VALUE: After Hours (S03 E03): Ketchup Physics, Pabrai and Marks Abandon Deep Value, Value vs Quality

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

  • Ketchup Physics
  • Pabrai And Marks Abandon Deep Value
  • Value vs Quality
  • Assuming The Multiple Fade
  • Charles Mackay – Men Go Mad In Herds
  • Buffett Market Timing
  • We’re In Crazy
  • Buying $MSFT Early
  • The Apocryphal Pig Farmer
  • NonGAAP – The Return For Investment Of Time
  • Adam Robinson – Losing Your Instruments
  • Will $PTON Acquire Equinox Or Planet Fitness
  • Oppenheimer Research Reports
  • $PLNT Valuation
  • All You Can Eat Pizza At Gyms
  • #neversell
  • $SPGI Is Buying $INFO
  • Growth Keeps Growing
  • Happy Birthday Ian Cassel

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

Jake: It’s go time.

Tobias: We’re live. We’re running this one on sticky tape and twine. Bill’s on his phone. JT is in his bunker in the Caribbean, getting ready for Armageddon. I’m stuck where I’m always in, in the middle with these guys. How’s everybody doing?


Bill: I’ve had better days.

Tobias: It’s 10:30 AM on the West Coast. 1:30 PM East Coast. 6:30 AM Australian Eastern Standard. I think it’s 6:30 PM UTC. We’re live. If you want to catch us live, just go to the YouTube channel. Click subscribe, get a notification.

Jake: January 19, I guess some people were asking for a little date notification during if they’re not catching it live, so there you go.

Tobias: Yeah, I don’t like to do the date notification, so then you don’t know how old it is when you hear it in the audio.

Jake: All right, well, never mind. Forget that.

Tobias: Townsville is in town. [crosstalk] What’s up, Queensland? 10:30 PM in Dubai. Lithuania, 8:30 PM, there we go.

Bill: You think we’re going to do this for like years? Do you think in two years we’re still going to be shouting out? I’ll tell you what, in two years if we don’t get paid, I’m going to be broke as a joke.


Tobias: We’ll see. Yeah, shout out to the Indians who pulled one out in the Gabba. My home Cricket Ground and get to watch this one because I’m over here. They don’t air it in the States, shocking. Don’t air test cricket in the States, don’t air the Australian-India game, you would think that’d be prime time. [laughs]

Jake: I don’t even know what you’re talking.

Bill: I would not– [crosstalk]

Tobias: That’s right. This is for the Indians on the pod and the Aussies. [sighs] What are we talking about today, gents?

Jake: Bill, what do you got?

Bill: I don’t know. I was probably going to talk about the Howard Marks’ letter and general compound town.

Jake: Hmm. I have– Ketchup Physics is what I’m calling this one.

Tobias: I like that. Are you going to discuss the Pabrai letter?

Jake: No. But you can.

Tobias: Well, I’ll discuss the Pabrai letter and some of the takeaways that I have from it more generally. I didn’t read it in its entirety, because I thought that one you guys is going to discuss it, but I did skim it right after this. [imitating intro music] Who wants to go first?

Bill: Well, my understanding of the Pabrai letter and Mark’s letter is pretty similar. In that, they’re maybe both opening their mind up to compound town a little bit more in these compounders versus maybe what has been historically statistically cheap stuff. The thing that people need to at least look at a decade of performance and contemplate is, are value investors a little bit too preoccupied with the downside. Jake got up and left [crosstalk] he likes this.


Bill: He said, “I’m out. I’m done.”

Jake: Can’t handle it.

Bill: Yeah. I think it almost certainly would have served people better to focus on the upside rather than the downside and say if I have 10 bets, if I’m right on the upside on one of these, it’ll bail me out of the ones that won’t work. I guess the tough question is, are we at the point in the cycle where that continues to be a good bet or not. I guess that’s where it’s somewhat interesting to see, at least– I didn’t think Mark’s– I didn’t read that letter as if he’s saying one way is right or the other. I read it more of a letter of saying, “I used to maybe lean towards saying that one was definitely right, and now I’m at least open to the idea that there’s a different way to skin the cat.” I do think if you want to see capitulation in it, you can, I’m not sure that’s what I actually saw. Look, man, it’s the stuff I’ve been talking about for a while, so it’s what Twitter did for me. I think that now you’re starting to see some other guys come out and say it, it’s just an interesting time to say it.

Value vs Quality

Tobias: I’m going to be Statler and Waldorf for this one. I’m throwing for it. I’m not a fan. Nobody can withstand it, everybody gets to that point in the cycle where they just say, “Take the pain away. I’m going to buy the stuff that’s going up. I’m sick of buying stuff that’s going down.” I’ve been having this conversation for a little while. I know we talked about it on Bill’s podcast, and I’ve seen some of the comments where folks think that I’m trying to transition to a Buffett style. I’m not at all. I just want to be very clear about what I think has happened.

I think the high-quality stuff has had an absolute blockbuster run, but that’s not unprecedented, it happens basically at the tail end of every cycle, that quality does a lot better than value. Value does treads water through the tail end. I think you can go back– this is one of the things that I’ve pointed out before when you compare the magic formula, which is a very simple quantitative expression of what Buffett does, high return on equity, return on invested capital, doesn’t really matter as a quality metric, and then sort of like an Acquirers’ Multiple– he calls it EBIT earnings yield, I call it Acquirer’s Multiple. It doesn’t matter if he is EBITDA or– gives you operating earnings, doesn’t matter, it’ll give you roughly the same answer. Just some value metric versus some sort of quality metric, combine them together. Most of the time, the value metric does better. However, there are periods of time like the late 1990s, and now, where having the quality metric helps you out.

I’ve cut this test a number of different ways. I tried it. I’ve been running it for the last few weeks. We can all agree on a definition of a high quality. We would say sustainable, returns on equity, kind of north of 20%, sustainable gross margins, 30% to 35% or greater. If you look at a list of those companies, they’re all the quality companies that we would all agree. There’s Microsoft, you’ll find some stuff in there like Intel and Biogen, you’ll find some cheap stuff in there too. They’re pretty good, high-quality companies. If you buy those high-quality companies cheap enough, and you hold them for the long term, you get very good returns. But the time to do that is when they’re cheap, and not when they’re expensive. We’re at the point the cycle where quality has started getting expensive.

The best opportunities right now are in deep value. Objectively, the better opportunities are there. I’m probably going to be the last guy. Pabrai’s gone, Howard Marks is gone. It’ll be JT and I will be the only the last two guys left on the island in the Pacific, thinking that World War II is going on.

Jake: [laughs] I’d love to see these kinds of things because to me, who is left to turn over at that point? Who’s left to sandbag it? There’s hardly anybody. That’s usually a pretty good sign that you’re at a turning point. So, I love it. I want more of those. Every time they declare Buffett’s lost it, he hasn’t. Every time value’s probably been declared dead, it probably hasn’t. It’s just the game. You just have to be willing to roll with it.

Tobias: I think we’re at that point in the cycle where it is very tempting to do that. I’m not criticizing anybody. I do understand why you do it because it’s sucks going backwards, particularly when everybody else is going forward. I think part of being an investor is taking a step back and having a look at the full cycle and understanding where we are in the cycle.

Where we are in the cycle is, I don’t know if it’s the tail end of a bull market, because I don’t want to say it’s the tail end because it presupposes that I know exactly where we are in the cycle. We’re not. It’s not March 2009, and March 2020 was not March 2009. It was still an expensive market. It pulled back. It bounced like a golf ball off a concrete path, but it certainly wasn’t bouncing off undervaluation at that point. It’s just bouncing because that’s sometimes what happens when the market takes a swan dive. It rips higher. I don’t think this cycle is over by any stretch of the imagination. I certainly don’t think March 2020 will prove to be the low point in this cycle.

No one wants to dive on that grenade?

Jake: I’m just letting Bill gather his thoughts.

Bill: No, I’m just thinking about it. I guess the thing that I think is an error– I don’t think that you can look at ‘09, which was a liquidity crisis and say, “Well, if we don’t get back there, we’re not cheap.” Then if you look at ‘09, and you say, well, we weren’t even that cheap in ‘09, then, I guess that the only thing that I would say is, then you better not have much allocated to equities because if that’s what you’re waiting for, there’s going to be nowhere to hide and you might as well just be in cash. If that’s the bet– but it’s not like value’s going to be spared in that downturn.

$PLNT Valuation

It may just get its ass kicked a little bit less. I have conflicting thoughts. I’ve been doing a little bit of work on Planet Fitness. That valuation, if people can walk me through a reasonable way to get double digits from here, I’d love to hear it. I’m not even saying that like, I know one and I have a view. I’m saying please help my mind figure it out, because I can’t figure it out, other than heaping a massive terminal value on something, which can work and has worked, but I don’t know that it’s how I want to invest.

It’s nuanced. I think that the tough thing for somebody that wants the underlying cash flow, and they want a juicy yield, it doesn’t exist right now, at least not in anything quality. Now, there are some things. That’s why I had said earlier in the week, I had tweeted out, like, get off your ass and start studying businesses, because I do think that there’s some interesting ideas out there, and they’re probably smaller, and they’re undiscovered, and some of them might be in foreign markets.

We’re In Crazy

It may require talking to a lot of people to try to get your head around how it actually works. Maybe you can’t get there. I don’t know. Maybe you’re just putting in the reps for nothing today, but down the road, you’ll have the work done. That’s more where my head’s at. I have no idea. I still think we’re probably closer to the beginning than the end of the melt-up, but that’s only because I think it can get crazy.

Jake: Crazier.


Bill: What’s crazy?

Jake: Oh, we’re in crazy.

Bill: I don’t know, man.

Tobias: What’s your definition of crazy, Bill? Here’s what I see, I get like–

Bill: I told you, Apple at $5 trillion is where I will tell you that I think we’re in objectively rich territory. I’ve been saying that for two fucking years now. It’s like you guys aren’t listening to me.

Jake: [laughs]

Tobias: Your indicator is one stock at $5 trillion. Can we get anything a little bit more robust? A little bit more broader based, like Shiller CAPE’s at 35. That’s really exceeded. The reason is that interest rates are pinned at zero.

Bill: Rates, bro.

Tobias: Rates are backing up a little bit, they’ve got rates. The 10 years backed up a little bit, and it’s helped deep value run a little bit more recently.

Bill: Yeah. Look, the best thing that I can tell you is that the way that I look at my portfolio is I have cigarettes for near duration cash flow, I have some energy MLPs as bond substitutes. I have some quality out there. My biggest position right now is Berkshire followed by Qurate. Qurate is objectively near duration cash flows. I don’t have a ton of duration risk that I’m taking throughout my portfolio. But I’ve also been fortunate enough to talk to some people that I know are thoughtful. Like Shomik at Minion Capital. That guy’s not a dummy. He thinks that there are reasonable arguments to be made for the valuations in the names that he has. Now– [crosstalk]

Tobias: Everybody thinks [crosstalk] undervalued. [chuckles]

Bill: I understand that, but I’m just saying, if you haven’t done the work, dismissing the valuation, because you haven’t done the work is something that I’m done with. Do I think it’s rich? Yeah. Do I understand it? No, but I’m not going to do that shit anymore because it turns my brain off, and it’s cost me a lot of money.

Jake: I don’t disagree with that at all. I think just more generally if we’re trying to ascertain base rates of what we can expect going forward, I just don’t like the setup relative to other times. There will absolutely be chances to be a really good sniper and have the rifle and take good shots. I like it better, and I find it easier when I cannot use a shotgun because it’s just become so obvious because of valuations. I don’t have to be as smart about it. I can be a pretty shitty analyst if I have the right amount of patience to pair with it. They’ve got all these other things, a lot of things right now require you to be an absolutely incredible analyst in order to have a good shot at a good outcome, and I’m just not sure that I have that kind of capability.

Tobias: That’s basically where I get to, too. When you look at the list of things that are high quality, so that definition that I gave before, ROE over 20%, gross margins over 35%, and then rank them all on cheapness, and you get names like Biogen and Intel, I think that those things probably do work out but I’m no pharma analyst and they’re pretty good– there are smart people who think that Intel is a value trap here. There’s nothing in there that’s just an obvious, easy, simple business that’s cheap, that’s got a solid balance sheet.

Everything’s financialized too, that’s the most frustrating thing. Everything I look at, they’re optimizing rather than trying to build in some resilience, which I just think all that stuff is the stuff that you see close to the top of the cycle and everybody gets religiony. I’m stunned that nobody got religion after March last year. Everybody was pausing, they were like, “Stop the buybacks for a moment.” Not so much debt. They’re like, “No, no, don’t worry about that.” That was over so quickly. That was just an opportunity by the debt.

Jake: I’m invincible. [chuckles]

Bill: Well, ‘09, you got paid for being a liquidity provider. In March, you somewhat did, but I just think that we’re at the point where the Fed is going to provide the liquidity, so I don’t know that you’re going to get paid for that. So then the question that I ask is like, “Okay, well,– it’s the old Chris Cole thing. Where the hell does it go to? You can’t suppress the risk. I don’t know where the risk is, but I’m just not sure, it’s in the equity valuations broadly. That said, I don’t expect very good future returns. It’s something that keeps me up at night.

Tobias: Well, Hussman today suggested the negative [crosstalk] 12 years. He’s got the–

Bill: Hussman has been wrong forever.

Tobias: I think that you can separate out, I don’t even really want to separate out the man. I don’t think he’s been wrong. Unfortunately, for him, he’s trying to apply some science and mathematics and reasonability to it. Whereas the market– [crosstalk]

Bill: You’re give me shit. No, no, no, no, no, you give me shit about people that own their stuff think it’s cheap. People that agree with somebody obviously, don’t think they’re wrong.

Tobias: Yeah, that’s fair.

Bill: [laughs]

Jake: There’s a great quote from JK Braith. It’s, “Faced with a choice between changing one’s mind and proving there’s no need to do so, almost everyone gets busy with the proof.”

Tobias: That’s fair.


Bill: That is a good quote.

Tobias: Hussman cops a lot of grief on Twitter. I think a lot of it’s unfair because it’s not like anybody’s– nobody’s disputing his numbers. Nobody’s arguing with him about his numbers. They’re arguing about his interpretation of it. I look at his interpretation, that chart, the relationship where they use it 12 year, you’re assuming that you mean revert back to normalize valuations over 12 years, or 10 years, I do it with 10 years, just because I can– it feels a little less data mine to me.

I just assumed valuations go back to the long-run valuation over a decade. The fit is good enough for me, that’s a pretty good fit. That little model says that the expected return on the S&P 500 from here is 9%, including 1.5% a year in dividends. The index return is negative to the tune of like point 6% over a decade. That assumes underlying growth in the order of 6%, or underlying earnings growth. It’s just we’ve got so far ahead of the ordinary multiples in the Shiller CAPE, that we’re likely to see very modest returns in the future, with a lot of volatility in the interim.

Bill: Tell me where this thought process is wrong because this is something that I’ve been thinking about forever and I just might not be understanding how the world works. If I’m looking at somebody like Planet Fitness today, and I have no working computers here, and I’m dealing with closing a home and stuff is going wrong with the deed.

I apologize if my brain is jumbled. If I’m paying $7 billion today, for this earnings space, I get paid on my $7 billion that I paid, and then I get the business’s return on the growth. But if the business’s return is pretty small relative to the $7 billion that I paid, I’m not going to do too well, or do I just not understand how investing works?

Tobias: Might be too many moving parts for my adult brain. You get the return, you’re ignoring what the stock market does, you’re buying on return. You’re buying an underlying yield and growth story.

Buffett-Kraft Heinz

Bill: Yeah, this goes back to the Buffett-Kraft Heinz thing. He paid a lot for a substantial earnings base. When you do that, or you pay a ton for a small earnings base, you really need a lot of growth to come in to bail you out if you’re a cash flow guy. The best way that I could say it is, I look at something like Texas Instruments, and I’m not a semi-analyst, so I don’t really know. Sorry. I’ve got people calling in. Anyway, I’m not a semi analyst, so I don’t really know. I think that there’s a reasonable shot that a business like that does pretty well from here, relative to the index. I think some of these high fliers, I just think it’s going to be very tough, but maybe it works. I don’t know.

Pabrai and Marks Abandon Deep Value

Tobias: I think that there’s some names in there. I look at Microsoft in my list of the little quality string that I was describing before. Microsoft comes in there. I don’t think Microsoft is egregiously overvalued. I think it’s a little bit expensive here, but I don’t think it’s egregious. You can do fairly well in some of those names. I think that there’s some undervalued stuff around. I’m responding a little bit to Marks and Pabrai, where these guys have said we’ve spent basically our entire careers doing cheapest stuff, and now we think that it’s time to go to compound town.

Well, I think the time to get to compound town was like 2015 when JT wrote his piece about the value opportunity being worse because the spread was so tight, because when the best stuff is priced, like the garbage stuff, which is what happened around that kind of time, then you want to be buying a high-quality stuff. Most of the time you get enough of a discount in the cheapest stuff that you’re still better off buying the cheapest stuff.

I think right now, it’s difficult to see because the expensive– there’s such a very broad spectrum of opportunities out there. It’s a question of pricing the growth properly, but I do think that the expensive stuff is, objectively on the numbers that you can pull off the French data website, it’s as expensive as it’s ever been.

The cheap stuff is not screamingly cheap. It’s basically a little bit rich to its long-run average, or maybe a little bit expensive to its long-run average. But I still think that’s a better opportunity set than the expensive stuff. The best opportunities are spread, long, short, and in the cheapest stuff. I think everybody piling into the compounders, they’re going to regret it over the next five years or so.

Bill: Well, I think to make a bond analogy, you’re basically saying, the spread between investment grade in junk is wider than it’s ever been and now’s the time to buy investment grade. That could be right– [crosstalk]

Tobias: In 2015– [crosstalk]

Bill: Well, [unintelligible [00:22:40] today. If you just think of compounders as investment-grade stocks, and value as junk stocks for this analogy, that spread is as wide as it’s been in a long, long time. It’s kind of interesting that people are saying, “Oh, well, now it’s time to buy the investment-grade stocks.”

Tobias: What do you think has driven Pabrai and Marks to write those letters at the same time? All of the guys out there who have been– the high-quality guys have been writing quite high for a long time, you just give up– it’s just too painful to hang out being a deep value guy?

Bill: I think that there’s a real shot that Marks has been sitting around with his son, like he said, and his son has had a lot of success in a different strategy. Maybe it’s made him to contemplate something. I believe that letter on face value, I don’t see why he would lie about it.

Tobias: I guess good for him for having an open mind about that sort of stuff. Experience does count for something as an investor. Seeing a few cycles should make us pretty wary about what you do at the top of a cycle. The two times when you really want to be careful are when you’re underperforming and the cycle is long in the tooth, and it looks easy to everybody else.

I really think you need to second guess your second guesses there. If you’re at the bottom and you’ve come off a big crash, and you’re in total devastation, maybe this is March 2020, think about it then, but I don’t know. I’m not changing style at this point in the cycle. I think the opportunity set looks as good as it’s ever looked.

Adam Robinson – Losing Your Instruments

Bill: Yes. I might go a little bit of veggies, steal from Jake a little bit here. I was listening to Adam Robinson. Do you guys know who he is?

Tobias: No.

Bill: Jake, you’ve heard him?

Jake: Hmm.

Bill: He founded Princeton Review. He’s a really interesting thinker. I like how he thinks. He was telling a story about how a cello, I think it was a cello player, it might have been a violin, it doesn’t really matter. At the end of the day, these guys that are insanely talented musicians, treat their instruments as if their limbs. This guy left his, and it was after a performance when he was traveling. Adam Robinson’s takeaway from that is, forget about the fact that they may lose their instrument, their entire wellbeing is at risk if they’re in the mental state where they would lose their instrument. They do it when they’re out of their normal comfort zone, and after a performance, so maybe some stress-inducing activity.

When you look at like baseball cards ripping, when you look at bitcoin ripping, when you look at quality ripping in parabolic ways, at least some of quality, and we’re all locked in in a pandemic, and on top of that value is underperforming, I think that capitulating at this time, if someone is capitulating, seems very akin to me to the musician that is traveling and just got done with their stressful performance. Maybe the best thing to do is just sort of put the pencil down for a bit.

Tobias: Yeah.

Jake: You’re on till.

Tobias: That’s it.

Bill: Yeah, that’s right. I did not read Marks and get that perception. I haven’t read Pabrai’s letter yet, mostly because today has turned into a shit show, so I’m on till.


Jake: The trick is to know when you’re on till, that’s the key.

Bill: Yeah, I won’t be working today.

Buying $MSFT Early

Tobias: I can build a model and test the model that just buys what we all agree, 35% gross margins, plus on average over a period of time, 20% return on equity on average over a period of time, and then buy them when they’re cheap, and then hold them until they become egregiously over expensive. So, I would say like the free cash flow yield dips below the 10 year, in which case, you should probably be holding the 10 year instead of that particular stock. That’s my thesis. Ordinarily, that’s been a pretty good bet, because ordinarily, on the 10 year, you’ve got about 6%, you’re currently getting less than 1%, so I understand why there’s no other alternative and all of those other theories exist.

What we have a tendency to do is we look back at the really great returns, someone who’s got from Microsoft– I’ve had a few guys on who’ve talked about– they got Microsoft the right time, Science of Hitting got Microsoft at the right time.

Bill: Shoutout to TSOH.

Tobias: You could have bought PZZA, P-Z-Z-A, before it had its big run. You could have bought Sherwin-Williams before it had its big run. Ross Stores. All of these names that have had these multi-year compounding runs where the earnings have gone up materially every year, and you’ve got the multiple expansion at the same time, which makes you look like an absolute genius because you get this parabolic rise in the stock price. It’s the right kind of return because it’s basically tied to the underlying performance of the business, plus you’ve got the multiple expansion.

But the time to do those things is when they are cheap, and you’re not really paying for that. That’s why you get those great returns. If the market knew that those great returns were coming, they’ve would have bid those stocks up already, and your returns would look more like a market level return. You still want to be exercising value discipline when you’re buying these things. People get to this point in a cycle, and they’re like, well, don’t go and buy all the cheap stuff, the garbage stuff.

Go and buy all this really high-quality stuff. High-quality stuff at the moment, it definitionally meets– meets the definition that I described, but it’s stuff that seems a little bit more– It’s harder to analyze, it’s Intel, which is harder to analyze. It’s Biogen which is harder to analyze. It’s not stuff that’s like PZZA, which was– you had to know that adding garlic salt to the pizza sauce was going to have such an outsized impact on the stock price, which not everybody did. It’s a simple business.

Bill: Well, that was Dominos, right?

Tobias: Dominos, sorry.

The Return For Investment Of Time

Bill: Yeah. I’ve got to tell you, I,ma plug-in again. I talked to him and I think the audio is lost, which sucks. Mike NonGAAP, the way that I think that the return on investment of time for following some of the proxies, and the way that he says to do it, I really think is something that people should pay attention to. By the way, Toby is the first one that found them off the interwebs and the first request, so tune into The Acquirer’s Podcast, because my boy finds– [crosstalk]

Tobias: With NonGAAP?

Bill: Yeah.

Tobias: Yeah, I’ve got a podcast up with NonGAAP. He’ll teach you how to read a proxy statement. That’s always helpful.

Bill: Well, and what he was saying is like how you can find inflection points in stocks based on what the board is doing. I think that that’s a really interesting thing to add an arrow in your quiver or whatever. Anyway, because [crosstalk] Toby– Sorry, go ahead, Jake.

Jake: I was going to say it’s a good initial screening in that there’s so many principal-agent problems in a publicly traded company. If you can get around some of those early on, boy, it just unlocks a whole lot of other levels.

Bill: Yeah. To Toby’s point, when Science bought Microsoft, everybody was telling them that that was a dead company.

Tobias: I remember it very vividly. I was at Value Investing Congress hearing, and I heard the pitch for about a year or so. I think it was like 2011, 2010, something like that, I can’t remember exactly, but around that kind of period. What folks forget is that they had their first-year revenue going down, and that was what made it really hard to analyze the opportunity. It was still underlying a great business, it still had those very fat margins, and at very high return on equity.

The return on equity in Microsoft, even now is just mind boggling, when you look at something that is that big, generating that kind of return. It just shows you how powerful their moat really is. You just can’t compete with them in some respects. It wasn’t like an obvious idea. I think it was a simple business, but it wasn’t it was just compounding away, and you just had to hold it, and you got all the compounding.

The fact that the revenue backdoor for one year made it harder, and it was Ballmer who was in control. And then it switched over to Satya Nadella, which nobody really knew who he was. Turns out, he’s one of the great CEO. He’s the real Jack Welsh, he should be writing, he should be getting all the plaudits that Jack Welsh got when he retired. None of that was obvious at the time.


I do think it’s a good argument in that instance. In that instance, if you’re hunting for these things that are high quality, and you’re remembering to not pay very much, that’s a good argument for never sell, because once it sort of turned out that Satya did know what he was doing, and they started compounding and getting those good returns, and buying back stock at appropriate times, the runway, all of a sudden look really long. You could still be holding Microsoft from buying around 2011 which Science has done, which Alex has done. That’s why his returns is phenomenal. Well done to him.

Jake: I mean, if you can recognize a Microsoft in that situation and understand what was going to happen with moving to the cloud and getting subscription and all that kind of stuff, you deserve to do really well. I just don’t think that there are as many people out there that can do that, as are declaring the count compound town– [crosstalk]

Tobias: I don’t think you necessarily have to see how you win in those circumstances. I think what you’re doing is you’re saying balance sheets super strong. Still a good business. Even if the revenue growth is not as consistent as it has been in the past, this is something that you can buy, and you can just sort of see.

That’s kind of what I think a lot of deep value is, you don’t necessarily have to know how it works at the time, you’ve just got to make sure management is doing the right thing. They have the balance sheet liquidity there to figure out what they’re going to do. It’s sufficiently cheap that it’s de-risked for you on a valuation basis, though it could sort of stumbled and it’s falling out of that little hitting window.

$SPGI Is Buying $INFO

Everybody’s talking about Standard and Poor’s at the moment, SPGI is buying INFO, I-N-F-O, to market. INFO is expensive and not as good a business as SPGO. A lot of SPGI guys, and SPGI has been one of those compounders, super high-quality business that everybody holds. Now, there’s some questions because while they’re slightly– I’m not a total expert on this, but maybe they’re slightly overpaying for INFO. I think it’s still a good business. I think they’ll figure out how to make it work, it’s probably a good time to have a go at something like that.

This is not investment advice. But I do understand that these are the times when you buy these sorts of businesses when they have that little stumble, but the underlying business is still good. I understand there are legitimate questions about the acquisition, but I think that they’ll figure out how to make it work, and so I do think that SPGI works from here. It’s that kind of thing, you’re looking for these high-quality businesses, when they have this little opportunity to invest in them. This is what I mean when I say, when you build an invincible portfolio sort of working backwards from– first, we’re going to start with really high-quality businesses, and then we’re going to try and buy them as and when they get cheap knowing most of the time, they never get cheap enough, you will have a swing at them.

Bill: Yeah. In those in those scenarios like worrying about multiple fade, over-indexing on that concern doesn’t do enough justice to the fact that the business’ underlying earnings stream has a pretty strong chance of doubling. Let’s say that the business can double twice over 15 years or whatever, and you get back one of the doubles to multiple fade, what does the rest of the world do in that scenario, right? You’re probably not going to lose too much wealth doing that. Now, can you run a hedge fund and have that performance? I don’t know, maybe not. But from an investment standpoint and building wealth, probably do okay.

Tobias: I never assume– [crosstalk]

Jake: You can use Microsoft again as the same example from 2000, where– I don’t know how much revenue doubled over the next from 2000 to 2014, but multiple fade took away all of your return in that instance.

Tobias: Yeah.

Jake: It’s not as easy as everyone is assuming right now. [crosstalk]

Tobias: That’s why the stock was so scary at the time because it had gone sideways since 2000. In addition to that, now, revenue was falling off. So, you had to be–

Jake: It was huge already.

Tobias: It was huge, yeah.

Growth Keeps Growing

Jake: The things, elephants tripling in size is not a normal situation. It hasn’t work– [crosstalk] hasn’t been, maybe that’s the new normal. But I think that’s what I would say, to give a very Buffett style caveated answer in summing things up, if growth rates are not going to be what they used to be like, if big can keep getting bigger and faster, returns to scale kind of argument, if rates stay low forever, if we don’t allow bankruptcies so there’s no reversion to the mean in businesses and creative destruction, if we’ve suspended creative destruction, if valuations remain where they are, then I think this will continue for as long as that goes on and you want to be in the growth area, if that’s true. If any of those things you don’t think are necessarily true, then there might be some problems.

Assuming The Multiple Fade

Tobias: On the assuming the multiple fade, I assume that the multiple fade is driven by a fade in the return on invested capital. If you do that, you just assume that these things fade back to normal over 10 years. It’s a lot harder to figure out the opportunity. If you assume that there’s no fade in the ROE, the ROE, it just keeps on earning basically what it has in the past, and that just keeps on going forever. It’s defying the base rates.

Yes, that makes valuation decisions a lot simpler now, because you just buy the stuff that’s better, and you assume that it never backs off, and then you can afford– you can pay up for it because in 10 years- time, it’s the same quality business, it’s just that it’s now grown three to five times over that period. I find that for the most part hard to believe, for most businesses, that’s hard to believe. I can see how you can make the assumption.

Bill: There is some persistence of growth rates in some of these SaaS companies. I was plugging around some VC Twitter today and I came across an article, but that thing was written in 2012, which is crazy. Good time to make that call. Look, I have no idea. Snowflake might be worth this. If it is, it’s good to the people that bought it.

Tobias: You get another opportunity to get it a bit cheaper, I reckon.

Bill: I would think. It’s hard to think that this is the cheapest it’s ever going to get.

Tobias: JT, do you want to do yours?

Jake: Yeah.

Bill: You’ve got five minutes.

Tobias: [chuckles]

Jake: Yeah, ready, go, sprint to the finish.

Tobias: My monitor has just gone down because I run on 19– it’s the same technology that they sent the astronauts to the moon in 1960. I’m looking down here, but I’m actually looking at my second monitor, so I’m not like ignoring you guys or anything like that.

Bill: I can’t even see your picture, I’m on a phone.

Tobias: There you go. [chuckles]

Ketchup Physics

Jake: [chuckles] All right, so this veggie segment is called Ketchup Physics. I actually have a little thing of ketchup here, just for fun, and it’s Heinz, so that’s good. Ketchup is interesting, in that, if you push on ketchup slowly, it behaves like a solid. It will resist the force that you put on it. If you shake it hard enough and it starts to move, it actually starts to behave like a liquid, and then it’ll move quickly. It’s not linear in that way. What’s going on? If we look inside here and what’s happening at a molecular level, ketchup is made of sieved tomatoes, basically, like really highly filtered tomatoes, water, vinegar, and spices.

Then there’s this other magical ingredient in there that is about a half of a percent of the total of it. It is these long molecules that are made up of chains of linked sugars, and it’s called xanthan gum. It’s a common food additive, it’s actually used or created– originally was created by bacteria that we then taken harvest from and put this into our things as a thickening agent. It also actually gets used in the oil industry, if you can imagine, to create this– It thickens drilling mud, which is sometimes what you want, I guess, in the drilling world. Anyway.

Bill: I wasn’t going into my body, that sounds great.

Tobias: [laughs]

Jake: I know.

Bill: Yeah.

Jake: When ketchup is at rest, these long molecules tangle themselves all up around each other. When you put some kind of force on them, they stay together, and they resist that force. Then, when if you get them moving, they start to untangle, and then it will then release basically and turn into a liquid, it’ll be more like water. As you’re shaking the bottle, there’s a point where you cross over, where enough of them will untangle before they can re-tangle, and that’s when you get a phase change within the ketchup. If we think about–

Bill: Then [crosstalk] starts to move down the bottle?

Jake: That’s when it will actually pour out of the bottle. When you turn a ketchup bottle upside down and go hitting it on the back of it, the problem is, is that it’s basically like a plug up near the neck, because that’s not moving at all, so it’s not liquefying, so it’s just running up against that. The trick to pouring ketchup, which most people I think know this already, but is you hold it, and you tap on the neck, and create the volatility in the neck that breaks up the xanthan gum connections enough to where it liquefies in the neck, and then it will come out much easier.

Bill: Okay, that is interesting stuff, Jake.

Jake: Thanks. A couple things to take away from that. Number one is, it’s interesting how the time of something, like how long it takes, the duration can have dramatic impacts upon the actual effects and what happens. In this instance, the volatility of disrupting the xanthan gum and untangling it, when you get enough of them untangled before they have a chance to re-tangle, it will liquefy. But if you’re just not much volatility or if you spread that volatility out over a very long period of time, you don’t get that phase change because it doesn’t untangle enough to liquefy.

I was thinking what if Xanthan gum is the equivalent of people’s belief and faith in the future, in growth rates, maybe the corporate dominance of whatever they’re invested in. Maybe it’s Fed intervention, maybe it’s that prices can never go down, maybe it’s that rates can never go up, and we have all of these beliefs– As long as people are together in it, and they stay tangled up in it, and there’s not too much volatility to shake them from that belief, they can stay as a solid.

Market prices appear very firm, and they appear to be a solid thing to rest your hat on. But if you introduce enough volatility, and you break those beliefs in a fast enough time period for people, you can see a liquidation just like the ketchup, and now all of a sudden, all their beliefs go out the window, they’re looking to sell, and you get basically like a market run. It’s this similar analogy to sand on the sand table, or earthquakes building up, or all the million other sort of critical state phase change analogies that are out there, but I thought this was kind of a fun one in the ketchup bottle world. Maybe you’ll think about that next time when you try to put ketchup on your fries.

Charles Mackay – Men Go Mad In Herds

There’s a good quote, it’s actually from Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds. Do you know when that was written by the way?

Tobias: It’s old. Is it 100 years old?

Jake: 1841.

Tobias: 1841?

Jake: Yeah. [chuckles] That’s how old all this is. He says men think in herds, it will be seen that they go mad in herds, while they only recover their senses slowly one by one. I just think it’s interesting to imagine what appears firm if enough people lose their faith in a short enough period of time, we get phase changes, just like in the ketchup bottle.

Tobias: Phase changes in the stock market, too.

Bill: [crosstalk] I think Chris Cole would like this too. Man, I tell you what, it’s hard to look at people rushing the Capitol and not think that some phase changes are going on with how people view the system. It’s a very interesting time to be alive to have valuations this high with risk as prevalent as I perceive it to be, but maybe I’m just wrong. It’s possible.

Tobias: I think it’s always very hard to know how impactful that is because one of the things about history when you look back at it, it looks a lot more linear than it actually is in the actual living of it. I’ve been enjoying this– There are these books by Alan Furst. He writes these spy novels, and they’re all set in 1939. They’re often in Paris or in Poland, or somewhere like that before Germany invades.

They’re not certain that it’s going to happen, and they advance– the guy is very good at making all the of arguments that there’s good reasons why Hitler won’t invade, and there’s good reasons why they can’t and why the Maginot Line will stand up. They advance all these things, as you read in the book, in the context of 1939 or 1938, or before anything happens, it all sounds perfectly reasonable. As a reader, because you know how it all ends, you’re always sick.

Jake: Yeah.

Oppenheimer Research Reports

Tobias: A lot of history is like that. You forget how not obvious it was at the time. I saw a good tweet the other day, someone was describing– someone went through a whole lot of old Oppenheimer research reports and was talking about what it was like being an investor in the late 1990s. They said, everybody basically knew it was a bubble, everybody knew it was over-expensive, but it wasn’t even the internet stocks that were the stuff that were the most published.

Jake: Large cap.

Tobias: We talked it before. Yeah, it was the large cap. Microsoft was one of them. GE was another. There were lot of these businesses that were very good businesses, very good returns on equity, very good margins, all that sort of stuff. They got too expensive. It’s the same thing we see repeatedly in the markets, the same Nifty 50 story from the 60s and 70s. You could pay any price for these things and still do okay.

Bill: They did outperform though. You just had to live through the drawdown.

Tobias: Nifty 50 performed eventually?

Bill: Yeah, I think it did. I think it just started, which is maybe another element of where we may be. You might think that that would be a full long cycle comment.

Jake: How long did it take you to get back from–? A lot of those were just absolute monster drawdowns like 70%, 80% plus for–

Bill: For a long, long, long, long time.

Jake: For inevitable companies. Oof.

Tobias: Is that also true for Microsoft? Has Microsoft now, from 2000, I think it’s now crested– You’ve been paid to hold on to Microsoft. I just think that if you’re a value guy, you knew not to be in it in 2000, and then you had a signal at least, you had people saying, get into it in 2011. The guy who bought it in 2000, his returns are probably okay, but the guy who bought it in 2011, his returns are spectacular.

You’re going to get those opportunities, that’s why I don’t think anybody needs to reach up. If it’s too hard if you have to– If it’s really an effort to do the analysis, then it’s probably not the right opportunity. You just need stuff that’s like, yeah, it’s obvious. Not a lot has to go right for this thing to work. It’s a good quality company, and it’s too cheap. If I stick it in and forget this for a few years, it’s probably going to work out.

Jake: You’re saying Buffett would say like, “Wait for your fat pitch?” [laughs] It’s like he’s got a quote for everything.

Tobias: It’s almost like– the shame of it is going back and reading those old letters and realizing how smart that man is. Every single time I get back, it was my inability to learn, not his inability to teach.

Jake: Yeah.

Tobias: Throw your questions in, dudes. We’re all [crosstalk] here.

Bill: I had a real quick thought on that. Well, fuck it. I’ll just talk about it later. I’m done. I’m not talking about it now.

Tobias: This is a podcast, that’s what it’s for.

Jake: Ketchup related? Only comments?

Bill: No. I don’t know why something that you said triggered something, but now I feel like it’s for us, so I’ll save it [unintelligible [00:49:15] over. The moment’s gone.

Jake: Ah.

Buffett Market Timing

Tobias: There’s a comment here, Buffett doesn’t market time. I’m going to take that as a question. I was thinking recently– [crosstalk] In conversations with a few guys, Value Stock Geek notably one of them, pointed out that, if you look at the fear and greed indicator that it gives you this pretty good opportunity every year basically when the market falls over as a sign to go in and buy some stuff. I thought that’s probably a pretty good approach to this business.

If you get your list of really high-quality businesses that you want to own and the only time that you transact in them every year is during that period, then you’re probably going to do okay. You’ll likely outperform the average holder of them because you’re buying them at the right time. Then, I found some common of Buffett’s where he was like, because what he’s doing, what Buffett is explicitly doing is wonderful companies. He says fair prices, and I think that’s because he’s buying some of these companies privately, he doesn’t want to tell people that he’s gouging their eyeballs up.

In the stock market where he doesn’t have to be polite to anybody, he’s definitely gouging their eyeballs out. He’s wonderful companies at wonderful prices. He just waits for them to get too cheap. Apple’s a classic example of that.

When he bought Apple, it was unusually cheap as it seems to get every three years or so. I think that what he said when this little comment was, there’s no point doing what I’ve just described where you’re waiting for the fear and greed indicator because it’s market timing, and he’s explicitly not a market timer.

He’s just trying to find those opportunities when they come in. He only wants to buy the high-quality ones, however you define that, but he’s using return on equity, as he said lots of times, and he’s buying them cheaply when they come into the cheap bucket. It’s just that you need extreme discipline, extreme patience to do it, but if you can do it for 50 years, you’re Buffett.

Jake: What’s the difference between that and market timing?

The Apocryphal Pig Farmer

Tobias: Well, he’s doing it on a case-by-case basis, I guess, rather than like me saying, “Wait for the fear and greed indicator that tick below 20 when the market does its annual selloff.” Market goes on sale once a year, basically, and has done pretty regularly. If you wait for that opportunity and you deploy all your capital, you’re like a pig farmer, the apocryphal pig farmer, he comes off his pig farm once a year when there’s panic and does his buying.

Jake: You want to be a securities timer, but not a market timer?

Tobias: No, I don’t. I’m saying– I thought about–[crosstalk]

Jake: It’s a [crosstalk] question, I wasn’t–

Tobias: I don’t think it’s a bad approach. Every time I think of something that might be a good approach, and I go and read some Buffett, I’m like, “That’s right. Yeah. I don’t want to do that.” [crosstalk]

Jake: Yeah, except that 1973.

Tobias: Yeah, he told you not to do it already. That’s why I’ve got “What Would Buffett Do?” I got that little poster, I put it up. Every time I think about buying something, that I have to go and explain it to Buffett, I’m just like, “Nah, that’s no point doing that. I could never explain it to him.” I think that’s more than a discretionary basis, like quantitative deep value, that’s always going to be pretty good at generating returns.

But if you’re going to take these singular swings where you only buy one or two positions a year, you want to make sure that just ticks every box for you at the time that you do it. I couldn’t put Biogen or Intel into something like that because if I went and tried to explain it, I just can’t explain the businesses well enough, and the risks are real.

Jake: Yeah. What would 1965 Buffett do for your other side? Is it a quant side?

Tobias: Yeah. Clearly, if he could do this, I’m sure he could still do– He said before, if he had a million dollars, he’d be getting 50% a year. Harder than it looks– [laughs] I don’t know if you’d really be getting that. Maybe in a ’65 market.

Happy Birthday Ian Cassel

Bill: Yeah, I think that’s right. That said, micro cap’s got to have some good opportunities in it, some of these structurally smaller things. Shoutout to Ian Cassel. Happy birthday.

Jake: Yeah, Happy Birthday.

Tobias: Happy 40th, Ian. Good job.

Bill: No, you didn’t have to put his age on blast. I was just saying the day– [crosstalk]

Tobias: Well, he tweeted it out.

Bill: Well, I’m just saying, not everybody’s on Twitter. You old man.

Tobias: He tweeted. It’s got like 1000 likes on it.

Bill: I bet your back hurts.

Will Peleton Acquire Equinox Or Planet Fitness

Tobias: it’s not a state secret. Sorry, I’m having trouble watching the questions. I’ll toss this one out to the boys, but I don’t know, will Peloton acquire Equinox? This is probably a good question for Bill.

Bill: Oh. I don’t know. Actually, I’ve been poking around in my head of Peloton and Planet Fitness make more sense to merge or not merge, but like form a JV. The amount of people that could be served by Peloton’s app and Planet Fitness makes a whole lot more sense to me than Equinox. Equinox has somewhere to go and see and be seen and pay too much for a trainer that keeps you fat.

No, I’m kidding. They’re very good-looking people there. I don’t think that’s the match. No. If you’re Equinox, why would you undercut your trainers like that? You’re making what, like 100 bucks an hour on training sessions and you’re going to outsource of all the Peloton? That doesn’t make sense to me. Peloton could in theory buy them, but then you’re entering the gym business? I don’t know.

Tobias: Aren’t you looking at Planet Fitness?

Bill: I am looking at Planet Fitness, yes.

Tobias: The gym business is good enough for you, but not good enough for Peloton?

Bill: I think that selling $10 memberships to people that never redeem their gym membership isn’t exactly the same business as Equinox. I’m not looking at it because I want to buy it. I’m looking at it because I’m intrigued by what makes it work. For instance, like a lot of their franchisees own three stores or more.

Considering the fact that I left the franchise system that is fairly successful, but most people only own one franchise, I’m intrigued by what is this franchiser do that enables people to be successful or is it something in the franchisee base or, is it cultural? That’s the stuff– I’m not particularly interested in that stock.

Tobias: Did you say the average franchise owns three franchisees? Are the other way–?

Bill: Yeah, man.

Tobias: Really?

Bill: Yeah, the franchisees– I don’t know that stat off the top my head, but the vast majority of their stores are owned by franchisees that own three or more.

Tobias: Planet Fitness hands out pizza at the gym?

Bill: Yeah, dude, in like bagels and they have tootsie rolls on their welcome counter. It’s absurd.

Tobias: [laughs] To keep you coming back?

Bill: I don’t know. It’s like [crosstalk] zone.

Jake: You earned it.

Tobias: [laughs] That’s genius.

Bill: You’re not allowed to throw around a lot of weight. They honk a horn at you or something. It’s like an alarm [crosstalk] telling that you’re [crosstalk] for that.

Tobias: Literally getting people in there and then not letting them get fit, like so you’ve got to keep on coming. You can’t lift heavyweight and you got to eat a whole lot of carbs when you go in, but it’s $10 a month.

Bill: Yeah, or $22 if you join their Black Card program, and then you can bring a guest at any time and you can visit any location.

Jake: And it’s all you can eat pizza.


Bill: The average member spends something 240 bucks a year there off the top my head. You look at like the CAGR on stores and same-store sales and memberships, it is like a very impressive marketing machine.

Tobias: That’s hilarious.

Bill: I want to figure out what the hell cracks like– how they crack that code. It’s intriguing to me, because I want to be able to recognize that pattern in another industry. It doesn’t seem like the gym industry would be particularly easy to do that.

Why Aren’t 0% Interest Rates Bad For Banks?

Tobias: Bill, we’re just about to run out of time, but I got a quick question for you from somebody. I took it off the screen, but it was why aren’t 0% interest rates bad for banks?

Bill: They’re not great. I think if the bank can borrow at negative two though, which is sort of laughable, but it happens in Europe, they can still make money.

Tobias: Yeah. Okay. It’s not a healthy system if that’s happening, but, yeah, all right.

Bill: Yeah, I mean, I don’t think that where we’re going is particularly great. If people think low rates, therefore banks die, I’m not sure that that’s correct.

Tobias: Did some of the experience from Europe make you nervous about that– Deutsche and UBS?

Bill: Yeah, I don’t think I own any banks outside of a look through exposure via Berkshire right now, because I watched Wells rip and did nothing about it because I tax law sold, that felt great.

Tobias: Thanks for this kind, super chat investor folks, that’s all we got time for. Next week, I think we all will be back where we normally are, and I’ll get my monitor fixed up soon. I’m not staring down here the whole time.

Jake: I’m going to be here.

Tobias: [chuckles] JT is now a lifestyle blogger from somewhere in the Caribbean.

Jake: Yeah.

Tobias: Check out his Instagram channel.

Jake: I’m not on Instagram.

Bill: I’ll never be in this house again after Friday. So, that’s that.

Tobias: Sad?

Bill: Unless you can’t find that deed.

Bill: I’m a little sad. I’m more sad to be leaving Chicago than the house. I’m looking at snow right now and I left in shorts, so I’m ready to get back home.

Tobias: Good luck, mate. Safe travels.

Bill: Take care yourself, boys.

Tobias: See you, fellas.

Jake: Cheers.

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