexible.

$AZO & $ORLY Buybacks

Tobias: That’s one of the nice things. If something is undervalued and generating good cash flows and buying back stock, and you hold it and you own it, really what you want is you want it to stay undervalued, because if it keeps on eating itself, so that’s like AutoZone and O’Reilly have both been really good at this for a long period of time that they’re just always a little bit undervalued, because they chew themselves up. They’re always buying stock back, you get really good– The underlying intrinsic value in those things is like leaping ahead, it goes really well. I think about that for my portfolio as well. I want them. It’s a little bit of a bond because it would be nice to have them go up, but I’ve kind of forgotten what that feels like, but at the same time, the cheaper that they are, the more stock they buyback. The cheaper they get, that’s a good scenario.

Bill: Yeah.

$IBM Shrinking

Jake: Yeah, like IBM. [chuckles]

Tobias: Yeah, IBM is a tough one.

Jake: I’m joking.

Tobias: I look at IBM all the time, I’m aware of the fact that Buffett chewed on it and spat it [chuckles] that doesn’t look that appetizing to me, but it looks cheap. It’s a good business.

Jake: [crosstalk] –some price where it’s going to work out, right?

Tobias: High return on equity, high gross margins, looks really cheap.

Bill: Yeah, that doesn’t matter as much when you’re shrinking, man, it’s not like you’re going to get– you need earning space to stay where it is.

Tobias: Yeah, well, that’s the problem. That’s the problem for all these things that they’re a little bit softer on that front, but there are plenty of stocks that are high return on equity, high gross margins, trading really cheaply and still growing. Nothing is free in this market. You’ve got to be able to look through, so it’s like– have a look at big — I don’t hold any of these positions. This is stuff I don’t hold but I look at that every now and again. I get they got a stimi check and so that probably flatters them a little bit but all of their customers got a stimi check. There are lots of these things around.

Bill: [exhales] Big lots, motherfucker.


Tobias: Why?

Bill: Oh, because I talked to Alex about this thing when it was close to the lows. God, that pisses me off.

Tobias: Yes, moved. A lot of these things have moved a lot.

Bill: I didn’t talk to him in March. That’s a lie. Late last year, I was looking at this, and I was like, “How does this lose?” Outside of a pandemic, I was pretty right.

Tobias: I’ll put [unintelligible [00:42:20] in that list. Intel’s in that list. I know all the arguments for why it’s not going to work. I’m looking for risk-adjusted bet. That’s a good risk-adjusted bet. None of this is financial advice, by the way. You’ve got to go and do your own research. That’s off the top of my head. Throw your questions in, folks. We’ll start taking shots at them.

Bill: Oh, well. Ideas are only good if you make money on them.

Dotcom 1.0s Trading Cheap

Tobias: That’s right, eBay’s in that list as well. It’s so funny to see dotcom 1.0s trading cheap. [crosstalk] -set by the same stream for too long.

Jake: Coming to a FAANG near you. [laughs]

Tobias: Yeah, that’s right.

Jake: Don’t think it can’t happen to you.

Tobias: Marcus Aurelius has a great line, where he says, “Look at the past how empires rose and fell. It forecasts the future as well.:

Bill: The difference is, I don’t know. Dotcom 1.0 was a bunch of high valuations placed on businesses that didn’t exist. The FAANG is objectively not that. It may be rich relative to what you want to pay, but it’s not these aren’t crazy dominant businesses.

Tobias: I don’t think FAANG is the best example of the most expensive stuff.

Bill: Yeah, it’s not.

Jake: No, it’s not. It’s just the biggest, so you can make the most fun of it. Everyone knows what it is.

Tobias: I saw an interesting tweetstorm yesterday, I think I tweeted it out. Somebody pointed up dotcom 1.0. Somebody went– I wish I could remember who this was where they went back and they read– I think they had access to– it could have been Bernstein’s articles from the late 1990s.

Bill: Oh, yeah.

Ackman’s SPAC

Tobias: They said they spent hundreds of hours reading through them on that. They had some takeaways. The takeaways were, at the time, nobody knew it was a bubble. Nobody knew that the bubble had popped until well after the fact including guys who were staking their careers on the fact that they were in a bubble that they were calling for it to pop. They didn’t know until well after the fact. That’s something that I’ve observed a few times too, that the market really just knocked sideways for about a year before it really– The 2007-2009 bear market, started in June 2007, but it really didn’t bite until fourth quarter of 2008 when people realized that they’d put down a lot, so you just don’t get any real forewarning.

The other thing that he pointed out was that the businesses that were really driving the overvaluation were all really good businesses. I’ve said this before too. It was like GE and things like that. These looked a little bit more NIFTY 50. The internet companies were a sideshow. Maybe it’s a little bit like the SPACs. Everything’s going public at crazy value. Like Bill Ackman, $500 million in Bill Ackman SPAC, trades to $700 million. Plus, he got his dilution coming in there as well. So, there’s 40% of hot air in there.

Bill: But it’s the Ack SPAC, bro.

Jake: You have to pull off pretty good buy if you’re going to get over that hurdle.

Tobias: But here’s the crazy thing. He’s got a closed-in fund out there trading at 25% discount.

Jake: If you SPAC the fund, arbitrage.

Tobias: Yeah. Somebody pointed that out. That’s a good approach.

Jake: [laughs]

Bill: You’ve got to hold what’s in the fund, which means you want Chipotle here.

Jake: What, a 1000 P/E or something? Mama.

Bill: They’ve got a good app, bro.

Tobias: JT was buying Chipotle at one stage there. This is a few years ago now. You’ve owned Chipotle, haven’t you?

Jake: Now my lament with Chipotle is that I didn’t buy it in 2008. Instead, I was tying up money in a bunch of illiquid net-nets that I thought I was not taking market bet risks.

Tobias: That happened to a few of us, so I won’t name names.

Jake: Yeah.


Bill: I’ll tell you an idea that I saw floated on Twitter yesterday that I found myself somewhat interested in was Simon Property Group. I think malls come back. They’ve got good malls. I bet their tenant base gets better over time out of COVID. I can see that doing pretty well.

Jake: Why not go all the way then, go Shield or–?

Bill: Because those are dogshit assets run by people that I have not seen any competence of actually returning anything to the shareholders outside of making Eddie Lampert richer.

Tobias: You’re not a value guy until you’ve lost money in Shield.

Bill: No. Look, somebody’s going to be like, “Well, Pabrai did well in Seritage,” like fine. You’re right. I guess that that’s changing a little bit. If I’m going to play in that space right now, with the amount of inventory that’s about to hit the market, I don’t want to do it with Eddie Lampert. I know that Eddie Lampert’s returns have been incredible, but I have not seen any evidence out of Sears over a longtime horizon that the minority shareholders in that entity have been taken care of. By the time that I can see it, I probably won’t want it anymore. Somebody else would probably be like, “Well, Buffett’s involved.” He’s on the debt side, it’s different.

Low Interest Rates & Banks

Tobias: I’ve got a good question. This is probably a Bill question. With low-interest rates– It’s an interest rate bank question. You can take a shot at it too. I’m just saying it’s not for me.

Bill: What is it?

Tobias: Yeah, low interest rates, good or bad for banks? Where do we need interest rates to get to? Because I noticed that the 10 years has now crept like 1.15, I think last time–

Bill: Yeah. Well, you need to spread between your short rate and your long rate more than where do interest rates need to be. You need the curve to be up.

Tobias: Yes. The shape of the curve is more important than the movement of the rates.

Bill: Yeah. Because you’re borrowing short and lending long. So, you want to arbitrage that.

Tobias: JT, do you want to just take a swing at that one too? To offend? [laughs]

Jake: Nothing to add.

Bill: I saw somebody else asked about Wells. I don’t have any strong view on– I think Wells still probably good. It was better when I said I liked it. I sold it because of tax purposes. I’m an idiot. I don’t own it now. I think Scott Powell will almost certainly get the asset cap lifted. I think Yellen is actually really good for Wells Fargo because I think she can use it as an example of when the government stepped in and changed an organization for the better. I think Scharf is going to turn out to be a really good CEO. Those are my thoughts. That’s all I got.

Tobias: He came from Visa?

Bill: Well, originally, he’s boys with Dimon, and was with Bank One. And then he got put into Visa, and then he left to go back to his family. Then he was at Bank of New York Mellon for a little bit. But that was only two years. People be like, “Well, Visa is a great business.” And he didn’t do much a Bank in New York Mellon. So, I mean, I guess if you want to hold that against the guy, fine. What’s your resume?

$SPGI Capital Allocation

Tobias: Do you guys have any view on– Have you followed Standard & Poor’s, SPGI?

Jake: Loosely, I know some people that like it. I think it’s a pretty smart idea.

Tobias: But you get a little– SPGI is buying Info, I-N-F-O, you a little discount if you buy Info through it, but the problem is that SPGI is stonkingly great business and Info seems to me like less good, paying a very high price for it. So, I guess you’ve got some questions then about what SPGI management regardless of their capital allocation? They’ve done pretty well, but I don’t know. Makes me a little bit nervous.

Jake: I suspect they have a pretty good sense of what makes Info’s businesses pretty good. We used to subscribe to a business called Informa at the bank and it was basically like Gartner for food and ag production. Look, is that a growth asset? No. But the bank is going to pay whatever Informa asks them to pay next year. Eventually, you get into this problem where you’re like, “Oh, well, they can just raise price in perpetuity.” Not everyone can do that, but it is really integral information. And it is a really important second set of data to check like the government, the USDA information off of. If that is representative of their portfolio, it may not be growthy, but those are really good assets.

Tobias: Will we enter a doom loop of higher rates and lower stocks, Jake? That’s a Jake question.

Jake: Geez.

Tobias: What happens if we get higher rates?

Bill: You’re going to have a problem refi-ing the debt.

Jake: So much problem with– Yeah, all the debt refinancing at every level that it has to be done. The pulling end of risk at that point, the duration– I think, we will see that people were making a lot of duration bets, they didn’t realize that they were making or maybe they knew, and they figured that someone would bail them out. Then maybe that is true. Maybe I’m going about it completely wrong.

Tobias: Well, they figured that they never be able to raise rates.

Jake: Yeah, we can’t raise rates. My duration bet is probably money good. Keep going. Okay, on the one hand, it’s short term bad, because everything’s going to get shellacked. On the other hand, I think it’s long term would be much healthier for us as a society. Our economy, I think would be less fragile. Punishing savers the way that we have for the last 40 years, increasingly punishing them, I don’t think it’s healthy for society, if you want to actually form capital and create jobs, and all those kinds of things. History will not look that kindly upon this era and cheap money, the same way doesn’t look kindly back at on John Law and other times where this experiment has kind of been done.

Tobias: Well, let me play devil’s advocate and say we seem to be doing pretty well on the business creation front at the moment, because Silicon Valley’s going bananas. What changes if rates go up? Doesn’t that go away? Isn’t it the reverse?

Jake: Well, does it? This goes back to that what we talked before about, are you overclocking the system in a way with low rates? Would we have made technological advances anyway with higher rates? People still want to find ways to do things in better ways? Does having a bunch of cheap money necessarily create the ideal soil in which that idea can flourish? I’m not so sure that it actually matters that much.

Bill: I don’t know. It seems like a hard thing to answer.

Jake: It’s a very hard thing to answer. Everything I should say should be put heavily discounted and caveated.

Tobias: Buffett’s got that note where it says, interest rates act like gravity on the stock market. So, interest rates go up, stock market goes down. Interest rates go down, stock market goes up. You’ve encountered that problem as an investor. If you’re looking at something that’s really expensive, and you’re thinking about selling it, what are your options? You’re going to stick it in the 10-year yield at 1.15%. So, the yield that you need out of a business to remain invested in is low, which means that the multiple that you pay for it is high. That means it’s expensive. That’s how we get to where we are, high growth, expensive businesses.

Jake: But it also means that you’re benefiting those who already owned the assets at the expense of those who wanted to accumulate the assets as they were coming up the ladder and saving. We’re pretty systematically advantaging one group of society against the other by keeping rates as low as they have been.

Wealth Inequality

Bill: Yeah. I think what is pretty true is, and I would need to see but I’m pretty confident this is right, the number of hours work to buy a share of stock in the S&P is going up, and that is a bad thing for society, I think. That to me, only exacerbates an issue that’s already a problem.

Tobias: Does that resolve itself by higher salaries at some point?

Bill: I think the thing that concerns me is what if all these tech valuations are correct? That would imply to me that maybe fewer people are needed. Maybe that’s a Luddite answer of me and maybe I don’t understand the jobs that are going to come up. But I don’t think that the jobs that are going to come up are going to be that easy to just retrain the people that are left behind. I think we might have a real problem here.

Tobias: But hasn’t that always been the case?

Bill: Yes.

Bill: Yes.

Tobias: Hasn’t that been the case since the Industrial Revolution when there used to be people who made fabric by weaving the loom and then they came up with a loom. Literally, the Luddites went around smashing the looms because they were taking jobs away, and you couldn’t retrain these people.

Bill: Yeah. I do think that has always been the case. I think that it is also true that inequality has not been this large before. I think there’s a fragility in that. I don’t know, I don’t have every data point. Do you have the data against it?

Tobias: I don’t. I just wonder when you had the French royalty in the palace at Versailles, and people were like living in the streets, was that–[crosstalk]

Bill: Yeah, but how’d that work out for them?

Tobias: It didn’t work out well. They lost their heads.

Bill: Right. That’s my point. I’d rather not go down that path.

Tobias: I’m not proposing that it’s a good thing. I’m just questioning whether it’s true.

Bill: Well, yes, I agree that there have been societies where the wealth inequality has been larger. I’m concerned about the current one we’re living in and what I see going on that– [crosstalk]

Tobias: I’m not disagreeing.

Bill: Then why are you disagreeing, Toby? Come on.

Tobias: I’m not. I’m just going for technically correct, which is the best kind of correct.

Bill: No, I think that is a reasonable thing to say, but I don’t know that this is a sustainable path we’re on.

Jake: Bill, you keep up that line of reasoning, you’re going to be sending bombs in the mail soon.

Tobias: Ooh.

Bill: What? Ah, dude, what–? [crosstalk] We almost had advertised–? [crosstalk]

Jake: That was the [crosstalk] manifesto.

Bill: We almost had legitimately–


Bill: –that we’re going to get 45 cents from Google split three ways.

Tobias: [laughs]

Jake: I’ll tell you what, this week–

Bill: And now, you have ruined it.

Jake: –have Google send me the bill. I’ll pay the bill for YouTube this week.


Bill: That works. I’m tired of splitting that.

Jake: Yeah. [laughs]

Tobias: I saw the social media companies took a little whack this week. I don’t know, maybe that’s a future.

Bill: Yes. Well, they all flex their muscles. So, we’ll see what ends up happening.

Tobias: Yeah, it seems to be that’s going to invite a little attack from somewhere. You want to be careful with that sort of stuff.

Jake: You guys find the piling on a little bit distasteful. We don’t have to get into a lot of politics, but like Grubhub, I’m not going to deliver your Wendy’s burger now, because you’re–


Bill: Yeah, well.

Jake: Okay. You’re inciting violence, so I’m not going to send you your burger. Is that where we are right now? I don’t know. That might be unfair.

Tobias: Yeah. I don’t know.

Bill: Yeah, no, I think I would draw the line short of that. I think somebody should be able to have a Wendy’s burger.

Tobias: It’s hard, right? Both sides think– [crosstalk]

Bill: At least until they’re tried. Once you’re tried, you don’t get your Wendy’s burger.

Tobias: You’re allowed to have a Wendy’s burger as your last meal, probably.

Bill: That’s true. Yeah, we do have a presumption of innocence.

Tobias: They just say, “Sorry, we don’t deliver.” What are you going to do now? Go buy one. We’ve devolved.

Bill: Ben Thompson’s the guy to read on this, in my opinion. He had some good thoughts.

Tobias: I think it’s one of those instances where both sides think that they’re arguing from principles. They’ve got interests that are conflicting with their principles as well. You just favor whichever– Whatever is currently in your interest at the time is the thing that gets– is the thing that everybody seems to embrace as being okay. But then, you turn around and you let the other side have the keys to the vehicle that you’ve built, and now it’s not so much fun. I would rather that we just play it a little bit more neutrally rather than trying to put our finger on the scale all the time. I think that that leads to bad outcomes. I hope that– [crosstalk]

Jake: Well, I shall take an Australian to figure this out. [laughs]

Tobias: I hope that was bleak enough that nobody knows what I’m talking about.

Jake: Yeah, and you’re not going to get flamed for that.

Tobias: I left it to the last thing. And that’s time. Thanks very much, folks. It was really fun. See everybody next week.

Jake: Cheers.

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