Low-Debt, High-Yield Strategy: Beating the S&P 500 with Selective Investing

During their latest episode of the VALUE: After Hours Podcast, Carlisle, Taylor, and Bloomstran discussed Low-Debt, High-Yield Strategy: Beating the S&P 500 with Selective Investing. Here’s an excerpt from the episode:

Christopher: Yeah. Well, the numbers are too fat for Facebook, and certainly for Microsoft’s Azure, AWS within Amazon. To let your chip supplier keep those margins, you’re going — At some level, do it yourself, you’re going to balloon your R&D, you’ll figure it out, whether AMD winds up being a competitor to the current iteration of chip. Who knows? But it’ll come. You’re not going to do 55% as a chip designer from here to eternity. There have been very few businesses that would run at a 50% margin. Visa, Mastercard would be a couple of them. But capitalism being what it is, you’re just in a period where there’s a shortage. And there’s a huge demand for processing. I’m not sure much of it’s new. You’re just processing way more data way more quickly.

But you look at the depreciable lives of the software and the hardware that goes into the data centers and equipment, they’ve doubled the depreciable lives of this stuff. Maybe that’s right, maybe it’s wrong. But I don’t think this is much different than the classical semiconductor cycle. You just happen to be in the sweet spot. There’s a retail craze now. A good friend of mine just lost a portion of a client’s asset, a doctor who wanted to put his entire million and a half dollar IRA. So, a fraction of his net worth, but put the whole thing into Nvidia, just a few days ago. A friend wouldn’t do it for him and said, “Well, you’re going to have to just eke it out and do it somewhere else, because I’m not going to do this for you or to you.”

Jake: Oh, man. Back to that again.

Christopher: Wow. That’s 1999, early 2000 behavior. You go to any cocktail party, talk to anybody, and everybody was loaded into the tech, and they did not want to hear how silly a lot of it was. Really good businesses. Some of those businesses were really good businesses, Sun Microsystems, Oracle, Microsoft. But they were priced beyond perfection. Some of these things are priced beyond perfection today. Competition will come. It’ll come from within. It’ll come among, to your point. They’re selling to the other big tech companies. Nobody’s going to keep a 55% margin albeit outsourcing Nvidia’s CapEx and heavy lifting to Taiwan Semites.

Jake: So, given maybe not the most bullish, call it, general S&P 500 for the next 10 years, your portfolio at Simper right now, I think, seems like you’re very excited about it. And just the metrics on how does that compare– And maybe this speaks to some of the bifurcation that’s happening in the market right now.

Christopher: So, if you run that two years, everything was flat. S&P and the Mag 7’s and all that were up just a little bit. We managed to make money. In 2021, we were up about a percent. We were up-

Jake: It’s 2022.

Christopher: We were up like 10. 2022. Sorry. We were up 10-ish last year. We were up something like eight or nine this year. But for that two years, we were up, call it, 10. So, we were ahead of all that. As recently as well year end and even before the world decided that Jay Powell was going to ease the Fed funds rate three or four or five times this year and implicitly, they’d stop shrinking the balance sheet below some number, call it, $7 trillion, that you lit the torch underneath the market and ballooned everything up. We were down for the year in mid-October, and went up quite a bit for the year.

And so, things were really cheap. But a year end, we were a little over 10 to earnings, with a 10% earnings yield with multiples to book and sales and cash flow at a third to a half of the S&Ps. So, we have twice as much earnings yield. Where I think we have a very long-term advantage is, if you look at our businesses, we don’t employ debt generally in the capital structure. We’re very debt averse. And so, our businesses are largely unlevered, which means they earn about as much on capital as they earn on equity. And so, our companies earn about 16 on equity, about 15 on capital. Well, the S&P earns 20 on equity.

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