VALUE: After Hours (S05 E19): John Rotonti On The $30 Billion Stock No-One Knows, Berkshire And Buffett

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In their latest episode of the VALUE: After Hours Podcast, John Rotonti, Jake Taylor, and Tobias Carlisle discuss:

  • Warren Buffett Buys Wonderful Companies Cheap
  • What Happens To You Physically During A Market Crash
  • New Technology – From Fire To AI
  • The $30 Billion Stock No-One Knows
  • Berkshire Hathaway – Retained Earnings Machine
  • If Warren Buffett Had Used Banking Instead Of Insurance For His Float
  • Key Take-Aways From The Berkshire Annual Meeting
  • Multi-Billion Dollar Valuations Used To Mean Something
  • Why The Inversion Indicator Is Such A Good Predictor
  • We’re Fully Invested Bears
  • Oil & Gas – The Long-Term Demand Outlook Is Strong & Growing
  • Recession-Proof Businesses
  • Why Truist Financial Stock (TFC) Is A Good Investment
  • Value Investing – 3 Points Of The Triangle

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

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Full Transcript

Tobias: This meeting is being livestreamed. What’s up, everybody? I am Tobias Carlisle, joined as always by Jake Taylor. This is Value: After Hours. Very special guest today, John Rotonti, formerly of The Motley Fool. Now an-

Jake: The agent.

Tobias: -individual investor, free agent, running one of the best Twitter accounts out there, @jrogrow.

Jake: What’s the name behind the name there? Or what’s the story behind the name for that?

John: First of all, thanks for having me, Tobias and Jake. I got on Twitter just about two years ago, and I started playing with– I wanted to do JRO for Show, [Jake laughs] but that was, believe it or not, taken.

Jake: Damn it.

John: Yeah.

Jake: Always the good ones.

John: JRO for Show was taken. Then, I have a growth mentality, not investing philosophy. Definitely not. But I want to grow as a person. I want to grow my mind. I do try to take care of myself, so I want to grow my muscles and all of these things. I’m not very creative when it comes to names, and @jrogrow wasn’t taken. So, that’s what I went with.


Tobias: It works. Let me do a little shoutout to all in the house.

Jake: Time for our obligatory geography lesson? [laughs]

Tobias: Yeah. Jim Hamilton in Toronto. First in the house. What’s up? Riyadh. Halifax. Lima, Peru, what’s good?

Jake: Wow.

Tobias: Hamburg, Germany. Hobbiton. Bangalore.

Jake: I had some of the best-

Tobias: Brandon, Mississippi. Norberg, Sweden.

Jake: -seafood in my life in Lima, Peru.

John: Peruvian food is just so good.

Jake: It’s very good.

John: I’ve been to Colombia several times, and one of the best restaurants I’ve been to in Colombia was a Peruvian restaurant. Just so good. Yeah.

Tobias: London, England. So, John, let’s start a little bit with, what were you doing at The Motley Fool?

John: I was at The Motley Fool for almost nine years. I voluntarily resigned in March of this year just to try to figure out what my next challenge is going to be. I was a senior analyst. And then we have three levels of senior analysts. So, I was level three senior analyst, so he most experience that you could get on the investing team at The Motley Fool, I guess. I was a portfolio lead, which means I led a Real Money Portfolio. We can talk about what a Real Money Portfolio is. And then, I was the head of investor training and development.

Tobias: Cool.

John: Yeah.

Tobias: What’s a Real Money Portfolio?

Jake: That’s as good as money, sir.

John: Yeah, it’s a subscription newsletter. So, we provide our subscribers with buy and sell recommendations amongst other things. And then a week or so, after we write up the trade, the recommendation, we take a little bit of The Motley Fool’s balance sheet and make the investments ourselves. And so, I was managing a small portion, but a portion of The Motley Fool’s money. And so, that’s why we call it a Real Money Portfolio, but it was on the newsletter side of the business.

Tobias: Tell us a little bit about your philosophy. How do you characterize what you do?

John: I was on a podcast last week called The Smattering, a great podcast. I told them I have my investing philosophy tattooed on my arm, actually.

Tobias: Don’t see it.

Jake: Yeah, don’t lose money.

John: Yeah. Can you all see that?

Tobias: That’s a first. That’s cool.

John: Yeah. My hope is that my philosophy doesn’t change too much over the years.

Tobias: [laughs]

Jake: [laughs] Yeah. Oh, shit.

Value Investing  – 3 Points Of The Triangle

John: [crosstalk] it does. Yeah, I’m going to have to update the art. No, all joking aside, I’m a value investor. And so, for every core position, I do try to estimate intrinsic value per share within a reasonable range. Intrinsic value investing is the heart and soul of my philosophy. So, the visual representation, the triangle has an oak tree in the middle. So, I’m not a geometrist. [crosstalk] Yeah, but I’m told it’s the strongest shape in the natural world. So, the triangle represents strength and resilience. The oak tree is also exceptionally strong and resilient. It’s got deep roots.

I know this from experience because I was born and raised in Louisiana, and we have these hundreds of year-old oak trees that they’ve survived hurricanes, and floods, and tornadoes, and just battering year after year. The roots of oak trees are so deep, and thick, and strong, and entwined that the root system represents how deeply entwined contrarian intrinsic value investing is to me. I think value investing is a part of my investing DNA because of life circumstance. We can talk about what that circumstance is, if you’d like. Yeah, so, the triangle and the oak represent resilient, strong businesses. I’m trying to invest in good businesses.

The three points of the triangle. Good businesses run by preferably great management teams that really excel at capital allocation and then at a great price. So, those are the three points of the triangle. I insist on a margin of safety. I don’t want to pay a fair price for anything. I would say that’s my overall investing philosophy.

Tobias: Yeah, man. That’s [unintelligible [00:06:10]

Jake: So, what do you do in the rest of the market [laughs] for most of the time when the market is a little overpriced?

John: Great question. One of the first tweets I ever sent out, like I said, I’ve only been on Twitter for two years was, in an average year, I check my– Not check, I log into my brokerage accounts three times a year. This is not even a joke. One of those times is to get my tax documents.

Jake: Wow.

John: Just given where markets have traded over the past decade or so, I tend to want to fade the market. The market’s been going up and to the right with ZIRP, and QE infinity, and all of this other stuff. What do I do? I buy very, very occasionally. I have been buying a little recently just in the banking sector. I know. It’s like everyone says, “Banks never touch them and all that stuff,” but I can’t help myself on some level.

Tobias: Are you like a money-centered JPM guy? Are you delving in the regionals?

Why Truist Financial Stock (TFC) Is A Good Investment

John: Yes. So, for the portfolio that I led at The Motley Fool, I led it for a year, and then I left in March of this year. But before that, I put J.P. Morgan, and Bank of America, and PNC in there. What I bought recently though was I bought Truist Financial. I’m not a banking analyst by any stretch of the imagination. I do cover the big money centers, because I enjoy it. I think they’re a good read on the economy. Reading Dimon’s letter is obviously very good. I want to understand how the banking system works in our country, because the US is dependent on our banking system. And then, of course, it’s the oldest profession on Earth, or at least one of a couple.

Jake: Or number two. [laughs]

John: Yeah, number two. Exactly. Yeah, I know where you were going with that. I don’t consider myself an expert on Truist, but I saw a couple of things. So, I bought it at $26. When I bought it was trading at seven times earnings, it was trading at 70% of book and had a 7% dividend yield. Now, seven is my lucky number. So, seven, seven, seven.

Tobias: [laughs]

Jake: Ah, winner.

John: Maybe that had something to do with it. But all joking aside, it’s the largest or one of maybe the second largest next to PNC in terms of regional banks. But it’s unique, because it’s not just a lending institution. It’s got the sixth or seventh largest insurance brokerage that it acquired when it got BB&T. It’s got an investment bank. It’s got wealth management. And so, my thesis was, this thing looks cheap. It’s large. So, the government’s going to take care of it in some way. It’s got all these other pieces that it could sell off if it had to in a worst-case scenario. And so, I did feel like that offered me a margin of safety.

If Warren Buffett Had Used Banking Instead Of Insurance For His Float

Jake: Actually, I’ve been surprised at how good of a business that banking has been over the years. You would think it seems like a relative commodity with a commodity being money, but they really have earned surprisingly high returns on equity, even not considering taking too crazy a leverage like they did during the housing crisis or before that. There’s an interesting counterfactual to imagine, which is, if Berkshire had not been forced to sell Rockford Illinois Bank because of the Bank Holding Act, would Buffett have found cheaper money than float through banking instead as the arm. He got pushed into using insurance as his vehicle to get his hands on a lot of money. Banks could have been another way for him to do that. I don’t know, would he look like JPMorgan today, potentially? It’s very interesting to imagine, what if him going in the banking direction for another 40 years, what would it look like today?

John: It’s a good thought exercise. You make a great point. For at least the last decade plus until recently, funding costs at banks were basis points. It was nothing. Deposits are reliable too. I was going to say, float is free as long as two qualities are met, I think. One, that you replace the float every year and you’re underwriting at a profit.

Jake: That doesn’t describe the average insurance company though.

John: You’re exactly right. You’re exactly right. Buffett is attracted to banks. I know he sold out recently. He obviously saw some of the excesses, some of the mismanagement when it comes to borrowing short and lending or investing long when rates were about to rise. Yeah, he’s attracted to banks. At the time, he owned Bank of America, which, by the way, he added to in the most recent quarter. So, he bought some on the dip. He owned Bank of America, he owned US Bancorp, American Express, does some lending, but he owned– What were the other ones?

Jake: M&T.

John: M&T. I don’t know if he owned some State Street, but he owned several banks. So, yeah.

Tobias: Has he ever owned JPM?

John: I don’t think so. Oh, you know what? He owns JPM in his personal account. He has said that.

Tobias: Okay.

John: I don’t know if it was 2008, 2009, 2010, he bought some J.P. Morgan in his personal account.

Jake: Too small for Berkshire. [laughs]

John: Yeah, exactly. $400 billion market cap. Yeah.

Tobias: Because he’s such a public fan of Jamie Dimon’s.

John: He is. The whole London Whale scandal, everyone was calling for Jamie’s head, which was ridiculous, obviously. But at the time, Buffett said, “I’ll find a position for Jamie Dimon. I will hire him.” Obviously. “I will hire him at Berkshire Hathaway.” So, yeah.

Tobias: They didn’t lose any money through 2008 or 2009, and they were well positioned going into this most recent turnaround, which has caught a lot of other people offside. So, he’s doing something– [crosstalk]

John: He’s doing good banking.

Tobias: Yeah, good banking.

John: He’s doing good banking.

Tobias: There you go.

John: Yeah, as for sure.

Jake: As Buffett says– well, I guess, he stole this from someone else, but there are more banks than bankers.

John: Yeah, for sure.

Tobias: [chuckles]

John: Just on that really quickly is, there’s probably going to be more consolidation, so they big will probably get bigger. J.P. Morgan, which I admire deeply as a bank, but also Truist as the largest regional, I think these banks get bigger.

Tobias: Given the macro backdrop, what sort of stuff are you looking at?

John: I would say in this environment, first and foremost, I want a strong balance sheet. So, enterprise value, all the way. I’m a huge fan of your book, Tobias.

Jake: [laughs]

Recession-Proof Businesses

John: I can’t tell you enough. But as a lot of your listeners know, market cap is just shares outstanding times the stock price, but enterprise value takes the balance sheet into account. So, I want a balance sheet strong enough to weather a deep recession. That does not mean no leverage, but I do really want to try to stress test that balance sheet for different scenarios. That’s number one. Number two is, personally, given my risk tolerance. I don’t want to own anything of size. If it’s a lottery tiny position, lottery ticket position, that’s fine. But I don’t want to own anything of size that’s not profitable and not self-funding going into a potential recession when capital markets could slam shut.

The other reason I want companies to be self-funding and free cash flow generative going into a potential recession is, because it gives them the firepower to buy depressed assets at distress prices. So, it allows them to play offense and defense. Number three, in a time of high inflation, which we’re still in, I want to own companies that have high or rising returns on invested capital, particularly, tangible invested capital. Fourth, and this is a big one. I know another one you all focus on a lot. If I’ve got this base case scenario that we’re going to have a sideways to slightly down market for a while. And so, if we’re going to have a sideways market, I’m really looking for high shareholder yield. So, companies that pay a growing dividend and that are buying back just truckloads of cheap stock, I do want to get paid to wait.

I think I’m on five. Cheap. Like Buffett, I’m looking to pay earnings multiples or price to free cash flow multiples of no more than 15 on a normalized mid cycle basis. Then maybe lastly, and this is not a requirement like the first five pretty much are. If I can find some positions in my portfolio that have a catalyst or maybe a merger arbitrage position or two, that would be interesting. So, some catalyst. That’s not necessary, but I’d like to find a few positions like that.

Tobias: Has Buffett been a net–? I know his 13F came out yesterday, day before? Does anybody know? Was he a net buyer? Net seller?

John: He was a net seller in the quarter. Yeah. Because I think he sold a lot of Chevron or something. Not a lot. I think he sold $7 billion or $8 billion of Chevron.

Tobias: He’s punched out of TSM.

Jake: That used to be real money.

Tobias: Yeah.

John: Yeah, exactly. Yeah, I think he was a net seller in the quarter.

Tobias: Have you been to Omaha? Have you done the Berkshire–?

John: I’ve done it. Yeah, five or six times in the past. I didn’t go this year, because I had trips on both ends of the Berkshire meeting. I knew I could livestream it. It’s not the same. Going and networking, and just getting that experience, and buying all the cool gifts, going to the dinners, it’s not the same, but hopefully, I go next year.

Tobias: Getting the peanut brittle diabetes.

Jake: Yeah.

Jake: [laughs]

John: Yeah, getting that peanut brittle. Yeah.

Jake: I still have a box in my pantry that I’m trying not to eat.

Tobias: In your lower intestine?

Jake: Yeah. [laughs] Well, that too.

John: I think it’ll probably last a while. Preservatives these days.

Tobias: I sit with JT and some other friends of ours, and their tradition, which is now my tradition as well, is to get a big box or multiple boxes of that stuff. So, there’s no breakfast. It’s just straight into the peanut brittle.

Jake: Oh, I think we ate probably six pounds of candy– [crosstalk]

Tobias: I probably ate half of that.

Jake: Yeah. During the meeting. During just the AM portion of the meeting.

Tobias: Straight to the brainstem.

Jake: Oh, my God.

John: Straight– Yeah. It’s like straight lining it or something.

Jake: Shooting it into our eyeballs.

John: Right.

Jake: [laughs]

Key Take-Aways From The Berkshire Annual Meeting

Tobias: We haven’t done our impressions yet, JT. Am I going to throw you off by asking for your impressions [crosstalk]

Jake: Of the Berkshire meeting?

Tobias: Yeah.

Jake: Oh, yeah. I thought it was great. I thought the boys were as good as they’ve been in probably three or four years, energy wise. Brevity of answers, which was a bit of a concern [chuckles] two years before Buffett was a little rambling.

Tobias: You addressed that straight out of the gate though.

Jake: Yeah.

Tobias: Because last year, I don’t know if it’s true, but he said that they only answered five questions before lunch. So, his objective was to get through 60 for the day. I don’t know whether they eventually got to it.

Jake: I don’t think we got through 60, but he did a great job.

Tobias: There were some afterwards.

Jake: Yeah.

Tobias: There was a third session. There were a few questions. [crosstalk]

Jake: Somebody got a little rowdy, I heard.

Tobias: Somebody got escorted out.

Jake: Yeah.

John: Yeah. [laughs]

Tobias: He got arrested.

John: Really?

Jake: Was it a full arrest? Okay.

Tobias: Yeah, evidently. $1,500 fine or something like that.

John: Wow.

Jake: I don’t know. Yeah, so I thought the boys were great. Actually, I thought a Jeep was pretty good. I thought Greg was okay. He was still a little bit subdued. I’d be curious to see how he does when he gets to be more the star. I think what I’m hoping is that he’s actually been throttled back to a 2 out of 10 this whole time, because he knows it’s not really his show, and these guys are going to take the– They’re on their victory lap and you don’t show up and try to outshine them at that point, if you’re classy, which I think he is. So, hopefully, there’s a little higher output wattage on the bulb after when it’s his time. Yeah, I thought it was great. It was everything I hoped for from a Berkshire meeting.

Tobias: They have extraordinary stamina to sit there for three hours at a stretch-

Jake: And bladders.

Tobias: [crosstalk] -break and then go back. Yeah.

John: Great bladders, because they’re pounding those Cokes. Yeah, great bladders.

Jake: Yeah.

John: Yeah.

Jake: [laughs]

John: I agree. I thought it was a good meeting. I thought they shared some good information. I thought a Jeep was so transparent, right? So open.

Jake: Earnest. Yeah.

John: He said, “If worst-case scenario, we took some risk in Florida, we lose $15 billion.” Just out of the gate. He said, “We have a lot of work to do at GEICO.” He said, “We have 600 different tech systems that aren’t talking to each other.” He was just extremely open, which was great. I like the idea of a panel. I think Becky Quick is incredible. She knows Warren very, very well. She’s the main person that gets Warren to do these great interviews on cable TV. So, she’s an incredible asset. I did like the panel when Greg, Warren from Morningstar, and Jonathan Brandt from Ruane, Cunniff. They also know the company extremely well, and they ask important questions that get right to the heart of how is Berkshire doing and what is Berkshire worth? Not all of the questions from the audience get right to the heart of what’s going on at Berkshire, the business. The questions are great, but I do like the idea of a panel.

Tobias: It was a great question a few years ago about the traffic snow in Chicago, which-

John: [laughs] Right.

Tobias: -I never heard of it. Buffet– [crosstalk]

John: That’s something that Charlie probably knows a lot about. Yeah, I know he doesn’t live in Chicago, but he just knows so much about random things, like, where the fish are biting this time of year and stuff like that. I bet he would have some esoteric fact about traffic in Chicago.

Jake: Yeah, Buffet was on top of that one.

John: Yeah.

Tobias: There’s a good story that Munger told about the $1,000 investment that he made in the oil field.

John: Goodness.

Tobias: How it’s $70,000 this year, and he made it in 1962. Extraordinary.

Jake: Oh, my God, what a legend.

John: Yeah. [laughs] It’s almost unfair, right? Yeah. They’re so good.

Tobias: So, many winners.

John: Yeah, so many winners.

Jake: I do love the old stories of even of people who I’ve never even heard of, and they’re talking about deals they made or deals that fell through. That stuff, I’m endlessly fascinated by.

John: Yeah.

Tobias: When the young guys– [crosstalk]

John: These guys got big deals.

Jake: [crosstalk] They were hustling.

John: Oh, yeah.

Jake: They were hustling big time. It wasn’t like just sitting waiting for the phone to ring. They tell that story about how they were looking for money. I don’t know if they traveled over there, but they were, at one point, looking at taking money from some sovereign in the Middle East in the 1970s. They weren’t so worried about the ability to pay it back in dollars, but they were worried about having to pay it back in dinars or whatever it was. The other side being able to set whatever the price of that is, like, they weren’t so sure about that. So, they ended up passing on it. But that’s hustling, right?

John: Oh, yeah.

Berkshire Hathaway – Retained Earnings Machine

Tobias: I got a question here from the crowd, which is a good one. “Could any experts here please explain if Buffett is expecting the MARKET CAP of Berkshire to be $1.5 trillion in 12 to 15 years when he was asked about a potential corporate take over?” My understanding is that it was net worth. I think they’re at $500 billion now. So, it’s a three bag, and we talked a little about that, JT.

Jake: Yeah, I think that’s right. I think my take was that, yeah, it was basically book value at $500 billion right now, equity book value.

Tobias: You had an interesting insight into that about what that implied for growth rates in Berkshire?

Jake: Well, I just did a little quick math on what a compounding rate would be. Let me look and see if I can find it in my notes real quick since we didn’t plan on talking about this. [laughs]

Tobias: I think it’s more exciting when I just throw you in the deep end.

Jake: I know. You like to do that. Appreciate it. Okay. So, I think Buffett let slip his expected return on book value basically over– He said 12 to 15 years, going from $500 billion to $1.5 trillion. So, when I did the quick math on that, that implies a 7.6 to a 9.6 CAGR.

Tobias: You were able to find that very quickly. What system did you have that stored in?

Jake: [laughs] Of course, that’s my Journalytic, my second brain. It’s where I store everything.

John: Yeah. It’s an incredible number. Largest net worth among US listed companies. And of course, it’s because he’s never paid out a dividend or– [crosstalk]

Jake: Nor would you’ve ever wanted him to with his ability to redeploy it.

John: You don’t want him to. But yeah, just retaining those earnings. He just recently, in the last several years, really started even buying back stock. And so, it’s just been 100% retained earnings machine. There’s just not that many out there when you’re looking at a company of that size.

Jake: Yeah.

Tobias: The big advantage that he has, I guess, is that they’re a high-performance conglomerate, where they’re not stuck in any single silo. So, anybody else is sort of they’re stuck in their own industry and you’re subject a little bit to the cycle in the industry, and when it gets expensive– The only sensible thing really is to send the money back, buy back some stock.

John: Sure.

Tobias: But they just shift into another industry, typically, what was just successful, what was just popular. So, it’s still good, but now it’s cheap instead of being good and expensive.

John: Exactly. It’s a formula-

Tobias: [crosstalk] –great example there.

John: -that works.

Jake: There is an odd thing about value investing, where if you do it in a way– This happens a little bit more, if you’re buying things that are cyclical but not in a secular decline. You get to look like you had a lot of foresight about, “Oh, this was going to recover and now you’re going to make a lot of money. Now, how were you so smart to have figured that out?”

The answer was, you weren’t. You were just buying it, because it was really cheap. I think oil, the last few years, is maybe a good example of that, where if you bought when prices were negative there for a little bit, it ended up working out pretty well, and you looked very smart. But the real thesis was just like, “Okay, this is stupid cheap. 50 cents on the dollar book value for a lot of these assets. I’m just going to buy them and see what happens.” I think Buffett’s done that a lot over his career.

Tobias: He’s still buying– According to the latest 13F, he’s still buying Oxy?

John: Yep.

Tobias: Sub 60 bucks, still buying Oxy?

Oil & Gas – The Long-Term Demand Outlook Is Strong & Growing

Tobias: The backdrop in oil is interesting. Do you follow energy at all, John?

John: I do. Yeah.

Tobias: What are your thoughts on what’s happening in the space?

John: I think that I’m still bullish on energy, a variety of sectors in energy. Regarding oil and gas, I’m bullish, because the industry underinvested for a decade at a time when demand is still very strong-

Tobias: And growing.

John: -and growing. That’s what I meant, strong and growing. So, supply is constrained, demand is strong and growing, that leads me to believe– I know it’s extremely hard to predict. I’m not predicting, but that leads me to believe prices can remain above 60 or something for a while. Some of these companies though are profitable at $40 or $45 oil. One of the things I’ve tried to do over the years is is follow capital cycles, follow supply, and just supply seems very low. These companies are managed now for returns on invested capital and return of that capital to shareholders.

Then if you just look at his investment in Occidental and Chevron, he’s obviously using a particularly with Oxy… a Permian lens, because the Permian is, it’s the best rock in the US, and Buffett obviously knows that. So, yeah, I’m extremely bullish. These things are trading at single digit multiples, double digit free cash flow yields, and the long-term demand outlook is strong. You are just talking about buy– [crosstalk] I’m sorry, go ahead.

Tobias: Sorry, John. Keep going, please.

Warren Buffett Buys Wonderful Companies Cheap

John: JT was saying, Buffett buys cheap and ends up looking smart. That is what happens when you buy cheap, by the way. I think one of the misunderstandings about Warren Buffett is that it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price. It’s true he wants to buy wonderful companies. It’s true that Munger got him to shift away from cigar butts and towards higher quality businesses. That’s all true. I can’t find any evidence that he wants to pay a fair price though. I really can’t.

Jake: [laughs]

John: I can’t. If you look at Occidental and Chevron, he bought those at double digit free cash flow yields. He bought the five Japanese trading houses at seven times earnings or 14% free cash flow yields. HPQ is a top holding. Right now, it’s at 8 times. So, he was buying that under 10 times earnings. I think he added to that one this quarter, by the way. When he started buying Apple in 2016, Apple’s average PE for the year in 2016 was 12, and it traded under 10 at points of the year. So, once again, 10% free cash flow yield. Taiwan semi, I know he busted out of this one, but it was a $4 billion investment at one point. Well, when he bought Taiwan semi, it’s 12.5- or 13-times earnings.

The quintessential example of Buffett paying up– I’m going to source your book now, Tobias. The quintessential example of Buffett paying up is See’s Candies, because See’s Candies, Buffett has always described it as this. It’s got a lot of brand equity. Therefore, it has pricing power. It earns extremely high returns on invested capital and it requires almost no capital to grow. He paid 12.5 times earnings. I got that from your book, Tobias. 12.5 times earnings per– [crosstalk]

Tobias: Because it was a private transaction too. That’s expensive for a private transaction.

John: Exactly. The average market multiple is 15 or 16. I don’t know what it was back then. 12.5 half times for his ideal business that he uses as his textbook example of paying up. He even tells a story. We almost didn’t pay the last $5 million or whatever it was, because he thought he was paying up so much. Last thing I’ll say about this is, he almost never talks about valuations of stocks he’s buying or business he’s buying in his investor letters. Almost never. But he did twice and I have these here.

So, in his 1995 letter, when he first became interested in Disney stock, he said, “Disney had net cash–” So, this was in 1966. This is 1995 letter, but he’s telling the story about when he first became interested in Disney stock in 1966. He said, “It had net cash and it was trading at five times pretax earnings.” Five. And then in his 1990 letter, he talks about buying 10% of Wells Fargo at a PE of five, or three times pretax earnings. There’s no proof that I can find-

Jake: [laughs]

John: -that he’s paying a fair price for anything. He’s paying double digit free cash flow yields.

Tobias: Wonderful companies at wonderful prices.

John: Yeah, at wonderful prices. That should be the quote.

Tobias: That’s the innovation.

John: Exactly.

Jake: [laughs] Six-minute abs. [laughs]

John: Yeah, exactly.

Tobias: What do you think about the TSM position getting into it and then blowing out? He did talk about that a little bit at the meeting. What do you think, JT?

Jake: Well, he said that he felt like the geopolitics had shifted and that it just felt riskier to him, which kind of a weird– That’s not a normal– I wouldn’t say Buffett’s done a whole lot for geopolitical reasons ever, at least in my estimation.

Tobias: But he’s stays inside the States a lot too.

Jake: True. He hasn’t exposed himself too much.

Tobias: You can see some of those early meetings, he was talking about not going much outside the States. And then he justified there was something– I forget now what it was. One of the early positions outside. I think it was Guinness. It’s as late as Guinness when he said Guinness is like Coke. It just happens to be situated in Ireland.

Jake: That was probably like early mid-90s?

Tobias: It is as far back as that. Yeah.

John: Yeah.

Tobias: Sorry, dude. I cut you off. Keep going. [laughs]

Jake: I don’t have anything else.

Tobias: We do veggies on this show, John. I don’t know if you’re familiar, but Jake has prepared remarks that–

Jake: [laughs] This is the–

Tobias: It’s the main reason that people come here. So, they get very upset if we don’t get the veggies out.

Jake: [laughs] This is the pedantic part of the show.

Tobias: We’re doing the vagus.

Jake: Yeah, vagus nerve.

Tobias: Sorry, dude. I’m stepping all over your piece. Go.

What Happens To You Physically During A Market Crash

Jake: Yeah, just stop. I thought this would be interesting to talk about what actually happens inside your body during a market crash. At some point, we’re all going to have a position or an entire portfolio that really moves against us, and we’ll wake up and we’ll see this ocean of red, and we’ll feel this fear of loss, and it’ll be very visceral for us. You have to remember that the typical human response of a panic is usually to sell, and that’s almost always the wrong thing to be doing at that point. The problem is that our DNA hasn’t had time really to evolve to match in the last 10,000 years of, let’s call it, agriculture and civilization with the millions of years before that created us. And so, our wiring is often in conflict with our modern environment. We have to keep that in mind.

So, I thought if I could explain what’s happening inside your body. When you feel your own blood in the streets, it might help you to slow down, stay on top of your reactions, and maybe we’ll have some things at the end of this that you can do now before there’s a crash to help prepare your body’s reaction, which gets into the vagal nerve that Toby was stepping all over. So, I’m going to be drawing some inspiration from this really terrific book called The Hour Between Dog and Wolf by John Coates. Interesting background on him. He was a trader on Wall Street for a long time. He then moved into neuroscience, I think, after he’d made enough money, and then has spent the last couple of decades doing research that marries the two of those together. I think it came out in 2013-ish, and it was actually recommended to me by a friend of the show, Dan McMurtrie, and he was very right. It’s a terrific read.

So, let’s start with like a little biological review just to help us all talk on the same terms here. A hormone is a chemical messenger that’s carried by the blood from one tissue to another, and there are dozens of them inside your body. What they do is they help us regulate our body to maintain this tight band of homeostasis for our blood sugar, and heart rate, and whether you’re hungry or not, or thirsty, a million different things that are happening in your body. And steroids are a particular class of hormone that have potent, widespread effects. There are three main groups of steroids. There’s testosterone, estrogen, and cortisol, okay?

So, almost every single cell in your body and your brain has receptors for steroid hormones. If steroids get released into your bloodstream, they have widespread effects that impact your growth, your shape, your metabolism, your immunity, your blood chemistry, your mood, your memory. They’re very broad, sweeping impacts. Steroids evolved basically to coordinate your body, and your brain, and your behavior during important archetypal reactions and situations like fighting, fleeing, feeding, hunting, another F word, we’ll call mating, and struggling for status. So, these very important things that help you to propagate into the next generation. Hormones are helping you coordinate a reaction to this.

So, what happens when you experience something threatening, like, maybe you hear rustling in the leaves and maybe you think it’s a bear, okay? Or, perhaps, when you log in and you see huge losses on your screen. The first response happens via an electrical impulse from your amygdala, and it registers the danger and then passes it on as a warning to other parts of your brain. This happens in a matter of milliseconds, okay? It’s instantaneous, almost. Secondly, the amygdala passes an electrical signal to the visceral organs in your heart and your lungs to increase your heart rate, increase your respiratory rate, your blood pressure, your breathing, and it uses the vagus nerve to send that signal. We’ll get into more on that in a little bit, okay?

The next effect is you get a shot of adrenaline. This is that fast acting hormone that takes effect almost instantaneously within seconds. It has a relatively short blood half-life of two to three minutes. So, it’s a very quick response and then it dissipates pretty quickly, and it prepares you instantly for fight or flight. I think we all have heard this one. But what else is happening is also that your arteries are constricting in your skeletal muscle or, sorry, they’re dilating the other way around, and they’re forcing more blood to your major muscle groups to prepare your body for a physical response. There’s tiny arteries in your skin that actually constrict to help reduce bleeding, if you’re injured. This is what can give you that clammy feeling, okay? That’s what’s happening.

Blood vessels in your stomach also constrict, and this is what gives you that sense of butterflies in your stomach. Your skin can start to sweat right away. This is preparation for physical exertion to cool your body off. Your pupils dilate to let in extra light and more sensory input, and salivation stops to preserve water, which is that feeling that you can have a dry mouth when you’re afraid. So, here’s all these things that are happening to you, okay? These unpleasant feelings from a stress are all your body’s way of preparing you for really the need to move and respond quickly, so that nervous stomach, higher blood pressure, elevated glucose, which is a big part of it, anxiety, these are your gastrointestinal, cardiovascular, metabolic, and really attentional preparation for impending efforts to save your life.

But what if the danger is a little bit more prolonged? It takes longer than the response of what adrenaline would impact. This is where we have another system, that’s called cortisol. This is really for that like, what if you’re being stalked by a lion for multiple hours? This is what cortisol is for. Adrenaline doesn’t last that long. So, cortisol orders basically all your long-term and metabolically expensive functions in the body like, digestion, reproduction, growth, storage of energy, immune functionality to be shut down. We’re in war mode right now. It floods your system with glucose, so that you have instant available ready energy. It effectively retools your body from leisure and consumption goods in favor of war material. It organizes really a coherent long-term physical defense to danger.

But this all comes with a cost. It shuts down the reproduction of growth hormones, it blocks the effects of testosterone and insulin, which are very important for your body over the long-term, because these lead to loss of muscle mass, weight gain from unused glucose that gets turned into fat, loss of restorative sleep. It’s basically strip mining your body for nutrients, because it’s a short-term response to help you get to the next round of evolution. It leads to hypertension, increased incidence of cardiovascular disease, and cancer. Even cortisol actually fertilizes the neurons in your amygdala, which is where fear response is happening. It’s like miracle growth for your amygdala as far as the neurons branching, which then leads you to thinking more emotional, less factual, and impairing your ability to engage in rational analysis. So, your brain is literally being shunted away from that system two, thinking that you should probably be using in these time periods.

In fact, they’ve done some studies where your neocortex effectively gets shut down and you’re running almost on impulse and emotion, which is obviously not where you want to be. Maybe that was good for survival in the savannah, but it’s not great for mining your portfolio. You’ll start to see patterns in randomness, and you can become actually irrationally risk averse. Price insensitive at that point when maybe now is the perfect time to be buying, but we’re all afraid because of what’s been happening to us.

So, let’s go back to this vagus nerve. That’s vagus, not as in Las Vegas. It’s vagus, V-A-G-U-S, in case you want to look this up later. There’s something really interesting that’s happening there where your resting heart rate is actually not your heart’s default setting. The default rate is considerably faster. The vagus nerve acts as basically like a break on the heart and lungs to keep it at this slower idle. When you’re jarred out of a relaxed state by some emergency, your fight or flight nervous system takes over and it raises your heart rate. But there’s an intermediate level of activation needed for minor stressors, which is controlled by that vagus nerve. So, this lets us save the big response of a full cortisol, a full adrenaline response for this real trouble. For these minor stressors, your vagus nerve can actually modulate to allow your heart to speed up or slow down, which it saves a lot of the wear and tear.

So, having good vagal tone, it’s called, which means like a well-functioning vagal nerve, makes your body better at controlling this regulation of your heart and your lungs, so that there’s less release of cortisol, less adrenaline, and you merely release the vagal brake a little bit to get the response that you need, and there’s less wear and tear. So, there are ways to improve your vagal tone. This is what we talked about trying to work on things before you’re in the middle of the shit hitting the fan, okay? So, here are some tips for that. First of all, like heart rate variability is a good proxy for vagal tones. So, if you’re using almost every single wearable that you have now has heart rate variability built into it, start keeping track of that. Like, see how it’s changing based on sleep, exercise, the various inputs that you have in trying to promote your health.

Yoga, meditation, breathing exercises, all been shown to have positive impacts on vagal tone. Cold plunge, actually, and even splashing cold water on your face when you’re in that panic state will activate your vagus nerve and actually calm you down somewhat. Avoiding loneliness, so, like, community lowers that stress response, increases vagal tone. Intermittent fasting does this as well. And then frequent movement. So, exercising when you’re stressed is super important, because you’re literally clearing out a lot of these chemicals from your system by getting your blood flow going. This makes perfect sense, because your body’s preparing for a physical action in this. That’s what we evolved to do.

But now, today, when you get into that fight or flight stress– and then you’re sitting in a chair staring at a screen, this is a terrible mismatch in your environment and your evolution. So, you have to do something to get that closer aligned. I think that’s regular exercise, especially when you’re stressed. Then just time in nature and resting and not just being chronically stressed and working constantly is another way. So, hopefully, maybe with a little bit more understanding of what’s happening inside of you, we can engage more neocortex to short circuit some of this stuff and even better do some prep before we get into the situation where we’re really scared and the shit hits the fan. So, hopefully, that’s our public service announcement for the week.

Tobias: That’s good, JT. That’ll be good for the crash that when it finally gets here. I’ll go back to this episode.

Jake: Yeah. Let’s listen to this one again. See how it ages.

Tobias: When you turn on, you see all the red in the morning just going, do some squats– [crosstalk]

Jake: Meditate. Yeah, go for run some sprints, go wrestle a bear. I don’t know. [laughs]

John: Jump in a cold dip. I love those veggies. On a personal level, I know personally I’m a better investor when I take care of my body, when I get enough sleep, when I get enough movement and exercise. In fact, some of my best ideas I’ve gotten on hikes or actually on a long cruise ski run, just cruising, random ideas will pop in my head from an investing standpoint. And then taking it away from me, personally, I do think there is a link between health and longevity and investing, because if Buffett, I don’t know, he’s 90 or something, 92. Munger is almost 100. Buffett, 90% of his wealth came after the age of 65.

So, if you do want to let your portfolio compound for as long as it can, then you want to let your body and your health compound at a high rate as well. And so, I do think that there’s a close link between health and longevity, wellness in your portfolio.

Jake: It’s my only chance of catching Buffett is I got to live to, like, 130.

Tobias: He’s made it tough, dude. He’s made it really– [crosstalk]

Jake: I’ve got to get– [crosstalk] I’ll never get his rate of return, but if I can add a couple more of those doubles on the back end that he didn’t get-

John: On the back end.

Jake: -that’s the only chance you got.

John: Yeah.

Tobias: The Fed could print us there. The Fed could get us there.

Jake: How [crosstalk] Toby? Come on.

John: It could. They were on their way. They were on their way.

Tobias: You would be a billionaire, but– [crosstalk] a cup of coffee will be a millionaire.

John: [laughs]

Jake: Oh, yeah. [laughs]

John: Exactly.

Jake: Jeez.

John: Yeah.

Tobias: The name of that book was– Just one more time, JT.

Jake: The Hour Between Dog and Wolf.

Tobias: We had some questions about that. How’s everybody feel about the market?

Jake: I could do 10 other segments out of that book, if I wanted to.

John: I’ve got to read it.

Tobias: That was good.

We’re Fully Invested Bears

Tobias: How do you guys feel about the market? We do update. I tracked the inversion. The inversion got as deep as it has been a week or so ago, and it’s been floating around about there. It’s got a pretty good track record. I’ve had lots of people let me know why it’s not going to work this time, because the– [crosstalk]

Jake: [laughs] Okay.

Tobias: I don’t know.

Jake: You almost have to have that as a prerequisite for it working, right?

Tobias: Well, probably that’s true. I don’t know. I just like tracking these simple metrics, because they’re so simple. There’s no interpretation required. It’s concrete. You know what should follow. If it doesn’t follow, then it doesn’t follow.

Jake: I think is weird about this and this is probably true all the time, and this is true in a lot of other domains too. Everybody hates Congress, but they like their congressmen. I hate this market, but I love my portfolio. [laughs] It doesn’t make any sense. I think everybody feels that way right now, like, this market is boring and stupid and everyone else is dumb, but I’m being glib. I don’t know, I feel like I’ve got quite a bit of value in there right now at the moment. So, I don’t know. We’ll see.

Tobias: What is that bias? You like the thing that you have, you don’t want to trade it for the thing you don’t have?

Jake: Yeah. That’s the– Mm, which one is that? Give me a second. You guys talk amongst yourselves.

Tobias: [laughs]

John: You got a point though. I think I heard Leon Cooperman recently say that he was almost a fully invested bear. This was, as of his last interview, I heard, maybe a month or two ago. But he says, “He doesn’t think the market is going to go anywhere for several years.” I think at one point, he even said 10 years. So, he thinks we’re going to have a sideways market, but he’s finding a lot of cheap stocks to buy. Actually, I think his largest position is a fixed income position.

Tobias: Endowment effect.

Jake: There you go.

Tobias: The hive mind got us there, the endowment effect. Thanks. Good job, guys.

Jake: It was a matter of time. I turned my brain off. I knew they had it.

Jake: The endowment effect. Yeah.

Jake: [laughs]

Tobias: Great job, guys.

Why The Inversion Indicator Is Such A Good Predictor

John: Yeah, same. I understand why the inversion. Tobias, you said it’s an easy metric to track. It’s got a good historical track record of predicting recessions.

Tobias: Just predicting deflation, I think, more than anything else.

John: Yes, and you understand why, because banks don’t want to lend when there’s an inverted yield curve. They can’t make the net interest margin work. And so, it makes sense. Credit is a fuel for our economy. So, it just makes intuitive sense.

Jake: Yeah, I think we overcomplicate these things, sometimes.

Tobias: It’s quite a long delay. That’s the other thing. It’s funny, looking at back tests, which I do frequently. It’s easy to just skip over a few years and forget– [crosstalk]

Jake: And picturing the meme of Charlie with all the paper and there’s connecting all the dots. [laughs]

Tobias: I try to make them simple. [crosstalk]

Jake: Toby in his office doing back tests. [laughs]

Tobias: I try not to layer them on top of each other, because I think that’s exactly how you get that Charlie in his office. But that one in particular, I think, does seem to have preceded every single recess– The data is not that great, going back that far. I think it hasn’t been proven wrong yet. So, this might be the time. But the lag is so big. So, it’s October 25 was when we actually went inverted and it was threatening for quite a while before then. So, I was watching it for a few months before then, at least, and talking about it before then. Then, the shortest time period historically has been six months. So, that would have been April 25 for the beginning of the declaration of the recession. They tend to be declared after the fact.

John: Yeah, post hoc.

Tobias: So, the average is October 25 this year. We’re mid-May. So, we’re five months plus away from just the average. So, there’s plenty of football still to play in this game.

Jake: Does a recession necessarily mean that your portfolio gets trashed?

Tobias: I think that the drawdown, absent a recession, tends to be about 20%. In a recession, it tends to be about 40%. It’s twice as bad. I think we’re now flat year on year, but we’re still down from the peak, which was the beginning of 2022, end of 2021. This tends to be the sort of environment where you get those big crashes where you’ve had a sideways– We’ve been running sideways for a long period of time. So, all of the fun has gone out of the market. All the speculators have gone.

New Technology – From Fire To AI

Jake: Yeah. Although it seems like AI is the new– [chuckles]

Tobias: AI.

Jake: Hot to trot on AI.

Tobias: It’s funny how quickly that just came out of nowhere.

Jake: It’s just right into it, again, huh?

John: I was joking that the new valuation metric is priced to AI.

Tobias: Yeah.

John: Yeah. Everyone’s talking about how AI is being referenced on all these earnings calls. If you go back 12 months, 18 months, it was Metaverse that was being referenced on all of these earnings calls.

Jake: [laughs]

John: Actually, on Twitter, there were all these charts showing how references to the Metaverse across industries had gone parabolic or something.

Jake: Yeah, gravel pit in the Metaverse. [laughs]

John: Exactly. They were going to sell burritos in the Metaverse and all this stuff. Hotel rooms and– [crosstalk]

Tobias: Companies and real state. Yeah, it was real estate.

John: Yeah, real estate. Now, no one’s talking about the Metaverse, and it’s just people are headline investors.

Tobias: Shiny new things. People like shiny new things.

John: Yeah, they do.

Tobias: Yeah.

Tobias: It was blockchain for all. That’s right. David Wilson says, ” AI is the new metaverse, the blockchain, the new cannabis, the new 3d printers” and so on and so on.

Jake: All the way back to fire [laughs] and a wheel.

Tobias: In long drawdowns like this, there are lots and lots of rallies. That was the thing I-

John: Sure.

Tobias: -noticed about 2007 to 2009, which was the first one that I was– I started work on April 2000. So, I saw the crash, but I didn’t really know what was going. It was just background noise at that point. But the 2007, 2009 one, I was watching really closely, at one point, I counted the rallies. I think there were like 14 rallies.

Jake: Really?

Tobias: 14, but 15%. 20% rallies.

John: Yeah, 20% rallies. Exactly right.

Jake: Heartbreakers.

John: Yeah, heartbreakers. Heart crushers. Yeah.

Tobias: Genuinely. We’ve had one since October. So, October, we had an April low, then we had an October low. We’re still not above the original high. We’re still below that, but it’s been a pretty sustained rally now for a period of time to the point that I think most people probably feel like it’s all over, particularly like year on year.

Jake: Is the flight to safety of tech a big tech, a particularly logical course of action?

Tobias: There’s a lot of earnings in there. They are giant. It’s funny to compare how big those companies are to everything else that’s in those indexes, because they’re so much bigger. They earn so much more money.

Multi-Billion Dollar Valuations Used To Mean Something

Jake: Dude, I saw Apple by itself is bigger market cap than the entire Russell– [crosstalk]

Tobias: Russell 2000.

Jake: Holy cow.

Tobias: The Russell 2000 is so small. The crazy thing is, it’s like, 75% by number of businesses, but it’s vanishingly small by-

Jake: By market cap?

Tobias: -by market cap.

John: I think 40% of them aren’t earning any money. But still, what is Apple? $2.7 trillion or something?

Jake: Is that a lot?

John: These days, we’re so desensitized. I don’t even know.

Jake: Totally desensitize.

John: Yeah, I don’t even know.

Jake: I actually watched The Big Short again last night. I showed my 15-year-old that, because I thought it would be interesting. I hadn’t seen it in a while. They’re talking about, they’re using millions and billions in this way where they’re like, “This is such a big number. It’s like $2 billions.” And now, I think we have totally shifted on how we feel about these things. Now, if it doesn’t start with a T, don’t even get me out of bed, it’s insane how that happened.

Tobias: Multibillion dollar market cap is a smaller micro.

John: Yeah.

Jake: I’m thinking more specifically about the losses, the interventions. All of these things seemed like big numbers at the time, and now, they look quaint in the rear-view mirror.


The $30 Billion Stock No-One Knows

John: [crosstalk] Yeah. Have you all heard of a company called Ferguson?

Tobias and Jake: No.

John: I know we just got a few minutes, but Ferguson is the largest distributor– I hope I’m about to blow your minds. It’s the largest distributor of– [crosstalk]

Jake: I’m sitting down.

John: Yeah. Of plumbing and HVAC supplies in the US. It has sales of $30 billion. It has a market cap of $30 billion. No one’s ever heard of it. No one’s ever heard of it. The reason no one’s heard of it is because until 2017, it was called Wolseley. In 2022, it switched its primary listing from the London Stock Exchange to the New York Stock Exchange. It’s not in any of the main indexes in the US yet. It hasn’t filed a US proxy yet. But this is a very high-quality business. Trust me, very-high quality business. At least, don’t trust me, but based on the research I’ve done.

Jake: Look for yourself.

John: Yeah. I think it’s a very high-quality business.

Jake: What’s the operating margin look like on a HVAC supplier?

John: The operating margins are solid. They’re very solid. It generates high returns on invested capital. I’m pulling up the operating margins for you. Very good free cash flow, free cash flow. So, EBIT margins 10%. 10%. It’s a good business. Now, here’s the thing. So, $30 billion business, I mean, sales $30 billion market cap. It has much higher sales than Grainger or Fastenal by double or more. But both Fastenal and Grainger have higher market caps. I don’t value things on a price to sales basis, but it just frames how large the valuation discrepancy is here.

Jake: It’s a good, clean measurement for a lot of things as a first approximation.

John: Yeah. It’s a $30 billion business. No one’s heard of it.

Tobias: I like that stuff, John.

Jake: 10 people have heard of it now.

Tobias: [laughs]

John: Yeah. There you go.

Tobias: Top stars.

Jake: There’s 12.

Tobias: We’re coming up on time, John.

John: Yeah.

Tobias: If folks want to get in contact with you or follow along with what you’re doing, how do they do that?

John: Yeah, I’m on Twitter, @jrogrow. I also recently joined LinkedIn for the first time ever. So, I’m learning how to use LinkedIn.

Jake: Oh, boy. [laughs]

John: That’s it for now. I don’t know what my next step is going to be yet.

Tobias: Well, that was cool. Thanks very much for that.

Jake: Yeah, thank you.

Tobias: Good seeing, everybody. Good seeing you, JT. We’ll be back same time, same bat channel next week.

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