In their latest episode of the VALUE: After Hours Podcast, Kyler Hasson, Jake Taylor, and Tobias Carlisle discuss:
- Michael Burry’s Market Calls
- Factors Influencing The Success And Longevity Of Public Companies
- Timing The Bottom Can’t Be Done
- Why You Shouldn’t Invest In IPO’s
- How Do You Extract Cash From Google?
- Value Has Outperformed This Year
- What Does Quality Mean?
- The Narrative Around Apple Could Have Been So Much Different
- Amazon Will Yo-Yo Between Profitability & Reinvestment
- Aviation Industry At 90% Of Worldwide Flight Miles Compared To 2019
- ARKK Down 70%
- Bernanke – Do Nothing Then Write A Book Called Courage To Act
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
Tobias: Preparing to livestream. We are live. This is Value: After Hours. I am Tobias Carlisle. Joined as always, by my cohost, Jake Taylor. Our special guest for today is Kyler Hassan, [laughs] Willis Capital. How are you, Kyler? Good to see you.
Kyler: Hey, thanks for having me on. Appreciate it.
Jake: You take one week off, Tobi, and you’re rusty. [laughs]
Tobias: It’s not like I’m at the top of my game when I’m fresh– [laughs]
Tobias: How’s this market treating you, Kyler? What are you looking at? What are you thinking? What’s it look like to you?
Kyler: Yeah, maybe a little background for the listeners. I run mostly taxable California money.
Jake: It’s very taxable.
Tobias: Me too.
Kyler: Yeah, very taxable. So, I’ve always thought the best way to handle that’s, just to own stuff long-term for the taxes. So, I tend to be a quality investor. So, 2022, didn’t have such a great year. And then this year, much to my surprise, most everything has come ripping back.[laughter]
Jake: Well, thanks. But I think since the end of 2021, it’s been fine.
Tobias: Let’s talk a little bit about quality. What does quality mean to you?
What Does Quality Mean?
Kyler: Ooh, it’s a big one to start, isn’t it?
Tobias: [crosstalk] right out of the gate.
Jake: Yeah, right out.
Kyler: Yeah, right. I think there’s a couple of books on this that I’ve read but barely understood. Certainly, not enough to talk about them. I think, for me, when it comes to companies– I think there’s business quality. I have always thought it’s a little easier to identify what’s not quality than to say, “Oh, these are things that are going to be great.” I think there’s vast parts of the investing universe that is, the businesses just aren’t very good and most businesses aren’t very good. I think capitalism is pretty competitive, and dynamic, and to have a great business for a long time is really difficult.
I think businesses that make things that customers want at price points, that make sense for them, that are providing value. I know Jake talked about this in his book, and I agree with a lot of what he said. At the end of the day, you’re providing something for a customer that they want, and hopefully, your customers [laughs] are going to be there long term would be another filter for that. I think on the management side, for me, it’s always been, is it run by people that care about the shareholders? Is it run by people that know how to allocate capital? And that can look different for different businesses, but generally, I think you want them to understand those two things, and to protect the earnings power of the business long-term. I think for me, those are the big ones. And then maybe you could layer on capital structure if you want, making sure that you’re not heinously levered, if you shouldn’t be.
Tobias: Yeah. So, less a factor definition, less a QMJ, and more maybe Buffett’s definition, where you’re looking at quality of the business, quality of the management, all the way down to the product, the uniqueness of the product or the difficulty to substitute the product.
Kyler: Yeah, I think so. I think one good quick filter is just why do the customers buy it. If the answer is price, then that’s difficult. If it’s something else, then I think you’re much more likely to have a quality business there. And of course, you can have a Costco, where price is the thing or progressive maybe. Quality can exist in those, but that’s more difficult, in my opinion. But if you can get it, if you can be a low-cost provider, that can be pretty unassailable as well, obviously.
Jake: I think you can look at it still in the financials. It shows up in different places, even though it feels like a squishy term. If you look at the very top with gross margin, that reflects the quality of the internal business. Start going below that on the income statement and then I think you start to see reflections of management and how are they handling SG&A. A cash flow statement for me is largely a capital allocation exercise, like, what are they doing with the money? Then balance sheet tells you a little bit of how conservative are they relative to cash and debt and somewhat of the business as well. Some businesses require more inventory, more working capital. So, financials really do tell you a lot of what’s actually happening in the real world, if you dig into them enough.
Tobias: Let me just give a quick shoutout to all the folks who dialed in. Santa Domingo. South Kingston, Rhode Island. Helsinki. Boston. Bendigo, Victoria. What’s up? Tallahassee. Jupiter. Oslo, Norway. Braunschweig, Germany. Have I said that right? Limerick island. What’s up? Savonlinna, Finland. Helsinki. British Columbia, Canada. There’s a lake here that’s got too many letters in for me. Lake Webster Massachusetts. Norberg, Sweden. Toronto, London, Wales. What’s up? Minneapolis. Holland Park, London. Finland. France. Good for you. I think you win. Scotch Plains, New Jersey. What’s up? Thanks, everybody. It’s good to see everybody again. I had a good break. Happy to be back.
Jake: What’d you do on your break, Toby? Give us the rundown.
Tobias: Went to Tahoe, had a look at the lake.
Jake: Oh, there?
Tobias: Went to see somebody. Had another look at lake there. Yeah, it was fun. Jumped off some rocks, tried to impress my boys. They weren’t impressed at all. [crosstalk]
Kyler: Did you do any flips off the rocks or just–?
Tobias: I went to Tahoe, where I haven’t been for a long time. Last time I was there, I jumped off this rock that in my memory is way, way up in the sky. I got back in there two places to jump off, and I looked at it, I thought I must have jumped off that high one, because that low one looks way too low, but I’ll go off the low one first. I got up on the top of the lower and I was like, “No, this is where I jumped off last time. [Kyler laughs] This is a long way down.” But there were kids jumping off this. Like, I was jumping, it was like two stories or something like that, which feels a long way. But there were kids jumping off this other one. It was twice as high.
Tobias: I don’t know how that– [crosstalk]
Kyler: Look like 30ft, 40ft, that kind of thing?
Tobias: Huge. Yeah, I don’t even know. Four stories, something like that.
Tobias: It was a long way down. Like, you could count the seconds all the way down to the bottom. There were a few boys who went up, a few boys who walked.
Tobias: I didn’t try.
Jake: Well, you know about mass and gravity.
Tobias: Yeah, that’s right.
Tobias: The mass adds a lot relative to– It’s like dropping an ant down a mine shaft.
Tobias: That’s right.
Jake: It’s just going to be concussed, but– [crosstalk]
Tobias: I could have emptied that lake.
Jake: Drop a horse down and–
Kyler: [laughs] Yeah. Once you start getting above– Have you ever seen one of those like 10-meter-high dives?
Tobias: I did.
Kyler: Those things are high. Once you start getting above 20 meters, 25 meters, it gets scary quick.
Tobias: When you stand up there too, you add a bit of extra height. And you look down, it’s a long way down. Your body knows that it shouldn’t be jumping off that height. It’s very unwilling.
Jake: [laughs] Did you wuss out?
Kyler: I actually back flopped off of 25ft once. It was not a good situation. [crosstalk]
Tobias: You landed on the back?
Kyler: Yeah, like straight on my back. It was a rope swing, and there was a little rope to pull the rope in. I was pretty young, and I took too long to let go, and I let go on the way back, and my leg hit the rope, and I just fell straight on my back. As I remember, my whole back was purple. So, anyways, maybe smart.
Jake: Don’t do that one. Yeah.
Kyler: Yeah. If I did that now, I’d probably be dead. [laughs]
Jake: Would you say that that’s what your 2022 felt like?
Kyler: [laughs] Yeah. 2022, portfolio is usually made up of a bunch of relatively expensive quality names. And then some growth stocks went down 10%, I said. I haven’t really bought many growth stocks historically. Maybe I should now. And then I put some money into those and quickly got just completely demolished as I should have.
Kyler: It’s like, I made every mistake in the book style drift, FOMO. [laughs] It’s like a disaster.
Tobias: I want to know why value got punished when it didn’t participate in the run up. We all got beaten up last year too. I didn’t get the run up beforehand. Just got the-
Jake: The stick?
Tobias: -the wet newspaper afterwards. Yeah.
Kyler: How’s value done since end of the year 2021? The market’s, what, down a little? Maybe 5% or something, 10%?
Value Has Outperformed This Year
Tobias: I would say, I think slightly outperformed last year. Slightly outperformed this year and then has had a pretty good run. This is one of the things that I was going to talk about. I tweeted these out earlier today. There’s two charts. One is from Alpha Architect that tracks the cheapest EBIT/EV decile against the– Well, it’s a little bit more complicated. It’s the median in that basket against the market. That spread has been very wide. I’ve said when that spread closes, there’ll be some pretty good performance for value. It’s been reasonably good since June, and there’s been a mass, but not to the extent that has closed up. So, there’s some turnover in that value portfolio that, for whatever reason, it hasn’t been captured in the move.
Then, the other one that I thought was quite unusual too was Gotham, which is the Greenblatt Fund. They have this little webpage where they track the yield on their portfolio, and then they have a back tested forward return over two years. So, in March, it was at the 95th percentile towards cheap, and they were forecasting returns of something like 65% over the next two years, because that’s what they have done historically when it’s been that kind of range. Here we are now, we’re in the 44th percentile. So, it’s come in a very long way.
Tobias: Now it’s more expensive than average, rather than that much cheaper than average. The forward returns are less than half just. It’s like 32% forward. I felt that move. I don’t know if it performed through that period. It did a little bit, but not to the extent that seems to have come in. I find a little bit baffling. It’s hard to understand, honestly.
Kyler: Is there turnover in the underlying?
Tobias: Oh, yeah. Well, there’s reconstitution of those portfolios. Yeah, that’s what’s caused it. But I don’t know why it is that clearly what that says is that they’ve earned less, that portfolio has earned less. And now it’s looking more expensive than it has traditionally. So, I don’t know what’s driving that energy, perhaps.
Kyler: Yeah. I was going to say maybe oil prices coming down. I would assume– [crosstalk]
Tobias: Still above average.
Kyler: Yeah, that’s true. Although down from– What were they last summer? 120?
Tobias: That would explain it. That would explain a lot of that move. Are you fully invested, or do you carry cash, or are you, what do you call it, ad hoc kind of, or do you manage towards some exposure? How do you think about that?
Jake: Absolute or relative return?
Kyler: Yeah. So, I invest money for individuals. And after what, I guess, now maybe 11 years of doing that, one good lesson is everybody probably wants a little more cash out of their account than they think. And probably even more than I think, even adjusting for me knowing that. People, they want to buy a house. So, usually, I do some financial planning for people. But then the surprises are mostly, “Oh, we want to spend a little bit the of money instead of we’re going to save–” [laughs]
Jake: It’s not, “Oh, yeah, windfall. We won the lottery. Here’s a bigger chunk.”
Kyler: Yeah, exactly. Listen, I think that’s really great. And sometimes, I think it’s, “Hey, we’ve made some money and now we can afford to buy a house,” whatever it is. So, at any rate, because of that, I usually keep almost no matter what maybe 20% of people’s accounts in, I would say, bonds. But over the last 10 years, that’s been cash. And then I’ll invest the rest. Then if I can’t find stuff I like, and for what I’m going to get after tax if I sell it, sometimes I’ll trim some stuff. So, this year, some things have rallied and gotten close to where I thought they were worth. And so, I’ll trim them. Maybe I’ve done that for seven things now, and now I’m sitting on a massive pile of Treasury bills.
Jake: [laughs] Unintended.
Kyler: Yeah, unintended. And then I tell them, “Hey, this is what the stocks did, this is what everything did,” so they could see. But yeah, just as a bottom-up guy, a lot of the quality growthier stuff that I happen to like has run, and most of it, I don’t think is that cheap anymore. Actually, I can’t remember last time I’ve had so much in cash hence right now.
Jake: Just to give you an update on that. So, since January of 2021, this is price only, so we’ll leave dividends out. S&P is like plus 16%, QVAL as a representative of statistical value was 27%.
Kyler: Since when now?
Jake: January 2021.
Kyler: Oh, yeah, got it.
Tobias: S&P is plus 17%, QVAL has represented statistical values plus 27%.
Tobias: Over two and a half years, that’s pretty good. Pretty good outperformance.
Jake: It’s not bad.
Kyler: I guess, it helps when you don’t get demolished in one of those years. [laughs]
Tobias: We all pulled back a little bit last year though. It wasn’t a demolition. I don’t know what we were down– I forget now exactly, but could have been 20% plus. I think it was maybe even a little bit more than the market over that period of time.
ARKK Down 70%
Jake: ARKK just to throw a little fun on there. Minus 70% from January 2021.
Tobias: But how much from the bottom? Like, 200%, 400%?
Kyler: No, come on.
Jake: Let me see.
Kyler: So, they go like minus 85% or something, pitch to trough?
Tobias: I think minus 80%.
Jake: It was January of 2021. It was 142%. Today, it’s at 42%. I think it bottomed around 30%.
Tobias: I felt like down 80%, it was going to do that old Einhorn thing where, what do you call a market that’s down 90%. It was a market that was down 80%, and went down half.
Jake: Yeah, that cuts half.
Kyler: I think my favorite joke is basically that exact same joke. But minus 80% and then minus 100%.[laughter]
Tobias: it’s very– [crosstalk]
Kyler: Unfortunately, I’ve had, maybe not a minus 100%, but a couple close to that. It’s not the most fun.
Jake: It double down into a zero? [laughs]
Timing The Bottom Can’t Be Done
Tobias: I tried to time the bottom, like find some way of systematic way of timing the bottom. There is none. I just tell you that right now. But the thing that I always was amazed by was, even if you enter these things late, you wait until there’s a lot of a drawdown has gone by and then you get in. You still taking a 50% hit for exactly that reason that the move from 80% to 90% is a 50% hit. For someone who’s in at 80%, it’s so hard to time it and then you take such a big hit anyway. You might as well just be in the whole way through. [crosstalk]
Kyler: Yeah, I think that’s one of the issues of some people will look at some strategy or something, maybe like low-quality levered small cap value off the bottom from COVID or something like that. I’ve heard people say, “Well, it’s tripled off the bottom.” And it’s like, “Wow.” If you were in it one week before, it hasn’t tripled-[laughter]
Kyler: -you’re 150% or something, but you’re taking the bottom tick. And also, if we didn’t get rescued, it could have been different. There’s all these– [crosstalk]
Tobias: Do you feel like every single crash over the last two decades just been rescued? I feel like 2009 was the same way. It was looking really gnarly, and they just did the– Who really knows what caused it? But John Hussman says, it was they changed the accounting definition, so the banks didn’t have to mark their assets to book mark to model and all of a sudden everything took off.
Kyler: Yeah, that’s how hard– [crosstalk]
Tobias: Going to let that one– [crosstalk]
Kyler: I think this is one of those first order, second order things. I don’t want to own something if we’re going to need to change the accounting definitions for it to be saved. I want to make sure I own stuff that’s going to be fine no matter what. That being said, the job of many people in the government is to make sure that the United States economy does not turn into dust. Every time something scary happens, I think they’ll try to do that.
Again, I’m not saying in 2009 or during COVID or whatever, you should rush out and go buy the most leveraged nonsense out there, because if they don’t do it, maybe you’re dead. But I think assuming that they’re going to try to stabilize things is probably fair. Taleb, I’ve always liked his idea that the more you just try to stabilize and fix stuff, people are going to take more risk, because they think nothing too bad is going to happen. And then finally, one day, it’s going to be a doomsday. I think that’s a good argument. So, I don’t know.
Jake: It’s not like this is a science experiment where you have a control group where you could say that, “Oh, we didn’t save the banks,” let’s say. Oh, wait, hold on a second. We actually do have that. It’s called Iceland. They let their banks fail and they– [crosstalk]
Tobias: How are they doing?
Jake: They recovered faster than anybody.
Kyler: Did they?
Kyler: oh, there you go. [laughs]
Jake: But anyway, I don’t want to make it all– [crosstalk]
Bernanke – Do Nothing Then Write A Book Called Courage To Act
Tobias: We’re currently in this rate hiking cycle. Presumably, it’s twofold. It’s inflation, which, who knows– I don’t know if the measures on that are correct or not. But ostensibly, the idea is that they’re trying to break the back of inflation. And then there’s also this housing as part of that that housing is extremely expensive, taking up a large portion of– I think the current mortgages are like 40% of income, which is higher even than 2006 at the peak. And so, they’re going to start–
The idea is that they raise rates until they break something, and then the moment that the stock market basically breaks, then they start cutting rates. But I don’t know to what extent it has any impact. If you watch them cut rates when the market falls over, they cut all the way down, and then some other thing that intervenes to make it turn around. I don’t know to what extent that helps.
Jake: It is kind of fun how they frame all this stuff as if it was like Godzilla came out of the ocean and is wreaking havoc on the city.
Tobias: Debt cut rates.
Jake: Right. Guys, you kept rates at zero all the way through until very recently. I mean, what are we doing here? Why do we trust these guys to do this stuff?
Tobias: I want to know why Bernanke gets a book called The Courage to Act, and he gets the big speaking tool. Like, you just pin rates at zero. I can do that. Anybody can do that.
Tobias: It’s the raising rates that’s the hard part.
Kyler: Yeah. Well, you know what’s funny? I remember John Taylor– You guys know John Taylor, the economist.
Jake: [crosstalk] Stanford economist?
Tobias: Right? Taylor Rule. It must have been 2009, or 2010, maybe 2011. But the economy was KOed. He was trying to argue that, “Well, if you use the Taylor Rule, short rate should be at three and a half or some high number.” That was just obviously wrong at the time.
Tobias: Where were they? Zero or something close? [crosstalk]
Kyler: They were zero. Yeah, and the economy was growing 2% and it was, I don’t know, 8% or 10% below. Sorry, a big number below potential GDP. It was pretty funny, because– In the Taylor Rules, if I remember right, I read the paper one point, he just did a regression on what central banks did and said, “Oh, it should be like this.” It was funny, because I remember reading this just like, “I’m glad this guy’s not in charge,”-[laughter]
Kyler: -because to anybody paying attention– Right now, rates need to be zero. And obviously, that’s not always true. But I don’t know, it could have been worse, I suppose. [laughs]
Tobias: While we’re discussing the market a little bit– So, you’ve ad hoc raised a little bit of cash without any sort of– you’re not making any bet on what’s happening in the market. But it does seem to coincide a little bit that when value guys or quality fundamental guys, I should say, raise a little bit of cash, it does tend to be closer to the top than the bottom just by virtue of the fact that you can’t reinvest at a reasonable rate. Burry has come out with– [crosstalk]
Jake: In theory, that’s how it’s supposed to work.[laughter]
Tobias: In theory.
Kyler: God willing, Toby.
Tobias: Yeah. Inshallah. That’s right.
Jake: Is that what you told me in 2017 when I was doing the same thing, and we had three more years of ripping–?
Tobias: We can have this conversation going back to 2012, JT.
Jake: Oh, I know.
Michael Burry’s Market Calls
Tobias: It’s been the same way the whole way through. To be fair, Burry has called eight of the last two crashes, but he’s got a $1.6 billion notional, which means that his premium that he’s actually spent is, whatever, $20 million or $50 million. I don’t know how he structured it. He’s got short puts on the– Sorry, he’s got puts on the Qs, which means he’s effectively– He’s short the Qs. He thinks that NASDAQ’s going to fall over. Do you guys pay attention to that? You think he’s got anything? He’s the big short. Nobody wants that one.
Jake: I don’t know. He’s a lot more tactical than I would want to be just in the way you go through his life. He’s doing a lot of stuff, and that seems harder than trying to understand what’s a business worth and then try to pay a little less than that.
Tobias: Did he talk about using some technicals in his– He did those early posts and the bulletin boards back in the day. Was he using technicals in there?
Jake: Yeah. He said he would use it for entry and exit timing stuff.
Kyler: I didn’t know. Interesting. Yeah. Like Jake said, I think you can think stocks are a little overvalued without thinking the world’s going to blow up. I think at that time, crash protection was pretty cheap as well.
Tobias: When he put them on recently? Oh, he said June–
Tobias: I would expect that is in June.
Kyler: Yeah. Hard to say, but– Yeah, I don’t know. Who knows? Maybe he’s got some longs, and buying some protection was cheap. I feel like that’s always a possibility.
Tobias: That makes sense.
Kyler: But I’m not an option guy. When people start talking about options, I can barely follow what they’re talking about. [laughs]
Amazon Will Yo-Yo Between Profitability & Reinvestment
Tobias: Well, how about this? Somebody’s left a question under– I don’t have my– Somebody left a question under our post about Amazon. You had a throwaway tweet about Amazon, which has come back to haunt me. Do you want to contextualize that?
Kyler: Yeah. [laughs]
Tobias: Is that what’s going on?
Kyler: Couple two years or three years ago, I had never– [crosstalk]
Tobias: That is going other way. [laughs]
Kyler: Yeah. A few years ago, I had never really followed Amazon that close, because– Listen, all the reason why most people wouldn’t– I will very rarely pay more than 20 times free cash flow, 25 maybe. That’s the range. It’s never reported much in the way of profits and all this. So, a few years ago, I took a long time to really try to understand Amazon retail, because the reporting is complex and they try to hide the profitability. And so, at any rate, I got comfortable with it. One of those stocks that I bought way too early was Amazon. I forget exactly when, but it was at $2,800 or $3,000 or something like that.
Listen, I think I have an idea for what the underlying earnings power of retail should be, have an idea for what I think UWS is worth and put them together maybe just for the science projects a little bit. I thought it would be fine. So, I bought it all the way. [laughs] Then a few months ago– I’m a fundamentals guy. If it trades at what I think it’s worth, I’ll sell it or trim it. I tweeted some of the effect of in, I don’t know how long, three months, six months, a year, two years. AWS, the growth rate is going to bottom and they’re going to show some profitability in retail. Every hedge fund and quality long only is going to buy it. Every single one in the whole world.
Kyler: It was tongue in cheek, but I think it will probably happen– Even if AWS goes, now it looks like we’ve stabilized here, but I was like, “Even if it goes from 3% to 4%,” people are going to be like, “Oh, it’s going back to 20% soon enough.” So, at any rate, that started to happen a little bit. The stocks up maybe a bit since I tweeted it, but it was pretty tongue in cheek, and that’s how a lot of people invest though. So, I was not trying to say go out and buy Amazon because this is going to happen, but I hope it does. I guess, we’ll see in six months. [chuckles]
Tobias: It’s always possible. Who knows?
Jake: Yeah. All that was missing was the little Adam Sandler fun, this is how I win.
Tobias: This is how I win?
Jake and Kyler: Yeah.[laughter]
Kyler: It’s funny because I think as you sit in the markets for a while, you see the stories that investors will start to like. One of the things with Amazon is, I think the earnings power in retail is like, I’m just going to say roughly $50 billion of EBIT, whatever, $30 billion, $40 billion, $50 billion, somewhere in there. But I don’t think they’re going to show it. They’re investing a lot via the income statement more than I think [laughs] anybody that owns it would like. The people that are running that company, they actually, to me, do seem focused on the IRR of their spend. So, as I was buying it down, it was like, “Oh, retail was “unprofitable.”” I think largely due to that spend. But once they got the logistics figured out, I thought I would do a little better.
But you need to believe the management team. They’re going to say, “Hey, listen, we’re not going to just throw away $20 billion or $30 billion a year forever, if there’s no return on it.” And my guess is, with all those companies, but with Amazon too, the employees own a lot of stock. If you’ve been there for 10 years, you could own, I don’t know, maybe a million dollars of stock. One of my ideas is that, if you run that company, you generally need the stock to work to keep the talent. And so, every once in a while, you can go through historical financials and they’ll show a little leg like, “Hey, this is what we could earn.”
Jake: [laughs] Right.
Kyler: I think what’s probably going to happen is, and I don’t know who knows the timing, but I would think that they’re going to show some profitability and they’re going to say, “Okay, now we’re going to ramp up the investment again,” and then they’re not going to show it anymore. I feel like it’s going to kind of yo-yo.
Tobias: [crosstalk] That was Bezos’ philosophy, wasn’t it, that he would mostly just keep on reinvesting and not show a great deal of profitability. But he stepped back. At least externally, it looks like he’s stepped back. Is he gone for good or do you think he’s just waiting for the–? Or, he’s monitoring the situation as long as it’s running to his satisfaction, then?
Jake: From the yacht.
Kyler: Yeah, it’s a good question. I don’t know. I’m actually not sure. I don’t know. Maybe some people do. It’s funny. Jassy caught a lot of flak because he became CEO [laughs] and the stock went down, I don’t know, by half pretty much immediately. It was funny because the retail profitability issues were basically, their business doubled over a couple of years. Sorry, the retail business. They had two options. One was, oh, let’s be really careful to try to match supply to demand. And two was, we don’t really know what’s going to happen. We need to try to put on as much supply as we can. If you choose the first one, you get it wrong, your customer goodwill that you built up for 25 years can go away quickly.
So, I thought it made sense what they did, but then we have a couple of years of extra costs on the back end. I don’t think that’s the biggest deal in the world long-term. But Jassy becomes CEO pretty immediately, retail is losing money and AWS growth is slowing, which I think they would try to help customers out and get their bills looking a little bit better. And so, it’s funny because I didn’t really dislike anything he was doing. The results were downstream of what they decided a year or two before. And then it’s coming out in the Wall Street Journal. He’s got an eye on some of those science projects and taken out some cost, which I think did make sense. So, my hope is, we’ll never have to find out if Bezos wants to come back, if the ship is sinking, because it runs great. [laughs]
The Narrative Around Apple Could Have Been So Much Different
Tobias: A little bit like Apple with Tim Cook stepping in that– A lot of the real innovation where genuine, just out-of-the-clear-blue-sky innovation with an iPod, I guess, and then the iPad and then whatever else has come on after that. Instead, it’s Tim Cook, who’s basically– He’s a supply chain manufacturing kind of guy. And then that seems to have been what Apple needed at that time to take off to the stratosphere. That’s what attracted Buffett ultimately, I think, and that’s worked out really well.
Kyler: If that transition happened, I don’t know, five years before, it could have been an issue. But it seemed like they built up so much goodwill and brand power that it was okay. It would have been an interesting experiment to me. I don’t know what you guys think of, if it was five years before and Tim Cook was CEO, if it would have worked out the same. I don’t know.
Jake: I’d be really curious just to see, if you stripped the market out– Let’s say that there was only a quote in 2015, and then there was another quote today. All you got to see were the fundamental, like, what do the income statement look like? What does the balance sheet look like? Share count? What would the narrative be of that business at that point? Because I think a lot of the narrative has been positive, because it’s something that’s worked really well. I don’t know, it’s always interesting to see how– [crosstalk]
Tobias: Are you talking about Apple?
Jake: Yeah. Of course, there’s reflexivity with that as well, where the stock’s working and the employees are happy, they do better work. Maybe people buy more. They go buy an Apple Watch because they did well on their stock. There’s all kinds of stuff that’s knock on effects, but it’s always an interesting example to think about. If the stock was in the crapper and you had these same fundamental results, what would the stories be about the people who were running it?
Tobias: Well, it had a big buyback. So, to some extent they’ve controlled that a little bit because they’ve been hoovering up stock the whole way through.
Kyler: Yeah. That’s– Sorry. Go ahead.
Tobias: I was just going to say it was a little bit against their will initially, because they had all the money, and that was what attracted Icahn and Einhorn whenever that was 2015 or 2014.
How Do You Extract Cash From Google?
Kyler: Yeah, that’s a really interesting case. I’m sure you guys have seen some people will compare Google’s valuation to Cokes, because it’s like so down. Well, Staples trade the way they do. Cokes may be a good example. The free cash yields, let’s call it just about what the dividend yield is. Yields three or a little more. You can be pretty sure that long-term, they’re going to grow their earnings around inflation or maybe a little more, and you’re going to get all the money. Like, whatever money they produce, that truly should go to the owner’s will. It’s just they’ve always allocated capital that way. And so, what is that worth if you can be pretty sure earnings are going to grow out inflation or a little more?
Yeah, 3% yield. That seems pretty reasonable. Google, which I do own, but I’m not like, “Oh, there’s no risk here.” It’s not like Coke– Technology can change in a bunch of different ways. And so, at any rate, I don’t think it should get a stable valuation. It doesn’t, which is fine. But it’s interesting because Apple does. I think that’s, like you said, from 2015 to now or whenever it bottomed, I don’t quite really remember.
It went from a tech stock and now people are like, “Oh, it’s a staple stock.” They pay you all the money and they’re whittling down the cash pal to see as I would argue, as they should. And people are like, “Well, the brand power is so high. It’s kind of a staple, and people are just going to keep buying iPhones.” It was really interesting to see the transition I thought– I wish I’d owned it, but I thought to see the transition from like– [crosstalk]
Jake: Multiple chains.
Kyler: Yeah, it’s a hardware company, and there’s terminal value risk, and they have $150 billion of cash for no reason to, “Oh, there’s no terminal value risk,” which maybe is true and maybe isn’t, but it’s going to grow a little bit and pay us all the money. We think that’s worth 30 times earnings. I not judging, but it was certainly interesting to watch and I think highlights why– [crosstalk]
Jake: Ben Graham had this thought experiment that he pulled out, I think, on the Buffett group that they used to or whenever they would get together. And so, he asked them, “Assume that you have this box. It’s a clear box, and you could see that it’s creating money inside of it. But there’s no way that you know of to get the money out of that box. How much would you pay for that box?” I think that this exercise actually describes a lot of potential investments in the world of, “Well, I don’t know how I’m ever going to get the cash out of that box.” But people are willing to pay sometimes extreme amounts for if they think that box is producing a lot of cash inside of it relative to other one, maybe– [crosstalk]
Tobias: That’s Google.
Jake: Well, yeah, maybe. That might be a good example of one of those like, “Well, how’s the cash exactly coming out of here?” Of course, they’ve been doing more buybacks. But yeah, it’s an interesting thought experiment to think about– If the value of any security or anything really is the amount of cash that you can get as the owner, what if you can’t get that cash is it still worth something if it’s being created inside of this box?
Kyler: Yeah, I think it’s a really interesting question. Actually, Berkshire, I believe personally, some people might not, but I think it’s a good example of that. If you look at how a lot of people value Berkshire, they say, “Well, it’s got all this excess cash,” and they do the investments per share thing, and they just add that up in the earnings. I’m like, “I don’t think that’s the right way to do it.” They run very conservatively. If you look back over, I think, since 2000, and you take the cash and the fixed income and the bonds, it depends how you want to treat the pref, but I’ll say that’s also fixed income that they’ve owned historically, it’s more or less always added up to the float, right?
So, if you look at the balance sheet, you’ve got, effectively, the shareholders equity and the float and the shareholders equity has been invested in stocks and businesses and productive assets, and the float has been invested in, let’s just simply say, cash. So, what’s that worth? For me, it’s worth what I expect. The after-tax interest income on the cash, they hold us. So, if it’s whatever it is today, I don’t know, $145 billion or $150 billion or something. I think through the cycle, it’ll yield three after-tax, I say, well, it’s worth $4.5 billion times, whatever you think it’s going to grow a little. Then you put whatever the multiple is. But people are like, “Oh, well, he’s going to go out and buy a business.” I don’t think so.
I don’t think you’re going to have a situation where there’s $150 billion afloat and there’s $60 billion of cash and fixed income because he bought some big business. I personally don’t think it’s going to happen. It could be wrong. But that’s the question is, if it’s not going to come back to you, then it’s worth the cash that it produces, which is probably going to be lower.
Factors Influencing The Success And Longevity Of Public Companies
Tobias: JT, do you want to do your veggies before we run out of time?
Jake: [laughs] So, this is from Michael Mauboussin’s most recent whitepaper, which is called Birth, Death, and Wealth Creation. And effectively, this is an actuarial treatment of public companies. So, there’s some interesting numbers that fall out of this, and I will share with you, so you don’t have to read it if you don’t want to. So, of the firms in the US with 20 or more employees, only 1% of them are public. But they’re the biggest and most important. The combined sales of the top 100 public companies are seven times those of the top 100 private companies in 2021. So, while it is a minority of companies, it is the most important tend to be in the public sphere.
Now, what’s weird is that there’s nearly 3,100 more listed companies in the US at the peak in 1996 compared to today. So, there’s way less public companies than there used to be. So, there have been different periods of time where there have been booms and bust in company births. When we say birth, it doesn’t mean the founding of a company. It means like a company going public. So, you have different periods of IPOs when they were popular. For instance, 1969 alone, 780 IPOs, which is, that’s actually 18% of the total of public companies today. So, it’s a huge. There are only 39 IPOs last year.
In 2005 to 2007, there were 124 SPACs, which is another way that companies can be “born.” 861 in 2020 and 2021, which was actually two-thirds of the total ever issued occurred in those two years. But already 209 of the 613 SPACs from 2021 have already been liquidated. So, that gives you a little sense. So, there’s actually a lot less IPOs that are happening, and a lot of it has to do with the cost of regulation, like, regulatory requirements of Sarbanes–Oxley, loss of confidentiality, potentially media scrutiny, IR hassles, there’s a lot of reasons to not be a public company, actually. But on the plus side, you get liquidity for your stock-based compensation, potentially. Maybe cheaper access to capital. That might be one of the reasons why there’s less public companies today is that there’s more private financing available, just in general for all companies. So, it’s made going public less necessary than it used to be.
Also, what’s happening is that smaller businesses are finding it probably increasingly attractive to sell themselves to bigger businesses as opposed to IPOing and going through all of that hassle. So, in general, you just end up with less companies that are out there. Companies are also waiting a lot longer to go public. So, 1976 to 2000, the median age was 7.9 years. Since 2000 to today, it’s nine and a half years. So, companies are older. They’re also bigger. So, you compare Amazon’s IPO was $750 million at launch when it went public in 1997, and it’s $1.4 trillion recently. It was only three years old when it went IPO. So, essentially, all of the wealth creation that occurred for Amazon has happened as a public company. Compare that to Meta, whose market cap was $133 billion when it went public in 2012-
Jake: -eight years after its founding. And now it’s at, I don’t know, let’s call it like $770 billion. So, basically, an entire 20% of the company’s wealth had occurred as it was a private company before it went public. There’s other examples that are even more extreme of most of the wealth being created as a private company, and then going public, and then there’s just not as much meat left on the bone. How about longevity? Public companies have a half-life of about 10 years. So, for every having of population, it’s about 10 years’ worth. So, the average company in the S&P 500, the average age was 12 years in 1996. Today, it’s 20 years. And the average market cap in 1996 was $21 billion. And today, it’s $78 billion. So, they’re older and they’re bigger today.
Tobias: What index was that? Sorry?
Jake: S&P 500. And so, how does a company get out of the population? This is like “death.” So, you have mergers and acquisitions, which actually explains more than half of how the companies are disappearing out of public domain. You have also the private takeouts. This is just happening a lot more than it used to. I think everyone knows, maybe at this point, you want to be the one who’s typically you want to be the one who was acquired, not the acquiree. The median premium is 29% for the person who’s acquired, and the average is closer to 45%. And then of course, you can also have a delisting for cause, which is bankruptcy or failing to meet exchange requirements. That’s about 39% of the “deaths.”
Tobias: I’m surprised that it’s as many as that. That’s a lot.
Jake: Yeah, it is. I think there’s a lot of microcaps and stuff that happens to a little bit more regularly. I don’t know guys ever seen this before, but the New York Stock Exchange requires a stock to sustain a price of at least one dollar, have 400 or more shareholders, and maintain a market capitalization of no less than $15 million. So, I’ve never seen those numbers before, but that’s little trivia for you. And then there’s 2% of the companies that just delist voluntarily, because they decide it’s too expensive to stay public or whatever. And microcaps have been the source of most of this extinction. So, in 1996, microcaps were 56% of the total companies that were public. Today, it’s down to 33%.
Next thing to talk about is like hot versus cold markets. So, in hot markets, there tends to be a high volume of deals. There’s big gains on the first day of trading. So, you think like, in 1999, 476 IPOs. The average return on the first day was 57%.
Kyler: Oh. [laughs]
Jake: I know. It’s crazy, huh? And then another 380 in 2000 with a return of 45% on the first day.
Jake: Compare that to cold, which was no surprise, 2001, the next year, 80 IPOs, average gain of 8%. And then only 66 IPOs in 2002, average return of 5%. So, also, this probably shouldn’t be a big surprise, but the delisting rate is much higher for companies that come public in a hot market than during a cold market. So, one study found that 41% of the companies that listed in a hot market had delisted within five years. [chuckles] So, maybe you’re winning early in this hot market, but it might come back to bite you, which is what we would expect right?
Tobias: [crosstalk] Trading in sardines.
Jake: A little bit, right? So, let’s see. Of course, we should talk about this Hendrik Bessembinder study, where he studied 28,000 public companies since 1996, and he defined wealth creation as anything that was over one month T bill results. 60% of the sample of his 28,000 destroyed $9.1 trillion in value. And then the other 40% created $64 trillion in value. So, you end up of the net $55 trillion that was created, $50 trillion was attributed just to 2% of that sample. So, we have a very power law distributed outcomes here. And the top three, which were Apple, Microsoft, and ExxonMobil, added $6 trillion all by themselves, which was 12% of that total. So, just three companies did 12% of the work.
So, what about outside of the US? Similar results were found in other studies. But of course, it’s not an easy ride for these huge wealth creation vehicles. Apple had three drawdowns over 70% over the course of that time period. Amazon was down 91% in the dotcom bust. So, good luck being able to ride in the entirety of one of these things if you can find it. Now, interestingly enough, there’s a little bit of recency bias, probably for a lot of us. It’s not just big tech companies that are in this. In fact, they’re actually underrepresented in the top wealth creation population and overrepresented were healthcare and energy, which might surprise people.
Of course, there’s financial metrics that they found that correlated with this wealth outcome creation. It’d be what you’d expect, right? Increases in net income, internally generated assets and sales growth, rising return on assets above average R&D spend, which is actually maybe a little surprising, and then cash accumulation. So, you have a business that’s working, you’re reinvesting in it, growing the base.
Why You Shouldn’t Invest In IPO’s
Jake: There was actually a pretty clever study that was done of 16,000 US firms since 1975. What they did was they calculated the lifetime earnings and then compared that back to the IPO price.
So, this really is like that box of cash calculation, but run in reverse looking backwards like, how much earnings were there for the entirety of this company, and then what did it IPO at? How reasonably efficient is the market at ascertaining what’s it worth on day one versus the lifetime? They found that the two-thirds of the companies failed to generate sufficient earnings to justify day one stock price.
Jake: Well, they did discount. Yeah.
Kyler: Oh, okay. Yeah. Sorry, go ahead.
Jake: So, as Buffett has always warned, you got to be really, really careful with IPOs because naturally you’re at an informational disadvantage compared to the person who’s selling, which is typically the founders who know what’s going on, they know where the bodies are.
Tobias: Private equity VCs.
Jake: Totally. So, yeah, those are some stats for you to chew on for– [crosstalk]
Tobias: Priors confirmed. Good.
Jake: Yeah, all priors confirmed.[laughter]
Kyler: Yeah, those are wild stats. I’ve always found it interesting that those statistics of 60% of the companies underperform T bills. Does that change how you invest? I’ve always found it’s hard to have too many conclusions from that.
Tobias: That was from IPO though, right?
Jake: Well, this is Bessembinder study of starting in whatever, 19– What did he– He did like that [crosstalk] onward.
Tobias: I thought there was some criticism of Bessembinder’s study.
Jake: There has been.
Tobias: [crosstalk] what it is.
Jake: I’m not smart enough to tell you exactly the ins and outs of it.
Tobias: I would say that it’s probably pretty good advice not to buy IPOs that’s probably– unless you have some–
Jake: I think [crosstalk] base rate, it’s probably not the best place to be fishing.
Tobias: Yeah. And then probably seasoned companies are a little bit better where they’ve actually shown an ability or in the very near future ability to generate some free cash flow, and then you need a management team– One of the things you said right at the start, Kyler, about being a negative process where you’re just excluding things that don’t meet particular criteria, that’s got to be the most efficient way of doing it. You just eliminate vast swathes of the market doing stuff like that.
Kyler: Yeah. I don’t think I’ve ever bought an IPO or close. I guess, I did one SPAC, and it turned out probably about how it should have, which was [Jake laughs] a 0% return through its buyout. I thought that was a real business, at least. Yeah, you know it’s funny. You probably shouldn’t be out buying stocks when it’s one of those hot IPO markets.
Kyler: I have a similar one now, which I think I’ve just realized, which is, when you see high yield issuance start to rip, like, same idea. You just got to be careful. A lot of my holdings, I get the lead mail alerts when they have an SEC filing. When TransDigm out in the debt markets, you shouldn’t be buying anything.[laughter]
Kyler: Put it all away. Just wait they issued some debt, maybe it was a week or two ago, high sixes. I was like, “Oh, okay. If they’re issuing debt voluntarily, markets are probably a little hot.” Anyways.
Jake: Yeah. What’s the earnings yield on TransDigm right now?
Aviation Industry At 90% Of Worldwide Flight Miles Compared To 2019
Kyler: That’s a complex one, because you’ve got the Aero markets– This year, we should be a little less than 90% of worldwide flight miles compared to 2019. So, usually, you grow 4% or 5% a year. Sorry, the worldwide RPMs, they’re called revenue passenger miles. They grow 4% or 5% a year most years. So, if we had normal trend growth off 2019, you should be, what, I don’t know, 15%, 20% above that level. And we’re at 90%. So, it depends on what you think the full recovery is. My guess, is if we didn’t get all the way back up, their EBITDA dollars would be maybe low $4 billion and 15X, 16X, maybe 16X that number, which– Yeah.
Jake: So you’re roughly in line with the debt guys on yield.
Kyler: Yeah, that’s about the right way to look at it.
Jake: Even though they’re in front of the line in front of you. [laughs]
Kyler: Well, hopefully, the EBITDA dollars are going to grow over the time.
Jake: Right. They [crosstalk]
Kyler: Yeah. 15X, if you waterfall it down, it is like 20X free cash flow. Sorry, 15X EBITDA is like 20X free cash flow, roughly unlevered. So, that’s always seemed like a reasonable place to trade to me. If it gets much below that, I think it’s cheap. But yeah, listen, how should I say, my clients and I own less of that than we did nine months ago. [laughs] I’ll say that.
Tobias: So, the revenue passenger miles as the metric that you track, and that’s still at 90%– It’s 90% pre-COVID. That’s funny, because I got some of the statistics that I have seen. I’m not disputing that that is correct. I’m just trying to square it with the statistics that I’ve seen, because I thought that a lot of the passenger miles were back above where they– I thought we’d found this new high– How do you reconcile those two? Do you know what I’m talking about? Have you seen them–? [crosstalk]
Kyler: Yeah. So, I think US, we’re above– [crosstalk]
Tobias: It’s just US. Okay.
Kyler: Like US domestic. But there’s some places that are above. There’s also International hasn’t quite recovered yet, and there’s generally bigger planes, more seats. It was actually funny. A family friend is the COO of a big international airport, and he just told me a few weeks ago, he’s like, “Beginning of the year, I had budgeted zero Chinese travelers. Literally zero.” And he was like, “And now we are–” I don’t think they’re quite back to pre-COVID levels, but it’s getting close.
Jake: They are larger at the back. Huh.
Kyler: Yeah. So, that’s been basically China reopened– That’s another every single hedge fund was like, “Oh, TransDigm is like the most levered the aftermarket growth, operationally and financially. So, we better go by that.” It just went vertical. Maybe ignoring the long-term earnings power a little bit, maybe not, but maybe. [laughs] Anyways.
Tobias: It’s funny. Every time I fly, which is only domestically. Although I did fly internationally, at the end of the year, everything was full. My international flight, which was to Australia was full. Domestically, everything I’ve flown has been full. It feels like we’re back. [crosstalk] so back.
Kyler: Yeah. I swear, like, once a week– [crosstalk] Yeah, I think like once a week, there’s an article in the Journal that it’s some bottleneck, because employment throughout the whole aerospace chain went down so much. It’s like, “Oh, we don’t have enough flight attendants.” And then the next week, it’s like, “We don’t have enough air traffic controllers.” I think it will likely maybe take a little while to get back to full capacity and growing, if the demand is there, which that’s another argument.
Tobias: It’s all interesting. That’s great having you on the show, Kyler. If folks want to get in contact with you or follow along with what you’re doing, what’s the best way to do that?
Kyler: Probably direct message to @willis_cap, that’s me, would be the best way to get in touch.
Jake: How are people going to know it’s you when you got those glasses on in your– [crosstalk]
Kyler: I changed it.
Jake: Oh, you are.
Kyler: Well, actually, I need to change it again because I changed it to the AmSafe seatbelt, which is the TransDigm part, is my new picture. But now with the stock where it is, I think I need something new, because–
Jake: You need some other dog in there now? [laughs]
Kyler: Yeah, full valuation. So, maybe time to change it up.
Tobias: Yeah, that’s right.
Jake: I like the glasses. That one always makes me laugh.
Kyler: Yeah, it could go. [crosstalk]
Tobias: I thought it was the Zorro mask like glasses.
Kyler: It was a disguise, but was funny because at the time, I wore glasses in real life.
Tobias: What did you get kicked off for, can you say, you don’t want to say that publicly.
Kyler: I think it was going to better to be anonymous.[laughter]
Kyler: It wasn’t kicked off or anything.
Tobias: Oh, you weren’t kicked off. Okay.
Kyler: Yeah. Some of the rules need to follow. [laughs]
Jake: Did you [crosstalk] fight Elon?
Tobias: JT, what’s Journalytic? You want to give a Journalytic plug before we hang up?
Jake: Oh, this is my software project that everybody already knows about at this point. But we’re still building even though it looks quiet from the outside, but we’re feverishly still building features and all kinds of stuff that hopefully, we’re leading towards an investment operating system that will be a pretty big game changer eventually, if we can get it built. So, yeah, it’s exciting. Stay tuned.
Tobias: Love it. Thanks, Kyler Hasson, Willis Cap and JT, as always. Folks, we’ll be back next week. We’ll see everybody then.
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