So, Amazon is a good example. One of the questions you may ask me is, “What is your biggest mistake in investing?” Certainly, one of my best investments and decisions I made in investing is probably to buy Amazon and the IPO, while the worst decision was ever to sell an Amazon. 

It came at a $400 million market cap, and it’s pushing a $400 billion market cap right now. So, I think with respect to something like Amazon, which we got right, and I still think most people get wrong about Amazon is that they confuse gap accounting profits with the creation of value. 

Value is created whenever you earn above your cost of capital, and you can reinvest it above the cost of capital. That’s been something Amazon has been brilliant at, and a way to gap accounting are those investments. Some are expenses. Some are capitalized. 

In addition, one of the things that Jeff has tried to do is to take in essence all of the excess cash that they have and invest it at what he still believes are close to triple-digit returns on capital, even though that may not show up for several years or even decades. The thing that’s interesting about Amazon right now is to compare it to Facebook and Google. Google has about a $500 billion market cap and Facebook has a $350 billion [market cap]. 

I think we’re the second largest buyer of Google on the IPO, for example. Both of those companies at their core are addressing or attacking the global ad market. That’s where they get most of their revenues. Now, they’ll go to different places. They’ll diversify, but that’s the core of what they’re doing. 

That’s a $500 billion market. About $250 billion in the US. $250 billion outside the US. It’s growing maybe a little bit faster than global GDP, so you have $800 billion of market cap just for those two companies, which are attacking a $500 billion pool of money. 

Amazon, on the other hand, is roughly the same market cap as Facebook, and we’ll call it rounding $350 billion. They’re attacking retail at their core. US retail alone is $5 trillion, so that market is 10 times the size of the global market that Facebook and Google are attacking. And that’s part of the reason that I think people continue to underestimate Amazon’s long-term growth and their ability to reach an enormous-sized market.

Preston Pysh  6:55  

I want to highlight something to our listeners that you just really couldn’t have illustrated more clearly, to me at least, is how big picture you are and how you’re starting with this really large idea. How big is the market size? How many major players are in it? And how much of that can they still capture? 

I think that so many investors out there are down in the weeds. They are looking at things that they don’t understand, which is the growth potential and what it could actually grow to. That is such an amazing lesson that you just pointed out. I want to just highlight that.

Stig Brodersen  7:28  

The next question, Bill, is a question that is really, really hot at the moment because it’s about cash. When we look at the actions of many value investors, some are describing cash as a great way to have optionality in the US market, and perhaps the prime example of that is Berkshire Hathaway’s balance sheet with over $70 billion in cash. So, I’m curious, do you agree with this allocation decision? Or do you think that some investors are proceeding with too much caution right now?

Bill Miller  7:57  

I think that all depends on the type of investor we’re talking about, so with respect to Warren and Charlie, they have this monstrous cap cash, generative machine that if they just sit there, it’s going to build vast amounts of cash just by itself, naturally. Whereas, if you’re a mutual fund manager like I am, you’re looking at a cash depletion machine, because we’re getting, at least up until the Trump election, steady redemptions all across the US equity space. 

I think, first of all, it’s going to depend slightly on: Are you getting cash inflows? Are you getting cash outflows, or are you neutral on cash? [It’s] how you begin to think about cash. In terms of optionality and cash, yeah, I think that’s an important thing. So, what cash gives you is the ability to take advantage of opportunities that the market might throw up for you. 

And again, if you think about this recent environment, when cash is earning zero, so it’s effectively earning zero, your opportunity cost and a low nominal return [are] not very high for holding cash. 

We’re in a world where the bonds, wherein you put it in 10-year treasuries that up until a few weeks ago,[it’s] one seventh with a lot of risk in that if things go the wrong way, as we’ve seen how they’ve done. On the other hand, I’m more I’d say…I differ from people like Seth Klarman, who are people who tend to hold lots of cash, almost all the time, because they don’t find the market cheap enough. They think the market might go down. 

And my thought on that is I think there’s a little bit of, again, I understand it, but I find it somewhat puzzling in the sense of, if you’re holding 40% cash, the other 60% that you have invested will obviously believe will be cash, so that would be cash, too. But if that’s going to be cash, once you have it all, you’ll lose 60%. Maybe hold zero cash. Then, if things get worse, sell off some of the names. Keep to better bargains. 

But again, I think it all has to do with people’s temperament, and my temperament typically has been to hold almost no cash. That comes out of what I try and be. It’s like Warren and Charlie, who said they are rational. If you look over long periods of time, cash underperformed stocks. Thus, the longer I’m holding cash as a percent of the assets I own, the greater the probability that that’s going to be doing poorly for me, and I’m going to need periods, where I can put that cash to work to make up for in essence a lower rate of return for the losses that are relative to the market by holding cash.

Preston Pysh  10:01  

I want to touch on this bond discussion because you hinted at it a little bit there, and I know you’ve been thinking that this bull market on bonds, it started back in ’81. It’s been running for 35 years. It was going to die for the last couple years. 

And this summer, we started sending out emails to some of our followers saying, “Hey, this is getting so asymmetrical at this point. Bond yields are hitting 1.7%, and Trump gets elected. And now, everyone’s seeing that there’s a potential for inflation.” That’s the new narrative at this point. 

It is that inflation is going to be higher in the US. They’re going to change these trade agreements, which is going to create this influx of capital, resulting in the bond prices to start going up. So, do you really think that because we had billionaire Ray Dalio come out and say, he feels that maybe we hit the top of the prices, but the bottom of the yields in the bond market. Would you agree with that thesis? Do you see these bond yields just going up from this point in a huge sell off? I mean, we had $1.7 trillion this month.

Bill Miller  11:03  

Yeah, I think the bond-bull market has been our life support since 2012. And it finally expired the summer of 135 in July. Even with the economy and the market being okay, since then, yields began to move up. You mentioned 175 or so. They’re around about 240 or so, I think. Today, we’ve had a huge outflow in bonds. I think that in this very short run, maybe it’s overdone. 

But in the longer run, I think that you’re looking at a long bond-bear market. I think it was Ray, who might came out today, who was talking about 6% yields. I think *Gunlock talked about that as well over the next few years. I think that’s not out of the question. That to me is a more extreme view, but I do think 4-5% is in the cards in the next 3 years. 

I also think that that’s both good and bad for equities, because the only time since the Financial Crisis, and with the exception of the Trump win, where there have been debt inflows into the US equity funds, it was in 2013 during the Taper Tantrum. 

All the other time, money’s been flowing out of that and into bonds. And there’s several trillion dollars according to Michael Goldstein that are empirical of excess allocation to bonds at an average interest rate of 2.75%. 

So, if we go above 2.75%, that money is all I got to think in reverse. And you can see very significant inflows into equities, pushing equity prices up more than people think, which is bad. Right? So, it would be good while it’s occurring, but if markets are too expensive, then that’s not good for long-term investments.

Preston Pysh  12:28  

Yeah, I think short term, you talk maybe a quarter or two if you see that same rate of sell off in the fixed income into equities. It’s going to be great for these equity investors, but it’s that parody in yield between equities and fixed income. They get closer to parody. I think that’s where it really starts getting scary for a lot of people. 

How far do you want to take it to that parody point before it really starts to unravel itself? Because whenever I hear Jeff Gunlock, Ray Dalio, and Stanley Drunkenmiller say 6%, and these guys are some of the brightest macro thinkers in the world, and they’re saying that it could reach that within a year or a year and a half…

Bill Miller  13:10  

I would disagree fairly strongly with the idea that that could be reached in a year or even two years. 

Preston Pysh  13:15  

Okay. 

Bill Miller  13:16  

I think we’re still in a low nominal rate-of-return world. The market is getting a discount, which is a positive-growth aspect to the Trump-stated policies. Those policies have to actually get passed. They have to get to work, and I think you’re talking about infrastructure, tax reform, etc. You’re talking a year or two years before that stuff actually begins to get passed and affects things. 

So, I would say 6%, maybe in five years. Maybe. I don’t think it’s going to get that high. 6% was what we averaged in the 1990s. I think we’re in a different world since the Financial Crisis, but again, I think 4-5% is reasonable. And I think around the 10 years, something in the 4% range would probably be breakeven against a market that might be treading moderately higher than this one, so you’d have kind of an equilibrium at that level.

Preston Pysh  14:04  

I was reading something that was published by Goldman Sachs yesterday, wherein they were saying that they felt that if you had to sell off some bonds, it took it about another percent. You’d be looking at a point where the equity prices would start getting a little scary. Would you agree with that, as far as you feel like it hasn’t about another percent of sell off in the fixed income market before it starts going in that direction?

Bill Miller  14:26  

Depends on the speed. If it were another hundred basis points in the next two weeks, it would probably be pretty bad for equities. And it takes a year to get there, probably not. We were over three 3% several years ago, the equity markets. The market wasn’t scared about that at the time. I think it all relates to the growth rate and the inflation rate. So, if we do get pro-growth policies, and we get moderately higher inflation, something called 2, 2 1/2 that actually you could justify multiples in the low 20s on that, even against the 3+% tenure.

Stig Brodersen  14:54  

So let’s shift gears here a bit. So this is a question I’m really excited about and I just know that our audience out there Like me, they’ve been sitting with a stock screener from time to time and thinking, hmm, how can I find the best metrics to filter the best stocks? 

So Preston, I’ve been discussing this a lot. And we feel that one of the best ways to discover value in the markets is filtering results based on a ratio of EBIT versus enterprise value. I’m curious to hear your thoughts on this. And if you perhaps know of a better way to look at across a broad range of securities, and sectors to find value investing gems?

Bill Miller  15:31  

Oh, I think that’s very sensible. I think every screening technique has pluses and minuses. You know what that one does? What enterprise value to EBITDA does, for example? It gets things in the right kind of order from cheapest to most expensive, and then you can begin making adjustments based on the balance sheet, for example, or the leverage or, the after tax adjusting the *EBIT, for example. I think that’s a very good solid way to approach things.

Preston Pysh  15:58  

Now if you were filtering on *Have that where would you be looking for risk mitigation? Now, you’ve got a great price. But then what would be the next couple of things that you’d be looking at in order to pin down that you’re not in some type of value trap at that point?

Bill Miller  16:14  

Well, first of all, we don’t use that as a screening technique for a variety of different reasons, the one that we found most useful to ourselves is free cash flow yield. And so once we find things that have very high free cash flow yields relative to the market market right now is about six, you know, close to six, five and a half to six, you know, and so we typically don’t get interest until around 10, you know, nine to 10. And what that does for us is then then we have to ask ourselves on free cash flow yield is normalization. So what’s going on? Why is the free cash flow yield so high here? 

And is it because they’re underspending on a very rapid capital spending program or is it because they’ve got returning capitals dropping in the business is getting worse, but all kinds of different reasons, but it gives us a filter to compare things to again, we’re looking at sustainability of that. Because our view is everything is priced off the risk-free rate. 

So you’ve got a risk-free rate. You have an equity-risk premium. And then, you’ve got the way in which the sort of the median free cash flow yield of the overall market. You’ve got a whole lot of data with history that has been relative to rates, and then you get to the outliers with much higher free cash flow yields, meaning much higher equity-risk premium for what you’re trying to do. Another question is: Is that justified or not? Is it likely to revert to the mean overtime or even go below that?

Preston Pysh  17:26  

I think for people who are listening to that, [they might interpret it as] you’re making that assessment of what you think the future free cash flows might look like. From a conservative standpoint, you’re looking at the current price that you’re being offered. And then, you’re figuring out what the discount rate would be based off of those two variables being fixed, correct? 

Bill Miller  17:44  

Yeah, partly and also again, it’s that’s just one. So, we also use a free cash flow total return. In essence, if you take a company like Amazon, which historically would tend to trade at around a 2-3%, free cash flow yield, but it’s growing its free cash flow 30% a year, that’s a 33% free cash flow total returns *was the market. And the question is: Can they sustain that and do that? But again, that forces you to think out a little bit longer term than just today.

Preston Pysh  18:10  

Now, I know for myself when I’m trying to understand the valuation on call it, Amazon, one of the things that I pay really close attention to is the top line revenue as opposed to a lot of the other pieces as you get further and further down the income statement. Would you agree that that would be something that you would focus more on for a growth company? Is the top line revenue what you’re looking at trying to make those estimates?

Bill Miller  18:32  

Yeah, absolutely. If you actually think *DuPont formula in terms of how to disaggregate the sources of return, and what it basically comes down to them over something a little bit, but if you earn above your cost of capital, then other things equal in that formula. The revenue growth rate represents the growth of value in the underlying business. And so, the faster the revenue growth, the greater the value accretion. 

If you look at Amazon, they’re a really good example. In the late 1990s, they had a very fast growth rate, and then we had the Dot-com Bust. They had to focus a lot more on the balance sheet at the time, because they weren’t profitable. They had to slow down the growth rate significantly, which meant the stock collapsed. Then, as the growth rate came back up, the stock fell back up. However, every company is somewhat different. 

So with Amazon, for example, we actually went through and did a regression. We actually regressed I think over 200 variables against each other to see what was really correlated with the Amazon stock price. 

And as you might expect, it isn’t gap earnings. It isn’t free cash flow even. What it is, at least as of two years ago, it was growth of gross profit dollars. And that was a really interesting thing. That’s what we actually thought it was likely to be, and Jeff Bezos had made a comment, easily 15 years ago, that that was what he was focused on. 

He wasn’t focused on margin. He was focused on gross profit dollars. And lo and behold, that had 95% correlation with Amazon’s stock price. If you begin to think about it, that actually made perfect sense, because the gross profits in essence, that’s the cash they had to work with after cost of goods sold. 

Preston Pysh  20:02  

Yeah. 

Bill Miller  20:03  

And everything that they did with that cash was “an investment.” It could be a capitalizable investment. It could be an advertising expense. It was an investment of one sort or another if the aggregate of those things was earning above the cost of capital, and that was a perfect correlation with the growth factors.

Preston Pysh  20:17  

And I think for a lot of people that that’s an amazing point, because a lot of people don’t understand necessarily the gap accounting on some of those investments not getting their R&D. They’re not getting listed onto the balance sheet, and so you’re not necessarily seeing that the way that you would maybe look at the equity growth might not be showing up. It’s just getting costed out on the income statement, so that’s a really interesting point. I love that! It’s fascinating to hear you say that.

Bill Miller  20:44  

One of the most serious things to me about that is when everybody talks about Amazon never making any money. They never make money but now it’s crazy. The stupid multiples they say is that we you know essence we’ve seen this movie before with john Malone and the cable business. 

And John Malone if you invest with John, when he first took over TCI, and then you sold your stock when he sold the company to AT&T, you made 900 times your money with him. And he never reported a profit ever had that happened? Well, because there was a lot of value. It just wasn’t showing up in normal gap accounting profits. Amazing.

Stig Brodersen  21:18  

Yeah, really interesting discussion about Amazon that I think most people, including Preston than me, haven’t really thought about. Bill. I’m really curious about your response to the next question, because the guests that we have had on the show, the audience, it seems like everyone’s looking for opportunities in overvalued markets, not only for equities, but basically, more or less all asset classes that there is. So I’m curious to know, what do you think is the one thing everyone is missing in the markets here at the end of 2016?

Bill Miller  21:51  

I think they’re missing the opportunities in the equity market relative to other places to put their money. I think for the last 35 years up until The Summer of this year, the bond market, you know, certain on a risk adjusted basis, even on an absolute basis has beaten the equity market. And so that was a very rational place to put your money. 

Right now, I think you have almost no choice. And by that, I don’t mean you’re gonna have really terrible returns in equities, I think equities will give you the best rates of return. And people still haven’t figured that out. They’re focused on the fact that over, you know, we’re six years or seven years into a bull market, it’s gone up so much. I think they’re missing the opportunities in the equity market that still exists.

Preston Pysh  22:30  

Now, I’m curious, and I don’t think that this question really applies to the typical investor because I don’t really recommend shorting for a lot of people. But I’m curious, would you be interested in shorting the long term 30 year bond or at this point, do you have that much confidence that the bond rates are going up at this point?

Bill Miller  22:45  

We actually have a partnership that we began incubating in the summer and will be kind of ready for primetime live and in the incubation phase, we’ve been short, the 20-year Treasury. So it’s worked out nicely so far. I think probably right now that we’ve had such a big move, it’s not the most opportune time, but I certainly wouldn’t if I was coming into it today. And would you rather be short or long and say, “Oh, to start a short position there, and if it goes against me and rates go back to do that, I’ll just keep increasing that by some more.”

Preston Pysh  23:16  

Yeah. Very interesting. So when we look across the landscape of great value investors, people like Howard Marks comes to mind. But what people do you admire? This is kind of the buffet question of like, who is some of your competitors out there in the value investing space that you really look up to and that you admire that are worth studying?

Bill Miller  23:35  

I’ll give you a group of names. When I get asked that question on who I admire, my initial answer is always the same, which is: anybody who can survive in the business for longer than 25 years. Because there’s actually a guy over the Times of London who claimed to have studied every investor who was hot for a while, and he said that if you made it beyond 25 years, then you actually had some level of skill. 

And he said even 20 years don’t. Do people get washed out at a certain point in time? I don’t know if that’s right or not. But I do think that just just surviving in the equity markets as a professional investor, best satisfied clients and consultants and people like that, it’s a tough thing to do because everybody’s gonna run through difficult periods and bad performance and people don’t have a lot of patience for that. 

So with that as a preface in terms of value investors, many of them come to mind my friend Chris Davis, I think is a very solid value investor whose family’s been doing it for three generations. Bruce Berkowitz, he’s having a great year this year after a terrible couple of years, but again, a great long term record and concentrated value investing in a company you know a name or two that might be less than a million other people. 

Tom Gaynor at Markel insurance company has been the Chief Investment Officer there. One obvious Seth Klarman at the outpost does it very differently from what I do. It does it brilliantly, and of course a great value investor.

Stig Brodersen  24:53  

While I was preparing for this interview, Bill, I had the chance to see you in some other interviews and one thing you said was that you’re really looking at Apple from two different angles. 

So on one hand, you’re really impressed by the technology, the relative of the class insurance, [and] the innovation. On the other hand, especially in terms of capital allocation, that was something where you really deem that they didn’t do a good job. So some time has passed now, and I was wondering, do you still hold the same opinion about Apple and their capital allocation decisions?

Bill Miller  25:27  

Well, when I made those statements about Apple, I thought that they were terrible at capital allocation. And I think they’ve improved very, very dramatically. And one of the things that made me sit up and take notice about how bad they were was when Tim Cook, on a call on an earnings call 3 or 4 years ago, was asked about their share buyback program, and the analysts said to him, “The stocks are down 30%, since you announced the share buyback. You buy more shares when the stock is lower.” And he said, “We like our stock at whatever price it is. So we like to buy it no matter what the price,” which of course is just a bizarre statement. 

Now, what subsequently happened sincerely, I think Carl Icahn has had a big influence there is that they’ve actually gotten much, much better capital allocation. And their problem capital allocation was a narrow one. It wasn’t the case that if you looked at when they spent money operationally or on a new product, but what they did was it generated such high returns, that they built up massive amounts of cash on the balance sheet. 

And when you have at one point in time close to half their market cap in cash on the balance sheet, basically, you’re destroying a large amount of value with that. So what they have done is not as aggressive as they should have. 

What they have done, though, is use a fair amount of that overseas cash issued bonds against it. And so the fees with the debt and bought in stock, I think they could have been more aggressive on the dividend side. But their capital allocation now is much, much better than it used to be.

Preston Pysh  26:47  

We saw Berkshire do that. I think about a year ago when they were issuing European debt.

Okay, so the thing that we learned the most from our big mistakes and I know For me, there’s no greater way to learn than making big mistakes, usually public mistakes. And so for you, I’m curious, what is one of the biggest mistakes that you’ve made in your entire career? And what do you do differently now that you learn from that mistake.

Bill Miller  27:17  

So I’m going to give you two mistakes because they operate two different levels. So one of them is called a micro mistake, any mistake at the company analytical level. So our biggest mistake, there was Kodak, which we owned for close to 10 years, and lost, almost all probably lost 95% of our money on the issue with Kodak, I’d say was twofold. 

From my standpoint, one of them was, I’ll call it the curse of mark to market. I think that going in to mark your portfolio market, there’s a certain blessing there, which is okay, if it’s market-to-market, the current news is in the price. So that’s already in there. 

But the curse of that is if you keep believing that the current news is in the price potential to keep you in things even when the news gets worse and worse and worse. That’s always the price. 

If you’re still optimistic about the business, so I think the mistake we made with Kodak was just staying with a serial disappointment or because their strategy was right. But we found out a culture couldn’t adapt to the change in digital technology, even though the management tried to get it to do so. So, the solution there, I’m sort of embarrassed to admit this is the old Ben Graham solution that he recommended probably 70 years ago, which is in these kinds of deep value situations. 

It’s really low price to book, low price to cash flow, maybe secular decliners, maybe not just put a time limit on it. It hasn’t worked for years, you sell automatically done. That would have saved us seven years of pain, I think in Kodak. 

And I think that’s a good rule. And that’s it. So we’ve adopted that rule, if we have a serial disappoint or it’s not that it’s gonna last three years, we just decide that they’re not making the business is not making the progress that we think it should, then we’ll sell then at the macro level, and much more devastating than any individual stock was we get the financial crisis from and I thought we had fairly robust macro problems. 

So I thought we’d have a fairly robust strategy. To deal with almost anything that had happened really since the post war period, so wars, political crises like Watergate, inverted yield curves, inflation going to double digits, all that kind of stuff. And what we didn’t understand was the difference between a liquidity-driven crisis and an asset-based crisis. 

Almost all the crises except since the Great Depression have been liquidity crises, and a liquidity crisis when the Fed turn restrictions on you jump in, and an asset based crisis as we learned later, once the academic research has figured this out, an asset based crisis, what happens is the 

Fed turns liquidity speakers on, you get a bounce in the market. That’s what we saw in the fall of oh seven, actually, to all the time highs, that rolls over again, because you haven’t solved the problem, which is the problem of asset values that are too high and they’re over levered. 

And so an asset based crisis, and they only come about because you’ve specified the safety of the asset, that case housing and an asset based crisis, the proper strategy is to do absolutely nothing except for get liquid until the authorities get together, prop up asset prices, or I should say, stabilized asset prices. That’s what happened with tarp in the fall of oh eight. 

So until tarp every time the government got involved, they wiped out equity, even though they told the banks to raise equity, right, and they wiped it out again. So tarp actually came in and preserved the equity of the bond via the equity. And there were no failures after that. 

We began to come out of that. So the lesson there is understand the type of crisis that you’re in, and don’t get involved in an asset based crisis unless there’s a concerted global effort to stabilize the asset question.

Preston Pysh  30:30  

So I’m real curious, because we talked to a lot of different macro guys. And one of the discussions that keeps coming up is this Deutsche Bank, Italian banks, you got the referendum vote that’s happening this weekend. So when people listen to this, they’re already gonna know the outcome of that, but I’m really curious what you think. Do you see similarities in what’s happening in Europe, especially in banking to what we experienced back in 2008?

Bill Miller  30:52  

Yeah, there are similarities and there are significant differences that mainly the differences are political with. So I think that’s why the recovery There has been much more Much, much slower than it was over here because the austerity programs were much more severe. We do own in the partnership. 

I mentioned Credit Suisse, which we believe has turned profitable and has adequate capital. We don’t [invest] on the other dilution coming, especially in the Italian banks. But even in something like Deutsche Bank, Santander looks okay right now, but the UK backs look fine, except for RBS, but we don’t see them as cheap enough. Hmm.

Preston Pysh  31:24  

I guess my concern, and we saw this play out in 2008. Let’s just say that, in reality, that’s the direction that this goes over in Europe. In the US, when one bank went down, the next one went down. I mean, it turned into a domino scenario with these banks, like overnight. And so I guess my concern over in Europe and for anybody else that might be listening to this, is they might be concerned with Credit Suisse, where they’re so dependent on their counterparts that they’re surrounded with over there. 

Let’s say that Deutsche Bank does have a major event or some of these Italian banks have major event. Couldn’t that quickly Turn and really become a nightmare scenario for call it Credit Suisse or some of these ones that look like they’re really good deep value picks right now.

Bill Miller  32:07  

It could be it could be it all depends on when it happened and how its spread and what the authorities response was to it. So if you go back to the 2008 crisis, and had the government done nothing, then I mean, Warren made a comment that even Berkshire might have gone down in that case, if commercial paper markets and credit markets were so disrupted. 

So I think the question is, if you have a systemic problem, it’s incumbent on the authorities stem that systemic problem. We’re already getting better growth margins out of Europe. I think bar standpoint. We think that systemic risk is much lower than it has been, but it’s not vanishingly small. And it’s pretty significant in the Italian banks. 

But we think even with the Italian banks monitor, I think that’s not going to affect Credit Suisse, except in the short run. Deutsche Bank had a scare over the summer, and the stock has recovered pretty nicely from that.

Preston Pysh  32:57  

Yeah, that was a little scary. It was amazing how they were all making announcements. They were doing everything they could to try to stabilize the price on that. But yeah, it has had a drastic turnaround. since that point in time, you had mentioned inverted yield curves. 

And some of the research that I’ve done, anytime you see a yield curve that’s really starting to go inverted. And for anyone who doesn’t understand what that is, whenever you have the front end, the short duration portion of bonds have a really high interest rate relative to the long end. They call it the 30-year, where it’s actually higher. That’s an inverted yield curve. 

Whenever I’ve seen an inverted yield curve studying the historicals on it, usually you are in for some very rough times in equity markets moving ahead. Would you agree with that? Does that make the hair on your back kind of stand up when you start seeing inverted yield curves? Or is that not necessarily something that you consider when you’re looking at value investing?

Bill Miller  33:49  

Oh, yeah, inverted yield curves have a high degree of correlation with various forms of economic stress. And so, it’s not a one-to-one correspondence every time they invert that there’s some catastrophe. But the correlation is high enough that and especially combined with other things, that you’d have to get worried about it. So I think, yes, we’re a long way from that. I think it’d be a long way from that for a long time.

Stig Brodersen  34:13  

If the bull market in bonds is over, what would that mean for the US real estate prices in the long run? And the reason why I’m asking this is that for our audience, a lot of the net worth is tied up into the home. Are you a bear because if we see this interest goes up, it will be all asset classes and clear also homes that will be affected by this. So I’m curious to know how you see the US real estate monitor.

Bill Miller  34:38  

I think it’s all systems go and all lights are green on us residential real estate. The only problem with us real estate is the price isn’t rising too fast. There was five over 5% over the last 12 months they should be rising. If they’re going to rise sustainably, call it 2%, 3% a year. If it rises over 5% you’ve got a lot of problems. 

First of all, reducing affordability. Second, and maybe more problematically or paradoxically, is that right now you can get 30-year mortgages, still it’s called 4% out there. Well, your house prices rise and five, and you’re borrowing for the big incentive there to load up on houses.

Right. And I think that’s the problem that we had back in 2000. Two to 2006 rates were too low, relative to the both the absolute level of houses and the way house prices were rising. So I would expect I think the current rise in house prices and residential real estate prices is due to the fact that not enough supply relative to demand was a 30-year low and new homes [and] new home inventory, for example. 

In addition, I think that and you also have a tougher, tougher time to get. So I do think that’s going to ease off in the next 12 months. So we’re actually really bullish both on US housing overall, and then on individual housing stuff. Social estates [are] different because the cap rates have adjusted man.

Preston Pysh  35:53  

Yeah, and the cap rates are so different depending on where you go or in the region around the US. I’ve got a question for you that I know A lot of people love talking about this one in our audience. And that’s Tesla Ilan Musk, the merger that just recently happened. What are your thoughts? When you look at a Tesla? Can you take us from like big picture down a little bit into the weeds on the income statement and how you might look at it from a value standpoint?

Bill Miller  36:19  

Yeah, one of those missed opportunities. Our mission is that we looked at Tesla fairly carefully when it was trading in the $20 range, that it went to what 300 or so after that, once it got to like 40. We said, “Well, we missed it. Well, we didn’t miss it at one time. I actually think that Tesla has a current price. Hey, I don’t think it’s attractive and not because Elon Musk isn’t a business genius. Maybe overall genius, but he is certainly a business genius. 

But I think the issue with that is that the merger with Solar City complicates the analysis of the business pretty significantly. And second, and maybe more importantly, I think you’re likely to have under a Trump administration probably a rethink of all these subsidies for alternative fuels and electric vehicles and stuff like that. That’s one problem, because that’s been an important part of the overall analysis that people go through with their buying a Tesla is what kind of credits can they get. 

But maybe more important that is that the auto companies themselves know as slow as they are to adjust or have now for the woken up, and Chevy’s coming out with, you know, with a competitor to the like, the new model three that Tesla has, that looks to be at least as good if not better, in terms of you know, range. 

BMW has gone very deeply into electric cars. And so now you have companies with massive resources that are going to be you know, rolling out a whole variety of different competitive models. And I think that’s the greater problem, or I think for somebody like a Tesla, we had thought that it would have been an interesting thing if Apple bought Tesla, and it still might be an interesting thing there because Apple has so much cash that that would not it wouldn’t strain them at all. 

And again, they’re very creative. It’s such a gigantic market that it provides a lot of opportunity for the people that are in it. So if Apple had bought Tesla for example, Apple needs to offer In gigantic markets, because they’ve already gotten over 90% of the profits in the smartphone market. So that would be an opportunity for Apple. And it would be an interesting thing to watch. 

I also think that I’m not sure probably what foreigners but the other auto companies have awakened now. And they represent a pretty significant challenge to Tesla. And I think Tesla’s market cap probably still exceeds above all Chrysler, for example, which doesn’t make a whole lot of the number of cars that just the number of jeeps that they’re cranking out at very profitably.

Preston Pysh  38:27  

Yeah, it’s priced in, and I want to say the market caps $30 billion or somewhere around there. And you look at Ford. I want to say it’s like 50. So it’s amazing where the market’s pricing and considering the number of vehicles that are out there. I think that the thing that’s really amazing when you look into the car industry is how much software [there is], and this Uber combination of autonomous driving where you could basically program your car to go out and make money for you as a taxi service when you’re not using all that stuff. 

It’s just so fascinating and really exciting in that space, and I agree with you combining with Apple or some type of tech company would really just kind of produce some quite amazing results.

Bill Miller  39:08  

Yes, Tesla’s $30-billion market cap and Chrysler is so amazing and very profitable.

Preston Pysh  39:16  

Yeah. And very, has a much better bottom line. All right. So Bill, this is the question, we really like to ask people. And I know that you’re a person who reads books that are well outside of the standard business reading list. 

And that goes to your background and what you’ve studied in your undergrad and graduate and doctorate level studies. But what book would you recommend to our audience that has had the biggest impact on you as a person and it doesn’t necessarily have to relate to investing. But what book have you read that’s really influenced your life the most?

Bill Miller  39:49  

Well, it’s impossible to get just one so I’m going to give you a thumbnail on a few. So the Reminiscence of a Stock Operator and the Money Game. You know, 1968. I guess it was both of those books. I think as good as it gets and understanding the behavioral aspects of markets. No Ben Graham and all the stuff that you learn in business school, or all the stuff you do in a CFA stuff tends to be, again, it’s Incorporated, especially in the CFA stuff, some behavioral aspects. 

But the market at the end of the day is all about human behavior, and how that works its way through people’s belief structures. And so, I’d say Reminiscence of a Stock Operator and the Money Game. Both really can’t be beat for giving you a feel for how that works.

Preston Pysh  40:27  

So Bill, what I want to do right now is give you a chance to brag because I know you’d never bring this kind of stuff up. But since I’m asking, I want you to tell our audience, the performance of your fund, because I know you guys have been knocking it out of the ballpark in the last couple years. Give us a little sample of what you guys have been able to do here in the last couple years as far as performance to the market.

Bill Miller  40:46  

So I do 2 products. The team here does 2 products now called the Legg Mason Opportunity Trust [and] the Miller Income Opportunity Trust. Those are both going to be rebranded probably by the second quarter of this year because I in the family or buying those products from like Mason, so they’ll both be named under a Miller name. 

But in terms of results in both those products, so if you take the opportunity trust, it’s actually in a very unusual position between the third quarter of this year and the end of this year. And the reason I say it, so it’ll be something that will never be repeated again, as long as I live out the guesses. 

The Opportunity Fund was the single best performing fund of all US mutual funds in the third quarter of 2016. And then, for the 5-year period, end of the third quarter of 2016, it was the single best performing fund of all funds in America for the past 5 years. 

That includes the four year that we’re having this year, we’re probably in the bottom 5% for the year to date this year. But as I said, that five year performance even includes that. So that’s that product, that product beat in the market, it’s got a 16 year record speed in the market on average by about 200 basis points a year over that 16 year period, not not every year of course, but on average over time. 

And then, the other product that we have a newer product, it’s called the Miller Income Opportunity Trust. It’s just It’ll be finishing its third year this year. But to give you a sense of the current stuff, for the past month, it’s the top 1%.

For the year to date, it’s in the top 3%. And for the one year, it’s in the top 1%. So it’s having a very good year, unlike the opportunity trust, and I do the opportunity trust with my colleague, Samantha McLemore, who manages with me, and then the Income Fund is done with my son Bill, the fourth. 

And I think the difference in the performance is really striking. And that the opportunity trust is close to the bottom of the page this year, and the Income Fund is at the top of the page. And those are being run with the exact same investment philosophy, the exact same analytical approach. It’s just the case that in the types of names that we own in the Income Fund, the market is looking very favorably on those so far this year. 

And in many of the names that we have in the Opportunity Fund that we’ve owned for a number of years, the market doesn’t like them this year for a wide variety of reasons. So you can get that divergence in opinion, even with the market standpoint, even when you have the same managers and the same investment philosophy, and in some cases, even some of the same names.

Preston Pysh  43:01  

absolutely phenomenal. I can’t say that I’m surprised. But that is just amazing the performance that you’ve had across your career. And I know I speak for everyone your responses to these questions. It’s just amazing to gain this insight. And we can’t thank you enough for coming on the show. So thank you so much, Bill, for taking this time to talk with us.

Bill Miller  43:22  

Thanks, Preston. I really appreciate the invitation.

Stig Brodersen  43:24  

Okay, guys, that was all the Preston I had for this week’s episode of the investors podcast. We’ll see each other again next week.

Outro  43:32  

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