Stig Brodersen  5:22  

Toby, talk to us about the backlog. You already touched upon this. I mean, if we look at it, it kind of looks like the last projects would be finishing up in 2019. It seems a bit irregular to me in the sense that I think it was just late April when you saw this big bounce. That’s like 70% or something in a day, because they announced a $250 million revenue project, which seems to be like the only new thing going on.

I know that’s partly also priced into the market. You already addressed that, but how and why do you see the demand still coming for the products? Will this not be exploited because it’s quite visible, looking at the company that perhaps they don’t have as much negotiation power, but people always knows that they need to make revenue in the *inaudible* new projects?

Tobias Carlisle  6:09  

The difficulty with a company like this is one thing, 80% plus of its billings come from one client. It’s always reliant on finding new work. 

The thing that I come back to and I do agree that it’s always hard to see where the next big deal is going to come from for a company like this. But I always returned to an instance like this, the price is so low. It only needs one or two deals for this to be far too cheap where it’s trading. 

I think that you are sort of rolling the dice a little bit on the work beyond the current backlog that I think it’s all the dust worthwhile at this price.

Preston Pysh  6:46  

I’m getting very similar numbers to what you got, Toby, as far as what you’re expecting to get on the return, but I’m kind of curious to hear what Jesse thinks. What kind of concerns are you seeing, Jess? 

Jesse Felder  6:57  

I looked at this thing, I said, one and a half times enterprise value to EBIT, that’s crazy cheap. Nothing close to that cheap that I’ve been looking at recently. I guess I need to check out Toby and sidle up more frequently.

Technically, to me, it looks like the stock has really good longer term support at this 37-50 level, where it kind of is now and downward momentum looks to be waning. So it kind of has like some of the technical stuff that I would look for, in addition to being super cheap. 

The one thing that I do worry about is the valuation has been one and a half times for years now. It’s hard for me to then argue how much more than that is it worth. And so, with a lot of the things I do, I put a three year time stop on… especially really deep value plays where if the market doesn’t justify my belief in this thing in three years time, then I’m wrong. 

The markets have been pricing this thing between one and a half, well, I guess the upper end of the range is closer to four times. It’s really near the low end of that range. I see a lot to like in this thing. 

Like Toby says it’s kind of a crazy good margin of safety built in so that even if they don’t find much in the near future, I wouldn’t be too worried that something’s going to come along and justify its valuation.

Preston Pysh  8:19  

They’re paying a dividend. With the low market cap, you’re just going to get a fatter dividend yield or they just start banking, a lot of that as retained earnings. It’s not kind of popping in the market price. I just think that you might get it back on the dividends that are being paid maybe. What do you guys think of that?

Tobias Carlisle  8:36  

Yield is 2.5% percent. It’s just gone *inaudible* dividend today. That’s sort of part of the reason it’s off about 2.5%. That’s probably the reason it’s off a little bit today. But you know, it started January this year, it was trading at $72. So it’s close to 40% plus. It’s almost 50% from its peak.

I didn’t think it was a bad stock at the start of the year at three times, but as Jesse and Stig pointed out earlier, it’s one of those companies that it’s got this concentrated customer base that’s pretty chunky and you never get very much visibility, which is why I tried so cheaply. 

It’s not one of those ones that I like three times Acquirer’s Multiple, which would ordinarily be very cheap for any other kind of business, but at one and a half times, I just think it’s hard to ignore. It’s one of those things that I don’t think that it could be a zero. Anything can go lower. Anything can go down by 50%, but I like the risk reward at this price.

Preston Pysh  9:34  

What was the narrative that brought it down so hard? Because when you look at the top line, the top line is really healthy for the company. I’m kind of curious what brought it down like that.

Tobias Carlisle  9:43  

It’s the future work. It’s the book of work that it has to do. They’ve been working through that book and they’re coming to the point where they really need to start finding another power station to convert.

Jesse Felder  9:55  

I love it when the market discounts or starts believing that a company that has proven that it can find new business for 60 years. The market starts discounting. They’re not going to find new business that’s *inaudible* situation.

Stig Brodersen  10:10  

I don’t know why I’m actually hesitant. It kind of turns out that Toby Is usually right. It’s not a nice thing to say, but like Toby typically pitches something that’s really ugly. That’s kind of like what you see, right? Like, it doesn’t have like a backlog and Toby would say, “You know, Stig, that’s why it’s cheap.” 

It’s really as simple as that and I guess as complicated as that. 

For me, it’s more… probably because I’m not as familiar with the stock as Toby. Whenever I’m looking at the cash flows and I can see how receivables are creeping up. I don’t think compared to revenue, it’s necessarily a huge concern but it’s probably something that I would monitor, if this was a stock I would consider investing in. 

Toby might have done that for a long period of time, but when you see backlog issues, whether it’s one way or the other, you sometimes see that number going out of control.

Preston Pysh  11:01  

One thing that I did notice on this and I found a little interesting, Toby, was the cost of revenue for the business five years ago was 65% of their top line.In this past year, it was 83% of their top line. So it seems like their top line has grown. It’s growing really, really well. 

However, the efficiency of what they’re able to bank out of that is really kind of deteriorated quite a bit over the last five years. It’s been pretty consistently curating over that five year period.

That was really kind of one of the only things that I could see that kind of like made me raise an eyebrow when I was looking at it, but I like it. Jesse, you seem to like it as well, right? 

Jesse Felder  11:37  

I do. I think it has a lot to like in terms of just the valuation. One of the things I like to look at is the company’s historical valuation. Like I said, it looks to me like over the last five years, it has traded 1.5 to 4 times so buying at the bottom of its range looks attractive to me.

The first thing I do when I look at any of these stocks though is read what kind of business they’re in and decide whether that is within my circle of competence. This one is not really within my circle so I’d have to do a lot of work about… I would have to do that work first to kind of try and expand my circle a little bit first before I would be comfortable buying some.

Preston Pysh  12:12  

All right, you guys want to do the next one? Anyone else want to go?

Jesse Felder  12:15  

Yeah, sure. I’ll go.

I like Annaly Mortgage Management. This is a mortgage REIT. Essentially, they call themselves a yield manufacturer. They borrow short term and lend long term essentially. 

Borrowing short means they use repurchase agreements, very short term 45 to 60 days. Then lend long essentially buying Fannie Mae and Freddie Mac mortgages then they use leverage to generate what is now 11.5% dividend yield on the stock. 

I like to think of it I mean, they used to be back in the day, thrift institutions, which were always fun to buy when they got cheap, because they had a very simple business model very similar to this. There really aren’t thrifts anymore today. All the banks have gotten into other kinds of stuff. I really try and avoid banks generally, because I can’t really understand their balance sheets anymore. 

However, this is a very simple business model for me to understand. I think of it as like the Bailey building and loan. It’s a wonderful life. Jimmy Stewart, family’s building loan, and essentially taking deposits and lending it to people to buy houses and making the spread. 

The difference here is that they don’t have any credit risk, because it’s all Fannie and Freddie products that they own. They don’t have any depositor risk because they’ve raised all the money through the public markets. 

What’s going on with the stock right now is it has been depressed for the last three or four years, because since the yield curve has really started falling, when the yield curve compresses, that is typically not good for banks. It’s been better for banks, or at least investors perceive it to be better for banks right now.

However, Annaly suffered because people always hate these mortgage REITs, when the yield curve drops like this and yields compress. There’s a lot of people worried about their ability to make that net interest margin in this environment, but currently it trades at about 90% of book value, which is historically pretty cheap. It’s gotten cheaper than this. 

When I look at the stocks, CAPE ratio trades seven times its average tenure earnings of the last 10 years. There are not a lot of stocks in the market traded seven times the last 10 year earnings. ITo me that’s incredibly cheap, especially in the markets where trades closer to 27 times CAPE ratio or something. 

The other side of it is that this stock has a .5 beta. So if you are worried about volatility in the markets and stuff, this stock does really well when people seek a safe haven when volatility rises. 

I really have been bearish on bonds the last 18 months, two years, and I’m worried about interest rates rising even further. That’s part of this thesis. It looks to me like we should start seeing a steepening of the curve. If that happens, that’s really good for the stock. 

For me, I don’t know if this curve steepening could happen as a function of short term rates going down, or long term rates just blowing out on the upside. I think that’s a real distinct possibility. 

So my point is bonds could not potentially might not be the diversifier that they were for equity investors during past volatility and bear markets. This to me seems like because they’re so good at hedging the portfolio, a really good bond alternative, especially because the yield is four times what a 10 year bond is.

Then over the last three or four years, there’s been big time insider buying. These guys have been just loading up on stock, I think the CEOs bought about $5 million worth of stock over the last six months, which is always a really good confirmation to me that these guys feel comfortable putting themselves in position to the rest of us shareholders. So

Preston Pysh  15:56  

that’s the only. So Jessie it seems like the long tail of the bond yield curve isn’t even moving. When you look at the short end, or the long end that you were describing, they’re kind of blowing out, it seems to me, like the long end is going to kind of stay put, and I don’t see the central banks allowing that to blow out. Would you agree with that?

Jesse Felder  16:13  

I think there’s a real distinct possibility right now that they are too far behind the curve. We’re seeing inflationary signs and wages. I’ve been talking with my friend Eric Cinnamond about this consistently over the last six months. 

Eric has been pointing to companies talking about inflation. So far, the 50 companies or whatever in the S&P 500 that have reported, have been complaining wage inflation and then other cost pressures are the number one concern to earnings that the 50 companies have reported already.

Bank of America is not showing up in the numbers for a variety of reasons. Bank of America showed in March. Their direct deposit cost saw an average of a seven and a half percent increase in their paycheck in March. 

There’s a number of reasons why it’s not showing up in the data, but wage inflation is here and cost pressures are here. I really do think they could lose the long end, because they’d be forced to start fighting inflation rather than trying to support the financial markets. They have to make a decision.

Stig Brodersen  17:15  

Basically, the company makes its money based on the spread between the interest earned, and assets and the interest payments made on the borrowing, whether that is in debt or equity, which they have been using.

If you look at some of the macroeconomic factors and talk about, I guess the risk for me would be how significant will it be if they can’t renew their funding on favorable terms? I mean, if you look at the credit, now it’s out of control. 

I would argue that we can expect a huge contraction with QE unwinding. Is that something you’re concerned about? How do you see the macroeconomic scheme playing into this? 

Jesse Felder  17:50  

I think their funding to me would be a concern if people were worried about the credit quality in their portfolio, which is why banks don’t necessarily do well when the yield curve steepens because otherwise, that’s a huge profit sign that they’re going to make more interest income.

However, a lot of the times when that spread blows out, that’s when they have credit problems. I don’t like the banks right now for that reason. 

Annaly has no credit concerns. During the financial crisis, they didn’t even experience a hiccup. That’s just because they don’t have any credit concerns in the portfolio. They use repurchase agreements. 

Basically, they’re borrowing money for 45 days and that’s collateralized with a Fannie Mae loan or Freddie Mac loan. 

People say, “Okay, I can get whatever it is, you know, 1% annualized return through a repurchase agreement for 45 days, with collateral that is backed by the US government.” I don’t see that funding drying up anytime. It really hasn’t. If we look back at the 20 plus year history of this company, during the 1998 crisis and the 2008 financial crisis, they’ve really not had any issues for those reasons.

Preston Pysh  18:59  

Jesse, talk to us about the payout ratio, because when I’m looking at their net income, and then I’m looking at the dividend that they’re paying, it’s a buck 37 for the end of last year for their bottom line. Then they’re paying a buck 20 of that out in a dividend. So like the payout ratio here is just absolutely huge. Is it sustainable?

Jesse Felder  19:18  

I think it’s absolutely sustainable. With this company, they’re the biggest, most powerful mortgage rate on the planet. Everybody wants to work with them. They’re the Berkshire Hathaway of this market. 

The reason I bring that up is because when you look at Berkshire’s earnings, Buffett has said in annual reports, when we have capital gains, don’t look at that. Because look, if Buffett were to sell off the whole portfolio today, the earnings would go through the roof, right? But how sustainable is that? That’s capital gains. 

So a lot of the fluctuation in Annaly’s earnings as capital gains losses is hedging and it’s all that kind of stuff that goes on. So you look at the core earnings of this company.  They’re super steady. $1.2 billion I think the last three years. In a rising rate environment and in a falling yield curve environment, they’re able to generate, you know, consistent profits. 

Their leverage is really low right now. They’re able to kind of try and capitalize on this yield curve phenomenon and say, “Hey, we don’t want to put a ton of money to work right now when spreads aren’t good.” But they could go from six and a half times levered to 10 times levered. This is why they can really maximize that yield curve widening once it starts to happen.

Preston Pysh  20:30  

So if you’re saying normalized earnings for the company look more like around 2 billion. I’m now looking at the cash flow statement. I’m seeing what their cash dividends are. And they’re around 1.2 to 1.3, which would make it around 60%, not 90%. So you’re saying that that’s the reason why it’s sustainable.

Jesse Felder  20:47  

Yeah. Most REITS use a non-gap metric to kind of help shareholders see what they call core earnings or normalized earnings. It would be aside from all the different portfolio dynamics that go on. 

Preston Pysh  21:05  

All right, anyone else has anything they want to add on this one?

Tobias Carlisle  21:08  

I just wanted to say I think it’s a good pick. I think it’s undervalued, probably worth a little bit more than given its position. 

The main concern that I had just briefly looking at the financials was the payout ratio, but I think that Jesse’s probably right there that it’s got lots of headroom.

Stig Brodersen  21:25  

I guess my closing remarks for the pick will be that if you do share this concern about credit contraction, then you might consider Preston’s pick. I’m just going to throw it to you, Preston, because I know that a lot of people when they think of a stock market top, they’re always considering this pick so please take it away.

Preston Pysh  21:47  

Normally, inflation and this is my pitch without saying what my pick is here. Most of this is because I want to seek some guidance from Jesse before I say what my pick is, but normally, inflation and gold have this inverse relationship. 

However, when inflation is rising more quickly than interest rates, pausing the real yields on government bonds to decline or turn negative, gold can actually do quite well. That’s kind of my argument for why I think we might be at a good point for gold. 

Now, anyone who knows me, they’re probably cringing as they hear me say that, because they know I’m a hardcore value guy, I’m not an expert at commodities or gold by any shape of the imagination. But I just think we’re in this unique environment, kind of similar to what maybe we were in back in 2007, kind of timeframe, where we’re at in the business cycle. I feel like in the next three to six months, we’re going to see gold make a big run. 

Jesse, you understand the technical side of things. When I sent out to the group that this is what I was thinking about and talking about, you sent me another article back about why silver might even be a better play. 

I’m kind of curious to hear some of your arguments, whether you agree or disagree with the idea of gold being a good position for people to be in right now.

Jesse Felder  23:09  

I’ve been bullish on gold for the last two years, really, since like late 2015. Meb Faber did an interesting article. I read around the time where he showed that when an asset class is down two years in a row, the third year is really good. It was down three years in a row. In 2015, gold was down I think four years in a row. 

There was so much hatred built up for gold by the end of 2015. That was just I mean, a contrarian’s dream… I think the Wall Street Journal had an article that said gold is the new pet rock. People were just calling it a worthless relic. All those kinds of things just really piqued my interest. 

Since then, I’ve done a ton more work on it, because I have not been interested in gold, until 2015 is when I started getting interested at least during this cycle. One of the most compelling cases for owning gold right now is to look at the ratio of financial assets to real assets. Real assets in relation to financial assets have never been cheaper in history than they are today. 

And so, financial assets, we’re talking stocks, bonds. Real assets, we’re talking real estate, commodities and gold. Imagine if you back out real estate out of that equation, because real estate prices are high, gold and other commodities have never been as cheap relative to financial assets as they are today. 

You look at what drives those cycles that push financial assets and push real assets. It goes back to this inflationary thing I was talking about earlier, which is if you look at the last time, real assets were really expensive to financial assets through the 70s and early 80s before Volcker broke the back of inflation. 

Since then, we’ve had a disinflationary period. That’s been really good for financial assets.  

I think right now gold is extremely attractive over the next 5 to 10 years, because I think we’re transitioning from a disinflationary environment to an inflationary one. There’s a lot of reasons for that, but I probably have to dominate the entire rest of the show to go through it all.

Preston Pysh  25:18  

I’m glad that you said that. Now, I’m curious what your thoughts are buying gold versus silver?Do you think silver’s going to give you a better return than gold over the next couple years?

Jesse Felder  25:26  

It very well could. I don’t own silver. There’s more to silver than there is to gold. I mean, there’s the industrial uses and things that you have to pay attention to for silver. Gold I think is the pure alternative currency and inflation hedge. 

The reason I think silver is potentially ready to explode is that I was looking at the silver to gold ratio,and it’s bumping up along the lows that it’s rarely seen in the last 10 years. 

To me, that’s just a sentiment signal towards precious metals. When people get excited about precious metals, they buy silver, because silver just has higher volatility and  higher beta than gold does. 

So the fact that people are abandoning silver is a bullish sign, to me a contrarian sign that the precious metals are still super underowned and hated right now. Then there’s also the fact that speculators in the silver market have the largest net short position on record in history. 

If these metals start to break out higher, the short squeeze is going to be incredibly powerful. 

Preston Pysh  26:27  

How familiar are you with ABX, the Barrick’s Gold Miner?

Jesse Felder  26:32  

I looked through all of them. The ones that I started buying in 2016 were trading… Gold Corp was trading at literally 50 cents on the dollar, half of its tangible book value. So those are the kinds of ones that I learned that Barrick and Newmont are the big boys. They usually don’t get quite as cheap as some of these other ones. 

Gold Corp is not a small company. I don’t like to really speculate in the smaller miners. That said, I don’t own any Barrick. 

Preston Pysh  27:00  

Well, my question is this because we’ve watched gold right when you started talking about it is when it really bottomed. Then it bottomed around, let’s call it 10.40, 10.50 in price and now it’s at 13.42. So it’s easily up 30% since when you first started talking about it. 

You go and you look at Barrick’s Gold Mining and it’s really had a rough time in the last year. The thing has been punished and it hasn’t been tracking the price of gold. I can’t figure out why that’s the case.

However, when you put a gold position on I’m kind of curious, because back when you first started talking about this… I read an article where George Soros put a call option on Barrick’s. He absolutely crushed it because the price of gold went up 30% within that first six months of that period of time. He sold the call. 

That really kind of caught my interest as maybe a really smart way to approach this because you get all these arguments of people saying that the gold market is manipulated and the argument about paper gold versus our tangible gold. Then you see a guy like Soros go out there and do a long term call option on a gold mining company. He just brushes it 200-300% in six months. 

I’m curious, do you think that that’s the way to play this into the next two years, or do you think you just have to buy some gold ETF?

Jesse Felder  28:23  

I’m very comfortable recommending to people that everyone should allocate a portion of gold to their portfolio. Ray Dalio said if you don’t own gold, you don’t understand history. Everybody should have some portion of their portfolio allocated to gold. 

My favorite way to do it right now for most investors is the Central Fund of Canada, which has just changed to the Sprott something I don’t know Sprott bottom out. 

This is a closed end fund that just owns gold and silver in storage. It still trades today at a 3% discount to the assets that it hasn’t stored so it’s crazy. This is another sentiment signal. 

There’s no reason why it should trade at a discount, because since Sprott bought this fund, they’ve made the shares convertible into bullion. So you can say, “I want to convert my shares of the Central Fund of Canada into bullion, please send me my gold coins,” and they’ll do that. There’s literally no liquidity risk. There’s no any type of risk in this thing.

Sprott is the biggest name in the industry, but that’s just owning the metals. I think that’s a really easy way to own the metals, the mining stocks are much more volatile. There’s a lot that goes into it. 

I’ve talked with my friend Bill Fleckenstein a lot about this because he’s really kind of an expert in the area. One thing he taught me was look at where the mines are, because a lot of these companies have mines in an iffy government, countries where assets can be taken over by the government so you really want to own things in Canada and other places where you don’t have to worry about geopolitical risk. 

I do have to plug Toby again. I saw back in February and March or something, he wrote something about Taho. I said this is one that hasn’t hit my radar. I bought it back in February or March or something. It was up 50%. So thank you, Toby.

Preston Pysh  30:17  

Is *inaudible* pick was on the front page of The Wall Street Journal as well. I guess Walmart’s trying to buy it.

Tobias Carlisle  30:22  

Yeah, that was a good one. I’m glad we’re not talking about the last time Jesse was on which was AGO and he had CF. I think in that horse race, I think my horse is still running. That’s AG, which I still think is really cheap. By the way, it’s way too cheap. But it’s going to take a little while for it to work through its problems. 

I really like gold. I think about early last year, that started last year, I met both people who are gold bugs and people who hate gold. I think this is a perfect position. The gold bugs hate it when you buy the paper gold like GLD. I’m not going to go and store gold in my house just in case there’s anybody out there who’s thinking about robbing me. There’s nothing here of any value at all for burgling the house. My gold is paper gold. 

And because gold’s been so beaten up, and quiet for so long, there’s absolutely no *inaudib;e*. So I was buying leaps at the start of last year in GLD. I don’t mind that as a way to do it. 

I looked at the way that GLD and gold performed the last time we went through 2007-2009, the last time the market got beaten up like that. The gold miners index got really beaten up. It didn’t kind of stand up.

It trades a little bit more like equity than it does like gold. Gold sold off a little bit too, but it wasn’t as bad with GLD, sort of as well. 

That’s just a different way of doing it. I don’t mind the leaps of it. That is the very long term call options. You find the longest dated call. You find one that’s pretty liquid and as close to the money as you can get. 

If you’re directional, you want to get close to the money. That’s what I have been doing every time it rolls one more year, I buy one more. So we’re about 18 months to the backmarker call option right now. That’s 2020, I think is the longest one you can get. The call is at the money on GLD, or a similar sort of gold trust.

Preston Pysh  32:13  

My opinion is if the price of gold kind of punches through this really hard resistance level that we’re seeing it like 137.0-13.60 ish, it decisively pushes through there. To me, that seems like it’s just going to go off like a rocket. Would you agree with that?

Jesse Felder  32:29  

Yeah. There’s a long term head and shoulders bottom, just from a purely technical standpoint, but like you said, goes from about 10.50 to 13.50.

Traditionally, you would measure that head to the top of the head or the bottom of the head. In this case, because it’s inverted, to that neckline $300 so that it would project $300 to the upside, once it completes the pattern. So break through 13.50, technicians are going to be looking for 16.50 next.

Stig Brodersen  32:55  

Jesse, and I’m really sorry if this pitch here from Preston turned into an interview of you about… but I think this is something that the listeners would find really interesting, because we’re talking about real assets and talking about gold.

We know that you’re giving perhaps so many hardcore Warren Buffett listeners out there, a lot of them do not believe so much in gold, but they still believe in real assets. So how do you see that as an asset class going through the cycles? How do you allocate? What’s your thought process about that? 

Jesse Felder  33:28  

I would show people who don’t believe gold is a good alternative currency, because that’s really how I look at it. It’s an alternative currency. You look at the long term trend in the dollar, essentially gold is, to a large extent, the inverse of the dollar. 

You look at what drives the dollar? Well, the biggest thing that I can find over the long term is federal deficits. You look at when the last time gold was extremely cheap was when we had a federal surplus during the dot-com mania. The capital gains created all the nice taxes. We had a nice federal surplus and nobody wanted to own gold. 

However, there’s a really tight correlation between the federal deficit and the gold price. This is the first time I think, in history right now where we’re seeing federal deficits widen during an economic expansion. 

If you’re worried about that, then you need to buy gold. period. And so, I’m seeing these deficits widen. Then you look at the projections of where these federal deficits are going, they’re only going to get wider. 

The projections don’t include a recession. If we get a recession, the deficits are going to blow out. This is the catalyst for gold breaking out to the upside. It is just widening deficits in my view.

Tobias Carlisle  34:43  

I have this deja vu of being on the show in the last few years and having this discussion about Buffett and gold. I think I pulled up this quote, at the time, I just think it’s worthwhile sharing it again. 

I wrote this in 2009 on Greenbacks. Buffett was being interviewed by *inaudible* and she asked him a question about gold. He sits there and looks at you. He didn’t really like it. 

I remembered that he wrote in his 1979 letter to shareholders that someone had pointed out to him that in 1964, one share of Berkshire bought one half ounce of gold. Then 15 years later, after playing back all the earnings, plus blood, sweat and tears from the greatest investor alive today, Berkshire Hathaway bought the same half ounce of gold. 

So it’s just worth thinking about that there are periods of time where you can invest as well as Warren Buffett without any of the effort over sort of very long periods of time. I think that gold is getting close to being one of those positions again.

Jesse Felder  35:46  

Yeah and I would just add that what Buffett might not like and Buffett is as plugged into the financial system as anybody. Alan Greenspan over the last couple years has been telling people to buy gold. 

When you have Sir Alan Greenspan, I should call him, I believe he was knighted. He who’s been responsible for this boom bust cycle that we’ve seen over the last 15 years, to see the situation, the fiscal situation that we’re in and saying people just need to start buying gold, to me is the only endorsement of it from a major public financial figurehead that you need. 

Stig Brodersen  36:21  

Yes, so my pick is United Therapeutics Corporation. Before you guys bring up the bet, I would just say that this is a very ugly company, as always, in the sense that it might be similar to what Toby talked about, except that Toby’s stock picks typically perform a lot better. 

After we have the call, this is a biotech company. They are developing and selling drugs to patients with chronic and life threatening conditions. It’s primarily to treat pulmonary arterial hypertension, PAH, which is a condition of increased blood pressure with the arteries of the lungs. This is as much as 94% of the revenue. 

In this market, there are like three main drugs and they’re the market leader. They have a very, very small portion of the revenue around 4% that comes from the treatment of neuroblastoma, which is like a rare cancer that forms for immature nerve cells. So that’s from *inaudible*. 

If we look at the industry as such, it’s a $6 billion market growing 5% a year. Really, lifestyle is the main reason for this so smoking, alcohol, the way we eat are all huge contributors. *inaudible* contribution is HIV and as with many other diseases, a lot of the causes are simply unknown. 

Really, the driver for the growth of the industry is the presence of the large population of 60. Though they’re immune to levels and they’re prone to get this disorder from that. 

Now, if we look at the competition, the numbers look great. There are definitely some challenges in the future but we are looking at the second highest operating margin amongst its peers. Again, it’s for various products, but in the industry. It’s up there with Gilead, which was Toby’s pick from Episode 166.

I just want to point out that despite things like healthcare not necessarily doing well since, Gilead has really held its own so that’s really interesting to follow. 

If you look into the future, and one of the reasons why it’s selling at discount, well, for one reason, the industry as such has just been punished. But more generic drugs are entering now, which is going to take its toll on the revenue, especially in 2018, not necessarily in 2019.  

I do want to point out that this is not the active ingredient in the patent. This is also what is around that treatment so it’s really like dependent on where the patient’s health is. There are five different groups, depending on how developed this disease is, they will get different kinds of treatments and there are a lot of new patents around those types of diseases that are not running out. 

So without sounding like a doctor or anything like that at all, that was the first part of my pitch. I’m very excited to hear what you guys have to say.

Tobias Carlisle  39:15  

I want to go first because I absolutely love this pick. This was actually going to be my pick until Stig cut in first and picked it. I’ll tell you why. 

It’s the second cheapest thing in the Acquirer’s Multiple large cap screener. I get it on the screen at four or five, something like that on an Acquirer’s Multiple basis. I think this is a spectacular stock on just about every metric. Massive return on invested capital, like 13% free cash flow yield. I like everything about this stock. I think it’s a really good pick. So I just wanted to get that out front and center. I think it’s a really good one. 

Stig Brodersen  39:50  

That’s so boring. You usually beat me up, Toby. It’s very easy for me to experience this.

Jesse Felder  39:56  

Well, I would just add to that, that this is actually a stock that I owned back in 2012 when I saw Martine Rothblatt buying a ton of stock. She is a fascinating person. She invented SiriusXM Satellite Radio. Then one of her kids got sick with this and she created this company to basically address this illness. 

Fascinatingly brilliant person, not to mention, she had the courage to transition from living as a man to living as a woman now back in the 1990s, before it became more accepted like it is today. There’s an interesting TED talk with her where she discusses a lot of these things too. 

I got interest in the stock 2011-2012 when I saw her buying millions and millions of dollars of stock. Then I sold it way too early, as I always have a habit of doing, but I’m looking at just the insider activity now. 

The one thing that just concerns me is yes, it’s very cheap. But there’s zero insider buying. Martine actually looks like she just has kind of a consistent sell program going. She does have the discretion to put that on hold. That I would at least like to see, you know, some type of confidence there where she said, “I’m not going to sell any more stock for a little while, it’s just too cheap,” or at least some insider buying by somebody at the company to kind of justify my idea that it’s cheap.

It does trade five times enterprise value to EBIT, which to me is extremely cheap. The only thing I worry about is that it is justifiably cheap, I come back to the second level thinking Howard Marks if you have to have a non-consensus idea, you have to be right for second level thinking. 

The non-consensus idea here would be generics are not going to hurt them in the pipeline is better than people expect. That was actually what was hurting the stock back in 2012. People worried about generic competition. It turned out the company overcame that and did really well, today. I wouldn’t have the same kind of confidence to take that kind of a non-consensus view. That’s just me.

Stig Brodersen  42:06  

To respond to some of this. First of all, I just want to point out that this story about the CEO is incredible and she talks about how she traveled across the US to find scientists who can propagate like one gram of this active ingredient to cure her daughter. I mean, it’s been amazing like offering $100,000 almost to random people at different universities, because it was really dangerous at the time to develop because things exploded. It’s a very, very fascinating story. 

She herself is a very interesting person with everything going on. I think she also flies, helicopters and wants to build a solarplex around growing organs, which is very fascinating, and almost like a separate conversation too.

In terms of what you say, Jesse about insider trading, that’s a huge issue and something that I really don’t like. She’s the founder and CEO, but she currently owns .12% of the company. She’s been selling off for quite some time. 

Now, I do want to say that her base pay is relatively small. I know that whenever we’re talking about a CEO whose base pays that relatively small. But still, when you look at the data and you will say, “Stig, that’s not like a small salary. It’s a high salary.” A lot of that at the time was tied up into stocks and stock options. That has later been cocked back back in 2015. 

They also got rid of Jeff, the co-CEO, I really don’t know why they would have a co-CEO. The way that the management said back then was that it was also to reward him and a reflection of the contribution he did for the company, which to me is like a huge red flag. If you have that kind of culture, where you are just patting each other on the back.

Preston Pysh  43:53  

I’m just curious if Jesse would consider all the share buybacks in the same light as maybe an insider buying because it looks like they’ve been buying back at $250 million to $500 million a year in share buybacks.

Jesse Felder  44:05  

I’m very skeptical of buybacks, especially these days. Insiders need somebody to sell to. When you run the company we’re going to buy back stock and provide that, I will say that there really isn’t any other selling going on, which should be more confidence building.

That said, when I was buying the stock, Martine owned 700,000 shares. Today according to what I’m looking at, she owns 8000 shares. She essentially divested almost all of her holdings.

Preston Pysh  44:39  

Stig, when I’m looking at the fundamentals, so I’m going to talk the fundamentals, then the momentum on it. 

From a fundamental standpoint, I’m kind of like you and Toby, it looks really great, based on the discounted cash flow that I’m looking at and all the numbers. I think at the current price, you could even get a 7.5% return if it could continue to pump out the numbers that they have been producing.

My concern and why I wouldn’t buy this right now today is just because the momentum is kind of really bad on it. I don’t see anything that kind of gives you the indicator that you’re seeing any type of statistical change in the price action. It’s very flat and somewhat just going down. 

I think if you’d see something that changed, I think this would be something that I would continue to monitor me personally. Then if I saw a nice change in the price action, then I might start buying, but I’m kind of with Jesse on this. I’m a little suspect as to what’s going on.

Tobias Carlisle  45:34  

I’m not looking at it, possibly the way Jesse might look at it, which might be on a single stock name, point to point on. I’m not particularly familiar with that at all, but I wouldn’t use momentum to assess this kind of stock. I wouldn’t know how to do that. That’s probably maybe trying to make myself sound a little bit smarter than I actually am in relation to that. 

Jesse Felder  45:52  

I would just say from a technical standpoint, it looks like the last four years or so it’s had a nice range between 100 and 100, 50-60 bucks. It does have lower highs. That’s potentially a sign of a longer term downtrend. 

However, what I would be looking for here is in terms of momentum, like you were saying, Preston. It is potentially another breakdown below 100 bucks. That’s going to freak people out. Get it below 100 bucks and then you could probably buy it, at least for a trade to see it pop back maybe even up to 120, 130, 140 bucks, just from a longer term technical perspective. 

Stig Brodersen  46:35  

Just to go back to what Toby said, and before I really put him on the spot with the momentum thing, I have started to look more and more at momentum, it was underrated. 

It was really interesting to hear how Bill Miller, one of the old school value investors is also using momentum when he validated the fundamentals. That was very inspiring.

I do want to say that just looking at the momentum for this, especially call something a 100-day average or 200-day moving average… you probably should not buy into this. 

I do want to point out the importance of insider trading. I think it was like a year ago or something like that, when we have the exact same group assembled, and I pitched Bed, Bath and Beyond. The group was like, “That’s the stupidest thing I’ve ever heard anyone say.” I  might not be accurate, but they might have said something worse than that. 

Then Jesse said, “Have you looked at the insider buying?” I was like, “Yeah. It does not look good but it’s really cheap.”

We talked about yes if they just sustain the current cash flows, it was still like 14% return at whatever it was at the time. It has just been crushed. 

I actually did end up not buying the stock. I should probably buy you guys beer in Berkshire.

Whenever I think back, because I was definitely emotionally attached to that stock. I’ve been following it for years. It’s just like, yes, now’s the time to buy. I started to pay a lot more attention to insider trading. 

So why am I still pitching this stock? I mean, it doesn’t look good in terms of insider trading. Martine Rothblatt definitely still has a hatch in terms of her stock. With the stock performance, it’s very important for her compensation. 

I think just a few years ago, when she was on the old agreement, she was like the highest paid female CEO or something like that in the States. So there’s definitely *inaudib;e* there for her, but no, it’s obviously not a good sign if the CEO and founder does not want to own what she created. I think that says it for itself. 

About what you said about the driver, Preston, really to address that. I think it’s true that especially in the short run is primarily like the value in itself. If you believe that or not, that will be the driver. 

I don’t necessarily see 2018 to be a great year. I think it’s going to be a hard year with revenue and net income picking up in 2019, with the new patents coming out. 

I do want to say that one thing that might seem completely off, but I think it’s still a significant out on the money option is all the work that they’re doing with growing organs.

What the company actually did was already back in 2011, they bought the spin off company o,  I think it  was an English Irish company who cloned sheep Dolly. They continue doing that research and already in 2023, they looked for FDA approval for part of manufacturing organs. 

This is not like this cool scenario where you just like necessarily print a kidney or a lung.  It does not work like that, at least not in the first five or seven years. They can fabricate or manufacture a part of that. 

This is actually something that they heavily invest in. Obviously you don’t see any kind of revenue from that at all, but if you look at transplants of organs in itself it is like hundreds of billions of dollars. It’s a huge market.

The way this works is that you would have an unfortunate incident and then that organ would be transplanted into that patient that really needs it. 

Now, the problem with lungs is that the rejection rate is really high. So as much as 80%. so 80% of the lungs that’s being tested for transplant, because it has to go really fast, they’re rejected. 

What’s happening is that they have an agreement, where they take the rejected lungs, and then see if they can get them back to life. Their success rate already, at the end of 2017, is 50%. This is something that was already rejected. This is not just like empty talk. They’re making some amazing progress in this field. 

So yes, it’s out there. In terms of timeline. I know that the CEO might sound ridiculous, when she was on Yahoo and she talked about doing 100x, or whatever she was doing on the current market cap. However, this is a very, very significant thing. They’re the market leader, as far as I can see, with the research that I’ve done. To me, that’s very interesting.

Preston Pysh  51:14  

If it’s going to do 100x, and she’s making statements like that, then you look at the position that she used to have in the company to what she has now. I guess I don’t buy any of it, if that’s how much she’s offloaded her position. If anything, it makes me even more concerned.

Tobias Carlisle  51:29  

The only thing to say to that is people sell for lots of different reasons. I just looked at her on Wikipedia when Jesse was talking about her. She’s 63 or 64. Traditionally, that’s been getting closer to retirement. You might not want to be fully exposed to the market or to a business. 

At that kind of age, people sell lots and lots of different reasons. People typically only buy for one and that’s because they think it’s undervalued. 

So the existence of selling I think is less significant than the absence of buying, which to Jesse’s point, there may be some information in that. 

Another way of approaching it is the way that I do it on the Acquirer’s Multiple side. I screen out stocks that are too heavily shorted. You can look at the short interest ratio, and under screen out the ones that are too heavily shorted. That’s one of the reasons why I didn’t like Bed, Bath and Beyond last year when Stig raised it. 

Now when it’s down a lot, I think that it’s still a very heavily shorted stock so you won’t see it in the acquirer’s Multiple, even though you might expect to see it in that list because Acquirer’s Multiple is low enough that it should be in that list. 

Stig Brodersen  52:32  

Toby, on the show, we talked a lot about how you should be able to argue both sides, which is why I say if you really like Bitcoin, what’s the best argument why it’s going to fail, and vice versa? 

I’m very curious about why you think that this pick is a bad pick because clearly, this is something that’s very exciting to you and you have your own bull case. What is your bear case? What is the biggest red flag for you?

Tobias Carlisle  53:23  

It’s the one that Jesse identified that the stock is currently priced as if earnings are going to continue dropping a few percent every year. It’s entirely possible with generic competition that causes that to happen. 

Also there’s a very large popular groundswell against the enormous markups that everybody who touches the health industry has been able to get for a very long period of time, based on patents or various other legislative… It sort of stumped the statistic today that it costs $1 to produce a bag of cylon and then hospitals sell it for $800. 

I think the markups are enormous. That’s been a good reason to buy this stock, if you’re a Buffet style investor. Enormous profit margins and massive returns on invested capital don’t really require a great deal of capital to grow their businesses so they’re able to reinvest, throw off lots of cash, fantastic businesses.

However, society allows them to continue to do that. Very strong arguments on the other side. So the way that I resolve that is I think that it’s just too cheap. I’m willing to take the bet at this price, but it’s by no means clear.

Jesse Felder  54:32  

Yeah and I would just validate your point, Toby, about the insider selling. To me, insider buying is much more valuable, especially when it’s on the part of executives, especially the CFO.

When I see directors buying, it doesn’t really excite me too much. When I see sales, it really doesn’t bother me too much either. It looks like she’s been divesting for a long period of time. 

I’ve seen examples. I remember seeing Bernie Evers. So every share of stock of WorldCom, literally a couple weeks before the fraud was discovered. Jeff Skilling sold every share of Enron that he owned a few weeks before the problems were discovered.

When you see guys go from having $50 million $100 million of the stock to zero in a week or two, that to me is the only type of selling that’s very compelling. It makes me dig deeper and look for problems, usually in the cash flow statement. I definitely don’t see that here.

Stig Brodersen  55:24  

Just to your point, Toby, about the backlash from the public and then  from the politicians in terms of regulations, I would still like to challenge that. Right now we’re talking about, especially with Facebook, but also the huge tech giants. We even had Jesse Philips coming on the show to talk about FAANG stocks. Fascinating interview. 

I think there’s a tendency to have this focus fallacy, where what we see right now,  especially in terms of regulations, just seems like something that we emphasize too much. I mean, yes, it’s been more public the criticism of the healthcare sector than it has been. 

However, I just think historically, not just looking at this sector, but also sectors, whenever you have this suspected backlash, you don’t necessarily see that materialize into the earnings of the corporations in time to come. 

If you look at the banks, they have been through so much criticism. What has happened? Every time they’re bailed out and they’re still making tons of money. That’s just how the political system works with lobbyists. 

I wouldn’t say that it’s not a concern. It definitely is. I just think that shouldn’t be overemphasized. I’m curious to hear your thoughts about this, Toby. I know you’re doing a lot of back tests and a bunch of things. Do you have any thoughts on this?

Tobias Carlisle  56:48  

No, I agree with you. I think that the system is broken. I have never spoken to anybody in the States who has said it is a wonderful system. I think everybody thinks that there’s an issue. 

But I think everybody’s thought that there’s been an issue for a long time. I think that the regulatory response is often… it can be a little bit arbitrary. I don’t know how it’s going to land. It could have an enormous impact. 

In relation to UTHR, specifically, I don’t see any specific legislation or anything that’s going to impact it. I was sort of speaking like what is the bear case for UTHR? What potential risks are there? I think that that’s one that at some stage, there’s some reining in of the cost.  I don’t know how that’s achieved or how it happens, but it’s worth watching.

Stig Brodersen  57:32  

I’m around like 10% return on the current price. Just as a disclaimer, because I actually think I forgot to say that about the stock 109 here a month or two months ago, something like that. So I am long, as I’m saying all of this with the bull case. What kind of return do you come up with an implied discount rate for your valuation of the stock?

Tobias Carlisle  57:53  

I think it has a wide range. I think fair value, it could be half price or fair value could be roughly where it is. That sort of means that I don’t think that has a great deal of downside. I think that the risk reward is right. 

I wouldn’t ordinarily give a fair value range as wide as then. I wouldn’t necessarily be as excited about something with a range like that, but I do think that the upside is it’s potentially half price dand that’s really hard to find in this market. I think that it is a worthwhile position to put on.

Preston Pysh  58:25  

Alright, so that concludes our Mastermind discussion. Jesse, if the audience wants to learn more about you, where can they find you? 

Jesse Felder  58:33  

I’m active on Twitter. It’s just @JesseFelder. I share just a ton of stuff, the reading research that I do on a daily basis, and then I put up a weekly blog post at TheFelderReport.com

Preston Pysh  58:44  

Awesome. We’ll have links to that in the show notes. How about you, Toby?

Tobias Carlisle  58:48  

The website is acquirersmultiple.com. If you want to learn about the process, I published a book six months ago, “The Acquirer’s Multiple” and that’s available on Amazon. I’m on Twitter all day long too. 

Jesse’s one of the best tweeters out there. My handle is @greenbackd. I like every single one of Jesse’s tweets like I’m stalking him.

Jesse Felder  59:23  

I honestly can’t recommend your book highly enough. I think that probably might be the best investment anyone can make in the current environment. Read up on that stuff so that you can take advantage of opportunities that are coming in the future.

Preston Pysh  59:38  

Well, guys, seriously, thank you so much for always coming back and having these discussions with us. I know I learned a ton when I get a chance to talk to you guys. I see Stig nodding his head as well. I’m sure our audience learned a lot from your participation here. Just thanks so much for coming back on the show.

Stig Brodersen  59:57  

Alright guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week. 

Outro  1:00:04  

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