[00:02:38] Scott Barbee: Oh, gosh, that’s a pretty big question. I got into investing, I think a little bit later than a lot of folks I’ve been interested in kind of, you know, I was mechanical engineer in college.

[00:02:48] Scott Barbee: I’d worked in at Chevron and did a couple of summer jobs at Chevron and was very interested in being an entrepreneur. And interested a little bit in investing, had followed some of my family in investments and bought and sold a few stocks. I really didn’t kind of catch the bug until I’d gotten out of college.

[00:03:07] Scott Barbee: I took a job at Simmons & Company, which was an oil service investment bank doing their analyst rotational program there. I started to listen to the conference calls. With the various oil service companies and really got interested in when, what made the market tick. I was a very junior guy, but also did the monthly oil service fact sheet.

[00:03:25] Scott Barbee: So I was coming up with what was going on with the various valuations or oil service companies on a month by month basis. So became interested in why different ones were going up or down as I would track those sheets and just got very interested in value investing. There was an individual who came in, a young guy who came in from the business schools for their summer and he’d heard of Warren Buffett.

[00:03:44] Scott Barbee: So I’d gotten interested in Buffett and what he was doing and just started reading everything under the sun about Buffett longer and all these various value investors. So when I got into business school, I came to the conclusion, I really wanted to make a switch. I bought a screen tool right when these market screening tools were just coming out and started looking at if you tighten up the screens really hard, you could see what came out and then went and hunted through the filings to try to really understand what these companies were about and came across.

[00:04:12] Scott Barbee: My first company was advanced marketing services, which is a bookseller that distributed books through Costco’s a Walmart’s and so forth. It wasn’t a classic Ben Graham net and bought it and made some money on it. And that really caught my attention then. And in business school, I saw that Barron’s came out and I think it highlighted the Kahn brothers, which was Irving Kahn was Ben Graham’s teaching assistant at Columbia and worked at Graham Newman and one of the kind of the value all-star original gangsters, I guess so, and Irving, so I, I’d noticed that brothers had owned advanced marketing services too.

[00:04:45] Scott Barbee: And so I started to reverse engineer kind of what were the other stocks that they looked at and. Ended up calling up Alan, who is gracious enough to start a dialogue with me. And that time in my early career in investing was really helpful. And then my real break was in some ways, a summer job that I picked up though.

[00:05:05] Scott Barbee: I had a guy named Ken Corngable who I’d passed at Wharton, who was walking across the campus. And he told me about a guy who he knew called Donald Smith, who was a deep value institutional investor. And that kind of chance encounter, really changed my life because I got to know Don and called him up and ended up working with him and Rich Greenberg over the summer and really starting to learn the business.

[00:05:27] Scott Barbee: So then for me, after that, I ended up getting to know a number of folks, a couple of people that left Khan Brothers. Alan had referred me to Bill Berno and Paul Gamble, who were down here in DC. They were the Washington DC office of Kahn brothers, but it left two or three years earlier and set up on their own a duly registered investment advisor, broker dealer.

[00:05:48] Scott Barbee: And after my summer, I hung my brokerage license that I’d earned while I was at Simmons with the Berno and Gamble. And I started marketing discounted securities to the street while I was in my second year of business school. And Don was gracious enough to help bring me along and show me the ropes of how to do real good research on these companies.

[00:06:09] Scott Barbee: And so got started to do that and ended up meeting a whole slew of others in the industry. I remember going to wall street and wrote to Bill Ackman back when he was running Pershing square and told him he was maybe three, four years older than I was and had started a hedge fund. So I’d saying, hey, I’d love to meet you.

[00:06:28] Scott Barbee: And I set up a time and took the train up to New York. One of the first times I’d been up to New York, I hadn’t been to New York much, but Bill was kind enough to make a whole bunch of calls and introduced me to a number of other people. And so very kind to a really new person in the, in the industry, which I’m really grateful for.

[00:06:46] Scott Barbee: I met Bob Rabati that day, which was one of the other folks you’d covered here recently. And got to know a little bit to some of the other guys, but then when I graduated, I ended up figuring out I could sort of, I felt like I had enough interaction with some of these folks was making enough money on my trading and.

[00:07:01] Scott Barbee: But it might be worthwhile to try to do this on my own. And so I came down and bought into the small broker dealer investment advisor here in town. And interestingly, on the brokerage side, they were covering at the time, Peter Cundell and Walter and Edwin Schloss. So I got a chance to kind of watch the way they were trading and how they scaled into positions and the kind of things that they were looking at.

[00:07:24] Scott Barbee: That was a real eye opener. For me around the business kind of worked and the kind of things that the value set we’re working on and looking at and thinking about. But Donald Smith was really one of my key mentors in the business over the years. We’ve been very close until he passed in 2019. It’s kind of the genesis of how I got my start over the subsequent years that I started the Aegis Value Fund in 1998.

[00:07:48] Scott Barbee: One of the guys at Simmons, Denny Consolmo, had an older brother who had started a mutual fund on a shoestring budget, copying other people’s legal work and all the big no’s. I figured out how to do that and got the mutual fund started in 98 and I think I’m sort of 27 years into the management of that now.

[00:08:07] Scott Barbee: I have, bought out my partners and in that 2000, 2006 and 2008, I’ve been kind of, doing sort of similar, deep value investing ever since.

[00:08:17] Kyle Grieve: So one of the most admirable traits that I find in many great investors is this unwillingness to sacrifice core principles and philosophies to fit in with their peers.

[00:08:27] Kyle Grieve: And I think a lot of the people who have influenced you probably have that exact same character trait. So you’ve been running Aegis like you just pointed out since 1998 now and obviously there’s been tons of ups and downs, tons of volatility, but you’ve essentially maintained your strategy here of buying low price to book companies all throughout the years.

[00:08:45] Kyle Grieve: So, with all these bubbles that you’ve gone through, and obviously you are observing a lot of these say like in 1999, high price tech stocks that were doing really well, but through all that, you just stuck to your strategy. So I’m just interested in learning a little bit more about, what is it about your underlying investing principles that maybe you’ve learned from some of these influences that have kind of helped you maintain your path and not get sidetracked by shiny objects.

[00:09:08] Scott Barbee: Well, I read somewhere that when you buy things that are under intrinsic value and you’re waiting for the prices to get up to intrinsic value, it’s more of an investing kind of orientation. And when you buy things that are above intrinsic value or own things above intrinsic value, hoping for a higher price, that’s sort of a wish upon a greater fool kind of idea that is more of a speculation oriented philosophy.

[00:09:30] Scott Barbee: I’ve always had the value philosophy. My history has been sort of an engineer. I’m a mechanical engineer and an economics major. I like the grounding or the idea of really determining the fundamental value and owning it at a margin of safety. So whenever things were higher than that, I didn’t have a lot of guidelines to really determine how to act and how to position myself.

[00:09:52] Scott Barbee: And so I was always much more comfortable. Understanding that here’s my assessment of intrinsic value and if the stock is at a discount and it goes lower, well, then it’s an even better deal. Of course you check your numbers, but if it’s still penciled out, I was not the person to be easily swayed.

[00:10:09] Scott Barbee: And when the markets got above intrinsic value or above what I kind of estimate, which I think certainly happened during TMT. Bubble in 99, it becomes a very difficult time and we were almost so small that we didn’t really have many clients to lose, but we had a lot of pressure and we’re getting a lot of growth and we’re just sort of sitting there and, but I empathize with guys like Jean Marie who would say, I’d rather lose half my clients than half my clients assets.

[00:10:37] Scott Barbee: And so I think there’s an element of cyclicality where a properly positioned investment oriented firm needs to allow some of their clients to move off. It’s always a struggle over those periods of time when you’re really underperforming a kind of a high flying adrenaline oriented market to me. And we just right at the beginning in 99, we’d started out with one of those.

[00:10:57] Scott Barbee: Load up those markets just after we started the fund. And the thing that was so intriguing to me though, is that a lot of these deep value names. Drop to even lower valuations as the capital flows from investors shifted to, to chase the shiny objects, as you say. Right. And so, it’s almost like the real returns that were being offered by the old economy stocks had to adjust to match the, the Ponzi returns that were available in these other highflyers.

[00:11:25] Scott Barbee: So I kind of thought it made a lot more sense to own the old economy stuff. That was the jewels that were being sold off that really had the baseline Cash flows, underlying cash flows that the companies were generating were supportive of valuations. And that approach seemed to fit with our whole strategy and positioned us really nicely for the, when things imploded in kind of a one or two or three, so that, yeah, that was the start of our, kind of way we dealt with it, but 08 was a real mess.

[00:11:54] Scott Barbee: It was just the opposite of the situation. everybody’s losing assets and so forth.

[00:12:00] Kyle Grieve: So I wanted to go over a presentation that you gave this year for the Ivy business school that I really enjoyed. So you listed some really fascinating reasons that are responsible for your outperformance and.

[00:12:11] Kyle Grieve: The one that really stuck out to me was some of the aspects that belong to the subject of being unconventional. So you said three primary ones here. So one was do not rely on historical price volatility as an effective measurement tool of investment risk, consider permanent capital loss. The true measure of risk.

[00:12:27] Kyle Grieve: Number two, we will concentrate capital in a particular sector and on a small number of holdings and number three, do not manage invested capital to avoid short run index tracking errors. So I’m just interested in learning a little bit more about, what helped you arrive at these three tenets of unconventionality and why do you think very few other investors follow these principles?

[00:12:47] Scott Barbee: Yeah, I think there’s a lot of confusion and folks think that the stock price is equivalent to the value of the company, but stock prices move around in a variety of manners and the value of the companies will move around as well.

[00:13:00] Scott Barbee: But they don’t always correlate. And in the long run, it’s the value of the company. That really is what matters when you have a stock price, some volatility or a huge downward shift in the stock price of some kind. If the underlying company hasn’t suffered the evaluation of the underlying company hasn’t suffered or hasn’t dropped nearly as much, you can get the investor base very negative on a particular company and thinking that there’s more risk involved in the company.

[00:13:29] Scott Barbee: When in reality, once the stock price has dropped, margin of safety is much bigger. It’s a lot of the air is out of the balloon or whatever metaphor you want to use and it’s much, much safer kind of time. So for us, kind of, we were much more thinking of. The true risks that occur in a situation or risks that really impair, long term value.

[00:13:49] Scott Barbee: And I think I kind of put those in the three primary buckets in terms of the way I view risk. One is multiple, when multiples are very high, even if it’s a good company, those multiples can come down just a little bit and you can lose an immense amount of money. So the higher the multiple, the more really the risky there is because clearly, growth hurdles that the management teams have to hop over to meet that really high multiple is that these hurdles are much bigger.

[00:14:14] Scott Barbee: The second one is leverage, so, when companies have high degrees of leverage. Yeah, clearly the, the company can get into cashflow problems much more quickly when they hit a problematic market or a cyclical downturn.

[00:14:26] Scott Barbee: And so, companies that employ leverage are clearly ones that have a higher degree of risk to long term capital. And the third is sort of the fundamental business risk or, your assessment of those business fundamentals could be off. And so you think that you got a good company, but you’ve missed.

[00:14:44] Scott Barbee: Two or three really key fundamental issues that are going on. And those are really three sources of kind of long term risks that we spend an awful lot of time. Focused on, and I think the other, when you focus on stock price volatility as a measure of risk and a lot of quants do this, it can be sort of helpful, but I think in some ways you can be off quite a bit.

[00:15:04] Scott Barbee: I think folks have gotten very focused on this volatility measure because we’ve had. 10 years of very low interest rates. And there’s a lot of leverage in the system. It’d be an officer investors will, they’re in pod shops, they’re employing leverage. And so they need to very closely watch volatility metrics because they are levered and they can’t.

[00:15:24] Scott Barbee: Yeah, they’ve got to, they’ve got to be much more mindful of a drawdown. And so I think that gives us a differential view on stocks that might have some near term problems, and we’re much more willing to focus in the longer run, even if a quarter or two directly ahead of us might be somewhat messy. So that’s our thinking on that.

[00:15:45] Scott Barbee: With respect to the number of concentration on a number of holdings in the sector. Or our focus on, industry concentration or index tracking error, we’re guys that focus a lot more on taking really, strong positions in companies that we, where we’ve done the fundamental due diligence.

[00:16:01] Scott Barbee: You can’t really beat an index if you’re trying to replicate it. And so we are really active in the way we pursue our approach.

[00:16:10] Kyle Grieve: So there was a quote that you said that I found very thought provoking, which was I’m often a contrarian, but not always understanding that sometimes the crowd can be correct.

[00:16:19] Kyle Grieve: So seeing as your investments definitely tend to diverge from the herd, I’m interested in just understanding a little bit more about how you have been able to best assess whether, the crowd is right or wrong about a business that maybe you already own in the fund, or maybe something that you’re heavily researching.

[00:16:36] Scott Barbee: Yeah, I think when I wrote that, I think I was kind of reminding myself. I’m kind of a genetic contrarian, as a little kid, one of my favorite books was survive the coming thermonuclear war, how to do it, which I remember carrying it around on a vacation one year and I must’ve depressed everybody.

[00:16:53] Scott Barbee: I think it’s really important though, for genetic contrarians to realize that sometimes, you don’t want to just be opposed for the sake of being opposed to people that the markets can sometimes be correct in their assessment of things. And often I think I saw a saying somewhere that crowd is wrong at the extremes and right in between.

[00:17:14] Scott Barbee: As I’ve gotten older, I’ve spent a lot more time trying to puzzle through where we are trying to fight my inherent. Dislike of crowds to think a little more about where we might be in that cycle and whether we’re at the extreme, either on the positive valuation or low valuation side.

[00:17:30] Kyle Grieve: So speaking of contrarianism, one of the contrarian plays that I saw that you make was in a business called or his own gold, which seems like a kind of a classic contrarian place.

[00:17:40] Kyle Grieve: So let me just discuss that in a little bit of a brevity here. So business that owns a mine in Burkina Faso. It’s had, the country’s had multiple coup d’état’s. They’ve expelled Western military forces from the country, and they have armed conflicts against ideological extremists. So definitely, speaking about what you just said to in, in relation to sentiment, it’s the pretty sour sentiment regarding this exact investment.

[00:18:03] Kyle Grieve: So I’m just interested if you could speak to the thought process on some of these contrarian plays like this one, how are you generating enough conviction in an investment like this when it is clearly surrounded by so much uncertainty?

[00:18:16] Scott Barbee: Orzone is one of a, one of many, we have a basket of these things that make up about a quarter of the fund and Orzone’s one of a dozen or so names.

[00:18:24] Scott Barbee: And interestingly, within the resource space, these precious metals mining kind of companies, they can have a whole slew of risks. There could be geologic risk, metallurgical risk, management agency risk, construction, regulatory permitting, country risk. there’s a whole slew of them.

[00:18:42] Scott Barbee: And war zone, interestingly, is the geology is excellent. The metallurgy works great. Management is phenomenal. Patrick Downey, he’s got a great reputation having turned around Claude resources in Canada and. Del radian, it was sold off under his directorship. He was on the board at del radian as well. So just a phenomenal individual construction risk, in West Africa, there’s the construction generally has been on budget and on time, which is.

[00:19:12] Scott Barbee: Big rarity in the resource space. Interestingly enough, the regulatory mind is permitted and there’s minimal permitting problems in Burkina. So what we’re left with is country risk. And clearly, on the one hand, like Rothschild said, you want to buy at the sound of the cannons and sell at the sound of the trumpets.

[00:19:28] Scott Barbee: So, then that’s the way to really make it in the world and going back to the contrarian mindset. We got to make sure we’re not, I’m not, maybe the crowd is right here or not, but this is something we’re all obviously thinking about as well. There has been a number of coups in the area.

[00:19:42] Scott Barbee: A lot of times with the various coups that mines keep working, there’s been some, a lot of unrest in the country with Islamic fundamentalists, coming into the North, in the North side of the country and, a lot of trouble, but this is a very big country. And the middle of the country is the, there’s a capital city and this mine is very close to the capital city.

[00:20:01] Scott Barbee: So it’s not really in the right next to an army base. So it’s really the idea of this being subject to some of the risks of some of the other minds in the, in the country, I think are a little bit, I think the risks are a little lower. Interestingly, the new military guy, Traore, who took over is a, was a former mining geologist, so, has some understanding of the industry through his, through his own history.

[00:20:23] Scott Barbee: And I think they, at the core, while they, I think they’re probably frustrated with the French who’d kind of run it as part of Francophile Africa. I think they are understanding of the fact that, Western know how and, and operations are really needed to kind of keep those mines running to keep the government, nicely funded.

[00:20:41] Scott Barbee: There is clearly risk in that situation, but I think the returns you need to judge risk, of course, but in the context of return. And I think that, in the case of war zone, they’re funded to do an expansion of their processing that should increase, production by 70, 80 percent in the next couple of years, after which if the current gold price holds on and, stays just static, doesn’t even go up, it just stays static.

[00:21:05] Scott Barbee: I think we’re at a free cashflow multiples that are. Almost 30, 40%. so once you get the benefit of this mine expansion coming on to me, it’s one of those where it looks like the reward is pretty darn strong too, and probably offset some of the risk factors, particularly given that so many of these other risks that plague mining projects seem to be a non-existent with Orzone or minimized, I’d say with Orzone.

[00:21:33] Kyle Grieve: So in an investor business daily interview, you said something that really got my attention. When we’re surrounded by many investors and lots of company, we get uncomfortable. So for you, I’m just trying to kind of wrap my head around this situation.

[00:21:46] Kyle Grieve: is it simple for you when you’re trying to find new ideas? are you just screening for low price to earnings or low price to book stocks that think that the investing industry is going to dislike as a whole? Or is there some sort of other heuristics that you’re using in order to help you find businesses that are just unloved and not appreciate it on wall street?

[00:22:05] Scott Barbee: Yeah, we spend a lot of time looking at the watch list, but looking at the screens that are coming off of the markets and the discount, the book screen is one of the key ones that we’ve used to help us sort of orient and focus are kind of limited analytical resources on the subset that we think might provide some of the best returns.

[00:22:26] Scott Barbee: And historically, the discount to book stocks have done very well against the broader markets. The last 10 years has been a little more of a hard slog. It clearly, I think some of that has to do with the interest rates having been submarket levels and I think some of that. It’s likely to change and back in the seventies, when you last had the interest rates spiking and concerns over inflation, the value premium of owning really heavily discounted price to book securities was really strong.

[00:22:55] Scott Barbee: So we’re pretty optimistic that this initial heuristic of evaluating on book is likely to come a little bit more into phase and deliver, but probably pretty solid returns. Yeah. When we look at the top of the funnel, of course, doing the quantitative analysis of the markets and focusing ourselves at that level is the start.

[00:23:15] Scott Barbee: We also look at cashflow, EVD, EBITDA, and then we’re looking a lot at other indicators of value, share repurchases or buybacks, whether there’s a restructuring, whether there’s been management change recently or activism and how much leverage is in the system. if the stock is highly levered, clearly that’s a big risk factor for us.

[00:23:35] Scott Barbee: Bear Stearns at 40 to 1 leverage, even if it’s at 50 percent of book value, the asset value drops a little bit and the company gets into a lot of trouble. So, highly levered entities don’t provide that margin of safety from an asset perspective that very low or unlevered companies typically can. So we watch a lot of those things.

[00:23:54] Scott Barbee: We don’t exclusively do price to book stocks. Price to book is excellent at picking up companies that are trading, that have a suppressed return on equity because they’re at a cyclical low. And so to catch some of these companies at cyclical turning points. Price to book is a very nice initial indicator, but we also do EVD, but kind of analysis to more cashflow type metrics in order to pick up some of these companies that might be producing a little higher return on equities, but the market might be missing something in the, and yet they’re trading at that low valuations on cashflow.

[00:24:27] Kyle Grieve: So one energy holding that stood out to me when I was researching your commentary was natural gas services. So this one has performed incredibly well for you. And I know you noted that during the first time you started buying it, it was trading at a discount, about 45 percent to tangible book value after a large shareholder had exited their position.

[00:24:46] Kyle Grieve: So how are you thinking just about the energy industry today? And are you still finding compelling investments in that sector, even though the 500 is a gone stratospheric?

[00:24:57] Scott Barbee: Yeah, natural gas services was a nice pick for us last year. We’ve probably made 70, 80 percent of our money presuming on exit today, which might not have occurred.

[00:25:06] Scott Barbee: But a year ago, this was an interesting classic case of a company trading at a big discount to book. There was some perceived CEO turnover as an old CEO tried to retire and the new CEO could come in and then had left the business after a short period. There was a lot of big CapEx that had been getting spent without seeing a lot of results.

[00:25:26] Scott Barbee: In terms of additional margin dollars coming in. And so there was a worry that maybe there was a problem there, I would suspect, and then on top of it, there was some significant selling by some other institutions. And that combined to just make an unloved kind of entity at the time. But we understood the compressor rental space.

[00:25:46] Scott Barbee: I had followed and owned in the past CSI Compressco. So we kind of understood what was happening. A lot of these companies in the compressor business, when you spend the CapEx, interestingly, you don’t get the benefit of the compressor being in the fleet earning for about 15 to 18 months. So there’s this long lag from CapEx to interest earning asset.

[00:26:06] Scott Barbee: So when you have a big expenditure and all the debt associated with that starting to come into the book and you’re not seeing the benefit of having that additional enterprise value growth offset with additional cash flow immediately. There was some concern, but. When you study it, you realize that these are long, it’s just this long cycle CapEx and these guys were seeing excellent opportunities for strong ROE compressor rental additions and they put those on, they were really ramping their CapEx very hard to grow their fleet.

[00:26:37] Scott Barbee: Interestingly, it was at a time when CSI CompressCo and a lot of the other competitors. They had levered up historically and because there was a big MLP craze from years back where they put a bunch of leverage on these things and you offer a big dividend and put it at an MLP structure. So a lot of compressor rental guys were in these kinds of structures and when interest rates went up really strongly, they were in a debt reduction mode and weren’t available to grow their own CapEx.

[00:27:05] Scott Barbee: So it left the supply response that you would normally see in the compressor space wasn’t occurring because of the leverage of the competitors. And so we kind of saw that dynamic and saw that it was a very productive one and bought in. Now, with respect to energy, it’s been our favorite sectors over the last couple of years, the supply and demand dynamics from an aggregate level appear to me to be really unusually strong over the last probably 10, 12 years.

[00:27:34] Scott Barbee: U. S. shale has been responsible for adding something like 8 million barrels a day of additional supply into the global oil supply. And today, those levels of shale expansion just do not appear to be sustainable in any situation. It looks to me like it is likely to be extraordinarily flat going forward on an aggregate basis.

[00:27:55] Scott Barbee: So this immense pulsing out of additional supply that had come out of the shale plays is likely to end. And on the demand side, there’s a little bit of a view that in the market that I think it’s driven more by politics than by evaluation of facts. And, as a result, there’s a view that fossil fuels are going to go away soon.

[00:28:17] Scott Barbee: That had been very prevalent in the market and still remains somewhat prevalent. I’m a believer in some of the work that’s been done by guys like Arjun Murthy at Veriton, who explains that the S curve of development of countries like China and India, even Africa, where the per capita consumption of energy is a small fraction of what it is in the United States.

[00:28:41] Scott Barbee: If you take China. And if you take India and Africa and non-China, Asia, and you bring the consumption levels just up to China, you’ve got almost a 60, 70 percent increase in the overall demand for oil. So, in some ways, if you’re going to try to mandate the end of fossil fuel use, you’re really mandating that these countries remain mired in sort of energy poverty in our views.

[00:29:08] Scott Barbee: Nevertheless, you’ve got this huge long term demand trend at your back and you’ve got this supply that’s kind of falling off the supply growth from the United States that is just slowing immensely. And I think that’s going to create a real inflection in the market over the next couple of years. So I like the underlying demand dynamics and then on top of it, within the energy space, there was an awful lot of companies that were being disposed of from pools of money that had chosen to manage the money based on metrics, other than maximizing risk adjusted return.

[00:29:44] Scott Barbee: So, for ESG purposes or anything else, but in some ways, very happy to come in and. Take advantage of these kind of pricing dislocations that have been occurring within these companies.

[00:29:56] Kyle Grieve: So obviously during this chat, we’ve talked a lot about book value, you obviously like cheap book value. And we talked a little bit about cash flow generation.

[00:30:03] Kyle Grieve: So I’m just trying to get a wrap my head a little bit more around your strategy here. So. Are you looking at more the low price book values being your margin of safety and then, any type of future cash flow generation as the growth driver for your businesses, or just give me a little bit more information on, how you use that as a framework for your investing.

[00:30:20] Scott Barbee: When we buy these companies, a lot of times, if you can assure yourselves that, you’re buying at a pretty nice discount to book and book is real, so we look a lot at book to market adjustments to try to evaluate.

[00:30:32] Scott Barbee: How good is book value? Sometimes you’ll have markets that, book value adjustments that are positive. Like you have a land position where the land is on the books at some value from 50, a hundred years ago. And, then you’ve got a kind of a hidden asset there, or you can have book values that’s overvalued.

[00:30:47] Scott Barbee: Maybe you have a malinvestment that’s occurred that you’ve placed your capital in the wrong business, the wrong industry in a sunset. And there’s a lot of additional reorienting your business structure, would require a lot of. Charges and one time charges associated with rationalizing the personnel or whatnot.

[00:31:05] Scott Barbee: When you look at both the assets and liabilities to come up with your book, a lot of work gets done there. If you can buy it at a discount, particularly an unlevered discount to those names, clearly that provides us a lot more downside protection. Because those assets will be there for quite some time when you can ride through a cyclical downturn in the economy or something on the flip side, though, sometimes when you’re buying it at these levels, we’re catching a bottom of the cycle, the return on equity, the return on that book value is very low and sometimes negative.

[00:31:34] Scott Barbee: And so, some of the analysis that we really do is to say, look, we’re trying to get through a lot of the, how do we get the car through the tunnel? Without us having to hand the keys to the car or to the banks. And that’s really the, yeah, there’s a lot of analysis that we do at cycle bottoms around that kind of analysis.

[00:31:52] Scott Barbee: When we do buy companies that have leverage, we want to make sure the shareholders, the equity guys are going to be able to avail themselves to the recovery before a failure. And so presuming that can be done, we’re looking several years out and we’re looking for tangible issues that can create an improvement in the return on equity of the business.

[00:32:12] Scott Barbee: And we do this in an engineering type way. There’s two ways you can get better EBITDA, right? And what I really want to focus on when we’re looking at this. I like the cost side in some ways better because you can determine how many heads you’ve cut and what that cost structure that you take out can be and how that can drive the cost down.

[00:32:30] Scott Barbee: I think those are more measurable with a higher degree of confidence than sometimes revenue growth that sometimes looks like a hockey stick. And sometimes that can get fairly esoteric and I prefer to try to tie that back to tangible situations. Like we’re talking about CSI CompressCo where there’s been 60 million that have been spent on compressors and they’re going to come on in the next 15 months.

[00:32:50] Scott Barbee: Here’s what they could earn potentially at a 20 percent if they were put on at 15, 18 percent ROEs. And it’s that kind of analysis that we like to see. So newly contracted situations or areas where we’ve already seen the price movement because two competitors have merged and, in the pricing, and the businesses has gotten better.

[00:33:08] Scott Barbee: And so you can then say, well, as our supply boats all come off of contract and they get renewed, here’s the bump up in revenues that we’re going to see. But we have as a tether, we could tether that all to today’s day rate, and say, hey, the day rates have already moved. And I find that to be so much more tangible thing to bet on kind of the cell phone penetration is going to be, X plus 10%, for the next 10 years or something like that, where these to me are harder to determine.

[00:33:36] Kyle Grieve: So one of the more prominent trends today in investing is investing in high quality businesses that can be held for, decades, Warren Buffett has obviously had a big effect on investors looking for these. Now, your strategy isn’t really interested in looking for, the highest quality businesses because oftentimes, those businesses aren’t trading for low price to book.

[00:33:56] Kyle Grieve: So I’m just interested in learning a little bit more about how you view quality. how are you looking at quality in terms of your own investing philosophy based around that low price to book?

[00:34:06] Scott Barbee: Yeah, that’s a good question because I think there’s a lot of misunderstanding around what value investing is all about.

[00:34:12] Scott Barbee: We all love quality businesses. I guess the real question is, what is the price of quality? At the moment, my perception is that it’s really important that quality is trading at a really very big premium now to cyclical stocks that have more volatility of their earnings. My guess is that a lot of that has been driven by the ability for quality companies to in a time when debt is available and very inexpensive.

[00:34:38] Scott Barbee: To lever up a more stable earnings stream. And so if the problem of the economy has been too much debt, I think maybe quality companies getting a premium might be somewhat related to that. So I prefer to stick with some of these other companies that might be perceived as lower quality with more volatile earning streams, because I think in many cases, these companies have reduced.

[00:34:59] Scott Barbee: Financial leverage pretty significantly over the last several years, because they’ve been in some cases because of ESG and the fossil fuel business, they’ve been kind of starved of their bank lines. And as a result, they’ve really pulled down on their leverage, quality businesses, the ones with stable earnings and stable, slightly growing earnings are kind of the darlings of the private equity.

[00:35:19] Scott Barbee: Buyout craze, and I find it interesting that Dan Rasmussen and Verdad, he’s done a lot of work on the valuation that a lot of these businesses have been bought out at these quality businesses have been bought out at continues to climb higher and higher. And so there’s an awful lot of kind of high multiple companies inside the private equity space.

[00:35:38] Scott Barbee: And I think there’s high, multiple quality companies inside of private equity that, if there is a downturn and an increase in interest rates, which has already occurred, if it, if a lot of these guys, as they start to roll their corporate debt up to today’s market rates, there’s likely to be a lot of damage in that.

[00:35:53] Scott Barbee: And we’re going to see perhaps a decline in the valuation of quality companies. And at that point, I think we may make a shift and get back involved in a more stable earnings type companies. But for the time being. I think there’s a lot of systemic financial risk that’s kind of associated with low wall and quality type companies.

[00:36:13] Kyle Grieve: So continuing on with the topic of quality here. So I’m going to loop it in, but I love asking really good value investors just about how they monitor their investments and also how they approach the selling process. So obviously with your style of investing, you’re most likely you’re buying these businesses lower than intrinsic value than selling when they get close to intrinsic value.

[00:36:32] Kyle Grieve: But I’m also interested in learning a little bit more about, what about businesses maybe that have, maybe they increase in quality while you own them, maybe it’s a hidden increase or maybe something that you did account for, are you willing to hold these types of businesses past intrinsic value if they’re increasing their intrinsic value at a high enough rate, just give me some more information on that.

[00:36:50] Scott Barbee: Yeah, there’s clearly a lot of tax advantage to writing a business that continues to grow and, it allows you to take advantage of growth in your own capital and compounding without having to pay taxes on that capital, as opposed to the sort of cigar butt approach where you’re buying things and you shift out into something new.

[00:37:07] Scott Barbee: That’s a very high tax arena. I think sometimes the valuations of the companies have adjusted to account for that. So you get perhaps better valuations within our space because of that tax issue that occurs in terms of the discipline or sell selling decision. I think one of the biggest issues of discipline, one of the biggest reasons why investors, professional investors anyway, might have problems with discipline, I think is that they have a fully invested mandate.

[00:37:33] Scott Barbee: And so they are then forced to hold things longer than they would otherwise. We don’t hold ourselves to a fully invested mandate. We’ll have higher cash levels from time to time. With cash being a derivative of the investment process, there are a couple of reasons why we might sell something. First is the positive stock goes up to the point where the multiple becomes more of a market based multiple or above market based multiple.

[00:37:57] Scott Barbee: Where it’s above our assessment of intrinsic value, where the margin of safety drops off because of share price appreciation will sell under those scenarios. If we don’t have something new to buy, we’ll just hold cash. In another case, something will be still at a discount, but all of a sudden, we’ll find something new in the portfolio will be a hundred percent invested.

[00:38:14] Scott Barbee: And we’ll find something new outside the portfolio that is a really good investment and it’ll be worthwhile to swap despite the fact that we’re selling an investment that we still believe is somewhat undervalued. It. So we’ll sometimes pull off the swap when I can get a bigger margin of safety elsewhere, risk return profile elsewhere, so, and then I guess the third, which is the problem case is, some new piece of information comes to light that makes you question your original analysis that you thought you were buying a dollar for 50 cents and you turned out you were buying a quarter for 50 cents.

[00:38:43] Scott Barbee: Are a dime for 50 cents. And then under those sorts of scenarios, those are really the most emotionally frustrating, but I think it’s important to really be willing to assess that accurately and not be stuck in your behavioral biases and exit. I keep trying to remind myself, you don’t have to make your money back where you lost it.

[00:39:01] Kyle Grieve: So as of June 2023, Aegis’ employees and their families invested a combined 48 million in the fund out of total assets of 342 million. So I’m just interested if you could comment a little bit on how you’ve created alignment between investors and employees in the fund to maximize value for both investors and your colleagues and yourself.

[00:39:21] Scott Barbee: Yeah, I personally have an immense amount of my own personal wealth, the vast majority of my personal wealth, liquid anyway, in the fund. It’s the way I personally would choose to place my investments. So I think I’m fairly strongly aligned. I think with the other employees here, we don’t have a real requirement.

[00:39:38] Scott Barbee: I’m kind of a freedom guy, a liberty guy. So I let people decide how they want to do it. That said, what’s been interesting is that over time, a lot of the people who work here end up owning a pretty nice piece of the fund as well.

[00:39:51] Kyle Grieve: So, during my research process for this call, I found another quote that you had that was really good regarding reputation.

[00:39:58] Kyle Grieve: So you said as a deep value investor, if you get it wrong, you can get hit. It’s one thing to forecast Cisco earnings wrong in 1999 and lose money conventionally, but if a deep value manager loses money, failing to spot an accounting scam on, say, a small mining stock, that can really damage their reputation.

[00:40:15] Kyle Grieve: Now this makes me think of one of my favorite John Maynard Keynes quotes, which is worldly wisdom teaches us that it’s better for reputation to fail conventionally than to succeed unconventionally. So, you’ve managed to avoid probably a lot, hopefully, of unconventional errors over the years. Now you, I’m just interested in learning a little bit more about how you’ve managed to do that.

[00:40:35] Scott Barbee: I wrote that quote trying to explain why precious metals mining such an interesting area is, because I think there’s probably a few businesses in the market where being wrong would very quickly determine that you’re kind of inept.

[00:40:50] Scott Barbee: And so, these shares carry a high degree of reputational risk associated with them from an investment manager perspective. And as a result, I think they trade more cheaply than the broader markets. And so it’s been a, an area that where there’s been a lot of misperception with respect to the precious metals, where the average, kind of the average guy thinks what a mine is, it was mine as a whole with a liar on top or say, and when you really dig in.

[00:41:17] Scott Barbee: You begin to realize that it, particularly after the 2013 to 2015, when the mining index dropped something like 85 percent in the context of a rising market, it just blew up all the mining. Investors out there, they just lost just about all their capital. And what was left in the business was, the folks that were the liars on top of the hole in the ground, they’d moved on to greener pastures is, they usually don’t take a down 85%,a market to, to work in that they went on to Bitcoin or whatever else, greener pastures for the speculators, but what they left at the, with the, in the mining space was a bunch of really interesting engineers and, technical people that I thought were really, As an engineer, I appreciate it and enjoyed, I felt like they were very focused on a, I’ll be at a volatile business where the commodity changes and that can create a lot of differences, but I thought it was an interesting area to dive in.

[00:42:06] Scott Barbee: Precious metals is so interesting too, that a lot of these guys have party reports on the reserves and on the mining plan. These engineering reports are available for everybody to read. And so the level of publicly available granularity, is significantly higher in the mining space, which is something that is totally off from what my original perception of mining might be.

[00:42:29] Scott Barbee: So being able to get in and do significant due diligence on these things and be able to tether your due diligence to third party mining reports and whatnot, it can be a very helpful way of avoiding kind of getting in a situation. it’s kind of interesting. I, there haven’t been that many times where I can say somebody really lied to me.

[00:42:50] Scott Barbee: But what I find kind of intriguing is that there are generally two kinds of ways that people will obfuscate. The first one I find that I can identify very easily. And that’s the guy who just doesn’t want to get into the detail. Because normally if you really love what you do and you find the right guy, they just really want to talk to you about their business and are excited about it and are, willing to give you, it’s like, sometimes it’s like drinking from a fire hydrant or, but there’s a second level of person that I have a much harder time with.

[00:43:19] Scott Barbee: And it’s the person that will give you a great, that it’s like the realtor or something that will give you the great detail on the granite in the kitchen. And it makes you think, well, they’re honest. Broker because of the level of granularity that they’re giving you and detail they’re giving you. And meanwhile, they’re totally ignoring that the bathroom is smoking or something.

[00:43:38] Scott Barbee: There’s a fire in the other part of the house or something. And that’s a tougher one because you end up getting somewhat, you feel a little more affinity for a person who gives you that level of detail. It, and you can give them the benefit of the doubt that they’re really giving you everything they think. So that’s something I’m still working on.

[00:43:55] Kyle Grieve: So I’d love to learn more about the drawdown that ages fund went through in 2007, 2009. So this was probably a pretty painful time for you as the fund went down about 72 percent during that period. So I’d just love to know more, how did you navigate this investing experience? And did you ever feel at that point, your strategy was no longer viable?

[00:44:15] Scott Barbee: Wow. Yeah, that was a tough time. I just had my first Child, seven. And so my wife and I were watching Friday night lights, and I’d been born in Texas and got to school there. And so I really liked the Friday night football series, but they have the slow guitar music at the, in the front of the show.

[00:44:30] Scott Barbee: And I’d felt like I’d gotten up and crashed my car every day, coming home for weeks, and then watching one or two episodes a night and going to bed. for years after that experience, when I heard that kind of show and the guitar music, that kind of get chills, it’s a very tough time, probably the toughest thing I’d ever gone through.

[00:44:48] Scott Barbee: Interestingly, with the kids wanted to watch it in 2020 during COVID. So that was a recast there. But, in terms of the drop off, these companies were trading at valuation levels when you sat down and you looked at the valuations. They were absurdly cheap. it’s not a problem on the whole in our stocks.

[00:45:08] Scott Barbee: It was much, much more of a problem of the other shareholders. Of the companies and not the companies themselves coming into 2007, a lot of the quantitative guys had really ramped up leverage on and playing of the value factor. So they were buying a lot of discount to book securities and they were shorting out the high price to book and playing convergence and that those guys gotten blown up in latter part of ’07 even.

[00:45:33] Scott Barbee: And then it just, it’s all sort of cascaded to the point where, you know, the proprietary trading desks of a lot of the brokerage firms that held a lot of the deep value special situation stuff we were dealing in, we’re really getting, repo funding pulled. And we’re being forced to liquidate these companies and in the fog of war, you kind of knew part of the story, but you didn’t know the whole situation until months and years later, really, but you’re trying to assess everything that is going on in the case of a fund.

[00:46:03] Scott Barbee: A lot of companies were trading down to very cheap multiples, even discounting a recession or a deep recession. Some of the leveraged companies had more significant declines, but some of them had no debt. Sometimes companies were trading down to levels below the cash per share. I didn’t feel like, oh gosh, unless the government bails out everything, these companies are going to go to zero.

[00:46:23] Scott Barbee: It seemed pretty obvious that there was going to be a purge of whatever these margin calls were all going to cause. And then there was going to be a reset. And, interestingly in 09, we went down. It was another 25, 30 percent to the bottom in 09, just in year to date 09 alone. And then we ended up for the year at 91%.

[00:46:45] Scott Barbee: And then, of course, 91 percent got us on the cover of the Wall Street Journal and whatnot, and saying, how did you do this? How did you navigate through it? Well, I felt very sheepish about that because I didn’t do anything. I just held the same thing. And the stock price went down because they were purging out shares.

[00:47:03] Scott Barbee: And then the stock price came back because they finished. And I think our holdings would have lasted a lot better, even if the government hadn’t done the big bailout. So we weren’t like a lot of the investment banks that were really going to be zeros if the government had just let the free market take its toll.

[00:47:18] Scott Barbee: These companies that we had would have struggled, but they would have, maybe at a poor market, but I think they would have come through with significant value on the backside of some of this. Now, it certainly may have taken longer if the Fed hadn’t, kind of went and juiced the monetary system a bunch, but yeah.

[00:47:31] Scott Barbee: So I guess here, the point I was thinking, the other thing was that source of stress for me during that time was one of, I built up a lot of clients. And it’s not so much a worry that the stocks are not going to recover. I had pretty high confidence that they would be able to recover. And it’s just a matter of waiting for the time for them to do it.

[00:47:51] Scott Barbee: The real stress was the clients and the fact that as they panic and pull assets, there’s no opportunity to recover out of those assets and come back. And so your permanent business value begins to suffer. And then you worry about everything, all the other employees in that company here, and how are you going to pull through? So that was a source of stress, but the underlying companies, not so much, not, that wasn’t the key source.

[00:48:15] Kyle Grieve: So in your manager’s letter from 2023, you mentioned how scary that the S and P 500 currently looks due to the multiple expansion of the magnificent seven. It’s gotten worse now. So it appeared at that time that a lot of the future growth was already priced into these stocks and, any potential earnings misses could clearly have a significant impact on their high price earnings ratios.

[00:48:35] Kyle Grieve: So, I don’t need any predictions from you for, from going from here, but you know, what are your thoughts on the S and P 500 today, especially, in regard to the valuations of the magnificent seven.

[00:48:45] Scott Barbee: Yeah, I was pretty shocked, to be honest, around the significant recovery of the tech stocks that occurred in three, I thought that, that this kind of, I thought there was sort of a bubble earlier.

[00:48:57] Scott Barbee: And then in 2022, when the valuations came down significantly on these, I thought this was the start of a longer term. A longer term trend and was a little bit surprised that we had the AI driven sort of reversal once again, reignited so much of the animal spirits here, particularly in the context of interest rate that had already, had been hiked up real high.

[00:49:23] Scott Barbee: historically when the S and P was very high, people would say, well, that’s because the interest rates are very low. So interest rate adjusted basis, that’s not really all that, the multiple is not all that stretched, but now you have interest rates at a high level yield. And yet you have these stocks having ripped higher.

[00:49:43] Scott Barbee: A very focused subset of these stocks, really driving, very narrow market driving everything. One of the highest percentages of stocks, S& P 500 are now underperforming. I’ve been underperforming the S& P because they’re not the seven. I think a lot about the work of Michael Green and Einhorn talked about the market sort of being broken.

[00:50:05] Scott Barbee: Horizon Kinetics has done some great work on the impacts of this immense fund flow that’s been going into passive. I think there’s this belief that, oh, we can just set it and forget it. Put this money in this fund and there’s no need to do anything else for the rest of your life. And you’re going to be fine.

[00:50:21] Scott Barbee: You’re going to outperform most money managers. It strikes me, what other investment product, and I think Horizon Kinetics had mentioned this, so I want to give credit to them because it was something that resonated with me. What other investment product do you know of? Where you can set it and forget it, and that works in the long run.

[00:50:38] Scott Barbee: I think Michael Green has done some work on this that shows that maybe there’s some market cornering aspects that are going on within the S& P and maybe the top stocks of the S& P where they’re becoming higher and higher, valued. I find clearly within NVIDIA, which sits at the top, there’s been strong earnings growth.

[00:50:58] Scott Barbee: But the sustainability of that, I would put in some question, I look at just the energy consumption of the NVIDIA chips that are supposed to be put out just this year. Each chip requires as much energy as one household. And when you look at the two and a half million that they’re contemplating putting out, that’s like a city, almost the size of Houston that you’re going to put into a 70 year old electricity grid.

[00:51:25] Scott Barbee: And, it doesn’t want to use coal plants, hasn’t built a nat gas plant in years, and doesn’t like nuclear either, and just wants to run on, solar and wind. There’s going to be the emergence of bottlenecks to the ability of these companies to continue to grow for sure, but also even to continue to produce at today’s levels with the margins.

[00:51:51] Scott Barbee: And as such, I think we may be at a time that could be close to 1999 again, where you had the NASDAQ 100 that lost something like 75 percent of its value after we got through March of 2000. So I think there’s some real risk in that sector of the market. I think for those who have been fortunate enough to have played in that, I think you, it would pay to remember what Sir John Templeton said that it always pays to change a winning game.

[00:52:21] Scott Barbee: And I think there’s, I can say it, but the chances of a number of people doing it are very low, but for a guy to have done this and to have the mental acuity and agility to get off of these. And to get into some of these others that haven’t performed as well, because the market is hugely binary and just like in 1999, when the tech stocks had sucked money out of everything else, clearly, when you look at fund flows, information technology, fund flows are way high and a lot of energy and so forth that continue to lose some assets.

[00:52:53] Scott Barbee: And so there’s a real opportunity here for somebody that has that mental agility to switch into things that are much, much cheaper and perhaps get a double run. We had clearly missed the backside of this. That could be pretty nasty, I would think. So yeah, that’s kind of what I’m thinking about the market.

[00:53:09] Scott Barbee: There’s a real big opportunity for somebody who’s made money in it to kind of pull back and reassess. And that I think I would suspect that the future returns of these kinds of companies are going to be significantly more muted.

[00:53:22] Kyle Grieve: Scott, I just want to say thank you so much for coming onto the show today and sharing your excellent insights. I was going to hand it off to you. Where can the audience, learn more about you and the Aegis fund.

[00:53:30] Scott Barbee: Well, thank you. I really enjoyed doing it. I’ve loved this podcast for so long, and it’s been a real delight to be on. And you can find me at aegisfunds, A E G I S F U N D S, plural, .com.

[00:53:44] Outro: Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app, and never miss out on episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.