Preston Pysh  3:35  

Yeah, absolutely. I mean, I think that you’re at 3% at best is what I would say. I can see you nodding your head. You kind of see it the same way. We’ve been saying that figure forever. When I was up at the mountain there with Jesse and some of the people that listen to the show, we were sitting around chatting. A couple of the guys said, “We’ve heard you talk about this narrative that you’re investing operationally, that you’re investing more on the private side than in the public markets. And for us, that makes total sense, and we totally get it because you’re getting higher yields.” 

I hate to continue to talk about that narrative, but not too much has changed. And then when in the public markets, they even go higher. That only makes you dig in even further into that position because the expected yield is even that much lower as the prices go up. 

One of the things that I think is a really important discussion is the idea of investing in ETFs versus investing in individual companies. So if you’re buying an ETF, you’re buying this 3% that we keep throwing around. That’s what you should expect to get with your allocated cash flow into an ETF today.

We’re talking about individual stock picks. We’re thinking that you could potentially bump that return. In our first pick here, I think that you might be able to get 3 times that return in this individual pick. But the risk that you have is now you’re dealing with an individual company and you’re not distributing risk across 500 companies. So that’s where we can’t tell you to do one thing or the other. That’s where you have to make that decision for yourself. “Do I go for three times the yield with the risk that it’s only in an individual company? Or do I take a much lower yield, call it 3% and buy an ETF.”

If the market crashes in a year or 2 years, and you lose a lot of that in the short term, but then it eventually comes back within another 5 or 6 years or whatever, that’s just part of the process. That’s just something that you have to be willing to accept – that volatility by buying into an ETF at such a high market price. So all these considerations are things that you have to be thinking about. 

With all that said, let’s go ahead and dive into some of these individual stock picks that we think are quite interesting. The very first one that I want to talk about is called McKesson Corp. And this is a healthcare company whose operations are divided into two major segments. They’ve got McKesson Distribution Solutions and they got McKesson Technology Solutions. It’s a business that sells pharmaceuticals at the retail level. And it also provides medical supplies and health information technology. 

This company is big. It is really big. And when you look at their top line revenue it’s $198.5 billion. Their free cash flow for the previous year was $4.2 billion. So this company is massive. It’s very big. It’s in the S&P 500. Just if you guys are curious about the ticker, it’s MCK. 

The first thing that I’m doing when I’m looking at this company that I really like, is looking at the top line. I’m looking at the raw number of the sales that the company is doing. There’s nothing that’s being deducted out of that. There’s no expenses being subtracted. This is the fundamental number of the money flowing into the company. 

And when I look at that, for this company over the last 10 years, it has done extremely well. Every single year, the revenues are going up. It’s going up in a nice trend. It’s going up in a very predictable manner. 

Whenever I look at the net income after you back out all of the costs associated with achieving that revenue, the net income is growing. The net income is doing fabulous. When you look at the free cash flow of the business after they’re making capital investments, their capital expenditures are being taken out. The free cash flow is doing fabulous. It’s trending up every single year. 

And so for me, that’s really exciting when you look at the balance sheet. The balance sheet is very healthy. I’m looking at the competitive advantages. We’re going to email this out on our email list. If you’re signed up on our email list, we’ll send out a write-up of our assessment of this, where we go through the competitive advantages, the enduring competitive advantages for the company. It’s an oligopoly, as far as we’re concerned. There’s other efficiencies of scale that we see with the company. There’s intangible assets that look great. And there’s economies of scale that we’ve identified. 

In general, this looks like a fabulous pick. When we go and we look at the future free cash flows, or when we come up with an intrinsic value of this business, I’m getting a very good number. We’re accounting for the potential for the free cash flow to even go down in our model. And with that said, we’re looking at about an 8% to 9% return on this company. 

So if that’s true, if we can get a 9% return based on the projection of the future free cash flows, then everything that we’re talking about here looks good. That’s three times higher than what you could get by investing in the S&P 500. 

And so then it goes back again to my original comment of: “Are you willing to take a 3 times higher return than the S&P 500, but have a little bit more risk because you’re only in one company that’s specifically in healthcare?” 

For me, I’m willing to take that risk. I think that this is a good pick. This is something that I am buying right now. I’m not buying a large quantity of it because I’ve got concerns from a macro perspective, but I’m definitely buying this company. I think that it’s going to do quite well moving forward into the future. 

Now, I want to highlight that this pick came to us from one of the members of our community. And that’s David Flood. David, huge shout out to you because looking through the numbers, this looks really good. It’s rare that I’ve been able to find a company with such incredible financials. It’s a large cap company that’s in a space that I think is going to continue to do quite well moving forward. So huge kudos to you for identifying this pick. We’re just really happy that you were able to help us go through it and look at this a little bit closer.

Stig Brodersen  9:59  

One thing that I really like to look for whenever I check out the stock is how the dividend is growing and how the shares are shrinking. It’s very interesting to look back at the past 10 years because what you will like to see for most companies is that they would just slowly increase the dividend, especially if you don’t know the company too well, and you’re just starting to do your analysis. 

Of course, we had this discussion before, like, how much should the company pay out in dividend? How much should be the stock buyback? How much should be retained and then reinvested? 

And of course, if you’re Warren Buffett, you don’t want to see a lot of dividend payments. But whenever you see that almost all the companies have that gradual increase, it usually means that the free cash flows – the money that’s flowing out, or the cash that’s flowing back to the owners is growing at a steady pace. That’s what you see in this company. 

What you also see is that the company is gradually buying back shares. It’s not to a large extent. It doesn’t seem like they’re really timing it. Yes, they actually bought a decent amount back whenever it was cheap after the financial crisis. But it’s more of how do we think about reallocating our capital. 

You see this trend with a company like Disney. You see that slowly increasing the dividend never had any problems. And then they slowly buy back the shares. You as a shareholder are just rewarded. 

However, I want to say that one of the main concerns I have for a company like this might be the red tape. I think this is a really interesting company. I don’t know if I’m necessarily an expert in this. I see a lot of regulations that might change, and I’m not too much into that. But the thing that really concerns me is how excited I was. I guess, like Preston, whenever I saw it was at, call it, 8%. 

He just shows you something about what you used to see. Whatever I’m doing in this calculation I would come up with -3% for this company or +1.5% for the other company. And then I finally look at something and call it, 8%, and I just get so excited. 

It’s important for me to remember that this is probably not the thoughts I would have, call it, 5 to 7 years ago. I want to be cautious. I want to say that given the opportunity cost, yes, this might be interesting for that kind of return. But also knowing that if the market should crash, you might be facing a very different result as an investor.

Preston Pysh  12:32  

I mean then that’s an opportunity to buy more equity of this. So this is a pick for me that I don’t really mind buying at such a high price for the market in general. The market’s very highly priced right now. I don’t mind buying this. And the reason why is because if the market does crash, I am holding something that I have no problems buying more equity of. If the price would even go lower, when I’m looking through this, Stig, I’m having a hard time identifying the risks. 

Usually that’s a red flag for me like, “Hey, you need to do more research or you’re messing up somewhere”. Typically, at this point in the credit cycle, you’re not able to find companies that are so quality that have such strong financials at such a returns. I’d charge the audience. If you’re seeing something that we’re missing, hit us up on Twitter because we’d really like to know. 

And we’d like to be able to identify that to the rest of the community. But honestly, when I’m going through this, and I’m looking at the potential risks, I’m not really seeing too many relative to other things that are out there. This is one of the best picks I’ve seen in a long time.

Stig Brodersen  13:34  

I really like this. It really makes me think of a target that we discussed not too long ago. There are very stable numbers there. They were not even as good as the *inaudible. It basically boils down to valuation. So what Preston is basically saying here is that he’s very confident that intrinsic value would just keep compounding for this company. And then if you see the market price crash, that’s probably a good time to buy a little more of that.

Preston Pysh  14:00  

Yeah, that’s an exciting time. I mean, I’d be looking forward to that. Just as long as I don’t see risks that mature out of a crash. They’re not really that leveraged whenever I’m looking at the company. The industry average for this sector is a .8 for the debt to equity, and the company is a .7. You look at the cash flow statement, they’re very healthy on the operational side. That’s where they’re generating the money to pay the bills. In general, I really like it. 

If you guys go into the show notes, we’re going to have a link into our forum for this specific company. We’d love to have people come in there and contribute some comments and some analysis. As a community, help us identify some of the risks. I think that this is something that we can get some serious value out of. 

Alright, so let’s go ahead and talk about the next pick that we’ve got here. This one is a Russian company. I’m sure most people probably know where I’m going with this. It’s Gazprom. This is a huge business in Russia. It’s one of the top 4 oil producers in Russia. It’s the country’s only producer and exporter of liquefied natural gas. The company’s ticker, if you guys are wanting to look this one up is OGZPY.

I remember talking about Gazprom on our forum 5 years ago, Stig. I mean, we’ve been talking about this one for quite a while. The reason we’ve been talking about it is because it always seems to be trading at a low multiple. I’ve never seen this thing traded at a high multiple. I think that that’s a consideration just right out of the gate. Like historically, from what I’ve seen from this company, it just does not trade at a very high multiple. 

Maybe that’s a good thing if you’re trying to accumulate more and more equity and getting decent earnings for the price that you’re paying. When you look at the free cash flow of this business, it’s very cyclical. It’s all over the place. And recently, you’ve seen the free cash flow kind of in a decline in 2015 to 2016. It seems to be coming back down. 

So when we’re looking at normalizing those free cash flows, we’ve tried to do a very conservative estimate moving forward. We have like a little graph that will be sent out on our email list. We’ll have some links to the articles that we’ve written on this stuff in our show notes if you want to see the charts that we’re coming up with. 

But in general, when you’re looking at this thing, and you’re looking at the multiples that you’re willing to pay compared to other companies in this sector, Gazprom has such a low multiple. This means that your yield is way higher than the other businesses that are trading at a higher premium. We have a couple different methods. We have a P/E multiple, a price to book multiple, and price to sales multiple. We go through these and we look at what the emerging market is in general. 

We look at the global market for this sector. We look specifically at Gazprom and compare it to all these other sectors. When we look at just the P/E ratio, Gazprom is at a 3.7 P/E, while the rest of the sector is at about at 10 to 12 P/E. So you’re looking at something that’s like 3 times less in price for the same amount of profits. 

Something else that I really like about Russia right now is the fact that the inflation rate is lower than it has ever been. I mean, the inflation rate in Russia right now is at around 3%, Stig. It’s not a lot. In the past when, when you’re making discounts to this company, specifically. 

You’re justifying why the multiple was lower. When they have an inflation rate of 7%, or whatever it was, you go back maybe 5 years ago. That was a very strong consideration that’s going to erode the profits that you’re making on the business. 

Today, I think that that is much lower. I think that maybe people were still thinking that that inflation rate is a lot higher than what it is. When you look at the trend of that inflation rate, it’s been going down. So in general, I think that there’s a decent return here. I think that the return is maybe around 9% to 10% up in that range. It’s pretty much the same return that we were looking at with the last pick. 

I think there’s a lot more risk here than the first pick that we were talking about. I think everyone knows what the risks are. The governmental risks associated with dealing with the Russian government. They could nationalize things. They could do all sorts of interesting things over there. I think for the typical Western investor, like myself, I don’t understand that culture of people that live over there. 

That’s a risk in itself. I just have to acknowledge that it exists whenever I make an investment like this one here. This is something that I have purchased recently. Again, not a very large position, but it’s a position that I’m comfortable taking. I think it was Peter Lynch who wrote in his book, it’s really hard to go wrong when you’re buying a large company that has a P/E multiple of 4. That’s kind of where we’re at right now with Gazprom. I like it. I think that it has some really good attributes. I’m curious about what you think, Stig.

Stig Brodersen  19:22  

I never bought gas before. But I bought lube oil a few years ago. It was not the best experience. I have to say that. Part of it was because the oil price was cut in half, even though I felt that the oil price was not too high back at the bottom. I think it was like late 2014 or 2013. But one thing I realized that was super important when investing in emerging markets, is what kind of dividend yield can you expect? Dividends are really hard to manipulate. After all, this is cash that’s going out of the company’s bank account to your bank account. And right now, for Gazprom that would be 6.6%. 

If you look at the payout ratio, it’s still very low. I think it’s in the 20%, or something like that. I mean, there’s still a lot more room. The free cash flow is still very appealing for this company. Martin’s really good. And then when you look at the risks, definitely, there’s a lot of risk in terms of the government. But I also think that you need to look at debt. That’s definitely a criteria that is not too burdensome for Gazprom.

Preston Pysh  20:30  

Just so people know, based on Stig’s comment there, that that debt to equity on the company is at .2, while the industry average is at .4. So it’s very healthy on the balance sheet.

Stig Brodersen  20:40  

When you look at the price to book, this is sort of a characteristic for oil companies, especially in Russia. You just see this ridiculous low number. So right now it’s .2. I would definitely be very concerned about putting too much emphasis on this number. I would expect goodwill impairments, which is basically just a fancy word for writing down the value of the assets and years to come because of the low oil price. 

I’m not an expert in oil and gas, but I would assume that there’s something there. Especially in the Russian oil and gas sectors, you sometimes see really high goodwill impairments. But that’s really just a testament on how much you should be looking into the free cash flows instead, and how much you should be looking into the year to dividend payments. 

One of the things that’s really interesting about Russia right now is the pressure that they have from the government, in terms of paying out more in dividend. They realized years ago that one way to attract foreign capital is to ensure stability in your investments. Preston already talked about inflation and how and that’s a big concern. 

I can say that for myself. When I bought lube oil, I was not happy about the development of the ruble, to put it mildly despite the company making a lot of money. Fortunately, that was in rubles. It’s kind of like a risk that you just have to account for. But one of the things that they’re doing to mitigate that is that they are putting more systems in place, in terms of always ensuring that the investor will collect a really good dividend. 

As we talked about before, it’s really hard to manipulate. It gives investors some type of certainty. And it also launched downside. As we also talked about before, the dividend yield right now is 6.6%. I don’t see that go down at all and the time to come. This is obviously a lot more appealing than, say, 2% on your 10-year Treasury or your expected 3% in the market. I think this is a very interesting pick.

Preston Pysh  22:40  

I just look at it from a basic level. So this company is trading for $4.30 a share. One year later, the earnings and the profit that this one share of stock is making is $1.13. When you take all the confusing terms and everything else for this thing, and you just look at it from a really simple vantage point. You’re making $1.13 for a $4.30 stock. 

This is a large cap company. You’re not talking about a $10 million company here. You’re talking about a $47 billion company. I have a lot of expectation that that profit is going to be sustained moving forward. At least some of it. 

If you even took a 50% cut on that profit, you’re still making a lot of money on this company. It’s price to perform. That’s what I really like about it. It’s priced to perform in a currency that has really kind of done quite well lately and has started to stabilize. It looks very promising moving forward. 

I compare $1.13 in earnings to a company. There’s a lot of companies in the US trading for $100 to get $1.13 of profit. Paying $4.30 for something, for me, that’s a steal. That’s something that I have no problem putting my money in, even if you’re at the top of a credit cycle. How much more can this go down? 

There’s something real quick that I want to talk about, Stig. It’s the oil and gas prices, and the commodity prices in general. I think that you’re seeing them at a somewhat steady position. If we would go into a market crash in a year, or whenever, I think that you’ll see the price of oil, or the price of some of this stuff come down because the demand is going to contract significantly. But I don’t think that you’re going to see things pull back. 

Anything we saw two years ago when oil went from over $100 a barrel clear down into the 30s was dramatic. That was total destruction. Now, oil is priced at $50 to $52 a barrel. You’re seeing other commodities hitting a steady state when you look at the derivatives market where these things are being traded a year from now or 3 years from now. The price is really flat. It’s like you’re looking at the spot price and the price that it’s trading for 3 years from now as being the same number. 

For me when I see that and that flatline, I think you’re at a kind of a steady state in that market. I like this. I think that this is another good pick. But I’m very curious to hear what the audience thinks. I would love for people to shoot some holes through this, tell us why we’re wrong, and help us identify more risks.

Stig Brodersen  25:25  

So I’m curious. You’re talking about this stock just being priced above $4. And then the listeners are hearing that you’re talking about a $1.13 the year after. Why would you come with an expected return of, call it, 8% to 10%? Could you talk about the process and how you think about that?

Preston Pysh  25:44  

Well, so that’s more just me being ultra conservative with what I expect to get out of it. I think on the high end, you might be able to get 20% out of this thing without any problem at all. But conservatively speaking, I think that you got a discount for some of those risks. I think you got to account for the fact that this thing usually doesn’t trade at a high premium to its earnings. 

I think that that’s probably one of the biggest factors of why you might not get 20% out of it. I think that in the long run, it’s always going to be discounted because of the fact that it’s a Russian company. A lot of people are concerned with the government there.

Stig Brodersen  26:22  

If people are thinking, “How can we get that kind of return? And why is it trading so low?” Well, let me ask this question instead, “How do you feel about investing in a Russian oil company right now?” And you know, everyone else has the same feeling. So that’s really the reason why. There’s so much psychology in this. This also relates back to what we talked about before with the old price. How can it be stabilizing in the 50s, and not too long ago was in the high 20s? 

Well, sure. If you look at this fundamentally, it didn’t make any kind of sense because you can’t extract all that counter price, and utility is so much higher. There was just all psychology. What does the consensus say right now? It’s the same thing you can say about the market price of Gazprom.

Preston Pysh  27:10  

Stig, something that I look at, like for me, this is really important for this company – the market cap. When I’m looking at a $47 billion company, there are a lot of people, hardware, and other things that’s been happening by the sheer size of this business. That doesn’t mean that it can’t go into oblivion and disappear. 

But when I look at how leveraged they are, they’re not leveraged hardly at all. They have that kind of market cap, and the revenue that’s coming in. I mean, man, this thing is not going down anytime soon. It’s not going to be destroyed anytime soon. 

There’s a lot of momentum behind a company of this size. When you see it priced for the profits that it’s producing. I feel very comfortable buying something like this right now. 

Alright, so enough about Gazprom, we’ll let the listener decide whether they want to buy a Russian energy company or not. But I think it’s an interesting discussion. 

So the next one here is a fun one. The reason that we’re highlighting this one is because we think it’s a horrible pick right now. But we think it’s a great business that’s making a lot of money. We want to highlight why we think it’s such a bad pick for somebody to own right now. We’re talking about McDonald’s. 

McDonald’s makes a lot of money. And whenever I say they make a lot of money, let me just tell you some of the figures here. So the top line for McDonald’s is: their revenue in 2016 was $24.6 billion. Their net income was $4.6 billion. So literally the money that is left over as retained earnings for this business was $4.687 billion before the dividend was paid. 

They’re making a lot of money. That is a very high margin, especially for the food industry. Everyone knows the saying that it’s a real estate company. But when you look at this, and you look at the margin, this margin is really fat. But let’s talk through why we think this is something that you would not want to own today, in 2017. 

It really comes down to the intrinsic value calculation. They have so much momentum. When you look at their top line, it’s been suffering a little bit lately. It’s been going down a little bit, not a lot, but a little bit. Their highest revenue or their top line was $28 billion, and now it’s $24 billion. That was four years ago when they were at $28 billion. They’ve contracted a little bit. That’s a reason that it should be trading at a discount. The revenues are contracting. It’s trading at a very high price.

Stig Brodersen  29:52  

I wanted to talk about McDonald’s because it has really been on my radar for quite some time. Going years back, I just liked the numbers. I like companies that I know how to value. A company like McDonald’s is just really easy to value because it’s so stable. And whenever Preston is talking about that their revenue has contracted,  and it has. 

Back in 2013, it was $28 billion. And now, their trading 12 months is around $24 billion. But that’s a high fluctuation for a company like McDonald’s. It really tells you something about it not being a high growing whatever. I mean, this is very stable if you look at the gross margins. We are at the 40s. At the operating margin, we are around 30. 

If something is very stable, it is easy to value. My dollar is definitely a good business. It is a good business in a sense that it really has no debt. For the conservative investor, it also has a high payout ratio if you look at the numbers.

Preston Pysh  30:52  

I’m just laughing here. It’s hard for Stig to retain it because we keep saying it’s a good company. But in my mind, I’m thinking, “Yeah, but I won’t eat there.” I’m sorry. Go ahead, Stig. I’ll try not to smile so much that it will distract you.

Stig Brodersen  31:05  

Sorry, Preston. I’m all about the numbers. I don’t know if I’m about the food, but I’m definitely about the numbers. And the numbers are good.

Preston Pysh  31:13  

Well, when you say the numbers are good. The numbers are good from the revenue. They’re stable. I don’t want people to get confused, but from an intrinsic value, the numbers are not good, right?

Stig Brodersen  31:24  

Yes, it’s a really good point. If you look at the numbers in terms of the stability, and the billions of dollars that it’s making every year, it’s a good company. If you look at how it’s priced, it’s not a good company. But I’m looking at our model putting in my assumptions.

We’ll have a link in the show notes where people can go in and read more about the assumptions. We’re probably looking at 1% return, something like that. I mean, it’s not a lot that you can expect. That would be even worse than buying into the market. 

But it’s also very interesting if you compare it to a company like Gazprom. As you can tell, we were excited about Gazprom. But Gazprom is a lot more risky despite its size. It is way more risky than a company like McDonald’s. But it all boils down to the price. If you’re paying $4, and then some for $1.13, that’s attractive. And then you look at a company like McDonald’s. It is currently trading at $166. That’s for an earning per share around $6. So it’s just not as interesting.

Preston Pysh  32:25  

So Stig, I want to clarify because you were saying that Gazprom is a lot more riskier than McDonald’s. But Buffett and some of these guys will say that the risk is actually in the price, not in some of these other things that people identify? This for me is a perfect example of that. Whenever I look at McDonald’s, all the risk here is in the price. 

The fact that the market is valuing it so highly, and that you’re going to get a 1% return if you buy it today in the long term. We’re not saying in the next year or in two years. But if you would own this into perpetuity or you plan on owning it for 30 years, I would expect to get a 1% return on my money annually for the next 30 years. This is based on how it’s priced today. 

For me, that’s a ton of risk because I can take that same amount of principal when invested in the S&P 500 and get 3% based on how it’s priced, or I can go to Gazprom and get what I think is 10% or even higher. So for me, when you talk about the most risky thing here, it’s a business that’s extremely stable and making a ton of money, but it’s priced completely to the moon. So that’s why I think it’s really great that we’re talking about this company. 

Other people might completely disagree with this. They might think that there’s a lot of growth opportunities, that McDonald’s is somehow going to grow their top line, which I don’t see happening. And so for me, I see this as a huge risk.

Stig Brodersen  33:49  

It’s really good that you clarified that because when I said riskier, which I probably shouldn’t have, it’s the thought of McDonald’s going from earnings per share of $6 to minus $2 or $3 for that matter. I don’t see that happening at all. 

I think that the likelihood of something like Gazprom could happen because they’re also in the commodities business. It’s a lot more cyclical. There could be a lot of other reasons why they would suddenly, like for legal reasons they would see it drop. I don’t see that at all for McDonald’s. 

McDonald’s is a very sticky business. Even though it’s not, it doesn’t have the same kind of stickiness as a company like Starbucks or Coca-Cola where people always get the daily Coke or daily cup of coffee. I mean, people do change what they eat. But still, it has so much more stickiness than other fast food chains. 

It’s also because of the location. I mean, it’s not always a question about the taste and the decor. I might get a lot of mad tweets because I’m saying that a lot of the fast food tastes similar. I know there’s a lot of hard comments. So I would say, it doesn’t at all. 

But I think it’s also a question of if you’re hungry and you want to go for a burger, sometimes you will just take what’s more convenient. It’s really hard to find a company, whether it’s in Europe or the US that have better locations than McDonald’s. It’s all in the right places, even though people sometimes might want to go to Burger King, Wendy’s or whatever,

Preston Pysh  35:19  

You know what you’re going to get in. It’s everywhere. Everywhere you look, it’s there. 

Alright, so instead of harping on this one anymore, the reason we want to talk about it is because it is a great company that’s making a ton of profits, but it’s probably something that you don’t want to own at this point in time in 2017. 

Now, as the market conditions change, let’s say we have a big pullback and a big contraction, and this thing gets priced and set up in a completely different multiple than it is today. This thing might be priced at a 15% return, and then it might be a great time to come in and buy this equity of this business. But today, we don’t see that at all. We think it’s important to highlight that so that you can see that a great business at a poor price is a lot of risk. That was our main point.

Stig Brodersen  36:07  

All right. So at this point in time of the show we would like to play a question from the audience. This question comes from Vash. 

Vash  36:12  

I’m a big fan of your show, guys. I really appreciate the opportunity to ask you guys a question. So with this massive push into passive now, you have a lot of big names on both sides of the indexing argument. You guys, like Buffett saying that the average retail investor should just go into indexing and forget about it for the next 20 to 30 years.

With that being said, the way I see it is we created kind of a positive feedback loop on the way up. I’m afraid that on the way back down, it’s going to be the same thing. It’s going to be a positive feedback loop where recession causes people to pull out of index funds. That further pushes down the market. 

You think that guys like Buffett are doing a disservice to retail investors because chances are most retail guys don’t have the temperament to stay in when they face the biggest correction that they’re ever going to see in their lifetime. So what are your thoughts? Thanks a lot, guys.

Stig Brodersen  37:10  

All right. I really like this question. And for people following the financial news out there, they probably can’t help but notice that indexing has really been something that’s been heavily debated recently. Indexing is many ways changing the landscape of investing. And right now, almost 20% of the global stock market is indexed. You’re seeing this polarity of indexes for a long time. At least the way it looks like now and the forecast you can make, it is expected to continue. 

And so basically, what you’re asking about is what’s that going to mean for us? I definitely think you’re right about the positive feedback loop. I think that index is a factor in what you see right now with the high valuations. But you could also say it has to do with QE or you might also say that it has to do with the general state of the economy. There are a lot of great narratives on why you see the stock valuations that you’re experiencing right now. 

But yes, I do agree that the ups and downs to experience in the market will probably be exaggerated to some extent. Now, in essence, I don’t think it’s different than what Warren Buffett’s Professor Benjamin Graham observed after the Great Recession. I’m sure you can argue that before, when stocks were expensive, investors flocked to the stock market, and the stocks were selling when it went down. As you suggest, indexing probably makes this worse. 

The question is, “How much?”. Let’s go back to your question whether or not Buffett is doing a disservice to the retail investor. I don’t think he is. As you mentioned, he’s been saying 20 to 30 years, or even a longer period of time for holding indexes. We’re not necessarily talking about going into indexes right now, but more like a general approach to investing in the stock market. 

I think that if investors start selling anyway, I really can’t see how Buffett can be blamed for people not following his advice. The other thing I’d like to add is, what is the alternative to the stock investor? 

Let’s say that he doesn’t invest in [an] index, and say that he wants to interview stock picks instead. So it’s important to keep in mind that even if you pick individual stock, it is by definition, a part of a market index. You might not buy the market index, but someone else is. They will also be owning your stock. I think you bring up a really good point about the psychology in the market. 

We usually know that people would sell at the wrong time. I do think most people have a harder time selling an index, even though it might sound counterintuitive to your thesis. When you have an index and say that you lost 30%, then you will have lost 30% when everyone else has lost 30%. It might be harder to hold on to a stock that has dropped, call it, 40%, or even just 20% because you don’t have that certainty of following the herd.

Preston Pysh  40:10  

So Vash, interesting question. I have no idea what the next recession is going to look like. I really can’t even comment on how deep I think it will go. I think any type of conclusion that I would draw would just be completely based on biases that I hold.

I think it’s going to be deep at -50% but that’s based on nothing. That’s just based on my feelings, which are worthless. I feel like the central banks have been pumping this thing up a lot. I think that I buy into the Ray Dalio narrative that on the way up, it’s reinforcing, and then on the way down, it’s also reinforcing with the way that credit contracts. 

It’s going to be really a function of how well the central bankers can prop this next credit cycle up after this starts to contract. You could make the argument that it’s going to be deep because they don’t have the amount of interest rates to drop like they did during the last cycle. There’s a lot of people making that argument. They think that that might be one of the reasons why it could go deep. But for me to be able to say, with any type of absolute certainty, I have no idea. I really don’t know. 

With respect to your second question about Buffett telling people that the best way to invest is in ETFs and that that might actually cause more harm than good, I don’t know that I’d necessarily buy into that. I think a person either has the temperament or they don’t have the temperament. 

If they don’t have the temperament, and I think all Buffett’s trying to do if I had to guess with what he’s trying to do, I think he’s genuinely trying to help people. I think he’s genuinely trying to help people get the best return that they can based on the amount of knowledge he expects the average investor to have. 

There’s one thing that I think that he has learned. Most people have no idea what they’re doing. Based on that, he’s telling people to invest in ETFs. That is simply because the fees are low. You can get the market’s return. 

Whether you have the temperament to stay in the market when it starts to contract or as it’s climbing or whatever, that’s completely up to the individual. It’s up to them if they want to keep the faith and continue the dollar cost averaging in the S&P 500, or whatever ETF they’re trying to track. 

So for calling in and leaving this great question, we’re going to give you a free subscription to our new Intrinsic Value course that we just created. This teaches you how to value stocks, how to look at individual stock picks, and how to come up with a value and an IRR calculation of what you think the yield will be on that stock moving forward. We hope you enjoy that free course. And for anybody else wants to check out the course, go to TIP Academy on our website. You can find it there. 

So if anyone else wants to get a question played on our show and potentially get a free course, go to asktheinvestors.com. And you can record your questions there.

Stig Brodersen  43:12  

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

Outro  43:19  

Thanks for listening to TIP. To access the show notes, courses or forums, go to the investorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. 

This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.