Stig Brodersen  01:34

Jesse, you might not know this, but I consider you to be a fantastic friend and you might day, “Why, Stig? Why are we such good friends?” Well, I don’t know if you remember, but back in quarter two of 2017, we had you on for a mastermind meeting. It was back on Episode 143, which we’ll definitely link to in the show notes. Bed, Bath, and Beyond, the stock we’re going to talk about today, that was trading at $35 Now the stock is trading around $10, and I pitched it to the group because I thought it was a great stock compared to the price. Then this guy, Jesse Felder tells me, “Hmm, I would probably think twice about that stock pick, Stig”, so I ended up not investing. So thank you so much, Jesse.

Jesse Felder  02:18

You’re very welcome. To me, “It’s the price you pay that determines your rate of return,” is maybe my favorite Warren Buffet quote of all time, and the price just didn’t make sense to me at that time.

Stig Brodersen  02:27

So Jesse, fast forward to today, you’re here on our show to actually pitch Bed, Bath and Beyond. We’re turning the tables. It’s going to be very, very exciting.

Jesse Felder  02:37

Yes. It’s a stock that I really wasn’t paying much attention to until you brought it to my attention. Then I started you know, looking at it, it’s funny, you know, this is a stock that’s gone from being a large cap $17 billion not too long ago to just over a billion dollar market cap today. It’s gotten absolutely crushed. So these are usually the types of things that pique my interest; what is the most hated stock in the market? Where’s the most fear in the market? I really think that Bed, Bath, and Beyond qualifies for those types of candidates right now.

Stig Brodersen  03:08

Let’s talk about what happened this year for Bed, Bath, and Beyond. It’s been quite a year. We had activists calling for new leadership, Mary Winston became the new interim CEO back in May, and we heard talks about turnaround plans. How would you describe 2019 for Bed, Bath, and Beyond, so far?

Jesse Felder  03:25

Well, it’s absolutely right in the midst of a transition, and there’s tons of question marks about the business, about the company, about the leadership. That’s usually what’s required to get deep, deep value in the market. There’s just tons of uncertainty surrounding this company right now. It’s right in the midst of a transition and leadership transition in trying to figure out how it’s going to run its business, what it’s going to do to turn around the business? There’s just tons of gray area that makes investors very uneasy; they sell the shares and push it down to an incredibly low valuation in reaction. That’s kind of the way look at it right now.

Preston Pysh  04:01

So Jesse, we’re going to get to all the risks and issues with Bed, Bath, and Beyond. Let’s quickly hear your bull case on why you think it might be a buy right now.

Jesse Felder  04:09

There are three things I consider when I look at a potential investment. I want to find something that’s cheap. The way I look at it, we could talk about my valuation system. This stock is one of the cheapest stocks that I’ve seen in years right now at its current price valuation, but at the same time, I don’t want to. This is another reason I didn’t like Bed, Bath, and Beyond a couple years ago. I don’t want to buy something that has strong downside momentum. I want to see something that technically looks like it’s trying to form a bottom and we could talk about the types of tools I use in that regard.

Jesse Felder  04:39

Then finally, I want to see what the insiders are doing and typically, I like to see heavy insider buying. There’s not been any buying here, but there really hasn’t been any selling on the part of executives, and executives have been exercising a ton of stock options recently and holding on to all of those not selling any for even tax purposes or anything. Interpreting that insider activity is important too, and I really think that’s not as bullish as I would really like to see but it’s pretty darn bullish. The fact that they’ve been exercising a ton of options tells me that they think there is a potential floor under the shares. Along with that, they have a massive buyback program left at Bed, Bath, and Beyond with I think it’s a billion to authorization, the market cap is a billion too. So if they pulled this off, they would essentially take the company private. I think that’s maybe what investors are looking at, or insiders are looking at too, is that the company could put a floor into the shares if they chose to right now.

Stig Brodersen  05:31

You mentioned before, Jesse, which tools do you use whenever you say that it might look like it’s hit bottom, and now you see a positive momentum trend?

Jesse Felder  05:40

When you look at the momentum in terms of the price versus a 40-week moving average and the price versus the 10-day moving average; recently, as the price has been hitting new lows, momentum has been actually making higher lows. So that kind of non confirmation tells me that downside momentum is potentially waning. You could also see it in those typical technical tools too. So on a weekly chart, look at MACD, RSI, money flow; all these things are not confirming the new lows in price which to me says okay this thing doesn’t have this super strong downside momentum that I would try and avoid. It’s kind of running out of steam to the downside potentially.

Stig Brodersen  06:14

Which tools would you use for insider trading? There are so many tools online and not all of them are consistent, especially for something like insider trading.

Jesse Felder  06:23

My friend, Asif, has put together a site called Inside Arbitrage which is terrific and he puts out a free weekly newsletter highlighting the most interesting buying and selling during the week, so I use his site. The site is also useful because he shows this options activity that I’m talking about. There’s another side I like to call The Open Insider. It is basically just buy and sell activity. It doesn’t show the options activity as effectively as Asif’s site does, but those two are the sites that I go to probably on a daily basis to just monitor this stuff.

Stig Brodersen  06:51

Let’s talk more about the company. One of the things that really stands out whenever you look at a company like Bed, Bath, and Beyond is just short float. That’s currently at 46%. Could you perhaps explain for the audience what is a short float? What is the impact for me as a long investor?

Jesse Felder  07:07

Yeah, so this is actually one of the things that has gotten me really aggressive in the shares right now, because typically when I look at a stock, and I see a very high short float, I typically assume this short sale is a right, so essentially all short float. So you take the float of the company, which is essentially the shares available for outsiders to trade in the market. If the shares are not held by 10% owners or other insiders, like the executives, the fact that half of those almost half of those shares that are available to trade have now been sold short sets up a potential for a short squeeze.

Jesse Felder  07:39

If things do not turn out as badly as people are anticipating right now, these shares have to be covered. They have to be bought in at some point. These short sellers have gone to their brokerage firm, they’ve borrowed the shares from the brokerage firm, they’ve sold them in the open market. At some point they have to buy those back and return them to the brokerage firm. I do a lot of short selling myself. I look at this and this is the last stock I would ever want to be short because it is so incredibly cheap, and because the short side has become so crowded that the potential for a squeeze is pretty serious.

Preston Pysh  08:09

So Jesse, what would you be calling a high number? Stig alluded the 46% being a high number, but what do you think?

Jesse Felder  08:14

Certain things to look at – you could look at days to cover like the number of shares that are sold short versus the average daily volume. It would take like 5, 10, 15, 20 days for the shorts to cover. Similar to like this 50% of the float. If you look at the history of the float in Bed, Bath and Beyond, it was really kind of minuscule for a long period of time. Now that the stock is potentially forming a double bottom, technically, and momentum looks like it’s waning to the downside. Now, shorts have really stepped up to go heavily into this thing on the short side and I really do think a lot of is probably just CTAs and trend followers who are not necessarily looking at the fundamentals. They’re not looking at any of these types of indicators that I’m mentioning. They’re simply looking at this stock is in a steep downtrend, and we’re going to short it as a basket of similar short *inauble* and technical downtrends.

Stig Brodersen  09:04

Looking at a company like Bed, Bath, and Beyond – it’s so unpopular, as you also mentioned, but how much of the negative sentiment is really about retail and about losing out to Amazon? How much is specifically tied to the performance of Bed, Bath and Beyond?

Jesse Felder  09:20

Well, you’re right. I mean, retail is really out of favor right now. I really do think this is mostly about Bed, Bath, and Beyond, the specific company issues because when you look at the valuation of this company, relative to its peers – which is one of the evaluation tools I look at; by peers, I’m talking about Kohl’s, Target, Walmart, William Sonoma, Restoration Hardware. Companies that are in kind of similar lines of business. If this stock were to trade in line with those companies based on price to sales ratio, price to free cash flow, price to tangible book value, this would be a $60 stock today if it traded in line with its peers.

Jesse Felder  09:55

It’s a $10 stock today, so it’s not only trading at a severe discount to the market, it to string a serious discount to its peers. you take the cheapest stock in that basket that I mentioned, which is Kohl’s and if Bed, Bath, and Beyond traded at the same valuation, as Kohl’s, it’d be a $30 stock. So it still trades at 70%, 65% discount to the cheapest stock in its peer group. This is definitely about Bed, Bath, and Beyond.

Preston Pysh  10:19

What kind of multiple are you using here, a P/E or what are you using?

Jesse Felder  10:23

I use a variety of different ones. I typically stay away from a P/E multiple. For this retail group I use price to sales ratio, price to free cash flow, and price to tangible book value. Those are the three metrics that I’m using in this case.

Stig Brodersen  10:37

It’s interesting that you would bring up these metrics and I know we were supposed to talk about Bed, Bath, and Beyond but I would like to take the conversation momentarily into another direction here. So we spoke to Bill Miller here on the show. We talked to Bill Nygren and they both talked about how P/E used to be a good metric in terms of valuation, but then gradually during the 90s, it started to change because of the shortcomings of that metric. Do you use price to earnings at all in your valuation today?

Jesse Felder  11:05

There are two reasons why I don’t like it. One is because leverage is at record levels, the price doesn’t factor that in, and that’s why I like enterprise value better. The reason I don’t like earnings is that corporate profit margins are also at record highs today. The only way I would use a P/E is to try and normalize it somehow. My friend Eric Cinnamon has done some great work on this. Retalks about let’s normalize earnings over the cycle, and I think if you’re not normalizing profit margins normalizing earnings, then you’re doing yourself a disservice because a lot of times you’re going to build a valuation on top of peak earnings which doesn’t help you at all. That’s part of the reason why I like using price to sales, price to free cash flow, and these other things.

Preston Pysh  11:45

Jesse, when you say price to sales and price to free cash flow, how much are those multiples also impacted by credit cycles, especially when you’re looking at them for a company like Bed, Bath, and Beyond?

Jesse Felder  11:56

This speaks to the broad market too, and I look at the broad market from a price to sales ratio which I think is much more valuable. The price to sales ratio takes out that cyclicality and profit margins, so that’s why I like that one. I do believe in cycles. I do believe the Federal Reserve hasn’t ended the business cycle. I want a valuation that’s going to build in that full cycle type of numbers for me. I don’t want to be assuming that we’re not going to have a recession built into my evaluation model, which if you’re using peak earnings, you’re essentially assuming that we’re going to continue to see economic expansion and I think that’s a very dangerous assumption that investors are making on macro and micro levels.

Stig Brodersen  12:34

Jesse, I was on a call with Bill Nygren from Oakmark Funds here the other day. He co-managed his $24 billion. This is an episode that will be out in a few weeks. He talked about why the bigger banks are gaining market share because they can provide services and a platform that is just so much better than what the smaller banks can. I talked to you and we talked about whether you would pitch Bed, Bath, and Beyond. I was thinking if the same principle would apply for a small company like Bed, Bath, and Beyond whenever it’s competing against Amazon.

Jesse Felder  13:05

Absolutely, one of the issues is that Amazon is a massive competitor. Wayfarer is another one that’s come into the market and has become a very important competitor for Bed, Bath, and Beyond. These are the issues. The way I look at it, does the valuation account for these risks, these challenges? Does the valuation not account for that? I would argue that the current valuation absolutely does account for the challenges that they’re facing right now. That is what’s going on with the company right now.

Jesse Felder  13:31

The valuation is so cheap because they’re trying to figure out okay, how are we going to best compete against these online competitors who have essentially zero percent profit margins at the end of the day? How do we compete against them without going out of business? It is a challenge.

Preston Pysh  13:46

So it’s somewhat absurd the amount of consolidation that we’ve seen in this sector. What’s your expectation moving forward, and are we going to see even more?

Jesse Felder  13:55

I think there’s two major kinds of macro factors going on right now. One is, you’re starting to see discussion around a renewed antitrust framework, which is really targeting Amazon, among a couple others. We’re starting to see Washington discuss breaking these companies up. At the very least preventing them from entering new businesses. If Amazon were to be restricted in its ability to manage its platform, and compete with its own customers that would be very beneficial to companies like Bed, Bath, and Beyond. I don’t think that you have to believe that’s going to happen to be bullish on the stock, but that’s one factor.

Preston Pysh  14:30

The other factor is what we’ve seen during this cycle. We’ve seen investors being willing to fund companies that generate losses and have no prospect of generating positive returns. That is also potentially shifting. So there’s Uber, Lyft,  WeWork, and I would throw Wayfair into this category. I do think investors are at the end of this cycle. I think we’re already seeing early signs that they are getting to the point where they are becoming more reluctant to perpetually fund these loss making businesses to the extent that that continues, it’s going to benefit companies like Bed, Bath, and Beyond.

Stig Brodersen  15:07

If you look at the top line off Bed, Bath, and Beyond since 2016, it’s been flat but margins just continue to decline. If you just take one example, the gross margin – that’s been going on for close to a decade now. So we went from 41% to now only 34%. Why has this happened?

Jesse Felder  15:26

It’s a combination of a couple factors. People are shopping more online and it’s the product mix that they’ve been able to sell. I think it used to be that foot traffic was a lot better in these stores, and Bed, Bath, and Beyond was maybe the best in the business at selling you things you didn’t realize you wanted when you walked into the store. They’d have all of these things all over the store that would catch your eye, grab your attention, and they would just sell extra products at higher margins due to the foot traffic and then their ability to monetize that foot traffic. Now that the foot traffic’s down, you know that business model is not working as well as it has in the past. They’re also being forced to compete on price. They have gone into online, the price competition has gotten more severe in recent years too. So I think it’s a combination of those two things.

Stig Brodersen  16:10

Another thing I would like to bring into the mix are those infamous coupons that they keep sending out. Whenever you are on these earnings call with the management of Bed, Bath, and Beyond, they talk about how it’s also squeezing margins. For me as an investor, I would be worried if they’re inflating themselves. It’s sort of like the fat, they just keep doing QE. Bed, Bath, and Beyond can’t do that, but they can keep on printing more coupons that will give people either free shipping, 20% off, or whatever it is. I guess also, as a consumer, I would think why would I ever buy anything at retail price? I would just wait for some coupons.

Jesse Felder  16:45

It’s a really interesting question because if you look at the attempted turnaround of JCPenney a few years ago, when they brought in as Ron Johnson, I think from Apple and he tried to go from a coupon based to everyday low prices to eliminate coupons, and it almost killed JCPenney. When you have a customer base that is addicted to coupons, if you take those coupons away, even if you’re very good at your messaging, saying we don’t need coupons anymore because we’re going to give you these prices all day every day, that’s not going to work.

Jesse Felder  17:15

People love to get a good deal. They love to feel like they’re getting a good deal, not an everyday low price. I do think you have to know your customer base. I think Bed, Bath, and Beyond is probably doing a better job with that in balancing that everyday low price with still giving people what they want, which is the feeling that they’re getting a deal by getting a coupon. They just changed over the board. I think it’s 12 out of 13 board members just changed over and those are all brand new people but they all have extensive backgrounds in retail. So I think they have a really good base to discuss these issues with people from diverse retail backgrounds and figure out what is the best way forward.

Preston Pysh  17:50

So Jesse, you were talking a little bit about the management there. So when you look at the old management of Bed, Bath, and Beyond, they were the very definition of excessive compensation, so I’m curious how you think about executive management compensation, and how maybe you value that or how you view that from a cultural perspective for the company.

Jesse Felder  18:11

It’s really critical. I think pay absolutely should be tied to performance but not to per share performance. That has huge incentive to buy back stock at uneconomic prices when executives are I guess incentivized by per share pay. All they got to do if they’re not going to meet their numbers that quarter is buy back extra stock, they can meet their performance hurdles and get those bonuses. That’s one thing I don’t like to see. Interests are not aligned between shareholders and management because they buy back stock to boost their own bottom line and potentially harm the company.

Jesse Felder  18:44

That’s one thing I’m really excited about Bed, Bath, and Beyond right now is they have the potential to bring in somebody new. Bring those pay practices back in line and they just started in their second quarter buying back a ton of stock at this $10 to $15 price range, which to me is, right now, it’s exactly what they should be doing. They have this huge authorization, they have the cheapest stock in the history of the company, so if there was ever a time to be buying back stock, it’s right now, and I’m glad to see that they’ve been doing that.

Stig Brodersen  19:11

For all the terrible things that was said about Bed, Bath, and Beyond so far, what’s the moat of the company?

Jesse Felder  19:18

This is an interesting thing to think about, too, because when you read analysts’ reports about it, especially reading through the Morningstar reports recently, and they refer to it as no moat. Bed, Bath, and Beyond, which tells you a lot about the sentiment towards the company right now. Investors want these companies with moats. They’re very few of them actually in the markets and that’s why they’re so highly valued right now. Bed, Bath, and Beyond probably doesn’t have much of a moat. I think generally in retail, it’s very difficult to find retailers with moats. It’s usually some type of branding, some type of unique products that they offer that creates that. That’s what Bed, Bath, and Beyond is struggling with right now. It’s to determine what our moat is. That’s the question right now and that’s why the stock is so cheap.

Stig Brodersen  19:58

I would highly recommend for the listeners to go back and listen to Episode 143, where I originally pitch Bed, Bath, and Beyond and then track some of the development that happens until today. But one of the things that Jesse said during that conversation was the old Warren Buffett quote that you are only as profitable as your dumbest competitor, if you’re in a commoditized business. Given that the biggest competitors Amazon, perhaps even more Wayfair are not really making any money. how should we, as investors, look at that quote today, Jesse?

Jesse Felder  20:30

Yes, you have to say, “Okay, how is this company going to survive in a commoditized business who are selling the same products you can go buy on Amazon or on TV or through wayfair? How are they going to survive in that framework?” I would just point out that the company has had over $4 in free cash flow over the last 12 months, even while competing with Wayfair and Amazon. That’s $4 in free cash flow. That’s cash from operating activities less capital expenditures. If they can generate $4 in that type of a competitive environment, that to me is a sign that they’re doing just fine competing against these guys. They’re still figuring out ways where they can sell high margin products using that foot traffic. Plus they’re finding ways to like a cost plus world market, they do have unique product lines that do give them some sort of a moat along some of those product lines.

Jesse Felder  21:19

I also think Wayfair is going to get to the point probably where investors are going to be tired of funding losses for a company that sells furniture. This is not Netflix, which can be $2, $3, $4 billion in negative free cash flow, and people will fund it because it’s a technological miracle that has very high capture among its audience. Wayfair is not that. People will switch away from Wayfair to whatever has the best product at the best price. As soon as investors get to the point where they’re not going to fund half a billion in losses at Wayfair any longer.

Jesse Felder  21:47

They’re going to have to figure out a way to become profitable. At that point, that’s going to be very, very beneficial to a company like Bed, Bath, and Beyond. I do think it’s important to think about, yes, they’re competing against these companies against Amazon, Wayfair etc. and others, who are happy with zero to no margins, but Bed, Bath, and Beyond has found a way to do it over the last 12 months, even in the midst of such incredible negativity among investors. They said, they’re going to earn $2 a share this year. It’s trading five times earnings. So if you can earn $2 a share in profits in this type of environment, then I think they’re doing pretty good.

Preston Pysh  22:18

So let’s shift gears and talk about the online portion of the company. Back in 2012, the company started to build somewhat expensive data centers, which increased their fixed cost structure and then in 2016, they acquired a company called Personalization Mall for $190 million as part of their online strategy. How do you evaluate their online retail so far?

Jesse Felder  22:40

The online is working. The return on investment for what they spent on that, I don’t know if that was worthwhile, but it’s something they actually have to do in order to compete with the online companies. They have spent money on it but I think comps were negative 6.6% in the last quarter, but the stores were closer to the higher end of single digit decline in comps. The online is growing, and it’s offsetting some of that decline in stores. It’s working. They’ve created a membership platform that gives people free shipping and whatnot to try and compete with Amazon Prime. These are efforts that are still kind of in the early stages. From my perspective, it seems like they’re helping to stem the decline in same store sales. So to that extent, they’re worthwhile.

Stig Brodersen  23:21

We already talked a bit about it, but let’s talk more in depth about Bed, Bath, and Beyond’s capital allocation strategy. The company has long been known for not paying out dividends, which stands back in 2017. A few years before that, they also took on a lot of debt. So that’s another thing to consider for this company. I guess my question goes to how do you evaluate the allocation strategy? It’s still buying back up stocks, it’s paying out decent dividend at 6.5%, but it also has to reinvest in the business. How do you evaluate what they’re doing right now with the new management,

Jesse Felder  23:54

The way I look at the enterprise value, and this might not come up in some of the standard ratios that you look at. They have about $900 million in cash, $1.4 billion in debt, and that doesn’t include, I think operating lease obligations, which is something I don’t factor in, that’s a new accounting standard. They have net half a billion dollars in net debt that would put the enterprise of I think market caps around 1.2 billion something I put the enterprise value around 1.7 billion, and the company does about 700 million in EBITDA so they could pay off all the net debt in one year’s EBITDA.

Jesse Felder  24:26

The other factor about that too, is if you look at their debt, and I was I was talking with Eric Cinnamon about this just yesterday when we were looking at the company together, and he pointed out that the company’s maturities are I think 2034 and 2044. They’re paying 4% to 5% on this debt. So if I’m Bed, Bath, and Beyond, and I could go issue more debt. I mean, this is why I don’t think it’d be hard to take the company private because you look at $1.7 billion enterprise I mean, or just $1.22 to buy out the equity. They already have $900 million in cash, they went borrowed another $500 million that matures in 2044 and borrowed at 5%. They could take the company private in a heartbeat.

Jesse Felder  25:05

The capital allocation strategy that I would do right now, if I were them and this is probably way too aggressive for any public company, is borrow a little bit more money with a 2049 maturity input. Issue a 30-year bond with 5% or 6% with today’s interest rates, and just say we’re gonna buy back stock until we buy it all, we will take the company private if we have to. They’re in a position right now to be able to do that, which to me is if I was a short sale, it’d be absolutely frightening.

Preston Pysh  25:30

Jesse, talk to the audience about what it means for an existing shareholder if the company would go private.

Jesse Felder  25:36

So today it trades at $10, they’d have to probably offer some type of a premium to today’s price and the blowback from public investors would be really severe. I mean, with the activists they have now the activists who are getting involved in the name are not buying it at $10, $11, $12 so they can sell it for $15, $16. They’re getting involved today so that they could sell it for $30, $40, $50, $60 a share down the road. I think that would be the biggest impediment to taking the company private as they would probably get sued by shareholders that would be unhappy with only getting $13, $14, $15 bucks a share or something like that.

Jesse Felder  26:09

Another issue of buybacks is the way companies should do buybacks, if they were really going to be aboveboard and not manipulate their own share price is to just use tender offers and just say we’re going to buy back this number of shares at this price and you can elect to participate or not, and keep your shares. I do thinkBed, Bath, and Beyond could do a tender offer. That would be a good idea. Generally, they have the ability to buy back a ton of stock right now and I’m glad to see that they’re doing it. When they were asked on the conference call about it, it was interesting too to hear the interim CEO and the CFO talk about it. They kind of didn’t want to answer the question. They giggled a little bit. To me that suggested that there’s something up their sleeve that they are planning on buying back a ton of stock this quarter.

Jesse Felder  26:10

Do you see the company stop paying out dividend in the future and perhaps even reinvest less in the business because of this plan?

Jesse Felder  26:27

I would love to see them cut the dividend to zero and just buy back stock right now because I’m getting 6% dividend yield. But buying back stock today at 5 times earnings is essentially a 20% earnings yield. So I would prefer them to cut the dividend to zero right now, use all that money to buy back stock, but that’s probably not going to happen because once you attract those income oriented investors like they have done, you don’t really want to alienate them. I don’t think it’d be necessarily a smart move PR-wise to cut the dividend but today, it makes much more sense to buy back stock.

Preston Pysh  27:29

What would be the impact of an activist for an investor of Bed, Bath, and Beyond?

Jesse Felder  27:35

Well, I always like it when activists get involved with a name, whether it’s, Carl Icahn, or Bill Ackman or any of these guys. They usually advocate for positive change on behalf of shareholders. It’s a good sign. I know that Toby has talked about how he looks for companies, that’s why it’s the Acquirer’s Multiple. He looks for companies that are trading at a cheap enough evaluation that will attract activists or attract buyouts. To me, the sign that activists are getting involved is a sign that this stock is cheap enough to get some very smart investors that have the power to affect positive change, and that’s what’s happening right now, so I look at that as a very positive thing.

Stig Brodersen  28:10

Keeping all the facts in mind that you presented here so far, what is your assessment of the intrinsic value of the stock?

Jesse Felder  28:18

I come at the intrinsic value or the fair value of the shares in three different ways. One is looking at it versus its peers. You know, if it traded in line with this cheapest peer, I get a $30 a share valuation. I look at the valuation history of Bed, Bath, and Beyond and this is difficult because the stock was very expensive for a long period of time, and traded at 30, 40 times free cash flow for a long period of time. It’s also why the stock has gone down so much over the last several years because it went from extremely overvalued, to extremely undervalued at this point.

Jesse Felder  28:48

If you look at the stock, the history of the valuation, if it just traded in line with its average valuation, the last five years, that I’m excluding all those times before that when it was extremely overvalued, it’d be a $45 stock if you just look at the cheapest levels that traded out in the last five years. I’m taking the low price of the last five years compared to free cash flow. Compared to these metrics, it would be $33 a share if it traded at its lowest valuation in the last five years.

Jesse Felder  29:13

Let’s just use that as the number. We get $30 relative to its peers, $33 based on its evaluation history. Then I do a very simple discounted cash flow analysis to write assuming a zero percent growth rate and cash flow, and then I’m backing out the net debt of the company and I get a $25 share valuation there. So I put those together, I get about $30, $29 a share fair value. I think $30 is a very conservative number for this and so to me to be able to buy a $1 for 33 cents in this name right now is a very attractive opportunity.

Preston Pysh  29:45

So how worried should a person be about the declining margins and potentially even declining revenues moving forward? How do those variables enter into the way that you would be valuing the company?

Jesse Felder  29:58

Let’s take the trailing. This is another fun thing I do with the discounted cash flow model and like I said, I only project out earnings three years. I don’t think anybody can project out more than that. So I project out three years and then use a terminal value at the end of three years. I look at what is actually priced into the shares right now. What does that mean for the company? Basically, I have to go to a negative 5% per share free cash flow and then I have to use a discount rate of 15% in order to get to the $10 stock price today. That tells me that even if cash flow declines 5% per year over the next year – this is cash flow per share, so this is with buybacks and everything – cash flow would have to probably going down 10% a year for per share to go down 5% a year.  I use a discount rate of 15%. That’s basically telling me even if I pay $10 a share for the stock price today, and cash flow per share declines 5% a year, I still should get a 15% return on my purchase today.

Jesse Felder  30:52

To me that’s one of the fun things about a discounted cash flow, because it gives you what’s actually priced into the shares today. What’s the scenario? If I use a 10% discount rate, I have to go to a negative 15% or more cash flow number. If cash flow declines 15% to 20% per year and pay $10 a share today, I’m still going to make a 10%, 12%, 13% return on my money over the next several years. This is how I approached that concern. I will just say that I’ve never had a really successful investment that I wasn’t scared to buy. You have to be a little bit scared. That’s what creates the opportunity.

Stig Brodersen  31:29

Fantastic. Jesse, we learned so much from you. Where can the audience learn more about you?

Jesse Felder  31:35

My website is thefelderreport.com. I try and put up a blog post there once a week usually about broad market stuff. There’s also a free newsletter available on the site every Saturday morning that I send out. Basically the five things I found during the week that were most valuable to me. They could be charts, links, stories, it could be a podcast that’s just at thefelderreport.com. I’m super active on Twitter. I’m constantly reading and sharing research and things that I find interesting on Twitter. That’s just @JesseFelder.

Preston Pysh  32:01

Jesse, thank you so much for coming back on. I know I always learn an absolute ton every time we get a chance to talk. I just really appreciate it.

Jesse Felder  32:10

Thanks! It was a blast as always and appreciate you having me on again.

Stig Brodersen  32:14

Alright guys, so at this point in time, the show will play a question from the audience. This question comes from Max

Max  32:20

Hi Preston and Stig. This is Max from San Francisco. Really love your podcast and the work you guys do. The question I have for this week is around macro factors and how those impact your projections for free cash flow when you’re trying to find the intrinsic value of a company. How do you weigh those? How do you not weigh those? It seems like today’s news cycle is constantly changing. It would be great to kind of understand your process when you’re projecting high growth or low growth, and trying to find your margin of safety.

Stig Brodersen  32:50

Thank you, Max, for your question. I would say that I generally pay a lot more attention to the micro factors. Meaning the stock itself and the industry, rather than macro factors like interest rate, inflation, or whatever it may be. But to answer your question, how do I include macro in my investment thesis? I would say that I always look at the main economic cycle. Unless you have a counter cyclical company, say a company that specializes in bankruptcy, you will see a decline on your bottom line when the economy is in a recession, and the boost whenever you participate in upswing.

Stig Brodersen  33:27

We have a lot of good economic indicators to make predictions, but it’s a lot harder than it sounds, which is also why I don’t attribute too much to the macro factors. However, It’s very good to have reasonable idea of where we are in the cycle. It’s not about knowing the specific date when everything will go bad. No one knows. Another macroeconomic factor I always pay attention to is the interest rate as it influences everything in business. I typically don’t invest in companies with significant debt, but it’s still important to consider. One reason is that competitors might have debt but more importantly, if the interest rate goes up, the comparative value of my investment would go down as with all other equities. So to sum up, the way I factor both cycles into my decision is that I like to have a rough idea of where we are in the cycle, and if the outlook is gloomy of where we are right now, I would add a higher margin of safety and vice versa.

Preston Pysh  34:26

Max, great question. So Warren Buffett is really famous for saying that he doesn’t pay attention to macro factors. I think that one of the reasons he’s always had this point of view is due to the countless companies you have to choose from whenever you’re making a stock selection. So on today’s show, we were talking about Bed, Bath, and Beyond. At the end of Jesse’s assessment, you heard him say that he thinks that the company’s trading at one third its value. Now, regardless whether you agree with his assessment or not, if you can find a company that you believe is undervalued by that kind of margin, the macro input should be somewhat negligible.

Preston Pysh  35:01

The one thing that Warren does pay attention to is the interest rate. But he’s not paying attention to the interest rate to make some grand projection on where it’s going to go next. Instead, he’s using the 10-year treasury as a ruler. Kind of like a ruler that you would measure the table with. He’s saying, “Okay, I can go out and get 2% return before inflation on the 10-year treasury, therefore, that’s my measuring stick. That’s what I’m going to use to see how many multiples of that ruler I can go out and get.

Preston Pysh  35:32

Let’s say he comes across the company that will give him a 200% return on his money. Well, that kind of seems like an obvious decision when you’re comparing it to a ruler of, call it 2%. You can see how when you’re doing these assessments of smaller businesses, and this is where it’s gotten really hard for Buffett recently is because for him to go out and buy a company like Bed, Bath, and Beyond, it’s so small relative to the capital that he has to employ. It’s a little bit harder. It’s a lot harder for him to do the things that he was doing when he was a lot younger. So you can see why his methodology is to pretty much ignore macro. He does pay attention to the interest rate because he uses it as a ruler but beyond that I don’t necessarily see him paying too much attention to macro factors.

Preston Pysh  36:17

All right, Max, thanks for the outstanding question. As a token of our appreciation, we have an online course called our Intrinsic Value Course that we’re going to give you completely for free. Additionally, we have a filtering and momentum tool which we call TIP Finance. We’re going to give you a year long subscription to TIP Finance completely for free. Leave us a question at asktheinvestors.com, that’s asktheinvestors.com. If you’re interested in these tools, simply go to our website, theinvestorspodcast.com and you can see right there in our top level navigation, there are links to TIP Finance and also the TIP Academy where you’d find the Intrinsic Value Course.

Stig Brodersen  36:53

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

Outro 37:01

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