VALUE: After Hours (S05 E29): Jonathan Boyar on Special Situations, $UBER, $BATRK and Jake on Ergodicity

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

  • The current state of the market
  • Opportunities in small-cap stocks
  • Ergodicity and the future returns of stocks
  • Is Callaway & golf on the rise
  • Two undervalued stocks  – Liberty Braves and Levi’s
  • Why Uber is a good investment
  • Past returns are not a perfect predictor of future returns
  • The opportunistic long-term investing strategy
  • Suits in the workplace

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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Tobias: This is livestreaming. This is Value: After Hours. I’m Tobias Carlisle joined, as always, by Jake Taylor. Our special guest today is Jonathan Boyar from Boyar Value. They’ve got a research service and run some funds. We’re going to talk to Jonathan about special situations, value generally, what’s happening in the markets. How are you, Joe?

Jonathan: Good. Thanks for having me. It’s been a long time.

Tobias: Yeah, it’s good to see you again. We’ve known each other for quite a while now. I remember seeing you at Value Investing Congresses. This is more than 10 years, I’d say.

Jonathan: yeah– [crosstalk]

Tobias: 2010 or something.

Jonathan: People got together in person.

Tobias: That’s right.

Jake: [laughs]

Tobias: They don’t do that anymore.

Jonathan: [laughs]

Tobias: How are you, JT?

Jake: I’m well. I pretty much ran the entire summer baseball gauntlet with the boys at this point, and then they’re going back to school next week, and-

Tobias: You’ve made it.

Jake: -life will hopefully get back to normal a little bit more. [laughs]

Tobias: Did you sweat down to a brand-new weight from all of the heat out there?

Jake: Oh, my gosh. [crosstalk] We were down in Stockton, which is about 15 hours and 30 from my house four days in a row, like, driving back and forth for games like Thursday, Friday, Saturday, Sunday last week for a tournament. It was hot down there. I think I did. I probably sweated out a good five pounds of just water.

Tobias: Yeah, I was at some tennis over the weekend, starting at 12:30 on Sunday. Wow, it is hot out there. But I wasn’t playing, so I feel bad for my daughter who was playing.

Jonathan: [laughs]

Tobias: This market has been a rougher one this year. Well, not this– [crosstalk]

Jake: Not for everybody else. What are you talking about?

Tobias: Yeah. It’s been a funny year. Superconductor’s the new AI. Did I see that we’ve got room temperature superconductors? The market must have been just slowing a little bit and they were like– [crosstalk]

Jake: We need a new narrative [crosstalk] aliens to work. [laughs]

Tobias: You got a big superconductor holding, Jon?

Jake: [laughs]

Jonathan: No superconductor holding. But it’s been an interesting year. I think if you look at it, it just take you the market as a whole. I don’t like to look at things from indices. But if you look at any of the strategists and you took their advice from the beginning of the year, you’d be a lot poorer than you are now. It just shows why you have to go on a stock-by-stock basis. I can’t remember very few people who were bullish coming into the year. They probably should have been. If you use historical trends, we were in the year before presidential election, that’s historically been the best time to be in the stock market. Everyone was gloom and doom. And now everyone’s playing catch up.

Tobias: Yeah, funny year. I think the underlying is a little bit gloom and doom, but the stock market has shrugged it off. The stock market is just discounted the recession and just sailed straight through it. Out the other side already. We’ve already had the recovery.

Jake: Well, let me ask you this as a thesis. What if the market is sniffing out the idea that political pressure will mount on the Fed to lower rates before an election, and therefore, everything wants to go to the moon again when we take gravity off?

Jonathan: It could. You might be right. But sometimes, you end up outsmarting yourselves, and trying to figure out what may or not happen. Just go on a stock-by-stock basis, there’s a lot of stuff that’s cheap. What’s crazy, you look at the top 10, which has been widely reported to, what, 32% of the index. I think they’re trading it 28 times earnings on average, which is nuts.

Tobias: On a TTM, yeah, that’s expensive.

Jonathan: But you go down to Russell 2000 land, you have to be real careful because there’s a lot of really bad companies there. About half of them are unprofitable. They’re trading at historically low valuations.

Tobias: Yeah.

Jonathan: Now, if you look at the last five years, the Russell 2000 has gone up 20% total. That’s just staggering, if you think about it, when it’s historically been one of the best indices to invest in over a long period of time. So, I think it’s going to play a lot of catch up. I think micro, small, and mid is where you want to be. The other ones– [crosstalk]

Tobias: Singing my song, Jon. Keep going.


Jonathan: Yeah. The other ones, good luck. But time will tell. It’s, what, 20% from its selling, I think 20% off its 2021 high. Even though it’s had a good month or two, if this rally is sustainable, you can make a lot of money. I probably was talking about this with you 10 years ago at the conference.

Jake: [laughs]

Tobias: Possible.

Jake: Likewise.

Jonathan: Professional sports teams-

Tobias: oh, yeah.

Jonathan: -which they worked out real well for us, and I still think there’s a long way to run. There’s really only two ways to play it. With Madison Square Garden sports and Liberty Braces. If you want to invest alongside John Malone and own a piece of the Braves at the same time, you snow have an opportunity to do so. He’ll sell it at some point in time.

Jake: Braves are first in the NL East too. Best record in baseball, I think.

Jonathan: Yeah, best record in baseball. They’re good. Yeah. Not like the Mets, which–

Jake: [laughs]

Jonathan: They’re now giving up and waiting for next year. I’m not sure how familiar you are with the Braves story, but it used to be part of Liberty Media, it was a tracking stock, so no one wanted to own it. But now, as of two weeks ago, it’s no longer a tracking stock. It’s a true asset backed stock, and it’s selling at a significant discount to the Forbes value. There’s valuable real estate there. You have a cold-blooded capitalist controlling it in Malone, and you got to think at some point in time he’ll sell the team. You have that two-year spin off rule there. It’s our understanding that if someone didn’t have a conversation with him and then approached him, it’s fair game for him to sell it. You’ll get a lot more than $39, which is what it’s currently trading for, if they sell it.

Tobias: Tell us a little bit about your strategy, Jon. You like special situations more than just deep value. Is that fair?

Jonathan: Yeah. I think we’re like to say we take a private equity approach to public markets. We’re opportunists. We try and want to make money for our clients. So, as we were talking about off air– We wrote about and we own Uber, which certainly is not a “value stock,” but we also own names that are in the value camp. We’re not in the deep, deep value camp. That’s how my business started by my dad in the 1970s and worked really well. Then that was like– I was born too late, and those kind of things.

Tobias: Hopefully, it’ll come again.

Jonathan: [laughs] It worked out really, really well. I think here you need a little bit more quality in there and have a mix of it, but we’re opportunistic long-term, tax efficient investors. It’s probably the best way to describe us.

Jake: Maybe it’s like bell bottoms. It’s going to come back around and–

Jonathan: Yeah, everything’s cyclical.

Tobias: I have noticed that certainly the case with suits. I had a nice loose suit. They went tight. So, I bought the tight one. Now it’s loose again.

Jake: Is it loose? Oh, gosh.

Tobias: Think so. Yeah. I don’t know which one looks worse. They both look really bad.


Tobias: It’s hard to say. Maybe the suit’s dead.

Jake: You’re an Adonis. What are you talking about? You could put a paper bag on– [crosstalk]

Tobias: It looks terrible.

Jake: [laughs]

Tobias: What’s Manhattan say about the suit, Jon, from your–? What’s Manhattan Finance say? Because that’s probably setting the standard for the rest of the country. Are people still wearing suits? Asking hard questions too.

Jonathan: I was going to say, we are wearing suits anymore. Sometimes, media stuff. “Maybe I’ll do it,” or if I’m meeting a client, but I think this is about as dressed up as I’m going to get. Not to bring everything back to stocks, but one of the names that we like that’s benefiting from that casualization, although the stock price hasn’t benefited yet, is a Levi’s. I can’t imagine that people are going to go back. It’s hard enough to get people into the office, never mind getting in the office and wear suits– [crosstalk] Yeah, that’s [laughs] a few years down the line.

Jake: I think Josh Wolfe has taken the other side of that and said that– He’s a technologist guy for Lux Capital, but he’s been in the camp that suits will make a comeback, and it’s about signaling and that you– It just like it used to be.

Tobias: That’s possible. But hats, men used to wear hats, and nobody wears a hat anymore. Some things do fall off and never come back.

Jake: True.

Tobias: And as a deep value investor, I’ve seen a few of them- [crosstalk]

Jake: Hard week.

Tobias: -owned plenty of them. This is the power to–


Jonathan: Yeah, I don’t think I want to own a publicly traded suit manufacturer.

Tobias: Love the way you look.

Jake: Oh, yeah. Joseph A. Banks. Remember that inventory thesis?

Jonathan: Oh, yeah.

Tobias: Men’s warehouse?

Jonathan: Yeah.

Tobias: Well, the Joseph A. Banks, that was a net-net for ages and ages. That have [crosstalk] huge inventory. And then John Hempton had the– I think it was Joseph A. Banks, he was like that inventory is very, very large. I don’t think that was ever resolved one way or the other, but he had a short thesis on that inventory not being there.

Jonathan: I think probably the only thing worse is tuxedo rentals business. [laughs]

Tobias: That’s not a good business.

Jonathan: I just can’t imagine how many people are wearing them now. People are just casual, but who knows? Everything changes. You just have to be patient, I guess. But being in New York City, getting people into the office to say, that’s been a struggle. If you put a dress requirement, I just think that makes your job that much more difficult. But I get, Jake, your point about the signaling part of it. Maybe a couple of years from now, that’ll be the case.

Tobias: [unintelligible [00:11:25] you’ve got a job.


Jonathan: If AI hasn’t taken over– AI doesn’t wear a suit.

Tobias: Jon, before we got on, you were talking about you don’t buy energy. What’s the reason for that? You just don’t buy any commodities? Is it that sort of argument?

Jonathan: Yeah. We’re taking everything through the lens of an acquirer, which I think you can, given the name of your fund, appreciate.

Tobias: I like that approach.

Jake: It doesn’t resonate.


Jonathan: Yeah. This has been instilled in me from my dad. I don’t want to own a business whose profitability is largely or solely dependent on the price of a commodity that I have no control of. They could be good trades. And listen, energy has been the best performing stock since the market bottom in 2020, a sector. They could be good trades, but they’re not names that you could hold forever or for very long periods of time, because they’re so cyclical in nature. So, we generally try and avoid them, because you have to be right twice. You have to be right when you buy them, and you have to be right when you sell them, and then you have to pay taxes, and all sorts of stuff that we don’t like to do. Obviously, it hurt us last– [crosstalk]

Tobias: I don’t really disagree as a matter of principle, but I just note that Buffett’s out there buying Oxy hand over fist every time it gets whatever it is, $50 something. He’s loading up more.

Jonathan: Listen, I wouldn’t want to bet against the greatest investor of all time.

Tobias: [laughs] [crosstalk] people do.

Jonathan: He also has the option of buying the whole company at some point in time as well. So, I know he said he’s not going to do it. He knows the energy business well. It’s a specialty of his– I’ll leave the hard stuff to him and have the mere mortals invest in S&P 500 X energy and heavy technology. [laughs]

Jake: What do you think about the counterargument to that though that in the long run, everything is a toaster? It’s commodities all the way down eventually, no matter what it is. So, in that instance, I know that they’re still special privileged businesses, but their competitively advantaged periods are not infinity, as best I can tell.

Jonathan: Yeah. No, listen, it’s a quote, [unintelligible [00:14:00] our favorite holding periods forever, but you realize something like a GE that doesn’t work, but you can still have very long runways there. It’s one of those we just choose not to play in that area. It’s been to our detriment last year, but it’s also kept us out of trouble as well. There’s been some pretty dark patches there as well.

Jake: Yeah. 2015 to 2020 was a lot of fell on that sword.

Tobias: It’s been tough economic [unintelligible [00:14:34] Yeah.

Jonathan: Yeah. So, if you look at the names that we owned or we write about, it’s an eclectic bunch of names from, something like a Howard Hughes, which we think is incredibly inexpensive. It’s controlled by Bill Ackman and it’s a real estate play in attractive areas of the country to a Madison Square Garden, Topgolf Callaway Brands. There’s no theme except we’d want to own these businesses outright, if we had the opportunity to do so.

Tobias: Let me just do a little shoutout. I couldn’t get my chat function to work, [Jake laughs] but now it seems to be up, so I can give everybody a shout. Santo Domingo. Munich. Moncton. Portugal, Surf Town. Nice. Valparaiso. You’re lucky too. Tallahassee. Gothenburg. Toronto. Milton Keynes. Mendocino. There we go. Ian Cassel. Lancaster.

Jake: Yay.

Tobias: Durham. Jupiter. Savonlinna, Finland. Bangalore, India. Wallaby Crossing, Australia. Is that a real name? Halifax. Courtenay, Canada. Minneapolis. Chapel Hill. What’s up, everybody? Good to see you. Thanks for joining.

Jonathan: You have a diverse audience. That’s amazing. Congratulations.

Tobias: We have a good global spread. Seattle. LaGrange, Boston. Yeah. Thanks, everybody. Good shoutout.

Jake: Great ZZ Top song.

Tobias: Jon, how much macro market prognostication do you like to do? [Jake laughs] Because it’s one of my favorite things doing this pod.

Jake: [laughs]

Jonathan: I’ll do as much as you want. I have all these statistics that I don’t know what to do with floating around in my brain.

Tobias: Hit us with them. What’s happened this year so far? That’d be good to know, first off, and then what do you think is going to happen for the second half of the year?

Jonathan: It’s funny. The S&P, we’re recording. What, this is August 1st. It’s up 20% this year. The NASDAQ is up 37%. The S&P is up 28% from its October lows. Looking historically, the market and I hate to do markets, but that’s what people like is–

Jake: [laughs]

Jonathan: The guy from CFRA Research, I forgot his name, had an interesting piece a few weeks ago that came out that said, “The S&P, when it has a great first half of the year, generally has a blowout second half.” So, I– [crosstalk]

Jake: Like it keeps going, you’re saying?

Jonathan: This keeps going.

Jake: Okay.

Jonathan: The momentum begets momentum.

Jake: Yeah.

Jonathan: I think that that could be the case. But I’m just nervous of the Magnificent Seven or Eight or whatever they call it. Some of those scare me, and I just wouldn’t want to be in them. So, who knows? I would just be cautious. But we’re happy with businesses that we own. None of them are blatantly overvalued. Most of our accounts are taxable. So, we’re very cognizant of selling anything. I think we could have a long way to go, if you’re in the right area of the market. And to us, the right area of the market, as I said before, is micro, small, and midcap names. They, up until very recently, have not participated in this party.

Jake: I saw something interesting that showed interest expense based on market cap sizes. So far, the only one who’s really been pinched by raised rates are the smaller companies.

Jonathan: Yeah. You have to be very careful looking– As I said before, I think 25%[?] of the Russell 2000, it’s unprofitable. You have to be selective with these and make sure you have companies that can fund itself, that have the benefit of time to turn around, that can go through this. When you’re in those type of names that are not as well followed or well loved, you have to be selective. That also creates the opportunity. Yeah, who knows? I’ve been so wrong on interest rates for 10 years that–

I don’t know where they’re going to be. But even some of the insurance companies, I was at the Markel annual meeting earlier this year. Markel should do quite well. Chubb, well run PNC company, not selling at a crazy multiple book. They should do quite well when it comes to a rising rate environment. They all had very short duration portfolios. And to me, that’s a better way of playing it than the money center banks.

Tobias: You think about anything like that 10-3 inversion. I talk about a little bit. It seems to have a pretty good track record.

Jake: And by a little bit, he means every week.


Tobias: For a long time, I was tweeting out anytime it hit a new record, which was every day for about six months. But I haven’t had to tweet that out a little bit. Recently, it’s been chopping around near the bottom. But most of the action happens after it uninverts, which it’s nowhere near that at the moment. The historical track record of it’s been very good. And if anything was to happen, it’d be like late October. Not that it’s this precise, but on average, it happens about a year after the inversion. And then I guess, the second half of the year has student debt repayments beginning again.

Jake: Yeah, there’s some safety net stuff rolling off here in the fall. I think that might be interesting. I don’t know.

Jonathan: For a variety of reasons, something like Target has been in the penalty box. That’s one of the reasons. Others have to do more social reasons for it. That’s all out there. It’s the unknowns that end up killing you. All that information out there, I think if you’re a good stock picker and you find these names that are cheap and also a catalyst, that’s the other thing that’s critically important that I didn’t mention. You want to have these names that have a catalyst for capital appreciation in the next couple of years. And that helps you avoid the value traps, because if you can tell yourself a story of why the stock is going to go up over a reasonable period of time, that should serve you well.

Tobias: What do you like for catalysts? Do you like corporate action or do you need–? It can be operations?

Jonathan: It could be anything. Take you from News Corp, which I’m sure Rupert is near and dear to your heart. He’s 92 years old. He’s not getting any younger.

Tobias: We have the same citizenship. We’ve both got Australian-American citizenship.

Jonathan: [laughs] Yeah.

Tobias: On average, we’re very wealthy.

Jonathan: [laughs] I think he’ll do things to unlock shareholder value or his heirs will. You have conglomerate discount there. You’re not paying very much for REA, which is a dominant business in Australia. Dow Jones is just getting better and better. They might be able to do some opportunistic corporate actions, buy more. They bought OPIS a little while ago. They bought Investor Business Daily at reasonable rates at a reasonable valuation. So, we look at things like that. Could you sell the company? Could you initiate a dividend? Could you buy back more stock? Every story is different.

Jake: Would you say capital allocation is an important part of your assessment?

Jonathan: Yeah, it’s critically important. Sometimes, the worst capital allocators can end up being the best investments because you get a stock that’s so cheap. Going back to the Madison Square Garden sports story, which right now enterprise value is $6 billion. You can buy the Knicks and the Rangers for $6 billion. The Knicks alone, on a standalone basis, probably would go for a little over eight Rangers. Three or four in that range. Three, three and a half. So, you have a big discount there, and that’s because James Dolan controls it, and people think he’s a terrible capital allocator. He’s a terrible owner of a sports team, as a Nick and Ranger fan.

Jake: [laughs]

Jonathan: The best thing he could have done for shareholders over the past 10 years since I talked to you about this at the Value Investor Conference, Toby, is not sell the teams because they’ve just gone up and up in value, and that’s been the best thing that could have happened. The stock price might not have fully reflected that, but these are the things that get us excited. So, you can have the terrible capital, perceived capital allocators that give you that opportunity, or you can invest alongside someone like John Malone, who for the most part, gets high marks in terms of capital allocation.

Tobias: When you look at something like Uber, how do you come up with a valuation for that network? Because I tend to agree with you. I look at Uber regularly. When it files, I take a little look just to see how it’s going. I still think it’s losing money. Still EBITDA negative, last time I looked, I think?

Jonathan: Now, it’s positive.

Tobias: it’s gone positive.

Jonathan: yeah, it’s just turned positive. If you look at it two or three years from now on their trends on EBITDA, it should be. We think we get the $60, $70 a share on the name. So, you have to look out a little bit there, but it’s compounding pretty quickly.

Jake: Did your unit economics work?

Jonathan: Yeah. Then they have things that they’ve introduced recently like advertising within the vehicles. Talk about a captive market you’re in, and they’re just so competitively advantaged over Lyft, where they’re able to get more drivers because they can have the delivery as well as the mobility part of the business.

Jake: It’s a great observation. I think it was Modest Proposal on Twitter said that, “On a long enough timeline, every tech company eventually gets into advertising.”

Jonathan: Yes.


Tobias: I thought you’re going to say it was the Chris Sacca. Remember when ICANN put the big investment into Lyft? Chris Sacca came out and he said, “I just don’t think you want to be in number two there, because it’s just a winner take all type dynamic.” I certainly have that. I’m not in a really built-up residential area. It’s hard to get Uber drivers to come up here to pick us up. There’s just never a Lyft. I try to use both, because I want to keep the little guy going to keep Uber honest. Maybe I’ll buy a big chunk of Uber and just use Uber exclusively.

Jonathan: [laughs] Yeah. No, I just think they built such a moat on that business, and people still perceive it as the money losing, high spending company that it was under Travis. It’s a totally new regime now. They’re much more cost disciplined. They’re only in markets where they think they can be the number one or the number two. They’ve done a good job. And they also hold equity stakes that are worth a decent percentage of the market cap in other ride sharing businesses and– [crosstalk]

Jake: International stuff.

Jonathan: Yeah, that they know they couldn’t compete in, so they just got out or sold their business for stakes in that. Every once in a while, they monetized it.

Jake: Can’t beat them, join them.

Jonathan: Yeah.

Tobias: I just always wondered what the landscape would look like after, because the taxi medallions were always famously like a million bucks for a taxi medallion, because there was such limited supply of them, which meant it sucked, if you were trying to get a cab late at night. If you have unlimited supply of the cabs, then the license value comes down. But Uber doesn’t care. Uber’s got the captive audience of– They want an unlimited supply of Ubers. That probably does work.

Jonathan: Yeah. No, if you look at it, it also a different way. It’s been around for 10 years. What does the next 10 years look like?

Tobias: Yeah.

Jonathan: We thought about it 10 years ago, the fact that you can pretty much be almost anywhere and order a car on your phone, which just maybe makes me seem just really old.

Tobias: It is magic. [laughs]

Jonathan: Yes.

Jake: It is magic. It’s amazing.

Jonathan: Now they’re having things like Uber teen that they’re rolling out where it’s going to be highly vetted drivers with the best star ratings, higher background checks, I think constant background checks. Parents can then also listen in and record what’s going on in the car. So, they’re really getting pretty creative in the types of services they’re offering.

Tobias: Yeah, it’s very interesting. I like Uber. I don’t know, I haven’t looked at the valuation, but I like it as a business. JT, do your you got some veggies for us today?

Jake: Yes, sir, I do. So, this segment is– it’s actually just some lessons from a simple little dice game that we’re going to construct. It’s adapted from a section of Mark Spitznagel’s book, Safe Haven, which is really about tail risk hedging, ostensibly. So, let’s play this very simple little game of dice. First off, let’s get this out of the way that the dice are fair, each side will come up one six of the time, so there’s not any tricks there. Here’s how we’re going to construct it.

If you roll a 1, you lose half of your money that you bet. If you roll a 2, 3, 4, or 5, you get plus 5% on your bet. And if you roll a 6, you get plus 50%. This, to me, it looks roughly like what the odds you might face in public equities, where a lot of times, you just kind of do okay, maybe get your cost of capital, and then some winners and some losers. We can easily calculate the expected outcome here. Add up all of the outcomes and then divide it by six. And so, that ends up being a 3.3% expected outcome or an edge. That’s actually pretty solid. Any casino would take a 3.3% edge in a heartbeat, if you can run enough into that.

Now, in our particular game here, you were allowed to roll the dice or die 300 times. If you did that with your 3.3% expected edge, your wealth then would be 19,000 times your starting amount. A 3% edge is a ton, especially when you have 300 rolls. Really any number that’s over 1.0 to the 300th power is going to be a pretty big ass number. That’s just the math. Now, first, would you want to play this game?

Jonathan: Okay. With leverage.


Jake: Yes.

Tobias: What’s the first? Number One, is it lose 50% or lose 100%?

Jake: Lose 50%.

Tobias: Okay. Yeah.

Jake: So, 50% down, 50% up, and then middle is a 5% gain, which is where your 3.3 really comes from. Let’s do a little reality check on this game first though, and let’s just imagine that we’re going to roll the dice six times and then see what is our outcome there. Let’s assume that it’s going to land on each face one time, because it’s one-sixth the chance of probability, right? So, let’s just walk through that and say that it went like 3, 6, 1, 5, 4, 2, okay?

Now, we’d expect our return to be somewhere around that 3.3% value that we were talking about. However, if you multiply out one times, 1.05 times, and then 1.5 and then 0.5, you actually end up with 0.912. You’re actually losing. So, what’s going on there? How did we end up losing here when we rolled after six tries? And also– [crosstalk]

Tobias: Isn’t that 50% up is not enough to compensate for 50% down?

Jake: That’s part of it. Yes. So, what’s going on? How are we going to get to 19,000 times our money in the next 294 rolls, if we’re already down after six rolls? Now, there’s an important assumption here that we need to understand that’s embedded in that average that we used. That 3.3% edge on every bet is the arithmetic average, okay? It’s calculated as if we allowed you to gather 299 of your friends and you would all have one die that you would roll at the same time. And then we took those and totaled those results and then gave you 19,000 times your money.

But that’s not how the real world works most of the time. Usually, you have to take rolls of the die in a sequential order through time and then multiply them out, right? So, there’s a compounding that happens. And that changes the underlying math of everything here. So, by the way, this is what non-ergodicity is. We’ve talked about this on the show a little bit before, but you’ve probably heard the term. It’s the difference between the ensemble average, which is you and 299 of your friends rolling at the same time, and the time average, which is you throwing the die 300 times in a row by yourself.

So, the time average has compounded your wealth after each roll, and it’s much closer to how the real-world works. So, this is probably what we should really be paying attention to. If you run a Monte Carlo where you play this game 10,000 times of 300 rolls of the dice and then you look at the cloud of outcomes that come out of that 10,000 runs, what you’ll find is rather shocking. Your probability of ending up with 19,000 times your money is somewhere around a half of a percent. So, it’s like 50 out of the 10,000 rolls are what are mapped out on the paths that you take through time. Almost never do you end up with your arithmetic mean.

We have to calculate instead the geometric mean, which is a completely different math to be done. I’ll spare you some of the details, but it involves taking E to the power of a log function. But if you run the numbers in our game, the geometric average is actually minus 1.5% compound annual growth rate. So, multiply that out times 300, and you end up with ostensibly zero at that point. That’s your geometric expected outcome. So, right now, you should be fairly flabbergasted. I just showed you that a simple game where you take this average that I think most people in finance use arithmetic averages when they’re trying to figure out the world, you end up with 19,000 times your money of an expected value. But if you actually do it in reality, that median outcome from the geometric average is more like zero. So, I’m thinking of Fight Club, where it’s like I Am Jack’s Cold Sweat.

Tobias: laughs.

Jake: So, let’s change the game just a little bit to see if we can learn some things here. We’ll pretend that when you win, you win quite a bit bigger. So, it’s like Bessembinder’s idea about this small percentage of stocks that provide most of the market’s return. They’re carrying the load. We’ll call this scenario, betting for the right tail. This is going to be a good outcome. So, all the same stuff, you roll a 1, you still lose half your money. You roll 2, 3, 4, 5, you get 5% return. If you roll a 6, you get 100% return. So, you doubled that previous 50% payout, okay? And now, let’s run these scenarios. Add up all of the outcomes and divide by six and you get an 11.7% expected return per role as the arithmetic average. Multiply that times 300 rolls and you end up with a final wealth expectation of 260 trillion times your money.

Tobias: [laughs]

Jake: Okay, we’re getting into some absurd. This is ridiculous. We’re also approaching St. Petersburg paradox territory here as well, which we’ve talked about. But what about the real world of geometric returns? That actually equates to a 3.3% compound annual growth rate. So, that’s the median outcome. Kind of a quick aside. Isn’t it a little bit interesting that we had to double that big payoff to get the geometric average up to that original arithmetic average of 3.3. That’s why I picked that number. So, a 3.3 CAGR times 300 rolls gives you 17,000 times your money. Now, obviously, it’s nice to pick winners if you can figure out that skew. This is what I think a lot of people are go for. They’re looking for that upside asymmetry.

All right. Now let’s examine if were to limit the losses in a scenario that we’ll call limiting the left tail. So, in this instance, if you roll a 1, you only lose 25% of your money instead of that original 50%. So, we’re protecting more of the downside. 2, 3, 4, 5, you get your same plus 5%. And if you roll a 6, you get your same 50% from our original scenario. All right. First, the simple average. Add up all the outcomes, divide by six. That’s a 10% expected return for the arithmetic average. Multiply that out times 300 rolls and you get 2.6 trillion times your money. That’s pretty good. But notice that it’s 100 times less than what betting the right tail scenario looked like.

I think there’s a bit of fool’s gold there is what I’m trying to get at. Then in a final aha here. Let’s run the numbers and find the geometric return of limiting that left tail. It’s actually plus 5.4%. So, multiply that out by 300 rolls of the dice and you get 6.2 million times your money. So, compare that right tail ending wealth with 17,000 times, your starting point, versus 6.2 million times. We’re not even in the same universe at that point. So, hopefully, I didn’t lose you with all of these numbers. I’m going to try to summarize right here.

Using the arithmetic mean can make you feel like you’re about to win big. When in reality, you might be about to lose it all. So, you have to be very careful when applying it. And doubling the payment of the big winner, i.e., fattening the right tail outcome is helpful to the geometric average that we should care about. It really makes the arithmetic mean jump off the page, which is tricking us into thinking that there’s more going on there than really is. And in the real world, limiting the severity of the left tail outcome leads to the massively positive bet, because you don’t have to make up for those major setbacks, which also goes by this catchy name, variance strain.

So, you can start to see how incredibly dangerous it is to use the simple arithmetic averages when a geometric average is called for. You can also see how dangerous most modeling is, if you ignore the non-ergodicity of the real world. And especially, when you mix it with leverage, which is basically what happened to long-term capital. As always, we’re going to end up here. Mr. Buffett got here first, and he summarized this entire veggie segments into just six words. Rule number one, don’t lose money.

Tobias: Yeah. Well done. That was great. It’s really hard to describe non-ergodicity and ergodicity, I think. When I said that Murdoch and I, on average, are pretty wealthy.

Jake: Yes.

Tobias: That’s the idea.

Jake: Right.

Tobias: You end up at the same– You get a group of investors who invest altogether, and the average across all of the investors at the end is the arithmetic mean. But it’s geometric for each person who is involved.

Jake: Yeah. You’re going through the world is going to be an N equals 1. So, you have to worry about what potential paths are you going to take on the geometric average, not the arithmetic average.

Tobias: It’s good stuff, JT.

Jake: All right, I’m exhausted now. You guys need to talk. [laughs]

Tobias: So, the real world, because that’s come from Spitznagel, he’s clearly suggesting buy some tail insurance.

Jake: What he’s saying is that the tail risk insurance, if purchased for cheap enough, lowers that variance to the point where you don’t have to make up as much, and it allows you to stay longer in general, and it is therefore then effective risk mitigation.

Tobias: Well, cutting your downside by half puts you 100% ahead of everybody else. Every time that happens, every time you get a big drawdown.

Jake: That’s a good place to be. I think you want to be able to– The other thing too is, we’ve talked about that. Is it like Shannon’s Demon where you get to play offense as well when you have that lower downside, and especially if you had some positive outcome from it, like what theoretically, the tail risks insurance provides a big slug of capital just when markets are the cheapest at their lowest levels theoretically? It’s an interesting concept.

Tobias: It’s got a good behavioral positive to it too, which keeps you invested. If you’re inclined to take your chips out at the wrong time, as you get nervous, you want to take your chips off often, that’s the best time to be buying some more. Yeah, that’s a good one. Jon, you look at any strategies like that, any hedging or you think about that when you’re putting a position on this might do better if the world gets uglier?

Jonathan: We don’t look at, let’s say, the traditional S&P 500 gig sectors and say, we want to have X percent in technology, extra energy, financials. But I think if you buy 10 or 15 or 20 or 30 businesses, you’re diversifying yourself. The key is not taking your chips off at that worst possible time. So, you have to be able to have that mentality of being able to face a 30%, 40%, 50% drawdown. Obviously, those are very difficult to recover from, but you can given time. But if you sell your position at a 50% loss and then just walk away, you’re never going to recover from that. So, that’s why individual investors and institutional investors for the most part returns are significantly less than what they could have been, if they just kept it there.

So, to us, we might hedge by maybe keeping in a higher-than-average cash position, which you’re theoretically losing money on because you’re not investing it in the market that does better than cash over a period of time. That’s our hedge. But it’s knowing your own personal and your own client’s tolerance, because it doesn’t do anyone good. The best strategy in the world, if people abandon it after that 50% drawdown, you’re going to have a terrible result.

Tobias: Yeah, I couldn’t agree more. I found lots of people in about 2012, I met a lot of people who’d taken their money out in 2009 at the bottom and were waiting for an opportunity to get back in. It didn’t ever present, did it?

Jonathan: To me, investing slowly over time is the best way of doing it. You might not have the best absolute returns there, but it’ll be good enough. If you’re just constantly putting money into the equity market over long periods of time, you should do quite well. But you shouldn’t invest more than you’re willing to lose, and that’s not going to be able to let you sleep at night. Otherwise, you’re just going to do bad things.

Tobias: Even the pros have trouble with it. I saw the aggregated hedge fund positions over the last few days, and of course, they’re maxed out, maxed long.

Jake: Long.

Tobias: The biggest holding is Nvidia.

Jake: You’re kidding me. Jesus.

Tobias: [laughs]

Jonathan: That can go south very quickly. It’s interesting.

Jake: Hedge once.

Tobias: Texas hedge?

Jake: Yeah.

Jonathan: Do you think Nvidia is the Cisco of 1999?

Tobias: Yeah, I think that’s a good analogy.

Jake: That’s probably a likely outcome, just base rate wise. Maybe it’s a Microsoft, I don’t know.

Jonathan: So, Microsoft, then you have 10 bad years and then you– [crosstalk]

Tobias: Completely change your business model.

Jake: 14 years, you get back to even from 1999. And then from there, you win pretty good.

Jonathan: Yeah.

Tobias: But they did have to change the business model. They did have to change the subscription model and then that chart just went like that. That chart got that nice ski jump look to it.

Jake: [laughs]

Jonathan: All you needed to have was bomb relief.

Tobias: Well, I say this every time. Microsoft is brought up. I was at Value Investing Congresses in 2010 where Whitney Tilson was pitching Microsoft as the long. The argument was revenues just come back for the first time ever. Steve Ballmer is CEO, but it’s yielding 11% on a free cash flow basis. So, it’s got some hair on it, but it’s still a pretty good business. That was the pitch.

Jake: Imagine, Microsoft with hair on it as opposed to the story being global dominance.

Tobias: Just the beast.

Jake: [laughs]

Tobias: It’s just automatically printing money every month more and more, plus all the other stuff that’s got going on there.

Jake: Hell of a business.

Tobias: Yeah. I wonder if anybody held onto it from that original pitch.

Jonathan: They should send Whitney a big check.

Tobias: Yeah. I wonder if Whitney still got it.

Jonathan: It’s a wonderful, wonderful business. It’s a tough thing. What do you do with a stock that’s 30 times, 35 times earnings that’s growing, but you have to pay big capital gains, if you sell it? I don’t think Ballmer sold a share except to fund the–

Tobias: I think he’s the biggest holder. I think he’s currently the biggest shareholder.

Jonathan: Yeah.

Tobias: That’s the difficulty with something like Buffett and Coke that he had such a gigantic return. It was clearly nosebleed. I do think that your analogy for Nvidia and Cisco is a good one, because the late 2000s weren’t– It was dotcom bubble for sure, but it was also a large cap growth bubble as well. All of those names, which included stuff like Walmart–

Jake: Coke.

Tobias: Everything that was big, got super expensive through the end of 2000. I was looking in 2015 at some of those names, because the leaps were all really cheap, because they had no volatility, they hadn’t done anything for 15 years. No one was interested in them.

Jonathan: Well, maybe small caps will be the same thing then.

Tobias: Well, let’s hope. I hope so.

Jonathan: [laughs]

Tobias: I do feel like the sentiment is that is true on a sentiment basis. I think that the sentiment for value and for small and mid is a forgotten category in there as well. But I do feel like that it’s completely overlooked. I think that most people would be surprised that value has done as well as it has over the last three years. I think that when Nvidia ran from whatever it was, February to– it’s probably still going, but certainly, February to June, that made a lot of the value guys feel like they were back in Nam for a little bit. [laughs]

Jake: Lost bags.

Tobias: It does feel like we’ve recovered a little bit. The Magnificent Seven has broadened out a bit.

Jonathan: Over the last month or two, you had the regional banks do well in July after obviously a horrible start to the year. And then you had energy do well in July as well. There’s still a lot of catch up for some of these names.

Tobias: What about Intel versus AMD? You guys got any views on those?

Jonathan: I don’t have a huge– We have a little bit of Intel, but I generally stay away from the semi type of businesses. Again, cyclical businesses.

Tobias: Do you have a view, JT, on Intel? Have we discussed this previously?

Jake: Yeah, Not one I like to share– [crosstalk]

Tobias: Not well formed– [crosstalk]

Jake: It is surprising to me to– If you look at Intel’s historical, financials, God, what an amazing business. Just dominant market share, very profitable, well run, outspending in R&D by an order of magnitude or two.

Tobias: Yeah.

Jake: You would have thought if maybe it was possible for a story to be there about them coming back and the original king re-ascending to the throne here at some point. But as far as technology goes– I know that they missed a few generations of chip advancements relative to some competitors. That’s happened before, by the way, and they caught up. If I had to know where the technology was going to be right and to win, then I wouldn’t really want to be playing that game. But as far as a company that has a pedigree of being a very well-run organization and producing tremendous financials, boy, Intel, you’d be pretty hard pressed to find a better business over the last 50 years, if you looked backwards.

Tobias: Yeah. Because they were the industry leader, their software was optimized for Intel chips, and there’s some chance that’s going away.

Jake: Perhaps. Yeah, those network effects just might be-

Tobias: Just locked in.

Jake: -unwound in others. The world is dynamic.

Tobias: I think with all the geopolitical risk for the other ones that– They could have figured something out, but it’s not over yet, obviously.

Jake: Yeah, I find that national champion narrative or thesis to be compelling as well.

Tobias: Yeah. I don’t hold it. I have held it in the past. I bought some, it went down, and I sold it. So, I didn’t do very well on that one.

Jake: Was it the financials deteriorated on you?

Tobias: Yeah, it’s a quantitative consideration. It was cheap, and then it’s just deteriorated over the holding period. It’s not my capriciousness.

Jake: It wasn’t because the price went up either. [laughs]

Tobias: Yeah, that’s the nice way of getting out. Nice when that happens. It doesn’t happen often enough.

Jake: [laughs]

Tobias: So, what do we got? What’s interesting now? So, energy, you can’t touch, Jon, or you’re not going touch energy? What about financials? You try to stay away from the banks. There’s same sort of problem basically all turning on the interest rate or–?

Jonathan: We like the big money center banks. I think they have dominant franchise there specifically JP and VAC. You can check it out. We have it publicly available on our Substack page. So, we like these real estate place. The one that is controlled by Ackman. I wouldn’t be surprised if Ackman takes over the whole company at some point in time. He’s been buying up shares. He tried to do a tender, was undersubscribed, and he’s been buying in the open market basically anytime the stock hits 75. So, there’s a put there. They own valuable real estate, and master plan communities in Vegas and in Phoenix and in Texas and Hawaii. They said the sports teams are interesting to us. Another one Topgolf Callaway Brands is another one. That’s one we like a lot. You’re buying a growth story at a value price and that’s what we like to do.

Jake: Jon, do you happen to know the unit economics on a Topgolf outfit? How much does it cost to build one and what do they–?

Jonathan: There’s three different– the small, medium, and large. So, it varies, but it’s like 50% to 60% cash on cash returns on these things.

Tobias: A year?

Jonathan: I think starting year two or three, they have a partner that they develop these things with. There’s about 86 of them. They think they can get to, I think, over 200– [crosstalk]

Tobias: [crosstalk] the real estate or do they lease the real estate?

Jonathan: They have a whole-

Tobias: It depends.

Jonathan: -thing with a publicly traded REIT that they do with it. So, they put about 25% down when they open up Topgolf. They open up about 10 a year. So, they’re doing it slowly. They don’t want to franchise it within the US. They’re franchising it outside of the US. It’s going to be 50% of their EBITDA by the end of the year. You’re buying Topgolf Callaway Brands at a multiple of a golf equipment manufacturer. I think with work from home, et cetera, the renaissance of golf is going to continue. It wasn’t just a stay-at-home fad. So, that’s one worth looking at. Again, that one was also on our Substack page. If people want to take a look at it, they can just download it for free. If they have questions, just let me know.

I think Howard Hughes and Topgolf are two names that are just not well covered, well followed. I think Howard Hughes only has five sell side analysts on it. These are the obscure names that should do well over the next couple of years.

Jake: At one point, Callaway was a net-net.

Tobias: Yeah.

Jake: I remember looking at it way back in probably 2008, 2009, 2010 time frame. I was like, “Wow.”

Jonathan: When it was Ely.

Jake: Yeah, exactly. [laughs] Probably should have bought it and held– I think I did own it at one point. A little position. I probably would have been smart to have just held onto it.

Jonathan: They changed the symbols MODG now for Modern Golf. The guy, Chip Brewer, who runs it does a pretty good job. He’s been buying shares in the open market as his CFO, and the company’s been buying back shares. So, all things we like to see.

Tobias: Do you have a view on that? Just this is a little bit off topic, but that work from home, it seems to me like we’re still like 50% of where we were pre pandemic. I can’t see that going back to where it was beforehand at any point in time, which is completely culturally broken now, I think.

Jonathan: With such a low unemployment rate, it’s going to be very difficult to get workers back into the office. You get any real recession, that might switch. But I don’t think where it’s going to be for the traditional office worker Monday through Friday in an office building. I just don’t see it. Maybe I’m wrong, but I think it will be more than what it is now. But if you go, we’re in Midtown Manhattan, you go there on a Monday or a Friday, it’s a ghost town.

Tobias: Yeah.

Jonathan: Especially in the summer.

Tobias: Yeah.

Jake: [laughs]

Tobias: I find it hard to believe that people will go back to the office in force– Jamie Dimon, who manages JP Morgan, did a good job there, kept their exposure low to all of that very expensive Treasury issuance that they managed to dodge a bullet there. He seems to think everybody’s going to go back to the office. But I think officers in big trouble, if it stays at 50%, because the 50% occupancy– They’re having trouble leasing out offices, everywhere I go, everywhere I look. I pay attention to it a little bit. And then all of that office debt is held on regional banks. So, if there was anything that was going to happen, I think it’s going to be office, commercial real estate, banking, something like that, is the path to the nasty second half of the year. It depends on when it all rolls off, I guess, when those leases roll off, when the debt terms out.

Jonathan: I don’t disagree with you. It’s hard to predict these things. If you use New York as an example or San Francisco, it’s a scary– I wouldn’t want to be an office a B or a C office landlord. I think the A buildings are always going to want people for ego purposes.

Tobias: I might not get the same premium rates that they were.

Jonathan: Yeah.

Tobias: The valuations will come down a lot.

Jonathan: Yeah. No, that– [crosstalk]

Jake: I’ve been wondering if the people doing activities now in that space are actually probably maybe doing some pretty good deals, actually. Assuming you weren’t too heavily involved before, if you’re now getting involved, there might be some decent opportunities to a little bit of value there for them.

Jonathan: Or, you do conversions too.

Tobias: Yeah. Well, I was just about to say the conversions. Yeah. [crosstalk] What’s the economics on that like?

Jonathan: I’ve never done one, from what I understand. I think it depends on the building.

Jake: Strong to quite strong.

Jonathan: Yeah.

Tobias: I think the conversions are quite difficult. Amenities are completely different.

Jonathan: Yeah. It depends how the floor plates are. I think there’s a lot of different ways of doing it. But if you have someone with a long-term vision right now, and you have a lot of distressed landlords, and you can buy a whole bunch of buildings on the cheap. Assuming you have a staying power of 10 years, and you can think in that long of a time period, and assuming you don’t think New York City is going to go bust, it’s probably a good bet. There are a lot of assumptions there.

Tobias: I’m with you. I think it does work out. I think it just takes much, much longer than anybody thinks. We haven’t really even seen the nastiness come off yet. We haven’t even seen the action yet. It’s not really permeated mainstream media. I don’t think the narrative currently is we’ve dodged the recession.

Tobias and Jake: The soft landing.

Tobias: It wasn’t even a soft landing. That’s all in the past, and now it’s glorious future. I’m like, “I still want to see.” Let’s just see the data first. I don’t think we’ve got through it. I think it’s in front of us.

Jonathan: Time will tell. The move up this year has been surprising, and we’ll see what happens going forward. But I think if you can take 3 year, 5 year, 10 year view and you invest in the right area of the market, you’ll do fine.

Tobias: Yeah.

Jake: Toby, do you want to use data or do you want to make money?


Tobias: Both, ideally. I want to be right for the right reasons. Thanks so much for joining us, Jon. If folks want to get in contact with you, follow along with what you’re doing, what’s the best way to do that?

Jonathan: Two ways. Just follow us @boyarvalue or go to our Substack page, and they’ll see our stuff. If you have questions, just get in contact with us.

Jake: I’ll put in a plug too that lots of smart fund managers read your stuff.

Jonathan: Thank you. I appreciate that. I hope they enjoy and they find value in it. We have a great team of people who are just coming out with, I hope, value added, pardon the pun work.

Tobias: [laughs] Thanks so much. Thanks for joining us, everyone. We’re off next week. I’m on vacation, but then we’re back the week after that. So–

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