In the latest episode of the Acquirers Podcast, Vincent Daniel, Porter Collins, and Tobias Carlisle discuss:
- Working With The Big Short’s Steve Eisman In Real Life
- The Big Contrarian Energy Trade
- Here’s Why Tesla’s Margins Don’t Make Sense
- Biggest Winners In The New Energy Paradigm
- Fundamental Momentum Investing
- The Real Systemic Issue – Too Much Debt
- Position Sizing In Energy Stocks
- We’re Years Away From The Bottom
- Pawnbroking & Options Trading
- Fed Has No Option But To Continue Printing Money
- Energy Companies Producing High Yields
- The Best Housing Stock Is Home Depot
- What Happens If Everyone Charges Their EVs At Night?
- Using The Acquirers Multiple To Screen For Ideas
- QE For Biden
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:
Tobias: All right, fellas, we are live. This is The Acquirers Podcast. It’s 10:30 AM on the West Coast, 1:30 PM on the East Coast. What is it where you are, Porter? Where is it, Houston Central?
Porter: Central time, 12:30 PM.
Tobias: Joined by– [crosstalk]
Porter: It’s a fantastic time zone to invest in, because market closes at 3:00 PM, opens at 8:30 AM.
Tobias: That’s very gentlemanly.
Porter: Yeah. Good deal.
Tobias: I’m joined by Seawolf Capital, Vincent Daniel and Porter Collins. Welcome, fellas.
Porter: Good to be here.
Vincent: Thanks for having us.
Tobias: We met in whatever that thing was in California.
Porter: Wealthfront Conference, I think it was, right?
Tobias: Yeah, Wealthfront. Was it Wealthfront?
Vincent: Yeah, something like that. An RIA conference that was hosted by– what’s that– [crosstalk]
Porter: Downtown Josh Brown.
Tobias: Was Downtown. Yeah.
Vincent: Downtown. Yes.
Tobias: And Matt Middleton. There were very few people who were, at least, as bearish as Jake and I, maybe a little bit more so. And so, it was nice running into you fellows and chatting to you while we were there. So, I thought I’d try and recreate that a little bit for everybody at home.
Porter: I have a great picture of you guys. I showed you of you guys presenting [crosstalk] conference-
Tobias: Nobody watched it.
Porter: -and there were four people watching.
Vincent: You’ve talked about the perfect channel check. I took out my camera and I noticed that there were five people there and sadly– we knew all four of them. And then if you want to cross the, I guess, whatever you want to call it, the beach or the parking lot, whatever it was, there was some digitized growth build your business thingy and there was about 75 people there, standing room only. I was like, “Oh, I got to take a picture of this.” That is about as consensus as can be.
Tobias: I think there will be a time to buy a whole lot of tech. It’s just when it’s really cringy and nobody wants to talk about it– I distinctly remember that around 2,000 and whatever it was– four, or five, or something like that. If you had a tech idea, nobody wanted to be anywhere near you.
Porter: We always look for the cold IPOs. We never want the hot IPOs because we’re big fans of the cold IPOs. You have to beg you to come get the deal done.
Porter: Or the salesperson’s like, “Oh, I need you to take seven slots. No one can fill this. I can’t fill this meeting.” And so, that’s always the good stuff.
Tobias: Do you guys want to tell everybody a little bit about Seawolf? Do you want to let us know what Seawolf does?
Porter: Go for it, Vin.
Vincent: Sure. Porter, do you want to take it away?
Porter: No, you got it.
Vincent: To just give a little bit of history, we started Seawolf, I guess now, way back when in 2011. It was initially a long-short fund that focused solely on the financial services sector. So, we were a sector fund, tended to run low nets, fairly low gross. We had, I want to say, what, four and a half good years, Porter?
Vincent: Something like that. And then in two months, we lost a little bit of money. After the first month of losing money, our LP came and redeemed on us. And we decided slowly, but surely to shut down Seawolf as a hedge fund. Then, we spent about a year and a half or a cup of coffee at a very, very large hedge fund that shall not be named. In some respects, it was probably a great education on how the large pools of hedge fund capital are running money. We still use, not that process, but at least the knowledge of what we learned to this day.
And then, when they jettisoned the division that we were in, Porter and I looked at each other and said, “Hey, what do you want to do?” I was like, “Well, why don’t we just rerun Seawolf? We’ll start with our own money and let’s run it as generalist.” Because the last thing we wanted to do was to do what we knew best, which was focused solely on financial services. So, we started becoming generalists and we said, “Well, let’s do it with our own money,” because I didn’t want to lose other people’s money on an experiment. Three years later, we still have been taking anybody’s money, but the experiment is actually working fairly well. So, here we are doing stuff like podcasts and talking about things other than just say Citibank and Morgan Stanley. Or we could talk about them, if you want.
Porter: It’s been a good run. I think we’ve run seven times our money in those three years, which is– [crosstalk]
Tobias: That’s a good run.
Working With The Big Short’s Steve Eisman In Real Life
Porter: Previous to Seawolf– [crosstalk]
Tobias: What’s the reason for that?
Porter: Previous to Seawolf, Vin and I started working together in 2003. Vincent had previously worked for Steve Eisman. And then, I the time was working for Steve at a hedge fund called Chilton. The three of us came together and started FrontPoint Partners. That’s where we worked from 2003 to 2011 at that time.
Tobias: That FrontPoint turns up in the Big Short and you guys are both played by-
Tobias: -slightly less good-looking gentleman than yourselves.
Porter: Ah, I don’t know about that.
Vincent: I don’t know. Jeremy’s a handsome man.
Porter: Yeah, Jeremy Strong. Vinnie got the best actor of the bunch.
Vincent: I did.
Tobias: Is that the Succession bloke?
Vincent: He gets to hang out with really cool people now as an actor. I live vicariously through him. When I see him doing movies with Jessica Chastain and Anne Hathaway, I’m like, “Wow, that’s kind of like me doing a movie with them,” which clearly is not the case, but I can live through that.
Tobias: He’s good in Succession.
Porter: Danny had by far the worst actor of the group.
Tobias: Who played him?
Porter: I forget his name, but he was–
Vincent: Is it Rafe Spall. I believe– [crosstalk]
Porter: Rafe Spall.
Tobias: Not a name that I’m familiar with. Who was yours, Porter?
Porter: Hamish Linklater. He’s in a lot of really good or bad B rated movies.
Vincent: Although he was one of the star pitchers in the Jackie Robinson movie.
Porter: Yeah. 42. Yeah.
Porter: Couple of Amazon series.
Vincent: He was also in The New Adventures of Old Christine with– what’s her name? Elaine. Louis-Dreyfus. Yeah.
Porter: Oh, that’s right. Yeah.
Tobias: Good stuff. You’ve seven bags you started. It’s mostly energy and natural resources. What’s the–?
Porter: I guess, we started in late 2019. And then in 2020, we obviously got wind of COVID happening and we were short all January and February. We were like, “Man, this market is not going down.” It finally went down. We made some pretty good money on the short side, I want to say, in about May or April, I don’t know when, we covered it and went long. We played a lot of the reflation trade. We didn’t do any tech really at all, I don’t think. It was energy and it was a lot of shipping, a lot of deep cyclicals that we bought. We stayed that way up until midway through 2021.
Then midway through last year, we started shorting pretty heavily. We can go through this. We did our screens and we did the screen of greater than 10 times sales and still not making money and we basically shorted the– not entire list, but we shorted probably about 15 or 20 names. We rifle shot at individual companies.
Tobias: I think that was the most number of companies trading over 10 times sales, certainly as far back as I can run the data, when I was looking at it.
Vincent: You might have run the data. I’ve the only comp that would be close to it. It would be 1999-
Tobias: 2000 or something like that.
Vincent: -early 2000. There were some names that were new to us from a bottom-up fundamental perspective. We would all know the names of where they were. But then, other names were directly in our wheelhouse, specifically names that were disguised as tech companies, but they really weren’t specialty finance companies.
Porter: You could name the names, Vincent. [crosstalk]
Vincent: Oh, no, I’m going to.[laughter]
Vincent: I’m getting there. Names like Carvana, Affirm, Upstart. These things were trading at north of 10, 15 times revenues. This is the third generation of seeing that type of company. So, it really was pretty simple once, don’t get me wrong, we tried to short them prior to Jerome Powell giving us the greenlight, but we really pressed into it once Jerome said, “There’s nothing I can do. I can no longer stay loose. I have to tighten.” We know every long duration trade then suffered a liquidity issue and everyone was exiting the door.
Porter: People forgot that the world doesn’t work in reverse. It doesn’t, right? When interest rates start going up, and home sales start crashing, and auto sales start crashing, things don’t work that way. When your EBITDA goes down, your debt doesn’t go down, kind of like the United States. Debt keeps going up and tax receipts are about to fall. And so, everything’s going to go backwards here. That’s why we think about the Fed. The Fed’s going to have to blink at some point. They just can’t keep up what they’re doing, because the laws of economics are going to hit them in the face too hard.
Tobias: There seems to me like there’s enough cover now that they could start easing on that a little bit and probably, there’s some cyclical element to that inflation that’s going to come down a little bit at some stage here. Why are they ramping now? So, they give themselves that ability to pull it down subsequently and then that’ll goose the market? What’s the rationale?
Vincent: [crosstalk] My perspective is right now they have a press release problem in that when you look at the stated inflation that comes out, it’s still extremely high relative to the Fed funds rate. Now, I don’t think any of us would think that they should take the Fed funds rate north of 7% or 8%. But historically in the past, they traditionally don’t cut until the rate of inflation is lower than the Fed funds rate. And so far, we’re not there. So, that they have that issue.
I think the other issue is that they had a lot of egg on their face. For the first, I don’t know, six months to a year of rising inflation, they dismissed it and they just said, “Well, it’s going to come down.” So, in many respects, it’s almost like the institution’s power’s on the line, at least the way I see it, so that if you don’t squash this inflation even though it seems inflation is coming down and you’re wrong again, I think Congress is really going to have to challenge why the Fed has as much power as they do. To a certain extent, I think, maybe this is a little bit too extreme, but I think they’re their power life is on the line. So, they want to make sure they nip this in the butt. That’s my opinion.
Porter: The problem is that we haven’t fixed a lot of underlying problems. The structural short energy exposure is not good for the whole world. We’re actually making it worse at this point. Talk about windfall taxes. That’s not going to incentivize Chevron and Exxon to pump more oil. So, it’s a problem. As soon as they pivot, you know the commodities are going to scream. And so, they’re in a bad spot. Listen, I think eventually they’re going to have to pivot, because the real economy is going to hit just like a sledgehammer.
Tobias: When they’ve previously pivoted– I think I tweeted out something from John Hussman today that the pivot is surprisingly close to the top of the drawdown, like the very vast bulk of the drawdown happens after they pivot. There were a few charts under that one that I retweeted from John Hussman, where they showed how many times they cut on the way down in 2007, 2008, 2009. They would have cut 10 times, something like that, and none of it made any difference. I think Hussman said it bottomed when they change that– It was one of the accounting regulations that stopped banks from having to mark to market– What stops at this time?
Vincent: In terms of what stops what? In terms of– [crosstalk]
Porter: The market going down?
Tobias: Well, either. What stops it going downwards? What makes it go back up?
Vincent: I think this time around, it will be Fed induced that will make the market stop going down and potentially go up. I actually am a subscriber to what [unintelligible 00:14:04] Strategist and Piper who said that we’ve never really bottomed until the ISMs go below a certain level or when housing bottoms, because housing is such a big piece of the economic pie that you’re going to need an economic inflection to really feel a bottom. What’s going to be interesting this time is that there’s so much financialization in people in markets, it needed to go higher that I think it’s going to be a bit more of a tug of war than it has in the past or it just simply takes a longer time than people would like to admit.
Eventually, I think it’s going to be that. And probably, eventually and I know, elections are not going to really allow this, but some sort of fiscal plan, where– We could get into that as well. Where you have additional demand coming in in the form of government stimulus. As I say that, I’m starting to choke and vomit given the amount of debt we have, but I can’t see them not going back to the old playbook, at least trying it.
Tobias: Isn’t that stimulatory to be running such a huge deficit all the time? How is that not stimulus?
We’re In A Debt Trap
Vincent: Oh, it is. It is. I actually question people who are bullish more often than not or permabulls, and they say, “Well, you realize that your entire bullish perspective is based upon a bit of a false narrative.” And of course, they get angry, understandably so. I say, well, it assumes that we as sovereign governments can run and spend more money than we collect in perpetuity for 40 years, doesn’t know how long. And somehow gone a lower cost of capital forever. And that makes no logical sense whatsoever. It just doesn’t make sense. If you could accept that illogical, then your whole premise of being bullish long duration assets at 15, 20 times sales makes no logical sense other than hoping someone takes you out at a higher price.
Vincent: If you’re really asking us what would make me really bullish, if somehow, some way we can fix our fiscal imbalances, but I’m not banking on that.
Tobias: That looks unfixable, doesn’t it?
Porter: Yeah, it’s unfixable at this point.
Vincent: Yeah. I think [crosstalk]
Porter: We’ve said it for a long time, we’re in a debt trap. I think we wrote about this in 2010 in one of our letters that were in a debt trap and we can’t get out of it. We’ve been proven right so far. You can’t get out of QE. Trying again here. We’re down, what are we down, $250? billion, right? Yeah, $250 billion.
Tobias: More a [crosstalk] trillion dollar.
Porter: I don’t know, I don’t think we can get out of this debt trap and I don’t think we can live without QE at this point. The economy is so financialized. You’re seeing the earnings just tailing off now. It’s just started in terms of the estimated revisions downward. I think you’re going to need to see the earnings, not inflect upwards, but stop going down. We’re just starting that process right now. People say the stocks are down a lot. Yeah. But again, we’re coming off the most overvalued market of all time. And so– [crosstalk]
Tobias: I think the main group had some analysis where they used ISM and they’ve found a relationship between ISM and S&P 500 earnings and they say, using that relationship where they think that S&P 500 earnings end up is around $190. I think it was $203 from last time. I looked at it down from $210 at the peak. So, that’s not quite even halfway there. Then it’s hard to see how you sustain a premium multiple in that kind of market. I think their conclusion after putting all that together was that if you saw trough earnings in 2000 at 12 times on $190, that gets you to whatever that is 2,300, which is what I think about fair value is for the S&P 500 2,350 or something like that. That seems to be a long way down.
I actually can’t believe that we’d get down that far, not in one go. That’s why I think it’s probably more likely that we see something like you see a big crash in 1969, have a little rally for a few years, even five years, and then you see 1973, 1974. And if I had to guess where we are now, I’d say we’re closer to 1969, then we got to 1973 or 1974.
Porter: I’ve said this for a while. This water torture type of roller coaster down is– As these markets bounce like it has this past couple of weeks, it just sucks in more bulls, they believe like, “Oh, we’re going to bounce, we’re going to bounce.” And it just sucks into a false narrative. We almost always stick to fundamentals. We have shorts that we take off when they’re super oversold, we’ll trim some. But unless the business cycle turns and these stock start turning, we’ll stay shorter or keep our shorts on.
The Big Contrarian Energy Trade
Tobias: On the long side, on the more positive side, you still feel quite strongly about energy, because it’s underinvested? Is that like a capital cycle theory like that–? The book escapes me at the moment– [crosstalk]
Vincent: Yes, Porter’s going to roll it out right now.
Tobias: You got it there? Capital Returns.
Porter: Capital Returns.
Tobias: There you go. Thank you.
Vincent: I’ll tell you where the evolution this trade- [crosstalk]
Porter: A great book, by the way. People should read that book. It’s good.
Vincent: -which turned into an investment for us. The trade started– talk about a contrarian signal, bell signal was when Exxon was taken out of the Dow. And so, typical guys like us, all three of us here, Exxon is taken out of the Dow, the majority of people buy salesforce.com, we buy Exxon. And we bought Exxon on a trade and then started doing work on it more of a bottom-up perspective. We started to realize that, “Wow, there’s more to this than just being contrarian.” They have not invested in this space for 10 to 12 years.
We did this the other day. If you look at the total assets of, say, Schlumberger and Halliburton, let’s call it the picks and shovels for the industry, the total assets for both of them have declined over the last 10 years. That’s a very simple way of saying that nothing has been invested in this cycle whatsoever combined with the bankruptcies and the like. On top of the fact that you have government policies that were trying to put all of these companies, and the industry itself, and the energy source into the ground forever, despite the fact that it probably is the source of 65% to 70% of the entire world’s energy. None of it made sense.
Then on top of the fact, all the asset managers completely sold out of every single, large fossil fuel-oriented company. Remember, Porter, we did about a year and a half ago sort of this very simple screening of looking at the holders’ list of all the largest fund complexes and saying, “Okay, let’s play a game. Let’s choose the first energy name for, say, Fidelity or Capri.” And you had to go to number 85 to get to the first energy name. So, there were 85 other companies that they invested in and then Exxon Mobil at 86, for almost every single one of them. So, we realized that this was the perfect setup for a long contrarian value trade. So, that was the genesis.
Porter: Just to reference what Vinnie was talking about, pulled up Schlumberger. Some people call it Schlumberger. Schlumberger’s assets were 2012, $61.5 billion. Now, it’s $41.5 billion, down 30%. I don’t know if it’s a great litmus test, but all the big oilfield services companies are like that. And so, you can see the underinvestment.
Tobias: There’s been a big push from government directly and also secondarily through ESG initiatives and things like that. I guess the question was always, which one wins out, whether it’s politics or physics, I guess, eventually. But I think some of that question has been answered a little bit in Europe, I think, when they don’t have any choice. You’ve just got to switch on or keep the nuclear going. You take your energy from wherever you can get it.
QE For Biden
Porter: I think a bigger litmus test is going to be when Biden finally stops selling the SPR. I call it QE for Biden, in terms of just an unnatural seller in this case of oil. Where’s the natural price of oil going to go? The world is of short oil, because I think based on capex and everything close to peak production. The US shale fields are peaking out here. It looks like Saudi Arabia has peaked out. And so, you’re not going to get much production. I don’t know how the world works if you can’t grow your biggest energy source.
What Happens If Everyone Charges Their EVs At Night?
Yes, people talk about transition to EV, but we’re not there. We don’t have infrastructure grid to do that. We don’t have the battery technology to do that. The electrical plants, we don’t have to do that. Can you imagine, if the whole world would charge their EVs at night, everything would shut down.
Tobias: Can’t do it in California. Not allowed to.
Porter: No. We’re not ready for that. These are the structural problems that we see. And so, instead of going hog wild shorting everything because we’re so bearish, it’s like, “Okay, let’s buy some of these–” Our more recent trade past six months as we’ve been buying these oilfield services stocks which are finally starting to inflect and you can really– We took the most torquey ones in terms of fair amount of debt. When you see the EBITDA inflect, the EV can go down a lot when they start paying back debt.
The funny thing is, because interest rates have moved so much, a lot of their debt’s below par. And so, these companies are sitting there buying back their debt below par and just further emphasizes the cycle.
Biggest Winners In The New Energy Paradigm
Tobias: If we’re going to be spending a lot on EVs and batteries over the next decades, isn’t that a good thesis for owning Tesla?
Vincent: Mm, good question. Good question. Perhaps, although I would argue that a good portion of the valuation in Tesla is already there. So, it’s ahead of the curve. I would argue, even though I’m not necessarily a huge believer in solar and wind as a predominant energy source in the next absent technology in the next 10, 20 years, the valuations are there for a lot of these names as well. It’s actually picking through the Inflation Reduction Act and finding, “Okay, what is going to win and no one’s really giving it the value or the credence of the value for it?”
Very good question. Based upon what you said, the question is should we really even be short Tesla? But I would say a bigger question is who are the winners that people are just not really ascribing the value towards the winners in this new energy paradigm where we’re trying to go. One of the biggest ones we come up with is nuclear and uranium.
Porter: I’m going to go off tangent here. Vin and I both bought your book last year.
Vincent: We did.
Tobias: Which one?
Porter: The Acquirer’s Multiple.
Tobias: The Acquirer’s Multiple?
Porter: We said, “Hey, we’ll see if it works.” And so, we have on our screen. And so, I’m pulling up The Acquirer’s Multiple screen that we’ve done.
Vincent: You’re not going to find Tesla on that screen.
Porter: Not going to find Tesla on that one.
Vincent: I’ll tell you that.
Porter: But the two biggest market caps, it’s loading here, I believe are both GM and Ford.
Tobias: There might be still [unintelligible 00:27:28] in there too– [crosstalk]
Porter: Number one is GM, number two is Ford, number three is Valero, four the Diamond– I’m doing the biggest market caps. Diamondback energy and we get to the homebuilders. Dr. Horton, Winnaar. CF Industries and Mosaic, those are both fertilizer companies, Sun Communities, a builder. [crosstalk]
Vincent: To be fair, this is US based. We did not do a global screening.
Vincent: But a global screening should be done. So, yes.
Porter: There’s a reason that Ford and GM are on The Acquirer’s Multiple. They’re cyclical businesses. The car business is hard.
Porter: Historically, they’ve been bad businesses, right?
Porter: Look, what happened to the GM during the recession? All of them, they had to be bailed out. And so, I think that Tesla is going to prove to be much more cyclical than people expect. It’s only lived during a boom expansion and mania over electric cars. And so, let’s see how it acts in a normal business cycle.
Tobias: To be fair though, does it seem to have been expanding its margins pretty impressively?
Here’s Why Tesla’s Margins Don’t Make Sense
Vincent: Look, to be fair, it is. Actually, I spent the time to build over the last month, at least the skeletons of a model that I built so I can really, truly understand what’s going on with these numbers as opposed to just picking them out. You do see the margin expansion, for the life of me can’t understand. I’m not saying there’s something fraudulent there or not. For a company that’s growing that fast to have R&D and SG&A expenses stay flat makes no sense whatsoever. You can’t grow 50%, 70%, open plants. Now, the interesting thing is– [crosstalk]
Porter: In fact, SG&A has been down each of the past four quarters.
Vincent: Now, interestingly enough– [crosstalk]
Porter: Opened two massive plants. It’s crazy.
Vincent: Not to get a little geeky into the numbers, but the escape valve for them, I’m not saying they’re doing this, but it’s very possible, is the gross PP&E, which is growing like a weed as you would expect. However, if I was a cynical, clever CFO, I could throw a lot of expenses through that PP&E line and depreciate it over what seems to be a seven-year life. So, all of a sudden, you are showing significantly better margin expansion and of course, the growth guys exclude depreciation and amortization to get to their core. But even so, I could capitalize it now, depreciate it over seven-year life, and show a massive for any type of expense that they would qualify as property, plant, & equipment. I’m not saying they’re doing that, but that’s what the numbers spit out– [crosstalk]
Porter: PP&E has been one of the fastest growing segments of the balance sheet.
Tobias: I think I saw one of them. They’ve hit $961 billion. I forget which line it was, but they’ve hit it two quarters in a row.
Porter: That’s SG&A. Yeah.
Tobias: Was that SG&A? Yeah.
Tobias: it’s surprising though. So, precisely on that mark two in a row, maybe they forgot to update that. So, I don’t know.
Porter: [laughs] Yeah, I don’t know. Something’s funky with the numbers. I’m not going to say it’s a fraud, but there’s something funky with what’s going on.
Tobias: Yeah, I’ve talked to a few people. Stephen Clapham, who does Behind the Numbers, who’s a pretty good forensic accountant. He has a lot of trouble pulling it apart and getting any sense out of it. Maybe they’re doing something that’s nobody’s ever seen before. It’s possible that they– [crosstalk]
Vincent: Add another conspiracy theory. If I was very cynical and if I were them, I would expense most of my expenses in the privates, where he has zero cost of capital in SpaceX-
Tobias: SpaceX. Yeah.
Vincent: -and now Twitter at the expense of the public, which has a public valuation on a daily basis. Again, not saying they’re doing that, but you could allocate a lot of R&D that might be going to X, Y, Z to those other places.
Using The Acquirers Multiple To Screen For Ideas
Porter: Going back a little bit back to The Acquirer’s Multiple, we own that list.
Tobias: [laughs] I might be– [laughs] [unintelligible [00:31:57]
Porter: We don’t own the builders yet, because on the builders, we’re waiting on a price to book basis to– I think you can get them to 2008 levels again on a price to book basis or something like that and that’s going to be a fantastic point what you do. But the rest of the list we own, we own a lot of– And energy pops up there like crazy. We’ve been looking at the fertilizer companies. We haven’t quite pulled the trigger yet on them, but they’re interesting.
Tobias: Yeah, they’ve got the [unintelligible 00:32:41] as an input, so that they’re a little bit squeezed on that side at the same time.
Porter: Going back to the– We are going to talk about how we screen for ideas. You’ve heard a couple of the ways we screened for ideas. In terms of price to sale, we did a price to sales one at the peak. We have debt screen. We have The Acquirer’s Multiple screen. And then, we do a financial screening for financials, price to book and then-
Tobias: ROE or something like that?
Porter: -ROE or something like that, yeah. Cheap in quality. And then, we do a lot of screening usually with relative strength indicators just in terms of– It gives us a sense of, if the market’s too oversold or too overbought, we’ll get a pop out a lot of names, the over 70 RSI and it all– We wish it probably short more or if all of our favorite shorts are under 30 RSI, maybe it will give us a heads-up to cover a little bit and that’s how we move our book around.
Fundamental Momentum Investing
Tobias: What about on the long side? What are you looking for in terms of relative strength or momentum when you’re buying?
Vincent: A big thing for us is against stock momentum, but we’re really fundamental momentum-oriented investors. And so, what we want is a fundamental backdrop, where it’s not necessarily might be showing up in the numbers yet, but it’s based upon our “where the puck is going” theory of that eventually we’re going to see an inflection. We love investing at the bottom of inflections, where the perfect marriage is where you see the economic or the fundamental backtrack of the sector is about to go up, the stocks are trying to bottom, but they’re bouncing off the bottom and the multiples are extremely low. When you have those three in tandem, then we like to invest in size and really take a large, concentrated position in a certain theme. So, those are the three things that really fit.
Whereas valuation alone, the builders are probably a great example right now. The valuation is there, we think it could get cheaper. But we think it’s going to get a little bit worse over the next six months. So, maybe we’re being a little bit too cute, but we’re hoping for an even better price.
And then coming out of the winter months, at least I know I have a cyclical aspect of the summer that might push up, maybe we have a cyclical aspect of prices have come down enough, where you might start getting that cohort of young people who are moving into homes, and then from there, then the margin of safety is so much lower that you can invest in it and probably even increase it in size given how low it is that you’re not worried anymore about that 30% drop, because the fundamentals aren’t quite there yet.
Tobias: I guess the difficulty with the homebuilders is that’s a very strange time to go through. Everybody was home, spending a whole lot of money at home, presumably expanding their houses, and doing that sort of stuff. Then, there’s been this kind of mania, I guess, in house buying that’s now maybe that’s tipped over a little bit. So, it’s a little bit hard to tell we were on the cycle here. How long do down cycles in housing seem to last for long periods of time? 2008 to 2012 or 2007 to 2012. 1990 was comparably– [crosstalk] Yeah, years.
Porter: This I the last– [crosstalk]
Vincent: The good thing is– [crosstalk]
Porter: You can’t buy a house right now.
Porter: You can’t do it. The prices aren’t down enough.
Vincent: Yeah. The good news is that this time, at least the housing market is not systemic. The banks are fine. What we really need is home prices to go down 10%, 15%. And this time, they will not crush the world and it actually will increase demand at some point. That’s a function of seeing the builders, the value of their lands come down, their gross margins come down, continue to come down, they have been. And then hopefully, we can get a nice place where supply does meet demand at reasonable margins and these are going to be great stocks at some point.
The Best Housing Stock Is Home Depot
Porter: To go back to– probably the best housing stock to own would be Home Depot. It got down to 10 times earnings in 2008, 2009. And so, you’re here at 17 times earnings. I don’t know when the backup the truck moment would be, but– [crosstalk]
Tobias: Not here.
Porter: Not here. I don’t know where we are in terms of the cycle of people fixing up and stuff like that, but I would think that the earnings are going down.
The Real Systemic Issue – Too Much Debt
Tobias: Do you see any systemic issues when you look around now? What are the systemic issues? Is it just chronically short investment in energy?
Porter: I think the systemic issues are the government balance sheets.
Porter: It’s a nightmare. We talk about it all the time. You can’t run these fiscal deficits like this. There’s too many countries running these massive fiscal deficits. The amazing thing about what Russia is doing– Luke Gromen came up with it. It’s a balance sheet war and they’re winning.
Tobias: Because they defaulted in whatever it was 1998 or whatever.
Porter: They’re an export nation in terms of they got a lot of raw materials and they don’t have a lot of debt. That’s the problem, is that there’s too much debt in the system and t hurts the growth. You get to this level of debt and it just hurts. I don’t know how. When we go into recession, it’s starting at a 10% budget deficit, and tax receipts are going to fall, and debt, as we know, only grows. And so, what do we do? Does policy come in in a big fiscal package and stimulate the economy? But that blows out even more then. So, I don’t know how you get out of this treadmill.
Vincent: The sad part is that for the last, what, 10, 15 minutes, we’ve been talking about more of a bottom-up things of what we do on our screens and The Acquirer’s Multiple and talking about the cyclicality of the homebuilding business. And then, Tobias, you come in and ask the bad question.
Vincent: Whenever I go top-down– [crosstalk]
Tobias: I’m just trying to get you to [unintelligible 00:40:02] [laughs] me.
Porter: I know.
Vincent: Whenever I go top-down, we do this so much, Porter and I do this probably once a day and go, “Fuck. Does anyone see how much money we’re spending over what we’re collecting? How is this sustainable for any period of time?” And yet, when you ask people this, it glosses over them. This is one of– [crosstalk]
Tobias: It’s too big to fathom. It’s too big to–
Vincent: It’s too big to fathom. It’s like, “Vinnie, no, no, no, stop. What should I do with if–?” No, my phone. “What should I do with Cap One or Citibank?” I’m like, “No, no, don’t you see this?” Yeah, I think we eventually have taken all of our problems of the past several cycles, we’ve taken all of our problems to the sovereign. Now, the problem is the sovereign. What do you do about it? What balance sheet can soak up the sovereign?
Tobias: The only valve is printing. The only valve out of that is printing.
Porter: That’s our conclusion.
Vincent: It makes us sad to say it, but yeah.
Porter: That’s why we own so much of this.
Tobias: [laughs] Yeah.
Porter: A gold coin.
Tobias: I want to keep going with that idea in a moment. But there was this famous paper, I forget exactly how old this is now, but it could be like 2006, something like that. There’s that Rogoff and Reinhart paper, I think those are the two– [crosstalk]
Porter: Got that book around here somewhere too, but yeah.
Tobias: I thought they made a fairly modest observation that countries can take on too much debt and then that has this catastrophic effect. At some point, there is some tipping point where you get too much debt. Up until that point, there’s no observation. It’s like going into bankruptcy. Bankruptcy is kind of a binary event. You’re not in bankruptcy until you’re in bankruptcy. And so, there’s no evidence that your financial condition is deteriorating unless you’re looking at it quite closely.
It turned out that Rogoff had some hardcoded error in his spreadsheet and it was discovered by one of his assistants, something like that. And then, Paul Krugman and those kind of guys just mercilessly bashed guys over the head for that error. But it now seems to be like that’s a crazy idea now, that a sovereign can take on too much debt. So, why is that not a crazy idea?
Fed Has No Option But To Continue Printing Money
Porter: Well, look what’s happening with the UK and then Japan. The problem is that all these countries are having the same problem at the same time. There’s just too much debt. Then, he rants all the time about the collateral problem that the world has. The problem is not the collateral. It’s just we have too much debt. You’re out of good options when you have that much debt. Just think about a company. When there’s too much debt, they’re out of good options.
We know the cash flow is about to go down in terms of tax receipts and that’s all over the place. So, you’re starting from a really, really bad point and that’s what scares us the most. You’re starting at a bad point, and it’s about to get worse, and what do you do? The only answer is print.
Vincent: And so, we too make the assumption– as I’m thinking about this. We make the assumption that they’re going to print and we’ll debase our way to greener pastures, I guess. If we truly believed that that wasn’t going to be the case, we shouldn’t own anything, right?
Tobias: [laughs] What would you hold? You cannot hold cash. Sorry, I didn’t mean to interrupt. Keep going, keep going.
Vincent: No, no, no, no, you’re right. I don’t have an answer for you.
Tobias: Yeah, you probably won’t.
Vincent: I think Porter has got it in his hands. It’s one of the reasons, oddly enough, that I get the Bitcoin maxis. I get them. I don’t say I necessarily, but I get what they’re getting at particularly that they are so disciplined and hardcoded in their view of what value is. But I don’t– [crosstalk]
Porter: We have been short microstrategies for a long time just because given the stupidity of levering ourselves up.
Porter: But you covered that. It’s not a great short at this point. I might be. Bitcoin goes down, but I don’t know.
Vincent: But our view is that we’re not going to get that. Yeah, it’s possible, but I think we’re going to get the opposite, which is sad. But we’re going to get debasing. It’s the only thing that can do.
Energy Companies Producing High Yields
Porter: You can see, all of our conversation– because I guess we started in financials, it’s the only sector where the income statement is not the first thing people should look at.
Porter: Even revenues are relative– [crosstalk]
Tobias: Accounting adjustment.
Porter: They are a relevant item on a financial. The first thing you do is you look at the balance sheet. If you go on and analyze a financial, the first thing you look at the balance sheet. And so, everything we do is usually starts with the balance sheet. We would go to these energy companies, first thing we do, look at the balance sheet. That’s why I think our perspective is a little bit different than most people. And then, when we look at the fiscal situation, we look at the balance sheet. It’s a problem. And so, I think that’s maybe why we’re too negative, I guess, or always revert to bearishness, because we look at the balance sheets like, “Goddamn, they have too much debt.” But you look at all these energy companies that we own, almost all of them are net cash positions. How bearish can you be?
Their net cash positions and the free cash flow yields are– we own probably anywhere from– Our lowest one’s probably 12% or something like that. We own Consol Energy, reported this morning. I think the free cash flow yields north of 50% at this point. I don’t know, were the earnings great? Eh, not really, but who gives a shit? They’re going to dividend cash back, they’re going to stuff cash in your face for a long time.
Tobias: Yeah, I think I had a look at PBI yesterday. I don’t want to try and say it but Petro Brasilia.
Tobias: The 22E, 23E, 24E, they’re trading at 12 bucks and they’re paying out 5-3-3 over the next three years. I don’t know how they can project it that far. But you’re getting all your money back in the next three years, basically. What are the prospects for windfall energy tax derailing some of that thesis?
Porter: Well, again, we owned– or still own stock in Canada, which has big natural gas assets in Europe, Vermilion Energy. It looked super cheap at the time. It still is super cheap. But the windfall profit taxes hurt. And so, it’s not as cheap as it was, but it’s still cheap. And so, yeah, it’s a problem.
Vincent: Yeah, it’s a risk. Now, the probability of him passing it through Congress is low. In many respects, it’s election grandstanding in my opinion. But nevertheless, it has been proven that the Biden administration could be a thorn in the side of our investments, as well as European policymakers could be a thorn in the side. It’s hypocritical, it’s inconsistent, but it is what it is. So, yes, it’s definitely a risk to our thesis.
Porter: Just thinking about what you talked about Petrobras. Vinnie, notoriously, he hates options.
Porter: His view of options is like, some someone’s out there trying to steal from me.
Porter: The dealers, they are trying– [crosstalk]
Tobias: The market maker.
Porter: We don’t have really many options. We own the PBR leaps.
Tobias: Oh, wow.
Pawnbroking & Options Trading
Vincent: I don’t mind when Porter does a leap. What I hate are the short duration options. I never really can understand it. Although I’ve rationalized it in my head, that most of the people who love to play short duration options, they tend to be gamblers and they’re usually sitting at the craps table, because they truly believe that their theory is going to work out in, say, two weeks’ time. I’m never that confident that what I think is going to work in two weeks’ time or a month’s time. And they’re willing to pay up a lot of premium to the street, or to truncate, or set their losses in stone. I hate that the street then controls-
Vincent: -at the end of sometime, where if I was a street, I’d aggregate everyone up there and say, “Okay, everyone’s pinned it here. I make this much money. Let’s make sure it doesn’t happen.”
Vincent: It goes everything against my grain to do an option, whereas I don’t have control of my timeframe of my theme, I’m paying too much for it, and then the street controls me. It’s like the three strikes are out.
Porter: It goes back to our experience of working at a very, very large pawn shop. Their whole game is they claim that like I think of your P&L, you make 30% of your P&L on the four earnings days of the year. They do a hyperfocus on the earnings. The problem is that you have a million of your other buddies trying to do the same thing. And so, what people think is, I’m there for the catalyst on earnings. Problem is the world’s figured that out. And so, playing options on an earnings beat or miss is a very tough game.
Tobias: It does seem to trade inside the implied for most of those days. I’ve noticed this recently, at least. I don’t mind selling short-term vol, if you can get enough premium to get into the– It just makes the position cheaper, if it moves against you.
Porter: Sometimes, you shouldn’t sell puts.
Tobias: If you want to own equity, that’s okay. [crosstalk] the same profile.
Porter: If you own the equity, yeah.
Porter: Selling the call, I don’t know, we’d never liked doing that, because then you get all tied up and twisted up. the stock goes up, and you’re like, “Oh, what do I do now? I’m not as long as I shouldn’t be.”
Porter: Yeah, it just messes with your head.
Tobias: If you’re in it and you’re ambivalent about it, and you can just capture some premium, and maybe you get taken out, maybe that makes sense. But I don’t know. I don’t sell calls, either.
Porter: Yeah. And if you have any discussions, you probably should just sell it anyway.
Tobias: Yeah, it’s probably right. Throw some questions in, folks, if you got some for these two gents. I wanted to pursue something before. I forgotten what it was. Sorry.
Position Sizing In Energy Stocks
Porter: No problem. Back to what we do to try to identify the longs, the shorts. Yes, we have screens, but we have a lot of themes. We try to come up with a theme and then do the work, and find individual companies, see if the theme works.
Tobias: How do you like to size individual names or positions?
Porter: We’ve found that sizing is a very, very difficult thing to do. The good ones probably can do it, but it’s hard to figure out what to do in sizing. We usually size based on a big position that can’t have a lot of downside.
Porter: We solve for downside, not upside.
Porter: Idiots that we are. But if you believe the stock, it’s so stinking cheap, the fundamentals are in your favor, we feel we can sit on a fairly large position and– [crosstalk]
Tobias: Have baked in percentage terms for single [unintelligible 00:53:12].
Vincent: I’ll give you a great example. Our largest position right now is around 15%.
Tobias: At inception or that’s what it’s grown into?
Vincent: It’s a good question. This one has grown into that.
Vincent: It’s rare that it would be since inception. But when we think about risk, a lot of it comes back as Porter said to the balance sheet. So, I’m thinking of one name that we’re involved in right now, Transocean rig, right?
Vincent: If you looked at their balance sheet, you would puke. [crosstalk]
Tobias: I know rig. I know rig.
Vincent: Yeah, and it’s controversial. But the rate of change in the fundamentals for the oilfield services is really good. If it works, you could have a double or triple on your hands. However, there’s a horrific balance sheet attached to that. So, you’re never going to make that a 10% position, because that would be too much capital at risk. So, we think about what’s capital at risk, conversely, our largest position is Peabody Energy, which is a coal producer.
Right now, their net debt is zero and we are waiting on structural catalysts that will free up the cash so that they could buy back stock and pay you a special dividend. They can’t right now, because of function of contracts that they’ve signed in the devil’s years that forced them to do very onerous shorty agreements and very onerous debt covenants.
The beauty is the coal business has been so great that they’re paying down debt and they have as much cash as that, so we’re just waiting for the catalyst to happen. The balance sheet’s fine. It’s pristine. It’s just grossed up. I have this much cash, I have this much debt, and cash is going to grow, the debt is not going to grow.
And then eventually, we’re going to collapse, and be able to buy back a heck of a lot of stock. That’s where the balance sheet is so safe, that yeah, of course the stock can go down. If anyone looks at Peabody or investment in Peabody, 20% moves down are to be expected. From the balance sheet perspective, it shouldn’t happen.
We’re Years Away From The Bottom
Tobias: I’ve got a question. It’s a little bit unfair, but I’m going to ask it anyway. I guess you can choose to answer any one of these. “When is the bottom?” Where’s the bottom? What does the bottom look like?” Any roll. It’s an easy question.
Porter: It’s like the answer for porn.
Porter: No one has the– [crosstalk]
Tobias: The Supreme Court?
Vincent: I love this hindsight one. All we could give is our history. In 2009, in February, that felt bottomy. Every day you walked in, market’s are little bit down. Not to pick on him, because we love him. He’s one of our favorite billionaires. Ed Hyman comes into our office, and we have such a great relationship with him, and he literally waved the white flag.
Porter: To be fair, we don’t know many billionaires, but you know.
Vincent: No, it’s true. That’s why he’s one of our favorites. We don’t know that many. But he’s a great guy anyway. He waved the white flag. He goes, “I’m done, guys. I’m not bullish. This is horrible. I’m bearish,” okay?
Tobias: Was that 6th March, 2009?
Vincent: February 2009.
Vincent: We have yet to get that person to really just say, “Well, there’s not a bull left.” I feel now the minute you get a pause or pivot language, it’s like the equivalent of being in April or May in the Northeast, and it’s 65 degrees, and the mosquitoes come up and just start biting you all over the place. They’re still there. The minute it happens, they’re still coming and swarming at you.
I truly get that we’re in oversold conditions. I do. But for all those people who are super bullish on the oversold conditions, which we’re not as oversold anymore, I can’t find a short-term trader that’s not bullish anymore or at least, they weren’t over the past week. At a true bottomy inflection, no one wants to touch anything. I don’t know– [crosstalk]
Porter: In my mind, a Wall Street letter writer recently said, there’s a bubble in bearishness, which drove me absolutely fucking insane, because the market’s structurally bullish. He should have known better. He was at that conference, the Wealthfront Conference, out in California. It was all bulls. It was 700 to 4. And so– [crosstalk]
Vincent: To be fair to him, that was really oversold and we were due for a bear market.
Porter: It bounced.
Vincent: We did. He’s incredible at sentiment. He truly is, and I listened to him as a result of it. But what I would like to see– [crosstalk]
Porter: But the comment, Greg still drove me crazy, but yeah.
Vincent: I know. It definitely would. But what I like to see is really just more of a reduction in the E and just a little bit less of an acceptance that maybe we’re not going back to all-time highs in six months. It still feels like it’s out there.
Tobias: Still buy the dip. Still aggressively buying the dip.
Porter: Yeah. People keep revising the estimates lower. We have yet to get a point where people are taking up estimates for a whole swath of or even small parts of the economy. If you believe in our interest rate thesis that everything is so financialized, people don’t buy anything for cash.
Everything’s on credit. And so, you need interest rates to come down a fair bit. I think the Fed eventually have to cut– if inflation comes down or the recession, the Fed’s going to cut and that’s when towards the bottom, you can finally– where people are like, “Oh, okay, I can go out and buy a home. Home prices have come down.
My mortgage payments have come down. I can buy a home and I can furnish that home, and I can put money back.” It’s such a huge multiplier on the economy.
We’ve spent the majority of our career looking at the home segment. Home mortgages, builders, all this type of stuff. There’s a couple of really good housing analysts, Ivy Zelman, this guy, Alex Barron. They’re all negative. They know what’s going on. They see it. They’re pretty negative. And so, I think at least years away before things bottom.
Tobias: Well, on that cheery note, that’s all we have time for. Thanks very much. Porter Collins and Vincent Daniel.
Vincent: You couldn’t end on a more optimistic tone?
Tobias: [laughs] Seawolf Capital. Thanks, gents. We’ll be back next week with–
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