Monthly Virtual Investor Networking Event: August 2020

Investor Summit Monthly Networking Event: August 27th 

Panel: The Widest Valuation Gap This Millennium!

Moderator: Ian Hunter from Hunter Value Capital

Panelists:

Nate Tobik from Oddball Stocks

Dave Waters from OTC Adventures & Alluvial Capital

[00:00:07] [Fred Rockwell]: Hello to all. Just making a couple of quick announcements, so everybody understands how the technology works and how the evening is going to go.

[00:00:17] [Fred Rockwell]: We have two great panelists, Nate Tobik and David Waters from Oddball Stocks and OTC adventure, regular blogs and then, Ian Hunter, another really knowledgeable value investor, who’s going to be moderating this evening.

[00:00:36] [Fred Rockwell]: The way it works is, we’ll have a conversation on the main stage that everybody can listen to; you can participate with Q&A on the right. Um and then, afterwards, we’ll stop with some time left over to jump back into the round tables and continue the conversations that are started on the main stage.

[00:01:00] [Fred Rockwell]: So, with that, I’d like to turn it over to our guests.

[00:01:22] [Ian Hunter]: Okay, can everybody hear me okay?

[00:01:27] [Nate Tobik]: You’re good.

[00:01:28] [Ian Hunter]: Okay, alright. Well, thanks– thanks Fred for having us here. Uh– so, just to kind of– uh, set the stage here for– for this conversation– uh, you know, we– we have the the old value versus growth debate and– uh, just to kind of set the table for, you know, by– by way of background– um, you know, as everybody knows value stocks– uh, versus growth stocks it’s– it’s been in the headlines a lot over the– over many years recently– uh, the gap between value and growth has– uh, has accelerated a bit in just in 2020. So, there’s various ways that you can quantify the underperformance of value stocks but– um, one way is the Fama French value index and that’s been popular for– for– uh, many decades and it’s got its own flaws but the– the Fama French value index has underperformed the Fama French growth index by 8% compounded per year, so it’s– it’s returned five percent and this is just over the last ten years. It’s returned five percent and the growth index has returned 13% per year over the last 10 years.

[00:02:45] [Ian Hunter]: So, this debate’s been clear for a while, but– uh, you know, just another frame of reference for us there’s a– a recent publication by Verdad Capital, which is run by Dan Rasmussen and I thought it was pretty interesting. It basically says that, if you look at the FANMAG group of stocks, which are the large cap– uh, Microsoft, Netflix, Apple, Amazon, Google– uh, Facebook and these are kind of a popular proxy for– for growth stocks and they make up over 20% of S– of the S&P. So, these– these stocks are trading at a PE ratio of 55 times– uh, earnings and a price to sales of seven times, but what Verdad Capital said was: “let’s just say that’s a reasonable price given their level of profitability, given their net– their net profit is 26%– uh, as a group. Their three-year Keger revenue is 22% per year and they have, you know, near monopoly positions”. So, let’s just say for the sake of argument that, that’s a reasonable price for that– that set of companies

[00:03:56] [Ian Hunter]: So, Verdad asked, “¿what is– what about the other 3 000 U.S. stocks that have a market cap above 100 million dollars– um, that are priced more expensively than the FANMAGS, but they have worse profitability?” And so, they said, you know, “¿what does that cohort look like?” And the answer is, there’s 500 stocks out of those 3 000 stocks that account for 7% of the S&P 500 and 25% of the Russell 2000 and so, they call this the bubble 500 and those– those stocks trade at a median 13 times sales and– um, and the median company is not profitable.

[00:04:38] [Ian Hunter]: So, they’re operating almost break even. So, you’ve got this situation where these companies out there that are even growthier than the FANMAGS, which is our big proxy for for growth companies, they’re not even profitable and this is a major share of the, you know, publicly traded companies.

[00:04:56] [Ian Hunter]: So– um, you know, just to bring it to– uh, to ahead, you know, that gap is– between value and growth is accelerating and with rates this low, there’s little hope of– of additional multiple expansion for these growth companies if, you know, if– if it depends on rates dropping to achieve that. So– so, the question is, you know, ¿what do growth investors know that value investors don’t?

[00:05:21] [Ian Hunter]: So, Nate and Dave, ¿what are your initial thoughts on this topic?

[00:05:28] [Nate Tobik]: I– I– so, I’ll start– I mean, I think what growth investors know that value investors– Uh, they know as well but they’ve experienced on the downside is momentum and riding a wave and– um, you know, while growth investors have rode a great wave into shore, we’ve been pushed under [laughs] you know, or swept out by the riptide.

[00:05:50] [Nate Tobik]: So– um, that seems to be a significant factor when I– when I think about this, yeah.

[00:05:58] [David Waters]: Yeah, that’s a fair statement to begin with and on one hand, we are dealing with a set of businesses that are part of the public company cohort now that, may truly be higher quality than they were a generation ago. There are a lot of businesses now that genuinely require little in the way of physical capital, have little constraint on growth in the short term, although the laws of competition will catch up with everyone eventually, but– and so, I do think that value investors need to understand that, just because a company appears to trade at a large multiple, to relative, to current earnings, doesn’t automatically make it a a bad value. Now, on the other hand, when you look at an index and every company or at least a sizeable percentage of companies in that index are all trading, as if they can grow almost without interruption for the next 15 or 20 years. Then, I think you can say we may have some issues of systematic overvaluation and I think, this is typical, it’s just investors– uh, excuse me if you’re getting dings from my text messages. It’s just investors assuming that current conditions will prevail from now ‘till eternity. Conditions have been wonderful for anyone in software and– uh, well, software is kind of eating the world as they say, conditions have been excellent there, but we know, looking at every industry in the course of humanity, that these conditions never last forever.

[00:07:38] [David Waters]: Uh, I mean, a decade ago or a little longer, it seemed like commodities producers were set to enjoy 20 or 50 years of prosperity and then, of course, that changed very rapidly. I remember that– yeah, the copper miners and the iron ore companies and the shippers associated to that industry were just– had their day in the sun 15 years ago and that came to a bad end and so, there’s no doubt in my mind that, there will be a reckoning when it comes to a lot of these– uh, companies and maybe, it won’t be in the Microsoft or the Apple or the truly dominant companies, but I do think there are a lot of pretenders– uh, that are actually second rate companies that are being valued as if they’re game changers, as if they’re set to dominate their industry and only two or three of them can in any particular industry, but there might be 15 competitors, all being priced, as if they’re set to dominate the world now.

[00:08:33] [David Waters]: So, just like automobile makers in the 20s and 30s, just like aerospace had their reckoning– uh, software and associate industries will have its reckoning as well.

[00:08:43] [Nate Tobik]: So– so, Dave to that– um, you know, and Ian your– your little intro kind of reminded me of this, so– uh, Scott McNealy, who was the– um, he was the CEO of Sun Microsystems back in the 90s. He was asked what he felt about the value of his stock and– um, so for anyone who’s unfamiliar, Sun Microsystems sold computer servers and they were kind of the– um, you know, pick and shovel manufacturer that everyone talked about in the gold rush and– um, you know, they couldn’t sell enough of these things to– um, you know, wall street and e-commerce and literally anything and I– I don’t know the exact number, it was 20, 30, 40 times sales and he– he broke down in this interview he said, you know, “I would have to– for the next”– we’ll say it’s 30 times sales for the next 30 years, “I need to take all of my revenue and  return it to investors and I can’t pay employees. We can’t pay to build these machines, we can’t do any of it” and then, on the 31st year, they finally get a return from the business and he said: “that’s just absurd, it’s so overvalued” and so– um, you know, anyone who kind of follows the history of Sun Microsystems, you know, they did fuel the dot-com boom– um, and– uh, and then, they were sold to Oracle for pennies on the dollar– uh, I don’t know, six years ago, something like that and– um. Now, I think they exist as a brand logo that Oracle puts on some of their products for, you know, companies who bought equipment 25 years ago and who are just locked in and they can’t upgrade and so, it’s just this– this husk of its former self and– uh, you know, investors who invested at that, if they would have held on, they wrote it down to nothing and– um, you know, that’s– that’s one outcome, right?

[00:10:50] [Nate Tobik]: Now, the interesting thing is, a lot of the innovations they came out with, other companies have taken that and ran with it and so– um, it’s not to say that what they did was– um, you know, worthless or anything like that. Uh, yes, they destroyed a lot of investor capital and– um, at the same time, they actually did something that, you know, kind of the tagline changing the world and all this stuff– It– they did. Um, it’s just that their investors were never able to benefit.

[00:11:22] [Ian Hunter]: So, there’s kind of echoes of what we think about today with these– these– uh, capital light tech companies that are platforms that are, you know, promised to– to hold, you know, huge potential and they do contribute to society and make it a lot better and in some cases, you know, this is an example one where that didn’t– that didn’t happen.

[00:11:43] [Nate Tobik]: Right, right. Yeah, sure. I mean, one thing that’s interesting too about that is– um, you know, within kind of the tech realm– uh, a lot– so, there’s an accelerator called Y combinator that’s really popular, it’s on the west coast and– um, you know, I guess, in theory, you go through this and you get a lot of mentoring and coaching, but the real secret, the real reason that Y combinator is valuable, is because they’ve had– I don’t know, 500 or 800 companies that have come through there and so, if you come in with a company that sells a product to their other companies, these other companies will all start to buy your product right away and now, you have 300 500 new clients right out of the gate and– um, you know, so this ecosystem, a lot of it sells to itself and so, there is some factor of– um, you know, companies that will survive and thrive and grow and then, other ones who are– it’s all just kind of that interlinked, they’re all selling to each other and– um, you know, it’s artificially inflated and if someone, you know, pulls the rug out on that bottom layer, a lot of those those fall apart and– um, you know, this isn’t like I’m not down on tech, I own a software company myself, so– um, you know, that’s just the reality of kind of what that market is.

[00:13:12] [Ian Hunter]: Right. Yeah, well, you know, on the topic of these software and platform-based business models that, you know, there is a case to be made that they’re– they’re so capital light and they can scale rapidly and they have huge– uh, addressable markets. These types of business models do seem to be well– uh, suited to this, you know, post-Covid digital acceleration. Um, so that– that’s– that’s the case today, but that was also generally true a year ago, even before Covid. So, ¿how would you say this debate between value and growth stocks is being affected by the current situation we’re in. this recession induced by covid, plus unprecedented stimulus? ¿Does the current environment provide any additional justification for the gap that we’re seeing in value versus growth?

[00:14:09] [David Waters]: I mean, I think that investors are, were, always will be, fairly short-sighted in their assessment of company prospects on– uh, economic cycles. Uh, you know how long it took for valuations in certain industries to recover after the financial crisis, even though the many issues have been resolved and I really do think that, long after Covid is hopefully a memory, the– the painful lessons that some investors got owning things like hotels or casinos or retail or food service or what– uh, will stick in mind and so, maybe five or seven years from now, when that memory finally is part of the rear view mirror, that could be a good opportunity to get into some– uh, some stuff, but investors similarly– um, love to forecast long into the future. I mean, the– the stock darling of the spring and early summer, of course was Zoom, which probably most people here have used in some capacity and not to say Zoom is a good company, I mean, they make money, they obviously have a gigantic user base, they have issues, but every company does.

[00:15:29] [David Waters]: At the same time, ¿are we permanently in a world where the majority of our interaction with other people occurs over video? I’m not ready to say that’s the case and yet, in order for the valuation of Zoom or companies like it to make sense, you kind of have to assume that a large percentage of human interaction is permanently shifted to the virtual world and I just don’t think that’s the case. I– I– I think, that some people are like, you know, “hey! virtual meetings actually do make sense. We– Maybe, I don’t need to jump on that plane every single time, I’ll use Duo or maybe, I won’t always be face-to-face”. So, a portion switches over, but I think investors are far too willing to assume that current conditions will, much like I said with software, will extend indefinitely.

[00:16:20] [David Waters]: And so, I don’t think that the courses that mean reversion have been eliminated or can be eliminated and so– but I think that’s what you see playing out a little bit in the– just in the disparity between– between growth and value. I think, it’s really about investors looking at companies and saying there are good companies and there are bad companies and every good company, will always be a good company and every bad company, will always be a bad company; we know that’s not the case. Uh, but all the same, investor perception can persist in very frustratingly long time. As– as those of us who buy the unfashionable stocks a lot of the time, they can tell you, but at the same time, once time it finally shifts, it can shift very rapidly and so– uh, it may not be to a point that the last true value investor has capitulated, but– but it can shift and it can happen fast.

[00:17:15] [Ian Hunter]: So– so, Nate, you are among other things, a specialist in the banking industry. So, ¿is it possible that part of the valuation gap that– that we’re seeing is explained by a perception that– that these companies, who are the growthiest companies– uh, they also happen to be larger than a lot of the the value companies and so, are better, therefore able to get financing than the typical component of the value stocks?

[00:17:46] [Nate Tobik]: Um, I would say no and and here’s why. So– um, if you walk into a bank and you say– um, “look, I have some business and we’re throwing off a million dollars a year in cash and I need to get– um, you know, half a million dollar credit line.” Uh, that’s a hard sell and– um, if you walk in and you say: “I have a business that has this factory and we have all these people there doing things and it’s on this plot of land you could drive by and– um, we’ve been here for 60 years and we sell some boring things.” Uh, bankers will fall all over themselves to– to lock you up for– um, a period of time, because there’s something there and– um, there’s something to lend against and so, kind of the– the biggest thing in lending is, you know, the banker always wants to get their money back and– um, that’s even more true now. So, regulations have changed and there’s these CECL requirements where– uh, banks need to now adjust– uh, their reserves at the time they make a loan for expected defaults, which– um, is– I mean, it’s totally crazy, right? Like, if I was gonna loan you money and I expected you to default, well then, I wouldn’t loan you the money, you know that– why– why would I do that? Um, but the reality is loans do default and– uh, so this is kind of like a, you know, a pro cyclical type thing and that’s the idea.

[00:19:25] [Nate Tobik]: So, when you– when you kind of look at this, it’s a bank sees something tangible and says: “I know I could get my money back or most of it back.” When you say: “I have this software product” or– um, you know, it could be a law firm, a lot of things and we just– we expect our revenue to– to grow 50% a year forever. It’s just very hard to lend against that and– uh, there’s some banks that do, but it that’s not a traditional model to lend against, which is why most of these companies go to the equity market or they go to venture capital and they raise equity because, you know, it’s very uncertain to give a loan and right now, it seems like it’s a great idea, but it might not be and so, case in point to this–

[00:20:14] [Nate Tobik]: The SBA changed their lending standards and so– um, you know. Now, with everything going on with Covid, what they’ve been saying is– um, “if your revenue accelerated because of Covid. So, maybe you have an online product that everyone is buying and loves.” Now, they’re saying: “well, we’re not sure that’s sustainable into the future once all this is gone, so we’re- we’re not going to be able to lend you money and if your revenue took a dip then, now it’s well– you know, it used to be X and now it’s Y and we’re not sure if that’s sustainable. So, we can’t really give you a loan until it normalizes and”– um, when I think of the those SBA standards and kind of that dynamic, that’s the same as lending to just giving someone a line of credit based on– on revenue or cash or nothing to secure it to, because you don’t know, ¿are the good times going to continue? Or you know, there’s nothing to anchor it to and so, you know, if you look at most banks balance sheets, almost all of what they do is secured lending. So, it’s commercial buildings, it’s– uh, residential buildings, it’s lines– you know, blanket liens on lines of credit that is secured by everything that can’t walk out at night and– uh, that’s just the way the system is built. So, you know, that’s the dynamic driving companies into the equity market for– for financing they– they don’t have a way to– to be financed traditionally.

[00:21:46] [Ian Hunter]: So, if we left out the growth stocks and just look at the rest of the stocks that have more tangible assets, there– there still is probably within that cohort more of a a perceived financiability among the larger stocks, ¿would you say?

[00:22:02] [Nate Tobik]: Yeah, you know, and– and the thing too is, a lot of these larger, you know, so some of these– um, larger companies– I mean, so look at like Apple, you know, that’s a big tech stock, I mean, they manufacture devices and– um, they have great products, but it– it isn’t like, you know, it’s not the when people think software, they think a couple people who take the elevator home every day and there’s no intellectual property or working out of a cafe in– in Thailand or something. I mean, Apple has– it’s just a traditional business and– um, you know, even like if you look at Facebook and Amazon, a lot of these– I mean, Amazon has an enormous logistics network and they have semis and planes and– um, you know, you look at Amazon, they have all these data centers and all this real estate. So, a lot of these capital-like companies started, you know, they’ve all acquired real assets, so to speak and that’s very easy to finance traditionally. So, I think back to what we were talking about earlier, what David mentioned was, this second tier of companies that are– um, overvalued that are are kind of the– ¿what did you call them Dave?

[00:23:18] [David Waters]: I don’t even remember, but pretenders, I guess.

[00:23:21] [Nate Tobik]: The pretenders, yeah, that’s actually where the problem is, right? Because it’s– they don’t make any money and it’s their fuel– they’re financed by hype and as long as they could keep the hype up, they could keep raising capital, but you cannot finance them traditionally because there’s nothing to finance.

[00:23:40] [David Waters]: At the same time, investors need to remember the concept of reflexivity. You can have a company, a bad company, but if it can tell its story and convince people that it’s the next great thing and– and get its valuation at 20 to 30 times sales, they can go out there and raise a billion or two billion in equity capital and maybe, become a real company. I mean, maybe that was the mistake that Sun Microsystems made is, when they were trading at 20- or 30-times sales, they should have issued another 30-40 % of shares outstanding and bought their way to– uh. So, I say watch out for that, a lot of people who have been really, really down on these companies for very good reason, because a lot of them are– are garbage. Well, they don’t count on the fact that, they essentially have access to endless capital as long as investors continue to believe in them. I mean, that was the thing with the dot-com bubble. The dot-com bubble stopped when investors stopped believing those companies and stop being willing to finance them, but as long as these companies can continue to convince people that they’re the future, they just need a few more quarters or a few more years, they can keep the doors open and so, that’s– that’s a warning for anyone considering going all in short on these companies or or being convinced that, their competitors are just– it’s just another couple quarters, so they flame out and the competitor rises. Well, maybe not, keep that in mind.

[00:25:06] [Nate Tobik]: Someone will shoot the moon, successfully. Yeah, for sure.

[00:25:13] [Ian Hunter]: So– so, on the topic of interest rates, you know, we’ve got 10-year rates that are– uh, 75 basis points and 10-year treasury and the– the tips are negative 1%. So, the market is basically expecting less than 2% inflation over the next decade. Um, a lot of us though, believe there’s a non-zero chance of seeing higher price inflation than we’ve had in the past decade, due to the aggressive monetary and fiscal stimulus. So, ¿how do you think about the prospect of higher inflation affecting value stocks versus growth stocks, given the nature of the businesses that– that comprise a lot of the growth stocks these tech companies? And– and– uh, ¿is there a perception that the pricing power could perhaps be a justification for some of this value valuation gap that we’re seeing in the event of higher inflation?

[00:26:11] [David Waters]: Yeah, I’d say a couple of points there– uh, yeah. So, I mean, inflation’s been low for a long time, most investors and people seem to just– assuming that, you know, inflation will keep ticking along at 1 to 2% for a long time and the best time to buy– uh, a hedge, is always when that hedge is cheap and so, with people not expecting inflation, if you’re concerned about inflation, it’s probably not a bad time to buy a couple assets that will do well in an environment of higher inflation. At the same time, I- I do think that long-term expectation of very low interest rates and low inflation rates does have something to do with– uh, the disparity that we’re seeing between value and growth. Growth stocks, of course, the majority of their cash flows– uh, if they materialize, are very far in the future. Uh and when you discount those values back to today at lower rates, you get a– a high value– um, with a 10-year under 1%, if the 10-year goes to 3% 4% Well, all of a sudden those very long-duration securities with all those cash flows massively far out of the future, become– well, they’ve become worth a lot less and– uh, I’m not guaranteeing that investors will rediscover the magic of value stocks or capital flow back, nothing is a guarantee, but it does seem to make them relatively more attractive if we see a world in which, higher interest rates prevail, but not a macro forecaster. So, I– I cannot tell you– uh, if that may be.

[00:27:51] [Ian Hunter]: So, Nate and Dave, you both are trying to invest in– in off the radar smaller– smaller cap stocks and some analyses show that small and micro-cap stocks have some of the lowest valuations within the– the value versus growth dichotomy. So, ¿what might be required for some of these smaller microcap stocks to start re-rating higher?

[00:28:17] [Nate Tobik]: People need to retire, give up, die. I mean, it sounds awful, but that’s– I mean– so, some companies that– um, I own and follow are at 15-20 year lows and– um, I– you know, what– what– maybe a lawsuit is what it’s going to take in some of these to– to unlock value or the environment gets difficult and– um, you know, the family who’s run it forever, they just throw in the towel and say: “I’m just not interested in running a business in a really difficult environment.” It’s getting a lot harder to– um, you know, to get that annuity stream of cash to keep flowing and so– um, you know, I– I– I think that’s what’s going to take in a lot of them unfortunately.

[00:29:10] [David Waters]: Yeah, to that I would add there’s been a general lack of interest in stock picking. Uh, in active strategies and I understand why– uh, indexes have done so well for so long that, a lot of people think: “well, what’s the point in trying to pick stocks if I can just earn 15 to 20% annualized in the S&P or the Nasdaq index and–“ However, if that was interrupted for any reason, if we suddenly got into a 3-5 longer year period of unattractive or absolute negative returns in this index, I think we could see a return to people being a little bit more interested in active management and actually trying to identify– uh, attractively priced securities where that exercise has honestly been a money loser for a lot of people for– for several years, but it’s always cyclical, it really always is– uh, I mean, I also–

[00:30:11] [David Waters]: A lot of little companies, but some of the type that Nate was talking about, where they really are radically cheap, especially versus the value of their assets and– and some of those require a catalyst: the retirement of the CEO or a management buyout or an asset sale or something. At the same time, there are a lot of little companies that are just doing the right thing, they are investing well, they’re making smart decisions, they’re– they’re growing, but they’re not being crazy about it and not chasing after– uh, buying this guy fantasies and I will say it is rare that I see a company that successfully executes on an intelligent business plan for years on end and still, remains absolutely cheap. It tends to be the companies that are a bit more scratching, that have a bit more of an issue, whether it’s a management issue or our business issue, whether they’re experiencing some headwinds. Those are the ones that require something more of an external event taking place, whether it’s activism by shareholders or whether it’s changing industry conditions to make money and so, I’d say, if you’re gonna pick around in these little companies, which I think are wonderful, it’s a lot of fun, there’s an opportunity there, you’re making a bet if you put either all of your capital into a basket box that requires the external catalyst or you’re also making it better and you put all your capital and companies that don’t have much in the way of capital aspects or hidden assets, but have a business doing well right now. I think it’s best to pull your best around a little bit there and have a little bit of heat, because you never know what your position will be.

[00:31:54] [Nate Tobik]: So, one thing you hit on that– um, is also the top Q&A item, is the– the active and passive and I think that, I think the flows into the passive strategies have just decimated a lot of these stocks because– um, you know– so, when I– when I log into a brokerage account, it shows the top leaders, it shows the top funds and– uh, you know– you know, when I talk to people who are not savvy at investing, they log in and see that exact same thing and they say: “well, these seem like good companies to– to buy.” And you know, a lot of cases they’re– they’re the leaders in the– the market– um, also, the funds are the lead, you know, the S&P fund and– um, you don’t see– it’s very hard to build an index off of a lot of smaller– smaller cap stocks, just because of the dynamics in the market. There’s– they have a low float, there’s just not many shares that trade and it– it’s the index creator would never make any money on the product, right? So– uh, you have to have a critical mass in the index fund to make any money on this thing and so– uh, you know, the current trend is really bypassive stuff because, I mean, ¿why wouldn’t you? Right? if you just buy a passive index and it goes up 1 to 2% every day, I mean, you’d be crazy to look at anything else and so, a lot of the money is redirected into that and– um, you know, the flip side is– uh, there’s nothing in– in the small cap and I think, there’s actually another factor along these lines that people don’t talk about, which is the– the popularity of a lot of the robo-advisors and–

[00:33:41] [Nate Tobik]: So, when I first started working out of college, you know, we got a 401k and it was all these funds and it was, you know, fidelity and Putnam and you know, American century and it went to active managers who were looking for– um, deals or, you know, value or whatever– whatever they were doing, who knows? They were ripping your eyes out with fees when they did it and– um, that was awful and so– then, you know, the trend became: “well, let’s– let’s give our employees this product that has a couple basis point fee, which is the best.” And you know, they have all this research and now, that’s what companies do and– and one of the reasons they do it as well is because, that 401k committee that has to pick the funds– I was involved in one at one point and the executives were very scared to pick a new fund because, what if it didn’t perform well? What if employees did poorly in it? And so, they would pick funds that had good five-year track records and they felt like an index fund gave them cover. So, a lot of companies have shifted 401k money to these passive strategies. You have a lot of pension funds that are doing these passive strategies and in all of that, there’s a ton of money that is not looking actively at smaller stocks and you know, it– it’s just– it’s a popularity thing, if there’s not many people chasing something it’s– it’s gonna be ignored.

[00:35:25] [Ian Hunter]: So, I’ll kind of wrap it up with– uh, with the last question here. So, there– there’s probably some various reasons to think that the future returns from today could be better in value stocks than in growth stocks, in addition to what we’ve talked about. U.S. 10-year treasuries dropped below 1% for the first time ever in march and another interesting thing I saw from Verdad Capital, they looked at Japan, which is a place where they’ve had a zero interest rate policy for 20 years and they said, you know, the– during that 20-year period, the large cap growth companies returned 0.8% per year and large cap value returned 4% compounded– um, the small cap value did even better at 7% per year. So, what they found was that, these returns corresponded really well with where the assets were priced at the beginning of that period, so the free cash flow yield for the large cap growth stocks in 1999 was 1.6 %, while for small cap value it was 8.2% free cash flow yield. So, their conclusion was basically that, it shouldn’t be a surprise that the entry multiple being paid on the cash flows was pretty predictive of which cohort performed better over the following 20 years. So, my question is, as value investors, ¿do you find it tempting sometimes, especially lately, to ignore where a stock is trading relative to its cash flow when we seem to be in a period where the best performers have barely any cash flow?

[00:37:07] [Nate Tobik]: I mean– So, I’ll say– uh, I think Japan’s Instructive, I don’t have– I’ve been reading a book called “the bubble economy”. Um, it’s downstairs. Anyways, it’s– um, it was written right after the Japan– uh, bubble crashed and– um, he talks about this a lot and so, it’s written without knowing how history turned out, right? So, it’s very interesting to see and– um, and he– you know, he– he pulled that same sort of thing out, in terms of the multiples people are paying it just seems crazy, right? And then– um, I– I– so, you aren’t stuck investing in the U.S., you– you don’t have to– you can invest anywhere in the world. Um, a lot of European stocks are not at the same multiples as U.S. stocks and– uh, Japanese stocks are still cheap and you know, the value thing has worked in Japan– um, I– I for– I did some net nets there and then, I– they– this– you know, the extreme value stuff didn’t work as well as– um, buying a company doing 10 or 15% on equity at– uh, 20 to 50% of book value. That was– that was the sweet spot and those companies, they would double, they would triple and you have to sell it, you can’t hold on, you’re not holding on forever to this thing, it’s– um and it was actually easier for me to do than a company in the U.S. because I don’t read Japanese. I was using google translate to try and pick these things and so– uh, anytime a company went up like that, it was a gift [laughs] You know, it’s like: “this is awesome, I can’t believe it worked. I– I need to get out and– and move on where–“ Uh, I find in the U.S., a lot of times I overthink things because I’m familiar with it and it’s– I’m trying to read too much into it about what’s going on or you know, about the personalities and so, um–

[00:39:05] [Nate Tobik]: It– the thing is this– it works, right? If you buy stuff that is extremely low valuations, eventually some person from across the ocean is going to stumble on these things and start to buy them and if one person is able to do it, you know, in– in however– you know, 7 billion people, it doesn’t take that many people to say: “wow! there’s stuff at a 20% free cash flow yield or a 30% free cash flow yield.” And– and then, it becomes– it’s a buy and– um, there was something I used to write about a lot, which was that, you know, value becomes a catalyst for itself, right? So, at some point– uh, someone’s gonna say: “wow! I have all this money invested in a company that will never make any money and at the same time, my alternative is– here’s some company that’s paying a 12% dividend every year and I get– I get 12% of my money back every– every year and–” um, and– So, you know, you say: “well, maybe 12 isn’t enough.” Well, what if that company then fell in half and now, it’s a 25 dividend and that sounds crazy, but Dave could attest, we have seen companies paying dividends like this that are just unheard of and it doesn’t take that many years of paying a dividend like that before people notice and then, you know, from 25, now it’s down to 12 and a half and then, now it’s down to six and it– you– it worked out really well as an investor.

[00:40:37] [David Waters]: Yeah, well said by Nate. Just a couple words for me. You mentioned about the pre-free cash flow yields in Japan at the time. Well, what is a pre-cash flow yield except a signal of market expectations? Uh, those small cap value stocks with the 8-9% free cash flow yield, the market’s saying: “well, they’re not going to grow or maybe they even shrink.” While large cap growth with– uh, one point whatever free cash flow yield the market’s saying: “oh well, they have a decade of 20 plus percent growth.” And that, of course, didn’t happen for the large caps and the small caps did much better than expected. So, you do well as an investor when you have a view that is different than the market and you turn out to be right and so, if these large cap darlings of the day don’t live up to the height and if the neglected– um, this favored small cap value can simply do okay, well then, investors will end up doing very well. The question is if that happens and that’s– that’s the question every investor has to figure out.

[00:41:43] [Ian Hunter]: Well, thank you guys.

[00:41:44] [Nate Tobik]: And that’s– and that’s a good, you know– So, just real quick and that the expectations is– um, you know. So, when you look at what a stock is priced for, a lot of stocks are priced for perfection and– uh, a lot of small stocks are priced as if they’re dead and– um, all it takes is one or two heartbeats and– you know, it– it’s alive and– and that’s your return as an investor versus– uh, every single thing having to work out right and– um, you know, I would say throughout history, anything that has been predicated on being perfect– uh, has– has not worked– um, but there have been a lot of situations where, you know, you think it’s– uh, you know, a team is out of the running or whatever it is and then, they surprise you and– and that’s– that’s all it takes really.

[00:42:39] [Ian Hunter]: Well put. So, Fred– uh, feel free to turn us back over to the– uh, the group setting.

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