Today, Dan welcomes first-time Investor Hour guest Steve Gorelik to the show. A 15-plus-year veteran of Firebird Management, Steve currently manages the Firebird U.S. Value Fund. And as a native Belarusian, there's no one better suited to manage Firebird's Eastern Europe and Russia funds as well.
The big question Dan asks Steve is how he has been handling the funds amid the Russia-Ukraine war. Steve shares his thoughts on Russia's investment prospects and the ruble's volatility. And he explains that, surprisingly, many Eastern European companies present very robust investment opportunities – as long as the countries' macroeconomics look good.
When it comes to doing the legwork on researching a prospective addition to your portfolio, Steve emphasizes that you shouldn't just look at how a company makes money... Seeing how a company spends its money is critically important, too. He also delves into the prospect he sees in a particular type of financial company. And finally, according to Steve, every investor should aim to hone this invaluable trait, especially in today's tumultuous market...
The number of people who are able to hold through a year like 2022... and then be afraid to get back into the market when things are bottomed out... it's the capacity to suffer. It's the capacity to take a loss and not be afraid of what's happening. It's the capacity of being able to do the hard thing and get rewarded for it because other people won't. And that's going to be a competitive advantage both in investing... and in life.
Fund Manager of Firebird's U.S. Value Fund
Steve Gorelik is the fund manager of Firebird's U.S. Value Fund as well as portfolio manager of Firebird's Eastern Europe and Russia funds. He joined Firebird in 2005 from Columbia Business School while completing his education in a highly selective Value Investing program. Prior to business school, Steve was an operational strategy consultant at Deloitte, working with companies in various industries including banking, health care, and retail. He holds a B.S. degree from Carnegie Mellon University, as well as a CFA charter and membership in the Beta Gamma Sigma honor society. Steve serves on the boards of Teliani Valley (Georgia), Arco Vara (Estonia), and Pharmsynthez (Russia). He speaks Russian, English, and his native Belarusian.
Dan Ferris: Hello, and welcome to the Stansberry Investor Hour. I'm your host, Dan Ferris. I'm also the editor of Extreme Value, published by Stansberry Research. Today, we'll talk with Steve Gorelik of Firebird Management. Steve invests in Eastern Europe and Russia, and he'll have some ideas for us about how to do that – amazing! In the mailbag today, not a whole lot – a good question about silver and an interesting comment about Russian real estate. And remember, you can call our listener feedback line: 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my opening rant this week, one key fact. I'll tell you what I mean in a second. That and more, right now, on the Stansberry Investor Hour.
"One key fact" – what on Earth could he possibly mean by that? What I mean is I think there's a lot of noise out there right now. Everybody in a bear market wants to be a market technician and they want to try to predict a recession or not. They want to predict, in this case, more inflation... less inflation... peak inflation... peak interest rates. You're just being bombarded with this stuff if you read all the usual sources: Wall Street Journal, Financial Times, Barron's, etc.
But I think there's one key fact. You know, you can't respond to all – you can't keep all the noise in your head and make a decision. You have to be selective. You have to decide which are the important facts and which are less important and which are pure noise. A lot of it is pure noise, and in particular, the predictions, the recession prediction, you know, or peak inflation predictions or even continued high inflation prediction. Any kind of a prediction is, generally speaking, noise.
I like to take my inspiration and my insights from history. History means a lot to me. And the one key fact, if he'll get to it already, right? I'm going to get to it right now. The one key fact is that we've never gotten out of a massive bubble with a little six-month 20% or 30% drawdown. That's it. That's the one key fact. And we've just been through an absolutely massive bubble, the everything bubble, in my opinion, the biggest bubble ever, bigger than 1929, bigger than 2000, bigger than 2007 – really 2005 through 2007 because housing peaked around 2005 or was it 2006?
Anyway, those were big bubbles. This one was bigger. You don't get out of this with, you know, six months, minus 20%, 30%, whatever – whichever index you're looking at, and then you're back off to the races making new highs. I don't think it works that way. And if you look at those previous bubbles, 1929 to 1932, Dow Jones Industrials were down 89%, peak to trough. The bubble in 2000 was really in the tech stocks. Other stocks fell, right? The S&P 500 fell, but it fell something like 49% or something like that, or 50% – ah, I forget. It was 49%, 50%, something like that. But the Nasdaq fell 78%, right? And in 2007 to 2009, S&P 500 fell around 49%.
So you know, if you – I don't want to – it's sloppy to take a simple average of all that, right? If you did, it's a big, ugly number that's far south of where we are now. And given that it was an everything bubble – and it was a massive growth stock bubble that we just lived through, right? The Nasdaq was the place to be, right? Big, large-cap, growthy tech stocks – that was the place to be. And even like lots of speculative tech garbage, the – I keep referencing the ARK Innovation Fund because it was a convenient repository for a lot of that garbage, and it's been crushed. I think it may yet wind up being down 80% or 90% when this is all over and, you know, a lot of the companies in it I don't think will exist.
So we're in early days. You'll recall on an earlier podcast, we noted that bear market rallies tend to be smaller in the beginning, larger toward the end, right? So we've seen small rallies, little 7%, 10% kind of blips so far. And that tells me we're early days. And history suggests that we're not going to get out of this without a big, nasty, extended bear market of more than year, something like 18 months, two years, something like that.
Am I predicting that? Sort of. If I am, I should just cop to it. I should just admit it. I should stop saying, you know, I never make predictions. What I like to think about myself is that I am a bottom-up value investor who simply cannot ignore the importance of cycles. What have I said over and over again? Ninety percent of them, 95%, 98% – who knows – 99%? I haven't really done arithmetic on it, but just ballpark, right? Most of the time, the overwhelming majority of the time, I don't care about the big indexes. I don't care what the overall market looks like. I don't care about the level of speculation in the economy and in the markets. But when they reach extreme highs or extreme lows, then I start to get interested. At the extreme lows, I'm looking around thinking, "Wow, let me find something that's really beat up that nobody wants to own, that is viewed almost as a distressed business maybe, something really, really viewed as toxic, that's super cheap that I think is a great deal." And at the top, when the valuation extremes go way, way up and hit an extreme high, that's when I want to look around and say, "Hmm, OK, stocks, in general, are really risky now. You know, your S&P 500 Index fund is really risky now." And I'm saying now because, like I said, you don't get out of this kind of thing with a six-month drawdown, you know, 20%, 30%, whatever it's been, depending on the index you're looking at.
So that's my one key fact. I don't think we're done with this. I think it's not half over. I think it's probably a third to a fourth over, and that means you'd better be careful what you're buying. I did note a really – I saw a really good note from the folks at Alhambra Investments, noting that just by the numbers, growth stocks are still really expensive and value stocks are – depending on what measure you look at, relative to growth, they're really dirt-cheap. But Alhambra's point was that if you just look at the headline P/E ratios of the value funds, they're actually about fairly valued. They're not overvalued and the risk is much lower. That was his real point. He was investing in – he wanted low risk, right? And he sees the growth stocks are still high risk and value stocks are lower risk. I tend to agree with the overall point, and relative to growth, of course, value stocks are super dirt-cheap, still scraping all-time, multidecade lows.
And commodities, same thing. And his message was same as mine. Commodities are probably due for a greater correction. They're extremely volatile. But through the cycle, through the bear market cycle, from the peak of the bull to the trough of the bear, commodities tend to perform very well if you can handle the volatility.
But I want to end on my one key fact, right? We never get out of this kind of thing with a mere six-month, minus-20%, 30% drawdown. I think you should keep that in mind. I'm keeping that in mind and that's how I'm framing every bit of advice that I give to Extreme Value readers with that one key fact in mind.
So I'll leave you with that, and now I want to talk with Steve Gorelik. Steve Gorelik is a fund manager for Firebird and he invests in Eastern Europe and Russia, and he also runs a U.S. fund, too – very interesting guy, can't wait to talk with him. Let's do that right now.
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All right, it's time for our interview once again. Today's guest is Steve Gorelik. Steve Gorelik is the lead fund manager of Firebird's U.S. Value Fund as well as portfolio manager of Firebird's Eastern Europe and Russia funds. We might have a little something to talk about there. He joined Firebird in 2005 from Columbia Business School where he completed the highly selective value-investing program. Prior to business school, Steve was an operational strategy consultant at Deloitte, working with companies in various industries including banking, health care, and retail. Steve, welcome to the show. It's good to have you.
Steve Gorelik: Hi, Dan. Thanks so much for the opportunity.
Dan Ferris: Yeah, so just for our listeners, Steve and I see each other once a year up in Vail, Colorado, and I don't know why I haven't had him on the show until now. [Laughter] What an oversight! So, Steve, I'd love to hear about – you know, a little bit of background about you. But it's really hard for me to be patient and not ask what in the world are you doing with Eastern European and Russian portfolios these days? I mean, it's got to be insanely difficult, right?
Steve Gorelik: Right. So I'll be very quick about the background just so that will give us more time to speak about the things that are truly more interesting. As you mentioned, I've been with Firebird, my current company, for over 15 years. Prior to that – originally, I'm from Belarus. This is where interest in Eastern Europe has come from. I've always been interested in investing, kind of got really excited when I learned that there's a firm in New York that invests in Eastern Europe that has a value bent to it. I kept calling them until they picked up the phone and have been there ever since, and it's been a long time at this point.
Some of my background is in operational strategy, which I think is quite relevant in investing because – especially our type of investing, because what we try to do, because independent of what market it is, either Eastern Europe or U.S., we try to understand how companies make money and how companies spend money. And that's really the basis of our investment approach, and we feel that that part is translatable. The part that is not necessarily translatable is the almost 30 years that our firm has of investing experience in Eastern Europe, and that's one of the reasons why we don't do other emerging markets as a firm. We do Eastern Europe, we do U.S., but in 30 years, we learned that chances are if you're looking at a company that is really cheap, there's a good reason for it. And if something is too cheap to be true, it probably is.
Over the years, we've learned enough and talked to enough people. And even so, we don't have people on the ground in Eastern Europe. We visit it often enough and we have the relationships that allow us to kind of understand, to know the players behind the companies, but also allowed us to really see how these companies have developed over the years and how the businesses learned to be capitalist over the 30 years that we've been doing business. Because if you go back to the history, what's different about Eastern Europe from other emerging markets, from most other emerging markets, is that you had a period of about 70 years, a little more, where you had a completely different economic system which had nothing to do with things like return on invested capital. You did not have revenue goals... you had goal in the number of widgets if you were a company. And if you produced a certain number of widgets, you hit it. It doesn't matter if anybody's going to buy them.
So it takes time to learn how to do things differently, and we've seen our region really evolve and develop. And companies, some of the better companies that we find in the region, some of the better companies that we invested in have developed really into world-class companies, and we love seeing that.
Dan Ferris: Yeah, it's amazing that somebody – considering the night and day difference between the incentives under the two different systems, it is amazing that a company could – however long it would take them, even if it takes them 10 years, I mean, most of them just don't do it very well, right? Most of them don't make the transition very well, correct?
Steve Gorelik: True. There were a couple of catalysts that we've seen that led to that education. The first one was the 2008 crisis, and to the extent that the crisis was a big thing in U.S... it was huge in the markets that we invest in. For example, in the Baltic countries – Estonia, Latvia, and Lithuania – those countries were fully dependent on funding from banks that were mostly banks from Scandinavia. And after the 2008 crisis, instead of money flowing into the region, money started flowing out of the region. So these banks were trying to get their money back because they had enough problems at home, but what you had in those countries is you had complete capital flight. And if you wanted to continue to run your business, you really had to learn how to get your money back, how to be capital efficient. For a long period, there was no outside money coming into those markets at all. And there's no better way to learn how to run a business when you really have to make money.
Dan Ferris: Yeah. [Laughter] More profound words about a business were never spoken. I mean, having to make money will certainly change your life if you're not used to doing it. So I wonder if you would talk a little bit about how you've handled the war situation. I mean, I can't imagine. You know, are you working like seven days a week, 20 hours a day since the start of the war... How have you handled that? Have you pulled lots of money out of Eastern Europe?
Steve Gorelik: So we have to separate, I guess, answering that question into a few pieces in terms of before the war and after the war and what do we do in Russia versus what are we doing in other places. As far as before the war, we spent a lot of time analyzing incentives, analyzing the information, analyzing the situation, and we ended up being completely wrong. We did not think that there were enough reasons for Russia to be invading Ukraine, primarily because of the type of outcome that we're seeing right now. It's a mess. The country, no matter what Russia would be saying internally, got – they call it special operations. The war, it's not going well. They've lost a lot of people. They have not made the gains that they expected to get. They became international pariahs. So this has not been a successful event for Russia, and we thought that the likelihood of this not being a successful event, at least in the short term, was very high, which would prevent them from making that step, from taking the step to go to war. Obviously we were wrong about that. Most other people felt the same way. I don't know if that makes it better or worse, but it is what it is.
In terms of what is happening right now as far as Russia is concerned, most of our time there we're spending trying to figure out the rules that are changing on a daily basis. There's different things that are happening from the point of view of what the U.S. investors are allowed to do, from U.S. point of view and from a Russia point of view, because there's different regulators that are putting in different rules. So for example, as of today no foreign investor – it doesn't matter where you're from, but no foreign investor in the stock market is allowed to take any money out of Russia. So even if you could sell your stocks, even if you wanted to sell your stocks, you couldn't get the money.
At the same time, according to the most recent sanctions and clarifications from United States, a U.S. person should not be buying anything in Russia at all. It's independent of whether the stock is sanctioned. One of the biggest companies in that market before was Sberbank, which I'm guessing at least some of your listeners have heard of before. It's really – really was a truly world-class phenomenon company that at this point is uninvestable because it's on a sanction list in the United States.
So you have – we're spending a lot of time trying to figure out the rules. They are changing. There's clarifications on a daily basis. And we're trying to figure out how to hold on to the positions that we had before in a way that – we do feel that at some point the situation will resolve, and at some point, hopefully within our lifetime, Russia will become investible again, and the companies that we have and we are trying to hold on to are going to be doing well once again. And that's what we're doing in Russia.
As far as other markets in Eastern Europe, that's where it gets really interesting because you had this reaction of a correction over the increased risk in the Baltic countries that I mentioned before, in Poland, in the country of Georgia, in the country of Kazakhstan. The valuations have come down from already pretty low levels before the war, to be honest. But I would argue that those countries have become safer and better investment destinations since the war than they were before, in part because – in part – so if we look at Eastern Europe countries that are within NATO, so the Baltics and Poland and Romania, NATO is a stronger organization today than it was in January, and Russia is weaker today than it was in January. So the potential threat that you may have had in Russia invading those places at some point has come down. Meanwhile, those countries are continuing to do well and they're really robust economies that have been growing, that have a strong history of growth. There is a history of conversion to the general European level. And when Europe is growing 0% to 1%, the countries that I mentioned are usually growing 3%, 4%, 5%. And the valuations that we're seeing there are very low. So what we're looking at is we're looking at companies, really high-quality companies that are operating on the European level, that are trading at a P/E of 5, 6 – this is the type of numbers that we're dealing with. And they're growing.
Dan Ferris: Wow, a P/E of 5 or 6 and growing. You don't see that a lot. So you sound like your firm is putting money to work there now.
Steve Gorelik: We are, absolutely. So the countries – so outside of Russia we are putting more money to work, some high-quality businesses that are there in places like Kazakhstan. One of our positions is the biggest bank in Kazakhstan called Halyk that is trading at something like 4 P/E and has become more dominant because about 15% of the Kazakh banking system was represented by Russian banks that had to pull out. This bank went from about 40% market share to something like 45% or 50%. It was already big but got bigger. And we have oil – there's a Romanian oil and gas company that is majority owned by Austrian company OMV, called OMV Petrom. This company is – there's a lot of interesting things going on there, but one of the things – they have established a new dividend policy at the end of last year, and they in the – I think in March or April they declared their regular dividend, which is about a 7% yield to current price. And just a few days ago they declared an extraordinary dividend that is based on their new dividend policy that is another 10% to the current price. And this is – I mean, based on our estimates, this is just the money that they made in the first half of the year.
Dan Ferris: That's OK. I hope you don't mind me jumping around a little, but one of the things that I wanted to ask you about was the extreme volatility of the Russian ruble has been – well, it's been talked about on the news a lot lately. But I suppose if you have capital that's kind of trapped in the country – I don't know, is it less of a concern or more of a concern? Or is this something you guys talk about a lot?
Steve Gorelik: Well, capital that is trapped in the country is really the reason for the volatility that you're seeing. What you have right now with the Russian ruble is that you have very few parties from the outside that are able to sell rubles. You have very strong exports because of the high prices of the commodities – oil, gas, fertilizers, you name it, whatever they can still sell. And the imports fell dramatically because of the self-sanctioning. Some of it is self-sanctioning and some of it is real sanctioning.
So you have a trade balance, extremely positive trade balance, you have very few natural sellers but a lot of natural buyers, so you see the price in ruble that you see. That doesn't mean that it's available to you or me to sell rubles if we had it.
Dan Ferris: Right. [Laughter] Yeah. I wonder how do you short rubles when you have no access to them, I guess is the question. Maybe you just don't. So, Steve, let's – you know, you're two things, right? You're the guy who's managing money in Eastern Europe and Russia, but you also run this value fund, a U.S. Value Fund, for Firebird?
Steve Gorelik: Yep.
Dan Ferris: How long have you been doing that? And it had to have been very difficult until about the past, you know, six months or so, right?
Steve Gorelik: Yeah. I mean, I've been doing it for about nine years. The genesis of that fund is taking our fundamental investment approach that I already mentioned where we look at – we really try to understand the companies' competitive advantages and how they allocate capital and apply it to a different market. And back in 2012 when the U.S. fund strategy was launched, we decided to take a look at what is going on in other markets. We didn't feel comfortable doing to other emerging markets. We're all – our firm is in New York, we're all U.S. citizens, so we figured let's try – and we'd been investing domestically personally pretty much our whole lives. So we wanted to apply our investment approach a little more systematically and just to see what kind of portfolio we can build.
And when I saw that I can buy companies like – within the framework that we established there were companies like Microsoft and Apple, a couple of insurance companies like Assurant, that looked like really tremendous, high-quality businesses that over the cycle would be able to generate very strong returns for you as an investor, we felt that this was an idea worth trying. And over time we've built it into a product that is very much focused on long-term returns to shareholders. We don't have a portfolio that would be typical for a hedge fund because we're kind of looking at it more from a long term. And yes, it's been – you know, some years have been easier, some years have been worse. But I'm looking at the portfolio today and I'm very excited about what the next five, 10 years would bring, and I have no idea what the next six months are going.
Dan Ferris: Fair enough, yeah. Who does? You know, most people didn't have any idea at the beginning of this year where we'd be right now, right? We all would've – we all might've behaved differently if we could see that clearly. So as you assess – by the way, I want our listeners to know when you were talking initially and you said you look at how companies make money and how they spend money, that is – for an individual investor, that's really powerful. It's something that you and I might take for granted, but I think a lot of people, they spend way too much time thinking about how a business makes money and not enough about how it spends money, and they may not even know how to assess that. And to me, that's an important thing. That's a really important thing. We spend actually quite a bit of time looking at that because we think it tells us something about the management, you know, without having to, like, interview them or know them personally or something, which is its own set of problems. So I wonder if you could talk about, you know, just the ways companies spend money, capital allocation, expenses, and so forth, and you know, just give us a flavor of your framework and how you think about those items.
Steve Gorelik: Absolutely, and thank you for that question because it is an important one. So if we're talking about how companies spend money, obviously the first way that you want your company to allocate in the type of businesses that we buy is they usually have high returns on invested capital. If you need to build a new factor to produce widgets that people are buying from you at higher prices because there's a brand, you want them to spend money on that. And that's kind of the easier part of the analysis because companies know how to do that. Any company that's worth its salt will know how to do that very well.
But the best businesses will generate a lot more money than they need just to grow their business organically. So then the question is what do you do with that cash? And then some businesses will be using it to make acquisitions. So then with those, I try to analyze what kinds of returns are they getting on those acquisitions. And you can take a look at things like – if you take a look at acquisitions historically for a company that does a lot of acquisitions, you can see what has been the impact of your acquisition or serious acquisitions on revenues and profitability and really look at the returns that they have gotten over time. And if you have management that's been there for 10, 15 years – this is really – a lot of companies we look for, we try to look at that track record. If they are spending money on acquisitions, we want to see how they did over time. And then when the next acquisition gets announced, we have a little bit of a background to be able to say, OK, chances are it's going to be good, or chances are it's not going to be good.
But the other thing – and there's a lot of debate over this – is that a lot of the companies now in our portfolio do quite a bit of buyback. And we feel very comfortable with that because chances are if this company is in our portfolio, it is already trading at a free cash flow yield somewhere in the high single digits, maybe even double digits. So if you have a business that is generating that much free cash flow yield and it's trading at that price, then for you, for that business to buy back shares I believe is value accreted, because you are deploying cash at that 10% free cash flow rate, or 8% or sometimes 20%. And that to me is a good capital allocation decision that is often overlooked by the market, and that's something that delivers value not within the next three months but will deliver value for you – for me as an investor it delivers value over the next two to three years because – and Buffett talks about it quite often, where if initially you owned 1% of the company but as a result of buybacks you own 1.5% of the company. Well, it's 50% more. You didn't have to do anything, right? So that's a thing that we find adds quite a bit of performance for high-quality businesses over time.
Sometimes you get this coiled spring effect where a company may buy 20% or 30% of its shares outstanding over four or five years and it doesn't go anywhere, and then all of a sudden their earnings per share explodes and the market reacts to it. And we feel comfortable waiting for it. We have amazing investors that clearly understand what we're doing and why, and we're blessed for that. And our strategy is very consistent and we communicate this on a quarterly basis, and it works.
Dan Ferris: I'm glad you mentioned share repurchases. This is something I look at and comment on and analyze every single month, every single time we find a new business to write about in our newsletter. And what I've noticed is that most companies, like the overwhelming majority of them, are so bad at it. I mean, they simply – they buy the stock when they have the money, and they have the money at the top of the cycle or whatever. And so they buy more when it's most expensive and they buy little or none when it's most attractive. So at least for our listeners' point of view, and maybe to provoke a comment from you, Steve, too, I just wanted to get it out there that what you describe is not the usual state of affairs, is it? And what Buffett describes – his favorite example, of course, is Apple. That's the one he's kind of been going on about with this. But they're not all Apple, are they? Or they're not all the type of companies you're describing, are you?
Steve Gorelik: Well, I would actually argue – So Apple is a great example because this is a company that we used to have in the portfolio but we don't anymore. And not to disagree with Buffett who is obviously a much better investor than I ever hope to be, but when we were buying Apple and owned Apple and when Apple was spending all of its money on buybacks, we owned it but it was trading at an 8% free cash flow yield. At that point a buyback makes sense to me. Today – so when we sold it, Apple was trading at a free cash flow yield of around 2%. Still a good business, but at that point, to me, if you're deploying all of the cash into buybacks, at that rate it's just not as attractive. And we found a different business that we thought was doing a better job, right? So today with Apple I think the free cash flow yield is somewhere in between, like it's around 4%. OK, it's a little different. Maybe it's attractive, still a high-quality business. But the reason why we sold Apple, rightly or wrongly, is because we felt that their capital allocation was no longer as efficient as we wanted it to be.
Dan Ferris: Right, OK. So you've actually – you've broached a couple of topics here that kind of come together for me, and one is, you know, you mentioned Buffett, you know, and his – of course, we all know he loves to hold stocks forever. He likes to buy great businesses and hold on to them forever. And you also mentioned that you sold Apple, which we all know to be quite a high-quality business. And to me this is an interesting topic, and the topic is simply a very high-quality business, a wonderful business, the kind that Warren Buffett would say he wants to hold forever, I find them much more difficult to hold forever. I find that there are points when even the most wonderful business in the world trades at a point that, as you've pointed out, it actually changes the fundamentals of how they're allocating capital internally and it warrants, you know, selling it and even just holding on to the cash and looking for something better, even if you don't have something better right away. To me this has been a revelation, this idea that even a very high-quality business should sometimes be avoided or sold, you know? We can't all be Warren Buffett, you know?
Steve Gorelik: There's a lot of things that go into that question, and I absolutely agree with you, that it's – sometimes businesses get too expensive no matter how high quality of a business it is. For individual investors and for fund investors – so a lot of the money within our fund is our money, so we do kind of think about tax implications. You have to remember that anything that you sell, especially if you sold it at a profit, there is a tax associated with it if you are a U.S. citizen. Sometimes it's short-term gain, sometimes it's long-term gain. So when you think about a reinvesting opportunity, you have to be thinking from the point of view of after tax. So from that point of view, the burden – the price at which you're selling is not necessarily the price at which you're selling there, but realistically it could be 15%, it could be 30% less depending on your cash rate. So does it still make sense to sell? So that's one of the things that we're considering.
But from the point of view of – like, sometimes the decision to sell for us, it consists of two parts. One is the company that we're selling and the opportunity – which is the opportunity cost, but also the company that we're trying to buy. We run a disciplined portfolio of no more than 30 companies. So sometimes when there is a new, tremendous idea that we want to put into the portfolio, more often than not we have to sell something. We usually run the portfolio more or less fully invested because I feel that our investors have given us the money that they want to have invested into the U.S. market with this portfolio, or in Eastern Europe, it's the money that they want to have invested in Eastern European market. If I was a fund manager then make a decision that I want to be 50% cash because I don't feel comfortable, I am not doing what my investors want me to do, because they make the capital allocation decision, not I. So we run fully invested.
But a company like – so once again, going back to example of Apple, one of the reasons why we were selling it is because I saw that it went from – when we were buying it, it was trading on a free cash flow yield about two standard deviations lower than the historical average. So we know that happens – you know, according to statistics, that happens about 2.5% of the time, so quite unusual, good price to buy. When we sold it, it was trading at two standard deviations above historical average. So then are you comfortable making the bet that we are going to be – to continue that you're going to be operating within an environment that happens 2% of the time, or you believe in some kind of reversion to the environment that is 98% of the time? And I had an argument with one of our investors over this, and I actually lost an investor over this, where they were asking the question. You know, why did you sell Apple? And I went through this. They said, "But it kept going up." Like, I get it, but then I'm making a very low probability decision from my point of view that I don't feel comfortable making.
So that's one of the things that we would look at, is that if the company is, from a historical perspective, looking very expensive, if the fundamental business didn't change that much, then we feel more comfortable selling. We could be wrong about it. So if the fundamental business has changed, then the company is supposed to be trading at a different multiple because it entered a different growth stage or because its cash flow generation capabilities have changed. Well, that's something that hopefully we can analyze and act on it. But otherwise, more often than not, businesses still operate within the environment that they did before.
Dan Ferris: Steve, you gave us some very specific ideas of companies, businesses in Kazakhstan and Austria and countries like Poland and the Balkans where things are cheap and high quality. Are you guys – you know, with markets officially in a bear market, as they say in the U.S., are you finding compelling ideas at this point in the U.S.?
Steve Gorelik: There is quite a bit, and in terms of the ideas and kind of the funnel, most of the last year I've spent probably looking at companies and trying to find companies that may seem interesting, but then once you start digging, it was really difficult to find any new ideas. And we spent – I don't think we put any new companies into the portfolio in the second half of last year.
We've put in a few new ideas in the portfolio this year, but one of the ones that comes to mind right now that we've had in the portfolio for quite some time but I think is a little bit misunderstood is companies operating in the credit card sector. And one of the companies that we like within there is Synchrony Financial, company with the ticker SYF. And so this is a credit card company, and obviously we don't know what's going to be happening to the consumer going forward. But one of the things that – but a few reasons why I think that credit card companies will do well, is that – so first of all, they've been doing this for a long time. They've been doing this through the cycle. So the companies that we own like Synchrony and Discover, they've been going through a number of economic cycles, so it's highly unlikely that they're going to be surprised by what's happening.
Their balance sheets are as strong as ever. Since the 2008 crisis, the Fed has been doing everything in their power to make sure that the banking system is as robust as it is. The capital balances, the capital adequacy ratios of pretty much any bank that you look in within the United States have gone up dramatically, in Eastern Europe as well. So these are banks with very robust balance sheets. As interest rates go up, historically what you had is you had expansion in that interest margin, even for credit card companies where you are starting from pretty high interest rates to start with. So they have their net interest margins go up, their default rates will probably go up as well, but if you take a look at a company like Synchrony, they've always been provisioning. For the last 10 years, they've been provisioning a lot more than they have been writing off. So there's a lot of slack within – a lot of cushion within how they've handled their finances over the last few years to allow for the higher default rate that will probably be seen.
But another thing that was really interesting that happened last year is that you had Synchrony that was kind of hurt by the market because people had too much money. Because of the stimulus, what you had is you had volumes – you could see the report, the volumes of purchasing that's going through their cards, and relative to the loan balances – the loan balances were pretty low because people had that extra money from government surpluses. They had extra money because they maybe didn't spend the money on travel that they would have otherwise, and they paid down their credit card balances.
We're seeing the opposite right now. So we're seeing pretty strong growth in the account balances for Synchrony, which for that business is good. So you have a station with higher net interest margins, higher balances, and this is a company – which should lead to higher profitability, obviously all depending on the provisioning. But I don't think we're going to see large surprises in provisioning because of the cushion that I mentioned.
But this is the company that has been spending all of its money, all of their free cash flow on buybacks. And since 2016 – so we're talking five years – their amount of shares outstanding is down, like, 30%, and they're continuing to buy back. And this is a company that's today trading at double-digit free cash flow yield, depending – you have to make a few adjustments because if you just look at the cash flow statement, they put back the provisioning which is I don't think the right thing to do because, you know, the losses on the credit cards are part of – it's the operating cost for them. But even if you adjust for that, this is still a company that's trading at a very healthy free cash flow yield, has a very robust business, and is a very good capital allocation.
Dan Ferris: OK, so we've gotten someplace that I always get, especially with value investors. There are – most people I think would say there are such obvious headwinds, macro headwinds, right? Interest rates are going up and that'll impact the consumer, and you mentioned the consumer – you don't know what's going to happen with them. But I think – I don't know, maybe you disagree, but I would think, like, there are these – a few sort of what Howard Marks might call first-level sort of obvious objections to this that are probably very compelling for a lot of folks. And I would imagine – like, even you said you expect the higher default rates. So a simple question might be, well, why not wait for that to materialize until you start buying the stock?
Steve Gorelik: That's a great question, and I think – so with – I have to premise this by saying that I am not a market timer. I'm not very good at market timing. And once again, over time we've found that getting into situations maybe a little bit early, it gives us an opportunity to see how the companies make – what kind of decisions that the companies make. And if we are correct on the underlying drivers of the businesses, being early does not mean being late because over time, as these companies report earnings over next quarter, over the next two quarters, this concern may prove to be not as much of a concern as it was. But also if I am proven correct with companies like this, I am buying at the same time when Synchrony is buying shares and I believe is getting a very good deal on their shares. So I kind of feel like I want to do the same thing. And if I'm right, it really doesn't matter if I bought before this inflection point that you're talking about. Or if I'm wrong, then I'm wrong, and time will tell.
But more often than not what we've seen is that the first-order effects that you mentioned, chances are they are in the price, because market, for all its faults, is a waiting machine of the things that we know, the known unknowns, right? It's the unknown unknowns that will mess you up. So I talking to one of our investors, an investor in the fixed income field, and he is saying that – he was giving an example of the Treasury rate, the interest rates that we're seeing on Treasurys. He's saying this is probably the most efficient instrument out there because you have literally millions of people betting on it on both sides, and there's only one instrument. So if you want to buy two-year Treasurys or 10-year Treasurys, there's only one. You don't have 5,000 different companies that you can invest in, so the market depends. So anybody who is trading the U.S. Treasurys, they will probably be buying or selling based on their opinion of what's going to be happening later on. And overall, you get to the wisdom of the crowds within the price of the interest rate... the interest rate that you're seeing on Treasurys. And yes, it may go up and it may go down, and then you look back and say, "Oh, I knew it. I knew this was going to happen." But what you knew was in the price because somebody else knew something else.
Dan Ferris: That's right.
Steve Gorelik: And when we're talking about these kinds of potential problems that the market is seeing in the consumer space or in the housing space, those are first-order effects that everybody knows. It's what happens after that or the severity of it that is going to surprise to the upside or the down.
Dan Ferris: All right, so then I wind up at a question – again, why not ask how much time does anybody – you or anybody at your firm spend analyzing macro data and thinking about macro issues?
Steve Gorelik: We still do a lot of things in Eastern Europe and majority of us are in Eastern Europe even after what happened this year. We spend quite a bit of time thinking about macroeconomics, but really more on a global scale than other value investors would, or at least that's what we think. It's an input in our investment analysis. So we will sometimes – so on Eastern European side, when we're entering – when we're looking to invest into a country, if we don't think that the country has the right macroeconomics, we just don't look at it. So one example within our region is Turkey, which has a number of extremely high-quality companies, tremendous businessmen. But we feel very uncomfortable with the macroeconomics there. We just don't understand what's going to happen and how you resolve that situation, so we just don't touch it.
So from that point of view, macroeconomics is a big piece of what we're doing. Back in 2014 when oil prices were at the low because there was a concern about whether China is going to continue to be buying – to be the same consumer of oil and gas than it was before, we went to China and we wanted to just see what's going on. And one of the surprises for us how cold it was in China and kind of realizing that – because we went in February, and most places didn't have central heating. And we kind of realized that, OK, as far as what's going to happen to oil, not sure, but gas? They'll need more gas because you have the process of conversions. People are getting wealthier over there. You have hundreds of millions of people moving into the cities. They just have a different energy intensity use when you have middle class as opposed to lower middle class or – OK, and people that live below the poverty line. So it's not a tremendous insight, but we do look at things like that. And you have to be aware of macroeconomics.
Dan Ferris: Very interesting, yeah. There's nothing like boots on the ground to change your perspective, especially when you're investing in another country, another culture.
Steve Gorelik: No, you know this feeling when you're reading a newspaper or a magazine and you get an article on a topic that you know a lot about and you're like, "Oh, they're so wrong," but then any other article within that newspaper or magazine, like, "Oh, that makes a lot of sense"?
Dan Ferris: Yeah.
Steve Gorelik: So it's just this – once again, first-order effects where whatever we're reading, chances are that is in the market. It's kind of going a little bit further than trying to analyze it.
Dan Ferris: Right. And chances are if it's in the, you know, Financial Times, Wall Street Journal, they're not going to China every week or Eastern Europe that week. So even if they may have, it's a little different. But I've come to my final question, which I'm very curious to ask you since you've never been on the show before. It's the same final question for every guest no matter what the topic is, and the final question is simply if you could leave our listeners today with a single thought, what would it be?
Steve Gorelik: It's a really good question and I knew you were going to ask it so I needed to think about it a bit.
Dan Ferris: OK.
Steve Gorelik: And I think the thought that I would have would be the capacity to suffer. It's the ability to do things that are hard to do, whether in investing or in life – it really doesn't matter – but you have to be able to do hard things. I looked – it was a big surprise to me. So I looked at the returns of the S&P 500 since 1924 or whatever it is, and I plotted them on a scatterplot, and you have this random walk. Sometimes it's 30% up, sometimes it's 20% down. Like, it does not look linear at all. But since 1924 if you were invested in the U.S. stock market, and I think anybody who's in the U.S. should be invested at least somewhat into U.S. stock market independent of whether you think it's expensive or cheap, you made 8% per year, which is a very good percent, over that time. And obviously if you held since 1924, you compounded thousands if not tens of thousands of percent.
Dan Ferris: Yeah, yeah.
Steve Gorelik: But the number of people that are able to hold through a year like 2022 when we're down 20% and could be down another 30 and then be afraid to get back into the market when things are bottomed out, and you only know in hindsight when they've bottomed out – it's the capacity to suffer. It's the capacity to take a loss and not be afraid of what's happening. It's the capacity of being able to do the hard thing and get rewarded for it because other people won't. And that's going to be a competitive advantage both in investing – and I tell my kids – I have three kids. That's what I tell them in life. Like, if it's easy, everybody's going to do it. If it's hard, that's where you kind of build your honor.
Dan Ferris: Well said, and very timely, I might add, very timely. Well, thanks for being here, Steve. I'll tell you what. How about if we don't wait a long time to get you back on the show since I waited so long to get you on it in the first place?
Steve Gorelik: It was a pleasure. Thank you so much for great questions.
Dan Ferris: Well, I'm glad that I finally got Steve on the show. I've seen him every year for something like 10 or 12 years, and he always gives really great detailed presentations. Sometimes he comes up with these really kind of obscure-seeming stocks because he does cover Eastern Europe and Russia. And he comes up with a lot of great ideas, actually, over the years, and just a very smart guy. I mean, that whole conference that we go to in Vail – it's a room full of people, all of whom are smarter than me and have a lot of experience. Most of them allocate capital for a living.
But I hope you enjoyed that as much as I did. Steve had a lot of specific ideas for us. I thought it was really fascinating, the idea that while Russia's getting weaker and Poland and the Balkans are getting stronger, and there's a lot of high-quality companies there that you can buy now that are really cheap. That really appealed to me. That's going to make me run off and try to do some homework on it right away. I hope you enjoyed it as much as I did, as we say very often on the show. All right, and I hope you'll enjoy the mailbag today. Let's go do that right now.
I think you know by now I'm always trying to tell you the really hard truths, even when – especially when what I have to say is unpopular. Today the hard truth is that your wealth is in danger. Everything you may have made in the bull market of the last decade could disappear very quickly. Some of it's probably gone already. This process has already started, and even if the financial markets somehow avoid a devastating crash from here, inflation is still eating 8% of your money every year. I've spent 20 years helping people prepare for extreme market shifts just like the one we're going to right now in my role at Stansberry Research. I've recommended 24 triple-digit winners and I called the collapse of Lehman Brothers with near-perfect timing.
Well, today I'm issuing my biggest warning ever. If you want to preserve your retirement and your lifestyle in the coming years, you need to act. I recently went on camera to lay out a simple one-step plan for what to do. You can set yourself up in minutes and likely forget about inflation, rising prices, or the worst effects of a market crash for years to come. This plan does not involve options, shorting, crypto, or anything complicated, and it doesn't require perfect timing. The perfect time to act is right now and you could see triple-digit upside in the coming years.
To watch my full interview with the brilliant financial journalist and hard asset expert Daniela Cambone, simply to go CrashProtection2022.com. Again, that's CrashProtection2022.com to watch our full interview for free.
In the mailbag each week, you and I have an honest conversation about investing or whatever is on your mind. Send questions, comments, and politely worded criticisms to [email protected] I read as many e-mails as time allows and I respond to as many as possible. You can also call the listener feedback line: 800-381-2357. Tell us what's on your mind and hear your voice on the show.
First up this week is Anthony H. and he says, "Dan, I believe it was last November Rick Rule was on talking about how markets work. One forecast he made was that silver would be much higher in six months. A little over six months later, silver is down to around $20.80 compared to $23 at that time. Is the price of silver mostly driven by inflation hedge and store of value investing, or is it from industrial use? Curious why silver has not panned out. Thanks, Extreme Value member Anthony H."
Anthony, I won't speak for Rick, but for myself, I've talked about silver before. Two important things about silver – well, actually let's go there. Let's go to three, and the first one is that it's really difficult to think about silver versus gold because silver has plenty of industrial use. As you implied in your question – you implied that you understand this – there's plenty of industrial use. But there's also this monetary or store of value demand as well, and so the monetary value tends to be on the margins. The other part of that is really difficult. Silver is hard because most silver is mined as a byproduct of other things. You know, you get these silver-lead deposits and even gold-silver and some other things. So a lot of it gets mined as a result of mining other metals, so the other metal fundamentals come into play with silver. It just makes it really complicated. So that's No. 1.
No. 2 is silver tends to rise – when gold rises quite a bit, silver tends to follow, not lead. It tends to lag, not lead.
And the third thing is – and this is just my personal insight from information that I've looked at just on long-term charts – silver is really spiky. You know, if you get a long-term chart of silver, it tends to have these really speculative spikes. I call it the meme stock of metals for that reason. And my strategy is going to be to hang on to it and maybe sell – maybe I'll sell silver equities into the spike because I'm selling silver equities. But I'll probably hang on to my metal, right? I've said that before on the show. I've sold gold metal before. I've never sold my silver metal. But it felt bad, man. It felt bad not having it. I didn't – you know, I did what I did at a good time, but hmm, it just – ugh. I don't want to not have my metal, so I probably won't sell my silver metal. If I do, I'll wait for one of those big spikes.
And so, you know, like a six-month time frame like Rick was talking about, that doesn't mean anything to me personally. He's much more in tune with those metal markets than I am, so he can make that kind of a call. And, you know, it didn't turn out this time, but you know, he's got a great track record investing in metals. So overall, yeah, he's brilliant... this one didn't pan out. But for me, I don't care about that. I just think that it's a good time to own precious metals, great time to own gold, and therefore probably a great time – not probably – I think definitely a great time to own silver as well, as long as you keep in mind that it's really spiky – you don't get the same kind of trending with silver that you do with gold – and that it tends to rise after gold. It tends to lag gold.
Keep those things in mind. That's my advice. You know, as to why it didn't pan out, I don't know. You know, a six- or eight-month call doesn't mean anything to me, so I can't tell you why it didn't pan out. But it's a good question.
OK, I'm going to do a little bit of housekeeping for the Extreme Value newsletter. Forgive me if you're not a subscriber. Mike C. wrote in and he said, "Hey, Dan, why don't you report the trailing stops, like, right on the back page so I can see them and use them?" You're right, Mike. We're going to take care of that. Thank you for writing in.
Next and last this week is Lodewijk H. Lodewijk H. writes in frequently. He's our frequent correspondent, faithful listener. And one of his e-mails this week – and there are always more than one each week – he says, "Your guest" – and he's referring to Vitaliy last week – "Your guest is spot-on. I'm negotiating to open small supermarkets in Russia in two airports selling coffee in a place where people are not price sensitive. It sounds like a good investment, but it is in the early stages." He says, "Worst case, I'll just buy additional precious metals, Lodewijk H."
Well, Lodewijk, I don't know anything about supermarkets in Russian airports, but it sounds interesting and I wish you all the best with it. And of course the latter part, buy additional precious metals, hey, why wait? I say do it now.
So that's another mailbag and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as I did. We provide a transcript for every episode. Just go to InvestorHour.com, click on the episode you want, scroll all the way down, click on the word "transcript," and enjoy. If you liked this episode and know anybody who might like it also, tell them to check it out on their podcast app or at InvestorHour.com. And do me a favor. Subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts, and while you're there, help us grow with a rate and a review. Follow us on Facebook and Instagram. Our handle is @InvestorHour. On Twitter, our handle is @Investor_Hour. If you have a guest you want me to interview, drop me a note, [email protected], or call the listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. Until next week, I'm Dan Ferris. Thanks for listening.
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