In their latest episode of the VALUE: After Hours Podcast Jake Taylor, Tobias Carlisle, and Steve Clapham discuss:
- Should You Invest in Microsoft or Google’s AI Race?
- Is Amazon’s Labor Intensity A Ticking Time Bomb in an Inflationary World?
- Charlie Munger’s 3 Rules for Career Satisfaction
- Tesla’s Accounting Inconsistencies and Management Turnover
- What Makes Alibaba Incredibly Difficult To Analyse
- ARKK Valuation Wildly Misleading
- From Ferrari to Wine: The Luxury Market Boom
- Audit Reports: The Secret Weapon Investors Are Ignoring
- Red Flags for Investors: Contingencies, Commitments, and Related Party Transactions
- Will Electric Ferraris Still Command the Same Premium?
- The Hidden Cost of New Technology: My Tesla Leasing Experience
- Vale Charlie Munger
- From Humble Beginnings to Mayfair: Bremont Watch Company’s Remarkable Journey
- Australia: Housing Market Bubble Ready to Burst
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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Transcript
Tobias: And we are [pauses] live.
Jake: [chuckles]
Tobias: This is Value: After Hours. I am Tobias Carlisle, joined, as always, by my cohost, Jake Taylor. Our special guest today is Steve Clapham. He’s Behind The Balance Sheet, forensic analyst, accountant analyst. How are you, Steve?
Steve: I’m very, very well. It’s probably a bit colder here in London than it is where you are, but I actually quite like the change of weather. I don’t know that I could cope with a very temperate climate all year round, but– [crosstalk]
Tobias: It’s warm in California.
Jake: It’s hell, Steve. It’s 62 degrees. I don’t know how people–
Tobias: 72 degrees around.
Jake: I don’t know how people do it. [laughs]
Steve: There’s quite a bit of snow here. Not in London, but we’re just getting ourselves geared up. I’m excited to be here. I know-
Tobias: We’ve got Christmas.
Steve: -it’s quite dangerous to do this live. [crosstalk]
Tobias: It is. Yeah.
Jake: Yeah. No safety net.
Tobias: What do you got there? You got a white wine, you got a Chardy or what do you–?
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From Ferrari to Wine: The Luxury Market Boom
Steve: Actually, I didn’t realize we were going to be doing the wine tasting. I brought the bottle. This is a South African Chenin Blanc from Oldenburg Estates, which, being a value investor, I apply this to my entire life. And wine, one of my friends said the reason to know about wine isn’t so you can be all posh and sniff it and do all that. The reason to know about wine is so you can buy a $20 bottle for $10. And that’s exactly what I do.
Tobias: Wonderful drinking at a fair price.
Jake: [laughs]
Steve: Yeah. Well, I think– First of all, the most important thing about wine is it’s been an incredibly good investment. So I was very fortunate to get my first really big bonuses as a hedge fund in a year, which was a cracker for, both Bordeaux and Burgundy. So I went out and I spent a fortune buying this wine. It’s given me two benefits. One, now that I’m poorer, I’m able to drink it and sell it because it’s gone up. Some of the bottles have gone up so much. I bought a cheap, cheap bottle case of drinking wine. £10 a Bottled-in-Bond. It’s now a £100, 10-bagger.
Tobias: Wow.
Jake: 10-bagger wine. How’s that?
Steve: It was quite cheap. It wasn’t picked by me. It was picked by an expert. I’ve sold probably 50% of the wine I bought and it’s funded a lot of other purchases.
Tobias: Why do you think there’s been such unusually good performance? Is it unusually good performance or why do you think there’s been such good performance out of things like wine and art and other things like that?
Steve: Well, I think there’s a combination of things. I think I’ve been lucky in that. I was very well advised. I like to drink it, but I’m by no means an expert. But I took good advice when I was buying it. In the same way in the stock market, stock market can go up and you can buy the wrong stock. So you need to know what you’re doing.
Secondly, there have been just a huge increase in interest. The Chinese have been buying vast quantities of wine. The prices in Hong Kong are a premium for some wines. So if you’ve got the right name– Wine has just become one of these every luxury good. If you go back a decade or 15 years, a Ferrari here was £100,000. It’s now £250,000. And every luxury good has gone up a lot, which is why Hermès, LVMH, Ferrari, why these stocks have done so well, because there’s a lot more people with more money and they’re prepared to pay more for those goods that are in restricted supply. And fine wine is in restricted supply.
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Will Electric Ferraris Still Command the Same Premium?
Tobias: You’re not a luxury goods expert though. You’re a forensic– Let’s talk a little bit about your approach to investment.
Steve: What makes you think I’m not a luxury goods expert?
[laughter]Tobias: Maybe you are.
Steve: I have a wife.
Jake: Yeah, there you go.
Steve: She is very good at luxury goods. No, I’ve been actually taking more of an interest in luxury products. I wrote a piece about Ferrari versus LVMH, which I actually want to revisit because I was quite surprised. Everybody’s terribly enthusiastic about Ferrari. I had been as well. I’d recommended a Ferrari long versus an Aston Martin short. You remember, Aston Martin came to the stock market, they didn’t raise any money. It was quite weird because the company had a current ratio of under one. It didn’t disclose its customer deposits, which is always–
When companies don’t tell you something that you think is quite important, it’s always quite unusual. You could see from the cash balances, they got quite a lot of cash, but it wasn’t in sterling. They had a lot of cash in renmembi and dollars. You think, “Well, why would they have cash in renmembi?” I think the reason was that it was customer deposits. They developed this Formula 1 car for the road called the Valkyrie, which was a £2.5 million car. So, what’s that today? It’s $3.25 million, say. But to buy one, you had to put a million-pound deposit down, and they were building 250 of them. And I thought, “Well, maybe they’d taken deposits on 100, or maybe they’d taken deposits on 200. They didn’t disclose the customer deposits.
But of course, what was fairly obvious was that once they started shipping the Valkyrie, unless they had another Valkyrie Mark II, an even better, even faster, even rarer guaranteed to go up version, then people were going to take delivery and their working capital was going to mushroom because they would lose all that customer deposits. And the mistake they made, the owners of the company made, the private equity owners, was that they were treating those customer deposits as permanent capital. And guess what? Customer deposits aren’t permanent.
Tesla uses customer deposits very, very significant amount. And if you buy a Tesla very unusually, I don’t know, if it’s the same in the United States, but in the UK, you have to pay for it a week in advance. I’ve only bought a new car a few times in my life. But normally you go into the showroom with a banker’s draft or you do a wire transfer on the day. But the Tesla, you’ve got to pay for it a week in advance. So, they’ve got that float, which mean really, really valuable for them.
But of course, they may find that more difficult, I think, going forward. I don’t really know. So I’d written about Ferrari because it was the same valuation as LVMH, and I said, “Well, hang on a second. Why do people buy Ferrari?” Well, so they can go into the bar and leave their car keys and look flash, and so they can drive down the road and look better than they are.
But Ferrari is an enthusiast car. I know there are a lot of wealthy people that aren’t enthusiasts that like to drive them. But the core, it’s the formula one heritage, and it’s the ability to take the car on the racetrack or take it down the road and drive it flat out. And people love Ferraris because they go like hell, they look beautiful, and they make the most marvelous noise, make just a fantastic noise. So, if you surveyed owners about why do you own a Ferrari, noise would be very, very high up in the list. I said, “Well, who knows what people are going to be looking at when they drive electric cars?”
You drive a Tesla today, it’s actually the differential between a Tesla and an internal combustion Ferrari is not that great, because the Tesla can be very, very quick. Because the center of gravity is so low, it’s got very phenomenal road holding. So, the difference between an electric Ferrari and an electric Tesla is going to be much, much narrower. Okay, they’re very beautiful cars. They’ve got the brand. I’m not debating that. But I just thought LVMH, people aren’t going to stop buying Louis Vuitton luggage or the stable of brands that they’ve got. They tend to be repeatable purchases. There’s no existential risk.
Now, I’m not saying that Ferrari will be out of business in 2035. I’m sure they’ll do a very good job. They’ll bring out a very good electric car. But will it be able to command the same pricing premium versus its peers is a very difficult question to answer? I don’t like that risk. I’m going to revisit that. I’m certainly not an expert in luxury products, but I’ve been looking at them more closely.
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From Humble Beginnings to Mayfair: Bremont Watch Company’s Remarkable Journey
Tobias: What do you think about the idea that–? We’ve seen a little bit of that in watches, where the brands in watches have been known for that incredible craftsmanship in a fairly complex mechanism in the back, and there’s now transition to everybody has a phone on their wrist, essentially. That really hasn’t affected the very high end watches. But any of that stuff that’s in the secondary, like Fossil or those kind of watches, the stock’s been absolutely smashed there for years.
Steve: I’m not familiar with Fossil as a stock, but quite interesting. So Bill Ackman has taken a stake in Bremont. So, there’s a British watch manufacturer which was started by two brothers. Really interesting story. So, they sponsor another podcast where I’m friendly with the guys that produce the podcast. They invited me along. They did an evening for their corporate partners and friends of the podcast at Bremont’s showroom in Mayfair in London, just off of Mount Street. I like to go along to these free evenings where you get [Jake chuckles] free glass of champagne and mix with potential customers. It was actually a very good night. I sold two courses to institutional investors that were there. So that’s my idea of a successful evening.
But it was actually a very funny situation because Giles, one of the two brothers who fronts the marketing did a presentation about how he’d started it. It’s quite an astonishing achievement to start a company making watches in the UK. It wasn’t like he’d done this before. It was a really remarkable achievement. And I said to him, I said, “How do you price it? How much of a discount do you have against the established brands?” And he just went, “Discount? We do not use that word.”
Tobias: [laughs]
Steve: Really very, very funny guy. Somebody heard me asking the question, said, “You’re Steve Clapham.” Because he recognized my voice from my podcast, which is quite funny.
Tobias: [laughs]
Steve: But the fact that Bill Ackman’s bought into this brand– This isn’t like a high, high-level brand. This is a sort of watch that we would buy. It’s a £3,000 watch if you wanted to– [crosstalk]
Tobias: Too rich for my birthday.
Jake: Yeah. [laughs]
Tobias: On deep value.
Steve: If you had a really good week in the market and it was your birthday and it was a big number change and you thought, “I’d really like a new watch,” it’s the watch that you wouldn’t go out and buy it. Bill Ackman went into the showroom and bought five and then bought half the company. But it isn’t a five-figure watch. What’s the most you’ve spent in a watch, Tobias?
Tobias: I don’t wear one.
Steve: Oh, you don’t wear one. Okay. Jake, how much have you spent in a watch?
Jake: Whatever. $400 for the Apple Watch.
Steve: All right. Okay. So, I’m wearing an old tag, which I’ve just paid a lot of money to have repaired. It didn’t cost me very much at the time. I think it cost me more to have it refurbished than it cost to buy it. But a £3,000 watch, it’s not a luxury, luxury product. It’s a mid-range luxury product. There seems to be plenty of people that are prepared to treat themselves to those sorts of things.
At the top end, there are so few of these really rare watches made and there’s so many people that want to sport how much they’re worth on their wrist that I don’t see a huge amount of risk in that market. Obviously, I’m not familiar with the individual brands. But Rolex have done an amazing job, if you think about the way they protected their brand. Just an amazing job.
Tobias: You can track those secondary prices for Rolex’s. They track those prices and that seems like a pretty good proxy for how people are feeling at the top end of town. They’ve come off a fair bit.
Jake: Oh, yeah. How bowled up they are, shows up in Rolex prices.
Tobias: Yeah. I don’t know when they peaked, but it’s probably along with– [crosstalk]
Jake: 21. [laughs]
Tobias: Every other asset price. Yeah, something like that. [crosstalk]
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Should You Invest in Microsoft or Google’s AI Race?
Steve: Not every other asset price. Euro stock market seems to continue to disguise. Why are stocks so strong? Tell me.
Tobias: It’s a handful of them. It’s not all of them. It’s a handful. It’s that Magnificent Seven that are unique. Google, Microsoft, Netflix, they’re all pretty stunning businesses. I don’t think they can get overvalued, but the underlying business doesn’t. There’s no obvious reason why those businesses aren’t going to keep on growing. They get ahead of their valuation. It’s not like the old Exxon would be 40% of the market and that was pretty. It’d be top heavy when it all got into the oil and gas right at the top of the cycle. But then they probably are pretty stretched, those Magnificent Seven. What do you think?
Steve: Well, I’m slightly puzzled. I own some of them, so I’m wondering about what I should do. You always look at things, you always think, “Well, I don’t feel comfortable. What’s the market think?” You don’t want to get out too early because people are still very enthusiastic and very bulled up. You look at Alphabet and you look at Microsoft, they can’t both win this AI war or maybe they can. It seems to me that people have assumed that Microsoft is a clear winner because OpenAI is a clear winner. That isn’t obvious to me because I think Google have some excellent technology in this area. They bought the UK company that was the AI expert. I’m sure they’ve got a huge amount of resource that they put into it.
But it’s not obvious to me that Google Search continues its monopoly. I think that’s far from guaranteed. It’s not hugely valued. I think last time I looked it was on 19, 20 times earnings. And people were saying, “Oh, isn’t it cheap?” I said, “Well, actually I’m not sure that it is cheap,” because there’s quite a wide range of outcomes, quite a wide range of probabilities for Alphabet, that 18 months ago would have been much, much narrower, so you had much more confidence. So you would imagine that this stock should have been quite significantly derated. It slightly puzzles me that more people weren’t asking that very obvious question.
I don’t know what the answer is, because when it gets into these deeper technological discussions, I find myself a bit at my death. I’ve learned from bitter painful experience and my wallet has the losses to prove it that when I don’t understand, I’m very likely to lose money. So I’m just looking at my Alphabet position and thinking, “Well, I probably should have something else.” But I haven’t yet exited, but I think it’d be highly unlikely that I’d be here. If we had this conversation in 12 months’ time, things highly unlikely that I’d have the same exposure to it.
Tobias: Yeah, Bill Gates had that observation in the late 1990s that, because of this obsolescence risk that can happen overnight in technology that they should probably trade it at lower multiples actually than a typical business. It’s funny how we’ve definitely ignored or forgotten that lesson. I don’t know, if when we’ll be potentially reminded but something to think about.
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Is Amazon’s Labor Intensity A Ticking Time Bomb in an Inflationary World?
Steve: The other one that slightly puzzles me is Amazon. I was looking at Amazon sales per employee the other day, and its sales per employee has fallen by 60% in the last 10 or so years. The reason being it’s gone into logistics. When I started on South Side, I was a transport analyst. I can tell you one thing that transport companies do not make good investments unless they have local monopolies. So ports and airports are good companies. Shipping companies, trucking companies tend not to be good investments.
Tobias: Doesn’t go to their moat though? Doesn’t that go to their competitive advantage? It just once they don’t need to hand off any of the– Once they’re vertically integrated all the way to the consumer, then it’s going to be hard to unseat them, isn’t it?
Steve: Well, I talked to Benedict Evans, the guy that used to be the Strategy Director, Andreessen Horowitz about this, because he’s always very thoughtful, always very smart and that’s exactly what he said. He said, “They’re reinforcing their competitive position.” But bringing all this stuff in house, it means you end up– To be fair, they’ve done a very good job of it and they’re very efficient, very reliable. But what it does mean is that they have a lot more in the way of physical assets behind each dollar of revenue, and they’ve got a lot more people behind each dollar of revenue. And that makes the business inherently more volatile.
I would argue riskier, because I’m not saying that anybody’s going to steal Amazon’s market share tomorrow, but you could see regulatory action in certain countries for example. And the fact is that, if their revenues don’t carry on growing, God forbid that revenues should start to fall. Well, that capital intensity will really bite them. The labor intensity, it seems highly likely to me that inflation is here to stay. I know that we’re all getting excited and inflation is going to disappear and we’re going to be– [crosstalk]
Jake: [chuckles] We’ve already moved on from all that. We’re on the AI now. Don’t worry about it.
Steve: It seems to me inflation is a bit endemic. I was having conversation today– My office is in– It’s not a WeWork, but it’s like a WeWork. I was having conversation today with other business owners, “How much are you putting your prices up next year?” Not one of them said, “Oh, economy is a bit weak. We’re not putting our prices up.” [chuckles] I was doing quotes for next year. So I was just wondering, the trouble is, asset managers are not experiencing the same tolerance for inflation as some other industries. I unfortunately sell into an industry which is a bit more price sensitive.
But inflation, I think, will be here for some time. If we are shifting from capital to labor, which seems highly likely, then Amazon’s business isn’t quite what it was when it didn’t have all these people on the payroll.
Jake: Price increases being baked into future contracts, which starts to make this structural and not just as temporary as perhaps we thought. I don’t know.
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Tobias: Let me just do a quick shoutout. I always give a shoutouts to all the listeners where they’re coming in from. Santo Domingo. What’s up, Danny? Winnipeg. Toronto. Minneapolis. Brandon, Mississippi. Oh, I just jumped all the way down. Sorry. There’s a lot here.
Jake: And many others. [laughs]
Tobias: Townsville. Milton Keynes.
Steve: Milton Keynes?
Tobias: Keynes. Kennesaw. Norberg. Maitland, Florida. Raleigh. Petah Tikva. Still there. Good for you. San Jose. Sugar Land in Texas. Bangalore. Valparaiso. Nice. Tallahassee. Kansas City. Miami. San Diego. Dubai. Durham. London. It’s a good spread.
Steve: Anybody from Australia?
Tobias: Yeah. Dino was in Townsville. It’s Durham, London. Charleston. Saskatchewan. Seattle. Galway?
Steve: Galway.
Tobias: It’s a good one. Massachusetts. All right, good one. Thanks, fellas.
Steve: The Australians like getting up early. I’ve been doing my—[crosstalk]
Tobias: Sun gets up there early.
Jake: [chuckles]
Steve: No, [crosstalk]
Tobias: Yeah, I was just checking. Keep going. Sorry.
Steve: Another. My cohort-based courses, I do this course, it’s like an eight-week program, where I go through the forensic accounting content I give to institutional investors. So we do an hour and a half every Monday night for eight weeks. I do it at 05:30 in a Monday night London time. I’ve got three Australians this time. I had three Australians last time. The Australians never miss– Well, one missed two till live, but they never miss a live session. I record the session, so they don’t need to get up at 03:30. 03:30 in the morning was one week. The first week I started, the clocks have gone back here, but not– Amazing.
Jake: It’s not even the same day.
Steve: It’s not even the same day. They’re getting up at 03:30, 04:30 in the morning. One of them is a surgeon,-
Tobias: That’s an early start.
Steve: -and he got very confused with the clock changed and he emailed me, “Where are you?” I said, “No, you’ve got the wrong time.” And he said, “Oh, don’t worry.” He said, “Surgeons have got an ability to just [Tobias laughs] sleep like that,” which I thought was a very good quality, but slightly worried me in the hospital. But I thought Australians like getting up early.
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Vale Charlie Munger
Tobias: Yeah. I guess the sun comes up early there. JT. We should vale Charlie Munger. We all found out the news during the podcast. We found out immediately after the podcast last week. You’ve dressed up for the occasion, got the great men’s photo up.
Jake: I did. Yeah. I wore my funeral attire out of respect for Charlie. Of course, you can’t be surprised when someone who’s 99 passes away. I’m not ready for it. I almost didn’t even really want to talk about it on the show in some ways, just because it feels like a personal thing. I don’t want it to ever feel like that we’re making content out of it, but I’m sure everybody just wants to know how we’re feeling about it since we have such respect for them. I’ll just say that– It still pains me.
I took the family out to a nice dinner that night, like, went to our place that we celebrate when we get a win as a family and had a big stake. I told stories about Charlie to the boys and what he means to me or what he meant to me. I tried to make it a poignant thing that I hope that they would always remember. We’ll see if it actually absorbs at all. I wanted them to understand how much I felt like he’s contributed. Even maybe more so than Buffett, honestly. because of–
Financially and business wise, Buffett’s the best. There’s nobody that’s even close in my book. But from living a life well led, and respectful, and honorable, and leaving the world a better place than you found it, and being an exemplar, i think i put Munger over buffet in that way. And so it really means a lot to me, or he’s meant a lot to me. So our little veggie segment will be a quick little thing that Munger had actually written relatively recently that’ll be fun and maybe everyone might enjoy.
Tobias: Yeah, it was a little bit sad last week. That was rough. I got some nice messages from people on Twitter though, who heard the news and thought about me, which I thought was really sweet.
Jake: That is nice, isn’t it?
Tobias: Yeah.
Jake: I got a lot of texts too, which made me feel like, “Well, at least some people associate me with what I would hope that the ideals I’m striving for, I might not always live up to it.”
Tobias: How about you, Steve?
Steve: Well, I only learned about it the following morning, because I’d been at a cocktail party the previous night. Ironically, I met there David Mayhew, who was the senior partner of Cazenove, which was the most blue-blooded stockbroker in London. He’s 87. He’s the Vice Chairman of JPMorgan and he still goes into work. He said, “It keeps young.” I was thinking about Mario Gabelli and Charlie Munger. But I didn’t find out until the following morning. I was speaking at a conference, an investing conference, and so I put up that picture that Jake has caught up. I put that up on the screen and I said, “I thought we would just have a few moments silence for Mr. Munger because he’s meant such a lot to me and I guess to everyone in the room.”
As I was thinking about what I would say, I had a lump in my throat and I felt really emotional. I thought, “Isn’t that strange?” Because I’ve never met him. I’ve been in the same room as him once with 35,000 other people when I went to the AGM. Thank goodness, I went to the AGM this year and actually was there.
Jake: Yeah.
Steve: But I think there’s so many people in the world that have learned so much from him. You couldn’t ask for more from a life, right? I feel that we should be celebrating. We had 99 years of him. I feel a bit sorry for him that you didn’t make it to 100 because that would be a good party. But crikey, what an amazing life. He was doing these dinners, somebody said that they felt he was doing the dinners because his eyesight and his other eye was going and that he couldn’t read as much and that perhaps he wants to have that personal interaction. I don’t know, I have no idea whether that’s true or not.
But you hear all these stories about people going for dinner with him and you can imagine that would be the dinner of a lifetime, wouldn’t it? Can you imagine having dinner with Charlie Munger? I don’t know, if you’ve read any of those things about you’ve got to assemble your ideal dinner party. People who are alive or dead. I always say Toby Carlisle, Winston Churchill, Charlie Munger.
Tobias: [laughs]
Steve: But if you polled any group of investors, I bet you more of them would want to have dinner with Charlie Munger than with Warren Buffett, I would wager. Buffett obviously has been the superior business brain. Exactly equal. What your feelings, Jake? But Munger, what an intellect and what a life. Just astonishing.
Tobias: Yeah. Life well lived.
Steve: Yeah.
Tobias: Can’t really ask him much more than that.
Jake: My favorite quote of his is, he said that, “I’m trying to emulate my great grandfather.” And just for context, his great grandfather was a fairly well regarded, prestigious judge, and it was not quite Supreme Court, but almost to that level. “So, I’m trying to emulate my great grandfather. When he died, they said about him, nobody envied the success so fairly won and wisely used.” I think we can give Munger passing marks on that. I think that he absolutely did emulate his grandfather in that regard and quite the life well lived.
Tobias: The talk that he gave to one of the universities and I thought it was just he ended with this– Sorry, excuse me while I just pull this up. He had this great– This was how he ended it. He said, “If you just avoid being a perfect idiot and have a good character and just keep doing it day after day, it’s amazing how it will work.” In the end, I’m like, The old valiant for truth in the pilgrim’s progress, my sword, I leave it to him who can wear it.” So this is the actual quote. “My sword, I give it to him that shall succeed me in my pilgrimage and my courage and skill to him that can get it. My marks and scars I carry with me to be a witness for me that I have fought his battles, who will now be my rewarder.” I thought that was a good way to send him off.
Jake: It’s very deep, Toby.
Tobias: Well, it’s his words.
Jake: I know.
Tobias: How are we going to get back to this podcast now, Steve?
Jake: [laughs] Do you want me to bang out the–
Tobias: Yeah, that’s probably good. Let’s do that.
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Charlie Munger’s 3 Rules for Career Satisfaction
Jake: Yeah. So, this was something that he’d written relatively recently, and it’s called His Three Basic Rules, which great. Like, three basic rules. I love that. This is for career satisfaction. This is really targeted for young people especially. So if you’re making a career decision, maybe this is a mental model to use. So number one, don’t sell anything you wouldn’t buy yourself. He’s made lots of comments during the AGMs that, he’s very thankful that he’s never had to be in a position where he had to compromise and pretend like he cared about something that he was selling that he didn’t actually care about. I think there’s a lot to be said for that, “Of being able to look yourself in the mirror then and not feel like you’re cheating anybody.”
Number two, don’t work for anyone you don’t respect and admire. Obviously, it’s very dangerous to– You’re going to emulate people who especially if they often have some authority figure, that’s just the human operating system. So always trying to find people that you admire and work with them. And then the last one is, work only with people you enjoy. I think that’s what Munger’s– He didn’t care about being rich particularly. He cared about the independence that wealth brought and being able to do whatever he wanted on any given day.
And of course, he tried to be deserving of great partners by being a good partner himself. He said that he had incredible fortune in his life when it came to these three basic rules. “And with Warren Buffett, I had all three.” And so there’s some career advice from Charlie that hopefully maybe if you have someone younger in your life that you might be able to pass on and would be helpful for them.
Tobias: Yeah, that’s good advice. Steve, how are we going to get this back on track now?
Jake: [laughs]
Tobias: How do we segue?
Steve: There’s just been so many people writing about Munger. I think it’s just very difficult to add anything because he’s obviously a hero. I think we should just celebrate the fact that the guy was still giving advice, age 99. And that interview with CNBC, I just saw clips of it. I don’t know, if it’s been aired in the US. Obviously, I don’t think we get it here. Just amazing that he could be so alive at that age. Physically, still in reasonably good shape. So I think we’ve got a huge amount to be thankful for. I now have to decide, do I come to the AGM next year?
Jake: Yeah. It’d be very interesting to see what the vibe is next May.
Steve: Well, I imagine that a lot of people will want to go because they want this to carry on beyond Munger and Buffett, and beyond Buffett now. I think I had really good fun. And so the only issue is, what do I have to give up in order to go? Because my wife treats this as a boy’s weekend.
[laughter]Steve: It’s not work.
Jake: It’s work, honey.
Steve: I think it’s a legitimate business trip. My accountant thinks it’s a legitimate business trip.
Jake: [laughs]
Steve: My wife has more difficult standards. So I’m just working round to that.
Jake: Yeah. Got to get paroled for–
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Tobias: Steve, we’ve got a question from a listener, one, William Brewster. His question is,-
Jake: Never heard of.
Tobias: – “What is Steve’s take on BABA? Even a dolt like me has to see this FCF yield and wonder if it’s worth the geopolitical risk. Do you have a view? Did you dig into an Alibaba?
Steve: It’s quite an interesting one, because Munger said that it was his biggest mistake.
Tobias: Right. It’s a good segue. Well done, Billy. You should be hosting one of these things.
[laughter]Steve: Yeah. Have you thought of doing a podcast, Bill?
Jake: Yeah. What are you doing next Tuesday? [laughs]
Steve: So, I’m useless. The segues are really difficult. I only do once a month. I think it’s really difficult to do it once a month, let alone once a week. But my next month’s guest was fantastic, because I always go in with a huge list of questions because I panic about the conversation stopping. It hasn’t happened yet, but I always feel having the list of questions. And funnily, Rachel Reeves, the Shadow Chancellor of the Exchequer. So, like the Secretary of the Treasury, but the one in opposition, she did this speech at the Sunday Times drinks party last week, and she was standing next to the stage. I happened to be standing next to her and I said, “You’ve got a piece of paper. Have you got written a speech?” She said, “You know, I just have notes.” And then she stood up and she spoke off the cuff, including making jokes about the incumbent Chancellor Exchequer.
She came down off the stage and I said, “You didn’t use your notes?” She said, “No, it’s like a comfort blanket having it.” And so I’m the same. But the podcast I got next month, I said, “Why don’t we go around the world?” James Aitken of Aitken Advisors, and we started off in the United States, and we then flew to Japan, and then we flew to Australia.
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Australia: Housing Market Bubble Ready to Burst
Steve: Australia doesn’t look too good, Toby.
Jake: [laughs]
Tobias: In what sense? As an investment destination?
Jake: All of it. [laughs]
Steve: Well, no– [crosstalk]
Tobias: It’s good as a vacation destination.
Jake: Yeah.
Steve: Did you know that the Commonwealth Bank of Australia, which I believe is the largest bank in the mortgage segment, will now give you 95% loan to volume? [crosstalk]
Tobias: It’s floating rate mortgages in Australia. Most of them are floating rate mortgages. I agree, that’s rough. But everybody over there is already eating 8% interest rates on their old mortgages.
Jake: And how long are the durations on those are shorter, aren’t they?
Tobias: Not 30. I said, they’re probably 25.
Jake: Oh, really? Okay.
Tobias: Floating rate is the standard. America is the only place in the world, as far as I know, that has the guarantee of the fixed rate. Nobody wants to lend fixed for 30 years.
Jake: Right. American exceptionalism.
Steve: But rates are going up in Australia, right?
Tobias: Yeah.
Steve: That’s not going to be good. We’re going to have a problem here because here, we’ve had the teaser mortgages. So, you get five-year fixed at 2.3%. So, my niece bought a property, she said, “What shall I do?” [crosstalk]
Tobias: Sorry.
Steve: I said, “Don’t take floating.” So, there’s a 5-year 2.3 and a 10-year 3.3 and I said, “Well, how long are you going to stay in the property?” because there’s a huge redemption penalty in the 10-year. So, she opted for the five year. She’s not maxed out, but 2.3% was a lot. Six. [crosstalk]
Jake: You should tell her to go watch The Big Short. That might help set some context.
Steve: There are a lot of people facing that circumstance in the UK, and in Australia and probably in Canada. Canada is also an area where there’s been huge property inflation. I don’t know whether Canada’s got the fixed rates. I’m less familiar. But the Australian housing market, UK housing market look very, very vulnerable.
Tobias: I did this project a long time ago now, more than 10 years, where I looked at the big four banks, because Australia has this four pillars policy, where there are four big banks that do most of the commercial and mortgage lending. It’s been so long since there’s been a recession in Australia, you had to go back to the 1990s, and then you had to look at what the impairment was across those books. When I ran that impairment across the existing books, like, all of the equity of those banks was wiped out. So that idea has been around for a while. Those banks are going to be in trouble if there’s any sort of recession. I’m guessing they’ll be bailed out. That’s the only way around.
Steve: Of course, the problem is the Australian economy is founded on shipping stuff to China for them to build homes, and that doesn’t look too clever a market right now, either. People have been forecasting the demise of the Australian property market for a long time.
Tobias: 20 years or so. Yeah.
Jake: [laughs]
Tobias: That’s not to say that when it happen.
Jake: Yeah.
Steve: I didn’t buy that apartment in circular key because I just thought, “Oh, it was quite an obvious property opportunity,” but I just thought the logistics of managing something that’s 12 hours’ time difference just didn’t appeal to me.
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What Makes Alibaba Incredibly Difficult To Analyse
Tobias: Let’s do Alibaba before we get too distracted.
Steve: Yeah, sorry, we were talking about Alibaba. I did this forensic accounting report on Alibaba and other four big tech stocks. I believe I may have sent a copy to Mr. Munger, actually. He probably gets quite a lot of inbound or got quite a lot of inbound mail. But one of the fascinating things about those companies was that the five big tech stocks in a six-year period invested mainly in Chinese startups, some other investment, a total of– well, I won’t ask you to guess, $500 billion.
Tobias: It’s that a lot?
Steve: A vision fund a year in China. Now, just the vision fund alone managed to inflate the valuations of loss-making startups globally. We know [chuckles] the field is littered with the WeWorks and the Greensills, and I can’t remember the dog walking company.
Jake: [chuckles]
Steve: Can you imagine what that’s done in China? Now, interestingly, I haven’t updated the work, but when I did the work, Alibaba had taken how many goodwill write downs? One. It took a write down in Alibaba pictures, because the stock price had collapsed and all investors forced Alibaba to take the write down like 12 months after they should have. Didn’t take that write down anything else. I’ve got a lovely picture in one of my presentations of this bulldozer with a 60-foot-high pile of bikes bulldozing the bikes into the landfill. Do you remember the rental bikes?
Tobias: Yeah.
Steve: I’ve forgotten who paid what, but Alibaba paid $2 billion 10 cent paid, $3 billion, or vice versa for stakes in bike rental firms. Now, it’s hard to imagine that those are worth what they paid for them. But they seem to manage without taking any proper write downs. And the Alibaba accounts are just incomprehensible. I reckon I’m quite good at this.
Jake: [laughs]
Steve: I spent quite a long time looking at the numbers, and I couldn’t– Yeah. They don’t even tell you what the subsidiaries are. They’ve got a summary list of subsidiaries. I’ve never seen this in any other company where they don’t tell you a complete list of subsidiaries. This is for a company that is listed is filing a 10-K seems extraordinary.
Tobias: When Alibaba was very, very popular, before it had its stumble, there was a website that was like a Deep Throat kind of trying to talk about Alibaba. One of the things that they pointed out was how many subsidiaries they created. The first year that I looked at it was like a subsidiary a day for the year. And then the next year, it was like two, and then next year it’s like three. They create subsidiaries like it’s their business.
Steve: It’s quite extraordinary. Now they’ve had a very strong position in the Chinese marketplace, but that shopping position seems to be undermined by Xi’an and now Temu. Those companies are gaining quite a lot of market share at Alibaba’s expense. And so I just think it’s one of these things that– It might well have a significant value. But sitting where I’m sitting, how would you know? It’s just incredibly difficult to analyze.
Jake: A little context on that what $500 billion that you said was venture capital. The US in 2021 venture capital invested was around $900 billion total, peaking in Q4 of 2021 at $260 billion alone.
Steve: But you know that’s money that’s evaporated.
Jake: Yeah.
Steve: You can’t justify the $500 billion by the fact that the Americans have wasted more.
Jake: No, I’m just saying just to kind of give us– [crosstalk]
Tobias: Contextualize it.
Jake: Yeah, just contextualize it.
Steve: [crosstalk] a trillion dollars. That’s quite a lot of money, even in America, right?
Jake: [laughs]
Steve: None of it’s going to give them a return.
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Tesla’s Accounting Inconsistencies and Management Turnover
Tobias: Steve, talking of indecipherable accounts, how do you feel about Tesla?
Steve: Oh, [Jake laughs] people always used to ask me about Tesla. Look, the accounts, when I looked at it, every quarter I picked up, the accounts were prepared in a different set of accounting policies. Not every quarter. There was not a great deal of– How do I put this? There was not the usual normal consistency of preparation that you would expect from a major public company.
Tobias: They did have a few CFOs one after the other there for a little while. But they seemed to have settled down into one.
Steve: The number of management changes, there was a deck going round which listed, I think, about 120 changes at not board level, but executive level one, level two. There’s an unbelievable amount of changes. And normally, I get very concerned about management changes because one of the Greensill companies– When we originally identified that Greensill looked like a fraud, one of the things was that there had been a fairly reputable finance director had been the finance director of a FTSE 100 companies had gone on the board as a non-exec and had left a month later. You think, well, that is not normal. And the most likely explanation of that is she’s gone in and she’s thought, “Christ, I don’t want to be associated with this. I’m gone.”
Now I’ve got no knowledge about why there was all the turnover. I’m sure that Mr. Musk is a very demanding boss and not everybody’s up to it. Some people don’t want to be up to it. But it can’t be a good thing, because if we think about very enduring, successful companies, they tend to have very limited amount of management turnover. I don’t know, what the management turnover at Berkshire Hathaway is, but quite low.
Jake: It’s pretty low at the top. [laughs]
Steve: That gives you a consistency that is very valuable, because those people have got a knowledge history that is actually incredibly important to understanding the culture of the business. And turnover is, by definition, I think, something, as investors, you should worry about. So, the Tesla accounts, I find them quite difficult.
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ARKK Valuation Wildly Misleading
Steve: What I find even more difficult is the Ark valuation, however, [Jake laughs] which just seems the most bizarre. I don’t even understand how they’ve done the valuation. I’ve never seen a valuation done like that before, ever. The numbers they come up with are so implausible. It just seems bizarre that an investment firm would be allowed to produce this sort of stuff in the UK. I don’t think they would be allowed to. I think the regulator would be patting them on the shoulder saying, “Hang on a second, you cannot produce this, because it’s–” [crosstalk]
Jake: Wildly misleading.
Steve: Mm?
Tobias: Wildly misleading?
Steve: Whoa. She might be right. You have to accept there is the possibility that she might be right. [crosstalk]
Tobias: I think, to be fair, a few of the things that they had said that the valuation turned on was like robotaxis and so on. I forget what year they were, but I’m pretty sure that all of the deadlines have passed for those things. So that must impact the valuation in some way.
Steve: No, you haven’t understood it’s about the future. The fact that we haven’t hit these milestones– [crosstalk]
Tobias: Well, at the time that they were written, it was the future. And then the future came to be the present and the thing hadn’t happened.
Steve: But they always seem to manage to find something else. So they found insurance. Tesla insurance is going to be the biggest insurance company-
Tobias: That’s an easy business.
Steve: -in United States.
Tobias: That’s an easy business [crosstalk]
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The Hidden Cost of New Technology: My Tesla Leasing Experience
Steve: They won’t need the capital that most companies need, because they will have better intelligence on the drivers. Funny, the Tesla have got cameras, and they record everything, apparently. So, I rented a Tesla in Spain a few weeks ago. We went down to Spain for half term and rented this Tesla. It was a very nice experience. I enjoyed driving the car. It was very eerie driving it down the freeway.
But we arrived at nighttime, and the car park at Málaga Airport. It is very narrow and very tight, and you can’t really inspect the car. We were late, and the kids just want to get something to eat and go to bed. So, the following morning, I go to get in the car and somebody scraped the car and hand painted, but like a big area. And the Hertz in Málaga are really quite bad. They are very, very difficult to deal with. And I thought, “Oh, no, I haven’t inspected the car–” When I returned it, I was just fingers crossed they don’t notice and luckily, they didn’t.
But I was thinking, “I thought all these things were filmed.” Somebody somewhere will be getting a big bill from Hertz for the hand painting of the car, but apparently Hertz are having a bit of a hard time because guess what? Tesla have become more expensive to repair than regular cars. Who would have thought that?
Jake: Yeah, the cost of ownership has proven to be more expensive than people thought, because these repairs are so–
Tobias: That’s been a little bit of a thing. I heard the same thing about the Rivian, that it’s more expensive to repair the Rivian. But JT, you were saying that the cost to repair stuff has just gone up a lot. That’s one of the problems for GEICO at the moment. It’s just inflation coming through.
Jake: Yeah, for sure. You had supply constraints there for a while, so you couldn’t get the parts. So of course, there’s no discounting happening, obviously. Labor inflation, shortages of cars in general. So, you’re going to fix up whatever it is. Like, you’re not going to go just buy something new. So yeah, you had a lot of pressure on price on the cost side for auto insurance repairs.
Tobias: But, Steve, that was a thing that Hertz did say that they had bought a whole lot of them, or they had planned to buy a lot and then they were stepping back from that a little bit because they were too expensive to run as a fleet.
Steve: Yeah. I think with any new technology, there’s always a bit of an issue that you haven’t got experience with it. So, you don’t know what the hidden costs will be. It slightly surprised me that Hertz were so enthusiastic about Tesla. I don’t know whether they got a particularly good deal on the cars or whether they felt that the residuals would hold up better than other cars. But when they brought out the Model S here, I took it out for a test drive. It was quite unusual because the showroom– That showroom is local to me is in a shopping mall. And so I was in this shopping mall, and took the kids to the Lego shop, and then I went into the Tesla shop and I said, “Can I have a test drive?” And he said, “Sure, come back next week.”
I went back next week, and I was taken for a test drive by a graduate from UCL, which is like a really top university, engineering university. This guy had a PhD and he knew everything about the car. I was incredibly impressed with it, because it drove really nicely. The panels didn’t fit very well, but the driving experience was superb. I thought, “Well, if I bought one of these–” I have to put this into context for all you American listeners. The previous year, I’d done 500 miles in my car, which was a [Jake laughs] 20-year-old BMW, because I live in central London. Boris put in all these bike lanes, so you can’t drive anywhere. [Tobias laughs] It takes you forever. So you need to go in a black cab– I mainly go on the subway, because it’s just the easiest way to get around, and otherwise you spend so much time in queues.
So I only use the car to take the kids to football practice or rowing, just the local journeys, and not very often. I was a bit concerned about buying a Tesla because I thought, “Well, what’s the residual going to be?” There’s no experience. So, I tried to lease one. And at the time, you couldn’t lease one. And the quotes that I got were like, off the charts expensive. And so I just forgot about it. I just didn’t bother. This is always the case with new technologies. It’s very difficult to get your hands around it all and to get experience of it all. You can lose a lot of money in new technologies I found.
Jake: Yeah, watches and wine only. Old technologies. [laughs]
Steve: I actually do like watches, and so I have a few. But there isn’t a huge investment in them.
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Tobias: We’ve got about three minutes, so just run through your red flags for– [laughs]
Jake: Just real quick.
Tobias: Yeah, [crosstalk]
Steve: Run through what?
Jake: Oh, boy.
Tobias: The red flags. Some of the things that you look for, Steve, some of the things that jump out at you as things to concern about when you look– [crosstalk]
Steve: Oh, right. I’m sorry. So, this is why I’m here. We’ve been talking about–
Tobias: Yeah, three minutes to go. [laughs]
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Audit Reports: The Secret Weapon Investors Are Ignoring
Steve: Sorry. So, one thing that I think people do not use and they really, really should use is the audit report. And now in the United States too, it used to be only under IFRS accounting, where the auditor will flag issues that they are concerned about. And now that’s included in the US– For some reason, the US, the auditors, I’ve only ever seen one single issue. In Europe, you can have 6, 10 issues. But this is like the auditor shining a spotlight on the areas of sensitivity in the report and accounts. It’s astonishing to me that people do not read this. People go, “Oh, it’s audit report. If it was qualified, the shares would have fallen and we’d know about it. So, we don’t even need to look. We don’t need to look who the auditor is.”
I tend to look at well, who’s the auditor? Has the engagement partner changed? What’s the audit fee? What are the non-audit fees? Because I like to make sure that the company is paying for a good audit, not siphoning off huge amounts of cash to the auditor for consultancy fees, so that they will do a crap audit and let them, “Yeah, you can have your $1.50[?] of earnings. We’ve got our $5 million consultancy fee.” I don’t like to see that. I like to see a good audit fee that will ensure an honest auditor. Not that any auditor would be dishonest, but we have seen a number of audits that haven’t been up to scratch.
But that one thing of looking at the issues that auditor reports on is one of the first things people should look at, because if there’s a problem there, you can then say, “Well, actually, I don’t really like to look at that and move on to the next thing.” So, start there.
Tobias: Perfect.
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Red Flags for Investors: Contingencies, Commitments, and Related Party Transactions
Steve: That’d be one thing. Another thing that I like to look at is an early on in the process. I like to look at the contingencies and commitments and I like to look at the related party transactions. What I found is that, if you have a company that’s got very significant contingencies or lots of them, very significant related party transactions or lots of them, or worse, both, usually it becomes far too complicated to unwind. Because trying to work out the value of a contingent risk, you’ve got to work out not just what happens if this risk crystallizes, what’s the cost of it, you got to work out the probability of that crystallization. So you’ve got two variables, and that gives you a huge range of potential outcomes. So however good you are at valuation, you’ve got this huge question mark. And that seems to me to be a risk that you don’t need to worry about.
I’m a believer that one of the skills of having the accounting background or having learned the forensic accounting skills is it saves you time, as well as saving you money. So I think I’m at this own conference tomorrow. We’ve got an advert in the brochure. We train analysts to be faster and better at interpreting financial statements. It’s that faster, you can very easily save yourself a lot of time by just eliminating stuff at the start. You find a stock and it’s got huge number of contingencies, don’t worry about it because you’re never going to know whether that’s going to crystallize or not. And why do you need to take that risk?
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Tobias: Steve, we’re coming up on time. If folks want to get in contact with you or follow along with what you’re doing, what’s the best way of doing that?
Steve: Well, I’m on Twitter at @steveclapham, but I very rarely tweet these days, except when I’m panicking to find out the Zoom link for this podcast.
Jake: [laughs]
Steve: I found Twitter has been much less engaging in the last 12, 18 months. But I’ve got a Substack, and you can go to behindthebalancesheet.com, my website, and in the top right is sign up. There’s a free Substack I produce every Sunday, fairly religiously. And you can pay if you want, and it’s even better for paying people.
Jake: [chuckles]
Steve: On the website, you can also see all my online courses, which I’m struck by how good a system it is to learn about investing or anything else online, because you can absorb the content at your own pace. You can do it in whatever detail you want to do it, but you also do exercises. The way we do it is you also join the community, so you can ask me questions. So behindthebalancesheet.com. It’s a website. Substack courses, and there’s an occasional tweet.
I must say, thank you so much for having me. It was a great delight for us to meet up in person finally in Omaha. We didn’t manage to get a beer. [Jake chuckles] I had this stupid idea that the connecting flights through Chicago were very awkward to get to Omaha. So I went via Des Moines. And then, because I booked late, I couldn’t get a hotel room. And so I was looking to try and get a hotel. When I was there, I said to the Marriott, “Can you please email me, so I can get a room?” I joined the list. They never bothered to email me. And so I booked in the Marriott, and I found– I think it was $1,800 for the four nights. I found it wasn’t the Marriott next to the convention center. It’s another Marriott that’s another 5 miles away.
Tobias: JT, anything to add?
Jake: I have nothing to add.
Tobias: Thanks, folks. We’ll see you all next week.
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One Comment on “VALUE: After Hours (S05 E45): Forensic Analysis with Stephen Clapham on $BABA, $TSLA, LVMH and $RACE”
gret interview. Stephen is a very down to earth brit, doesn’t mystificatiously obscure how he thinks.
much appreciated.