Tobias Carlisle  06:23

One of the interesting things about Japan, and its CAPE is at in 1990, which was the peak of their stock market, it got to a 100 times CAPE. But to contrast that with the US in 2000, it got to 44 times. China very recently was that 100 times. CAPE is not very predictive over a short period of time, but over 10, 20, 30 years, it becomes increasingly predictive of the experience of investors in those countries.

And so Japan, the index has performed poorly. It’s down from where it was 26 years ago. China is struggling a little bit at the moment. The US has sort of surpassed its 2000 peak, in nominal terms, possibly also in real terms,. I’m not sure. But we’re still very expensive at 26, 27 times.

What is interesting though in Japan is that value investing has worked quite well since 1990. Even though the index is down, cheap stocks have performed. So if you were Japanese, and you were restricted to the Japanese stock market, if you were only investing in the very cheapest, using simple measures, price to book, price to earnings, price to cash flow, you could have performed reasonably well. I think the returns to that cheap decile have been in the order of 20% a year compound. So sometimes the index is helpful when you’re thinking about the global macro. But for an investor, the best place to look is your own portfolio. So I always think that looking for undervalued stocks, even in very expensive markets, you can still do well.

Stig Brodersen  07:44

So interesting points, Toby, and I completely agree with you that you can pick individual stocks and if you look at very simple metrics in Japan, yes, they have indeed been profitable. But I think my advice to someone that is going to *inaudible Japan is not to buy an index. And also if they’re going to look at individual stocks, they had to do it from their systematic point of view. So, say they’ll buy the cheaper stocks on a PE  basis, or a price to book basis. I think that would be a good approach. But other than that, I again, this is just my point of view, I think you probably shouldn’t go into Japan at the moment.

Preston Pysh  08:19

I just look at it as like you’re making it hard for yourself whenever you’re buying undervalued companies in an overvalued marketplace. So using the US, and the US at the end of the summer was probably a much better example because the US has contracted a little bit. It’s still overpriced relative to other things, but not nearly as overpriced as it was last summer. And I think whenever I was looking at that market, there were individual companies that I was finding and that might have been great value investing buys, but I just don’t know the company well enough. I don’t know what’s going on and why that’s been penalized so badly in the market price. For me, to have a lot of confidence to say, “Yeah, I’m going to go out there. I’m going to buy this individual company, even though I know credits are getting ready to start contracting, and it’s harder for this company to turn a profit moving forward.”

Tobias Carlisle  09:08

Just a brief counterpoint. I do agree with you that expensive markets when they fall, they tend to take everything down with them. So undervalued stocks, for the most part, don’t provide much protection in the actual crash. They do tend to recover a little bit faster from the other side.

 

But one thing that is interesting, in 2000, in the US when the market was at its most expensive because there was that great difference between the dot-com stocks and the old-line businesses. The old-time businesses were so cheap that even though the market fell, you did quite well, by buying these undervalued businesses and long-only value investors. So long only someone who just buys the stock doesn’t then go hedge it by shorting the index or shorting individual stocks. Someone who just bought stocks made money through 2000, 2001, 2002, during a period when the stock market itself was falling, because undervalued stocks were so undervalued and there was a sort of mean reversion or getting back to normal of those valuations. So I think indexes speak to risk. But in terms of return, it’s the undervaluation of the place to look.

Preston Pysh  10:13

Okay, so believe it or not, we cut the tape from right where I last spoke, and we dialed Hari in. So you didn’t have to listen to the dial-in our initial conversation. But Hari has joined us. We have no idea why he was late in joining us. So right now we’re going to ask him to explain why he was late.

Hari Ramachandra  10:32

Hey, guys, I’m so sorry. My son was sick last night.

Preston Pysh  10:35

Oh, get out of here. Now, you make me feel bad in front of the entire audience.

That’s too bad. All right. Well, we’re thrilled to have you here with us, Hari. So everyone knows Hari runs the website bitsbusiness.com. He works out in Silicon Valley and he is executive over at LinkedIn. He provides us some of the greatest insights of what’s happening out there in the valley.

So Hari, great to have you with us. And I was going to help promote your newsletter because you recently sent out this great newsletter.  I was very impressed with the content that you had in there. I want to tell everyone in our audience that they need to go there and sign up so that they get all this valuable insight, but because you were late, I’m not going to tell them that now. Just kidding. All right. No, I seriously mean it that your newsletter was fantastic. So great job with that.

Hari Ramachandra  11:22

Thank you.

Preston Pysh  11:23

All right, so what questions you got? Let’s just go straight to you. We’re not going to give you any break or any breath here. What’s on your mind?

Hari Ramachandra  11:29

One of the things I have been thinking about is the slump in the oil prices and the *inaudible it can potentially have. And one of the reasons I have this question is in the Silicon Valley, I’ve been observing that a lot of companies, executives, and venture capitalists all are kind of in the mood of tightening their belt and being cautious. They see uncertainty ahead or turbulence ahead. I see companies being very cautious in hiring overall. And the overall mood in the valley is somber. So I just wanted to throw that out to you guys. From your perspective, what do you guys think is happening in the economy today?

Preston Pysh  12:18

I think that the oil thing is not the issue. I think that the issue and I think, Stig, I don’t remember when we recorded this or when we talked about this. But we think that the issue is the dollar and the strength of the dollar at this point. And we’re recording this on the 28th of February.

Just I think it was Friday or Thursday, they came out with a report that some of the inflation information is somewhat up, which is, in my opinion, that’s a bad thing, because then that gives the Fed even more ammunition to tighten the dollar potentially even more, or gives them a reason to say, “Hey, maybe we need to tighten the dollar and rein this little bit of inflation we got in,” which is like nothing. It’s hardly anything, but it’s something it’s not negative.

So as the dollar continues to get stronger and stronger, stronger. I mean, how in the world are US domestic companies going to be able to perform as the dollar gets stronger and stronger and stronger? I don’t know.

Stig Brodersen  13:10

I think is a great question, Hari, and I’m very cautious About the oil market at the moment. And for one thing, the average oil company is twice as leveraged as the S&P 500. And a lot of the old hedging contracts, they’re running out. So I think Q1 here in 2016 is only 15% ahead to the moment basis and historical comparisons really, low. And I am not saying that we need to hedge the price, that’s always a good idea. I mean, in essence, hedging is often very good for the oil company because then they know what kind of revenue they will be getting. And it’s good for the buyer, say being an airline company because then they know whatever the cost is.

Hedging just means a certainty. And having certainty for what you will see here in the Q2, the certainty of low revenue is not a good thing. That being said, we do know as value investors that the market is almost always overreacting. And I definitely see that the market is overreacting in terms of all stocks at the moment, the earnings have been down more than 70% year over year in the oil sector, but I see a lot of value in companies in very low debt.

Preston Pysh  13:53

So I have a follow on the point then I want to throw it over to Calin, because Calin lives up in the oil sands, okay? He lives up in Canada, where all of this death and destruction is taking place in that industry. But I have a point. My point is this, what is going to cause the shift to make it go higher?

And it comes down to it’s almost like a couple of variables here. The variables are the supply and demand changes. All of a sudden, there’s not as much oversupply and it’s starting to come at parity with each other. That’s going to push the price up. I don’t see that happening, as long as you have the same number of players in the market that are all fighting for market share. This is like a fight until the death of somebody or something that happens. I don’t necessarily think we’ve seen that yet. I think that you’re starting to see the signs of it and you’re starting to see high yield debt and all their borrowing. The cost for them to borrow goes through the roof because no one trusts any of them anymore, but I don’t see that happening. So that’s one of the things that I’m looking for.

The other thing that I’m looking at is if the dollar continues to be strong like this, that is a crippling effect for oil. So we haven’t seen the dollar lead up. And so when you have those nothing has changed. So whenever I’m looking at oil, it jumped up to… Where is it at right now, Stig? $32 or $33 a barrel or something? The lowest has been being $25. So a lot of people see that jump and they’re like, “I’m jumping in.” And I’m looking at it more from fundamentally why are you jumping in? Did supply and demand finally balance itself out? I would say the answer is no. Now, they are dropping rig counts, but you’re still having this oversupply issue. So what I’m going to do is we’re going to throw it over to Calin because I want to hear Calin’s opinion on what it’s like to be living up there in the oil sands area.

Calin Yablonski  15:58

Okay, so it’s been like a game of limbo here where everyone is guessing to see how low oil is going to go. And for perspective so far, in about the last 18 months, the oil and gas industry in Alberta has shed about 100,000 jobs and these aren’t 50,000 a year annual salaries, these are jobs where people are earning, you know, 100 plus thousand dollars a year.

So for Canada, not just Alberta, it’s had a dramatic impact because Alberta effectively subsidizes other parts of our country. We have equalization payments, which subsidized provinces like Ontario, Quebec in the Maritimes. So it’s a scary situation now because we’re starting to see the trickle-down effect through our local economy. You know, one person spending is another person’s income and when you cut out 100,000 jobs, what’s fueling our economy, you start to see weakness in the construction industry. You start to see weakness for local businesses, and it’s just continuing to compound

Preston Pysh  16:58

I’m curious to hear the answer to this question because I’ve heard so many different numbers on what their breakeven price is up there in the oil sands in order to be profitable. What is the number that you hear? I mean, you live there. So what’s the number that you hear?

Calin Yablonski  17:12

We’ve heard anywhere from $40 up to about $60 a barrel. And it depends on what form of extraction they’re using, whether it’s oil sands, whether it’s carbonated, which is very expensive oil to extract. That’s typically the range that we’re hearing, somewhere between $40 and $60.

Preston Pysh  17:29

So it’d be safe to say that at $30, they’re all losing money?

Calin Yablonski  17:34

Absolutely, and it seems like every week we’re hearing that there’s another round of layoffs due to the fact that they just cannot continue to afford their staff. They’re closing down rigs, they’re closing down facilities. And really, the trickle-down effect is probably what’s been most striking were some of the northern cities in Alberta, such as Fort McMurray, for example, which is purely an oil and gas town. Not only has it had an impact on just employment, but also things like real estate prices. They have absolutely tanked. And so it’s been interesting to see how your engine for your economy which in Alberta, it is the oil and gas industry, once that engine slows down, the trickle-down effect to all of the other segments of that economy also slow down.

Hari Ramachandra  18:21

So a couple of things that I wanted to highlight here is one of the *DJCO annual meetings, which is the daily journal down here in Los Angeles. Charlie Munger has once told that when the oil prices are low, it’s better for the United States to import oil, rather than produce our own oil. He said just let the oil be in the ground. That’s good for our civilization because our next generation will benefit. Just use up all the cheap oil from others. And I know that it’s very painful for people who are involved in the industry, but as a society as a country, it might be good for the United States that we are now getting cheap oil from outside.

Tobias Carlisle  19:04

I think this is a hipster stock market crash. It’s not an overall stock market crash. It’s just occurring. And these sorts of artisanal small-batch micro crashes. So every day I see some company report earnings and they tend to miss. And where previously the market might have ignored that they’re being hit hard sort of down 20 plus percent. This are big companies, that the ones in my sort of largest 1000. Do you see eventually that filtering out to the rest of the market?

Hari Ramachandra  19:33

Toby, I agree with you. It’s kind of what Pabrai said in his annual meeting. He’s kind of the *inaudible Nifty 50, where one by one, the Nifty 50 stocks were taken down and shot. And we saw that with many of these, the darling of Silicon Valley is one by one they are being short when they disappoint the investors on Wall Street in terms of their expectations, or projections are even earnings.

What is interesting and not visible to most of us is what’s happening in the private market. A lot of these unicorns are going through downward valuations. Many investing institutions are writing down their investments in some of these companies.

Preston Pysh  20:21

I’m curious, what multiple do they pay over the user base of whatever website they’re trying to put onto the open market? They don’t value businesses off of their net income. It’s off of like the user count. Is it a multiple of 20? No, it’s a bad joke. But go ahead. You guys keep your conversation.

Hari Ramachandra  20:39

Yeah, I mean, it used to be eyeballs and all that stuff before. Now, I think one of the like, you know, strong opinion from the valley like Marc Andreessen, and many other VCs was that “Hey, this is not a bubble. Now, there are real earnings, whereas in 2000, the dot-com era, there were no earnings.” The only problem was there were real earnings. But as you said, the multiples were ridiculous. Like, for example, Uber is valued at close to $70 billion, or at least was valued at $70 billion. %heir revenue is like, probably $1 billion or so. So there is no kind of, you know, real valuations there. It’s just hype and expectations in most cases.

Tobias Carlisle  21:26

I got that just after Google went public in 2003. I think, like 2003, or maybe it was, like 2004. And they did it via this Dutch auction, which was a very unusual IPO process. Basically, they listed at the low end of their range, which is around $80. And it was a depressing time. One of the things that were previously people had sort of wanted to go public, you build your little business, and then you try to list it in a blockbuster IPO. What they were trying to do at that stage was to get it’s called HAC, hired-acquired. It’s a combination of two words. It means to acquire and hire, basically you get a little bit more than a hiring bonus.

So what guys were doing what everybody who is sort of new socially because I was a young lawyer at that stage, they were all you’d find something that Google did. So Google Maps, it just sorts of just started. And you’d build like a Mission Burrito locator. And you’d fit that into Google Maps. And then you’d go and take it to Google and say, “Hey, I know how to build one of these things. You can take me on until they give you a million dollars for you and your other tech partner to come on.”

And that was kind of the big that was the big exit. I didn’t think that Silicon Valley, ever recovered from that. That’s a thing that a young man thinks, I think you don’t realize. The only reason I bring it up because I heard you say and Grayson before. The funny thing is that when Andreessen arrived in Silicon Valley, he thought that it all happened already. And he admits that he missed the party. And of course, he then went on to create Netscape Navigator, Netscape Communications, which was the IPO that kicked off the next tech boom. I wouldn’t count it out. But I do think that Silicon Valley is probably coming off the top of another pea and it’s going to be a few years before it recovers.

Hari Ramachandra  23:06

Yeah, I agree, Toby. And you brought up a couple of very interesting points because, in the last couple of years, I’ve heard a lot about three or four engineers who have come up with some product. And that product once acquired, will be pretty much killed. There’ll be nothing coming out of that product. And you will always see and it’s interesting if you should keep watching the proxy of these companies after they acquire, and there’ll be a lot of writedowns a couple of years down the line. And most of the time, the acquisition is called either strategic or talent-based acquisition, but there is little valuation there. That’s when I get scared and you know, you never know like Yahoo at the peak of the dot-com bubble paid, I don’t know how many billions to the broadcast.com.

Preston Pysh  24:00

Six billion.

Hari Ramachandra  24:01

Wow. I mean, that product, they didn’t even make a single dime out of it.

Preston Pysh  24:08

Yeah, if you go to broadcast.com and you type it into your web browser, it’ll take you to the homepage of Yahoo.

Hey, I’ve got a question. This is a risk that I wanted to kind of present to the group. Sorry to change the gears on you.

24:22

Moving forward, one of my biggest concerns with the current market conditions is all these companies that are fighting to maintain their peg on the dollar. So the one that I think is kind of one of the biggest risks right now is not China. I think that that one’s a risk, but not in the short term here, in the next couple of months. I think Saudi Arabia is more of a concern for me, and that I would expect them to kind of get in a position where they’re going to have to do a devaluation of their currency, but they’re going to have to do it in somewhat of a large scale here like, not a couple of percents. But I could say like 10s to 20 percent devaluation on their currency and basically drop that peg in an abrupt way.

If that happens, I think that that would pose a lot of risk to the market, because then it immediately makes the dollar even stronger if they drop off that peg. It makes the yuan over in China even stronger.  Every other currency in the world basically gets stronger when they do that. And then I’m concerned about what ripple effect will that have? And what message will that send to other countries, as maybe call it a Saudi Arabia would do something like that? Does it set a precedence for other countries to say, “You know what, they just devalued they’re and dropped their peg? So now, now we can do that.”

And in effect, all it’s doing is making the dollar stronger and stronger, stronger. It’s almost as if the Fed would be raising rates at that point, which even makes it worse for US businesses. So I guess my question is this: do you guys agree with that concern? Do you kind of see that as maybe the next big thing to kind of play out as the market goes forward? And I know we have no crystal ball here. But when you’re basically looking at all the potential risks that are lining themselves up, do you kind of see that one playing out next year? I’m just curious to hear your thoughts.

Tobias Carlisle  26:06

I have to say it’s not something that I track closely because I’m a deep value guy. All I’m looking at is individual businesses and their stock prices and try to find ones that are cheaper than they’re trading for less than they’re worth. I do agree that there are all of those macro risks definitely impact the price of oil, the price of the dollar, all of those things do have a huge impact on these sort of businesses.

The thing is I don’t think it’s so unpredictable. I don’t think that macro doesn’t seem to follow any kind of sensible path. So I think that there’s a great quote and I don’t know whom it came from, but he said the Portuguese biscuit maker only worries about selling more cheaper biscuits than the biscuit maker down the road. H doesn’t worry about global macro. I do think that there’s something too that you can’t just focus on undervalued. companies.

Yeah, it’s the macro investors’ argument that value investors ignore this stuff and get hit by is absolutely right. And if I had some sort of good insight into it, then I would definitely include it in my analysis. The thing is, I just don’t. So I got to use the things that I know that I can do marginally better than other guys. And I’m sort of subject to the stuff that I can understand. And I think that on the stuff that I can’t understand on balance, it kind of works out over the long run. You get lucky sometimes and you get unlucky sometimes. You just have to be in a place where bad luck doesn’t hurt. And good luck doesn’t help too much.

Preston Pysh  27:32

All right, Stig. Do you have a question you want to ask?

Stig Brodersen  27:35

Yeah. So my question today is somewhat about oil but not completely about oil. Specifically, I would like to talk about Exxon Mobil. So as I revealed a few episodes ago, or some episodes ago here in the podcast, I took a position in Exxon Mobil.

For me it was, I wouldn’t call it any brainer, but it seemed to be an obvious choice for me. Strong cash flow. Strong balance sheet. And I still like my pick and saw report the earnings for last quarter and earnings was down 58% year over year, which was, in my opinion, quite decent. I mean, it was not as bad as I expected, and they still make a ton of money and I like almost everything about the company. And still, when I compare price to value, I think that the value is definitely vastly more than the price.

28:28

Now, so this is what frustrates me. So Exxon has decided to hold its share repurchase program, and still, they don’t cut the dividend. And this is just the opposite asset allocation of what I want to see. So this is the thing that frustrates me is that Exxon there don’t cut back the dividend but they are halting their share repurchase program. And it’s right now that you should be repurchasing their shares. It’s now that it’s undervalued. If I look back as since 2000, Exxon had twelve periods where they’ve been buying back shares and ten of the times has been at prices higher than this today.

And in a way, this is quite obvious because management doesn’t like to cut dividends, they know they get penalized if they do that. Investors don’t like that. But at the same time, if they’re responsible for the management, you should be buying back stocks right now. And I think that, obviously, this is just my opinion. And when I look at the numbers, I think it’s undervalued. But even if you just look at it from a historical perspective, this should be quite obvious that now’s the time to buy back shares.

And even though they see a drawback in the earnings, for me they still have very, very strong cash flows to do this. So my question to you guys is that when you see this behavior, from the management of a company, even though if you could like the company, in general, you like the number, like the valuation compared to the price, is that something that would tick you off and perhaps even sells the stock off at some point of time?

Tobias Carlisle  29:57

That sort of behavior is incredibly frustrating. It’s one of the factors that I look at when I’m considering an investment in wholly quantitative. So I’m not considering management’s actions by themselves or management’s discussion of their actions. I’m sort of looking at the impact of management’s actions in its financial statements.

So one of the ways that you can do that is looking at buyback yield or shareholder yield, which is a combination of buyback yield and dividend yield. And it’s very clear that shareholder yield is one of the most powerful and predictive measures of future stock market performance. So the better the shareholder yield, the better the performance. So when they’re cutting their buybacks at a time when they are cheap, if you maintain the same level of buyback and your market capitalization shrinks, your shareholder yield goes up, because you’re buying back more stock. That’s more undervalued. So yeah, that’s a real shame to say that because it’s kind of the opposite of what they should be doing.

Preston Pysh  30:52

I’ll tell you the thing that’s frustrating as an owner, if you were an owner of that stock is that they get taxed on the dividend. But they don’t get taxed on the share repurchase. So then you have to ask yourself, okay, so why in the world would management do that? Because that makes no sense whatsoever. You can return just as much value by buying back the stock.

So for me, that’s a very weak board of directors. And that is a very strong management team that knows that they might get fired tomorrow because of the market conditions and they’re trying to align their pocket with as much cash as they can. That’s how I would read that.

Hari Ramachandra  31:28

Good point, Preston. So I wanted to understand what is the *inaudible for not just Exxon, but many other oil companies in terms of paying dividends. So one of the things that I’ve seen is, say Conocophillips, recently, cut their dividends and there was a lot of volatility in their stock. Are these oil companies scared to cut their dividend? I think many of them treat it as sacrosanct because a lot of people are depending on income, maybe? So that has something to do with this kind of, you know, unwritten rules that you *never can do it for oil stock. I don’t know whether they are taking that very seriously and essentially cutting down on their buybacks to maintain the dividends.

Preston Pysh  32:10

So there’s an intelligent response and you’re exactly right. They’re making sure that the market price and the dividend don’t get a double whammy to all the shareholders. That’s why they’re not dropping the dividend because they know as soon as they do that, the market price is going to get hit with it. So you got all these people just sitting on it… What’s the dividend on it, Stig? 5%?

Stig Brodersen  32:29

Yeah, 3.6. Yeah, but you guys are absolutely right. This is an exercise in management has to look good. And just see this over and over again and this is also what frustrates me. This is not only for Exxon, you see this for almost oil companies that the last thing you want to do is to cut the dividend because it just makes them look competent. When when you think about it, cutting the dividend at times like this makes them seem very competent, but that’s just not how most investors perceive it.

Preston Pysh  32:56

I can tell you one thing, if I was the CEO of the business, this is how I would handle this: I would do an initial cut of the dividend, you’d see the share price get brushed, okay? And then you know what I do with all the money? I’d go back and I’d buy all those shares off the open market at an even cheaper price. And then me as the owner, I’m killing it. I’m killing it, you know what I mean?

Like why? I’d take advantage of that. And this is such an important and fundamental thing to understand: every single weakness has a strength that is tethered to it, and every single situation in life, it’s like there’s a rope tethered these two things together. So if there’s a potential weakness that if you drop the share price, because you killed the dividend, what is the strength that you can then maneuver on to take advantage of that?

Hari Ramachandra  33:47

So what is surprising to me is Exxon Mobil has a very good reputation, their management, especially in terms of thinking long term and taking a long term view of everything. In fact, as I remember reading this book, “Exxon Mobil: The Private Empire,” where the author is very critical of the company for other reasons.

But one of the things he points out is, whenever they are going for a new site for exploration, they run it through a model where the oil prices are between $25 to $200 or so. At the time, when I read it a couple of years back, I thought, why were they doing that? Now I understand why they think like that. They think long term. Having those qualities in the management, it is surprising that they have to make some optimal choices in some situations. So if I give them the benefit of the doubt, I can think that they are under siege in terms of their own tradition or their own commitments, which might not be perfectly logical, as Preston rightly demonstrated right now. But nevertheless, it’s like our Fed right, like many times what the Fed does, doesn’t sound logical, but it still goes out and does it.

Preston Pysh  35:00

That’s a fantastic point, Hari. It’s the culture. It’s the culture of groupthink. And maybe the CFO understands very well what I just talked about, but being able to convince the rest of the culture there, and the Board of Directors and everybody else that that’s the right path, you know?

Stig Brodersen  35:16

Yeah. And I also think it’s a question about how you look at the management because you can also have people out there who are saying, “Exxon Mobil is doing a fantastic job, never cut the dividend, it’s still increasing, they have no debt. And when there are problems that have that, just make sure that they always pay out the dividends that you’ve been caught a Capex here with the 25%, we can completely trust ExxonMobil.”

I can definitely see why someone who is looking to retire soon is thinking this is the best management that will ever see. But that’s just not the position that I’m in. So I think my takeaway from this is also that you need to have a management that is aligned with your interest. So I’m not looking to retire. I’m 31. So hopefully it will take quite a few years. And it is important to me that I get taxed on the dividend because all the money I make, I reinvest that back in the stock market with whatever asset I can find that looks more attractive to me. I don’t have to live off that income. So I’m just at the side of the fence where the management is not aligned with my interest. You will have someone who is 100% in agreement with Exxon Mobil’s management.

Tobias Carlisle  36:20

One thing that we haven’t covered yet is that Buffett’s *letter came out yesterday. Has everybody had a chance to read through them? Anything jump out that was interesting?

Stig Brodersen  36:32

I think that Buffett did better than the market once again. So the per-share book value of Berkshire increased by 6.4%. And that’s compared to the S&P 500 which was 1.4. But the interesting thing about that is that the Berkshire share price has been penalized a lot by the market. So it’s been down by 12.5%. And generally, I don’t want to talk too much about valuations on mutual companies. Even though I said that Exxon is highly undervalued and I’m sticking to that, but I think Berkshire is very appealing too.

Hari Ramachandra  37:07

What struck me was like many other investors have been observing, value investors especially whose portfolio has taken a beating. When I attended their annual meetings or when I read the letters, there is some aspect of defensiveness. They’re trying to justify their decisions or their portfolio and trying to explain why it feels so illogical for their positions to be down or their performance to be bad. I didn’t see any defensiveness in Berkshires in Buffett’s letter, basically. He never even talked about American Express and IBM going down. He never talked about some of his, like, you know, subsidiaries as suffering. In fact, I think in his case, BNSF did very well last year. But still, that was pretty interesting to see Buffett’s take on the world. I mean, he is not apologetic for any of his decisions, and neither defensive.

Preston Pysh  38:03

So I want to beat up on Buffett, I’m tired of reading the same song and dance, every single shareholders letter, and not having somebody discuss and trying to solve this disaster of a problem that we have. So whenever I read the shareholders’ letters, they’re great. You know, I’ve read every one of them since 1965. It’s great. And I think that he’s putting out great information.

But I think it’s time for him to start talking about things that could potentially solve this situation that we’re facing globally. And for people who don’t think he knows that stuff, or thinks that he doesn’t know, macro or whatever, and can work with people in government, he might be doing this behind the scenes. But I just kind of wish that he’d be talking about that as much as he’s talking about all this other stuff. I think it’s terribly important that we have leadership in this country, not just in the US but globally, that tries to come up with a remedy for this problem.

Hari Ramachandra  38:59

I think his letter this year didn’t have anything new. I think you’re right. I mean, there was nothing, no insights about what’s happening in the world, about the interest rate environment or even the oil prices. It was as if it was written in some other year, not this year.

Preston Pysh  39:14

I look at how much influence he has, and what kind of a difference he could make. And he’s just totally acting like it’s not even there. Like there’s this elephant in the room, and he’s not even talking about it. And trust me, I love Warren Buffett, this guy’s taught me more about finance and everything else in any person on the planet through his writing. So I’m deeply appreciative and don’t please don’t take it that I’m not. I’m deeply appreciative of the contributions that this gentleman has paid to society, in a moral way too. I mean, some of the morals and things that he’s personally taught me through the books, recommendations, and whatever. I couldn’t be more appreciative. But I think this is a time where we need stern leadership from very smart people that have a lot of credibilities and a lot of influence and we’re not getting it.

Tobias Carlisle  39:56

He has addressed it in an essay that’s about five-plus years old. He uses the analogy of greenhouse emissions and he describes him as greenback emissions. And he says that it’s not good for society to be sort of pumping out so much greenback emissions. I think that he’s constrained a little bit by the fact that he’s watched so closely. And he can’t… I wonder sometimes, you know, he’s criticized for perhaps being seen to be too close to the establishment. And I wonder sometimes if he restrains himself a little bit.

If he was to say something about the Fed, then people would say, well, the Fed is an independent body and here you are you’re a multi-billionaire trying to influence what the Fed does, even if a lot of us might think that… We would agree with what he would say but there’s equally… there’s an enormous… The orthodoxy in academia would say that the Fed is not being dovish enough. Paul Krugman would say that the Fed is not being dovish enough, that they’re not printing enough money, the interest rates are too high. They should be running negative interest rates. So I don’t think it’s perfectly clear cut.

Preston Pysh  41:00

So I’m holding an article from Bloomberg that I printed off from the 27th of February. We’ll have this up in the show notes. It’s called “The G20 government doing more and the central bank is doing less.”

So this is my frustration with people that understand what in the world is going on because I think there’s a few of them out there. I think they’re far and few between and the ones that do understand are, I guess, being vocal enough and using their influence in order to shape things in the right direction.

In this article, this G20 article, they come out and say that the central banks have to start doing less because all this QE and everything is creating the problem and we need to implement more fiscal spending in order to offset all this polarization, zero percent on interest rates. And I totally agree 100% you have to get people to understand this, that the fiscal arm and the monetary arm have to be working hand in hand, okay? And if they’re not, you’re just basically saying the Fed has to fix that. That’s not the solution here.

So how do we educate people in order to do this? Well, I think it’s people like Buffett or Carl Icahn kind of beating their chests and getting out there in the media and saying these things over and over again because people listen to those people.

Stig Brodersen  42:19

So but did you have anything that you would bring to the group?

Tobias Carlisle  42:21

I had some comments about Buffett as well. The first one was that I thought that, you know, it’s like saying, a favorite band. You know, the first album is always their best album. And everything that comes out after that gets increasingly less interesting, even though they’re kind of better as they get older. I think that Buffett’s best letters are his first letters. If you can get your hands on his Buffett partnership letters, they’re the best. And the letters that came early on was when he was running Berkshire Hathaway, excellent, too. I think he’s become increasingly aware that he’s being observed. And so he’s become more constrained about what he says. And so they’re less interesting and I don’t think that they teach as much.

42:55

But the two interesting things that I found when I was scanning through the letter, one of them was that he gave some justification for hostile takeovers. He said that Berkshire won’t engage in them. But he thinks that there are times when they’re justified. It’s one thing that I often encounter with other people that they don’t realize that Buffett did start out as a corporate raider. You know, Berkshire Hathaway was a hostile takeover. And he undertook some liquidations and various things and he’s now got an image that’s much more friendly. But he did start out as sort of a much more aggressive kind of investor.

43:26

The second interesting thing that I took away, he’s addressed this on many occasions, but he brought it up again in this letter is the use of EBITDA. For people who don’t know what that is, that’s earnings before interest, taxes, depreciation, and amortization. The two parts of it that are important are the depreciation and amortization. Basically, those are non-cash charges from the acquisition of assets, where the cost of the acquisition is spread over the useful life of the asset. So, a 10-year asset, you can put some portion of 10% per year to that asset.

Amortization is in relation to intangible assets. So that’s patents and copyrights and other intellectual property. Depreciation is in relation to tangible assets, which is equipment in any given year, that does two entries that are deducted from the net income on but they’re cash that flows into the company or accounting earnings that fall into the company. Interest in taxes is the other element of that. Basically, the reason that you add them back in is the capital structure of a business, it’s a mix of debt and equity. It impacts how much tax you pay because interest is tax-deductible. So you add all of those things back in and it gives you the clearest picture of what the actual business’s operations are generating.

44:37

So Buffett has said that, from reading the letters, he has two complaints about. One is that it’s an adjusted number. And it’s often touted by management’s as look at our EBITDA number. And his objection to it is that it’s often the companies that have the biggest expenses in terms of depreciation and amortization, who quote that number. So what they should be doing is saying here is our EBITDA number, but here’s what we spent on capital expenditures this year too to give you a better idea of the wash.

The other objection that he had was similar to that in the 1980s, that the leveraged buyout guys would use it. The fact that he has those complaints about it, I don’t think necessarily invalidates its use. You just have to be careful when you’re looking at it to understand what it is. So it’s not a net income line. It’s not something… You can compare the net income line versus the market price, market capitalization of a company. And you can then go and look at alternative investments, putting cash in a bank account, buying a 10 year. You cannot do that with acquirers’ multiple, EBITDA, and enterprise value. The use of those sorts of metrics is in comparing different companies that have different capital structures, different financing of their assets to see which of those two is the cheaper of the two companies. And when you do that, and you test that over a long period of time, you do find that it’s quite a predictive way of finding cheaper companies.

Preston Pysh  45:57

So in short, Toby, just to make sure I understand what you’re getting at here is, you’re saying, it’s a very useful number when you’re looking at it from a basket of picks. But if you’re using it from one individual company to another, like you said, if the company has a lot of depreciation and amortization, of course, they want to use that number and they want to compare it. So I think what you’re getting at is although Buffett highlights that in the letter, Buffett’s kind of looking at it from a narrow scope, and he’s looking at it from comparing one individual company to another. But if you’re the type of person that’s more of a basket, quant kind of investor, it does become a very important number and very useful and valuable number and you’ve statistically proven that in your book, I know. But that’s a great point. That’s interesting that you brought that up and kind of pick that out of his letters.

All right, guys. I think that’s all we got for this week. If you haven’t signed up on Hari’s newsletter, I’m telling you, I read his last one. It was phenomenal. So go over to his site bitsbusiness.com. You can sign up for his newsletter there. He also has some phenomenal posts. I’m sure he’ll do a recap on the shareholder’s letter that just recently went out and some other stuff.

Toby Carlisle, he has a website called Greenback. He also has another one called the Acquirers’ Multiple. He has both of these websites, he’s constantly making blog posts. He has a screener that helps people filter out the most valuable stock on the market. So the acquirersmultiple.com.

We’ve got Calin Yablonski. His website is called Inbound Interactive. And he is an SEO expert, search engine optimization expert. For anybody else out there that has a small business, that’s what he specializes in. If you have a small business, brick, and mortar in your local town and you want to try to boost your search engine optimization results on the web, this is the guy to talk to. So this is our MasterMind discussion for the first quarter of 2016. And we appreciate everybody joining us. So will see you guys next week.

Outro  47:42

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