Value stocks have struggled compared to growth stocks over the last decade…
Which is causing some investors to wonder, why bother with value stocks at all?
So this week, Dan decided to bring Tobias Carlisle onto the show, to shine a light on this underreported area of the market.
Tobias is the founder and managing director of Acquirer’s Funds LLC. He also serves as portfolio manager of the firm’s DEEP value strategy fund. Tobias has a long track record of success investing in value stocks and has written several books including, Deep Value, The Acquirer’s Multiple, Concentrated Investing, and more.
Tobias shares his investing philosophy while looking for value stocks, including where he looks to find his biggest winners.
The pair make an incredibly compelling case for why many of the world’s best value stocks could see a strong resurgence in the coming years, massively outperforming many of the world’s most popular growth stocks.
Founder and Managing Director of Acquirers Funds
Tobias Carlisle is founder and managing director of Acquirers Funds, LLC. He serves as portfolio manager of the firm's deep value strategy.
Tobias is the creator of The Acquirer's Multiple. He is also the author of the books The Acquirer's Multiple, Concentrated Investing, Deep Value, and Quantitative Value.
Tobias has extensive experience in investment management, business valuation, public company corporate governance, and corporate law.
NOTES & LINKS
1:50 – Dan takes a look at some historical data from 1926 through 2019 about party power and market performance and the results may surprise you… “It shows that U.S Stocks have outperformed by an average of roughly 5% per year during Democratic administrations…”
4:43 – Dan tells listeners some moves he’s making before the election… “I have two election day trades and they’re real simple…”
12:38 – Dan shares some research from typically bullish investors that shows a top could be coming in the next 12 months… Could a market top possibly be coming soon?
16:12 – This week, Dan invites Tobias Carlisle, founder and managing director of Acquirer’s Funds LLC. Tobias also serves as portfolio manager of the firm’s DEEP value strategy, and has extensive experience in investment management, business valuation, and has written several books on value investing over his career.
22:23 – Looking back over 200 years, Tobias points out there’s actually been three great depressions. And each one showed great opportunities in value stocks… if you knew where to look.
29:26 – So why has value investing suffered lately? “We’re in this odd period of time where if you rely on fundamentals, like a lot of value guys do… your price information has been destroyed by central banking…”
35:40 – After some questioning from Dan, Tobias explains in detail the ideal profile of what’s he’s looking for in a deep value investment… and where he differs from Warren Buffett.
40:25 – Tobias says that “96% of businesses do tend to cycle.” So he looks for ones that are currently undervalued and are likely to see some mean-reversion.
47:34 – Tobias names a few well-known companies he’s considering dropping from his DEEP fund…
52:40 – Tobias makes the case for value investing today… “We’re now at a stage where it’s so compressed, it’s so beaten up, and the businesses in there are still pretty good businesses in many cases… and they’ll massively outperform.”
57:15 – On the mailbag this week, one listener asks Dan about a claim made about synthetic THC on last week’s episode. Dan reached out to Tom Carroll for a response and shares it with the listeners. Dan also gets some questions about investing in weed stocks with a security clearance, modern monetary theory, and what he’d say to Jamie Dimon if given the chance… Dan gives an answer you do not want to miss.
Announcer: Broadcasting from the Investor Hour studios and all around the world, you're listening to the Stansberry Investor Hour.
Tune in each Thursday on iTunes, Google Play, and everywhere you find podcasts for the latest episodes of the Stansberry Investor Hour. Sign up for the free show archive at InvestorHour.com. Here's your host, Dan Ferris.
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 my friend Tobias Carlisle. Toby is a true, dyed-in-the-wool deep value investor. So we'll talk about why he's still doing it even though everybody says it doesn't work anymore. This week in the mail bag a response about synthetic THC from last week's guest, Tom Carroll. Plus, I will respond to reader comments and questions about security clearances, too-big-to-fail banks, and modern monetary theory. Heavy stuff. In my opening rant this week I'll talk about why elections don't really matter for the stock market overall, but I'll also tell you my favorite election-related trades, including the one I'm personally doing. And then we'll talk a little bit what's happening with my colleague Steve Sjuggerud's Melt Up idea. That and more right now on the Stansberry Investor Hour.
A lot of things to cover today. Let's get right to it and talk about election outcomes and the stock market. You've probably heard many times that Democratic administrators outperform Republican administrators, and that's true – if you go through the historical data back to 1926 through 2019, it shows that U.S. stocks have outperformed by an average of roughly 5% per year during Democratic administrators. Like the Democrats are crushing the Republicans in the stock market.
Now, look, that's a nice statistic but it's an average. And every time I hear the word average, the hairs on the back of my neck stand up. Because a six-foot man can drown walking through a river with an average depth of three feet, okay? And there's a real good book about this by a guy named Sam Savage called The Flaw of Averages. Really good book. And easy to understand. Good stories. So what are some more meaningful statistics? Well, one of them would be: how does the stock market perform when it's Democrats in the White House and in the Senate and in the House? And they call these unified administrators, when one party is in control of the executive and legislative branches of government.
And this guy Bob French at McClean Asset Management – he did this. And what he found is eerie. It's eerie to me. Now, of course, I don't want to get fooled by randomness just because this statistic is eerie. So I'm not saying that it has deep meaning. But the statistic is: U.S. stocks rose an average of 14.52% per year during unified administrators no matter which party was in control. Weird, right? I mean, if I had to sort of take a wild guess as to why this is, I would say that the market likes the predictability. The market thinks maybe it has an idea of how Republicans are going to respond to certain societal and economic outcomes and how Democrats are going to respond to certain trends in the society and the economy and so forth. Just a guess. Probably doesn't mean anything.
But, in other words, I'm guessing at that because I just want to try to figure out if it's reasonable to expect that in the future. Maybe it is. I don't know. So it looks like right now, if I had to guess, I'd say we're going to have a unified administration. We're going to have Democrats in the White House, Democrats in the Senate, Democrats in the House. So maybe we get 14.5% a year for the next four years. Wouldn't that be nice? So that's that. Don't worry about who gets elected. I think it's more important, frankly, to just get it on with – get it over with. Right?
So I have two election-related trades that are real simple. And it doesn't matter who gets elected. The point of them is just that we get the election over with. And the first one is cannabis. And if you want to know why, just go back to last week's episode, episode 177. Listen to my interview with Tom Carroll, the cannabis guru. And we got right to this topic right at the beginning of the interview. I'm going to let you do that. And, long story short, once we get past this election, both Trump and Biden are good for the idea of legalizing cannabis at the federal level. And that's a very big deal. So that's my first trade related to the election.
The second one is bitcoin. Now, bitcoin, as I speak to you, is up like 9 of the last 11 days. And some people could say, "Well, there's this big PayPal news, right?" So the PayPal news is that you're going to be able to buy and sell and hold cryptocurrencies through your PayPal account I think starting next year. And that's real good. Because they've got 300 million customers and 26 million merchants and it's a lot of people for whom buying cryptocurrencies will become much easier. So there was a little juice in bitcoin based on that announcement.
But bitcoin is getting close to being a double this year. And that's not based on some news that happened like a week or so ago. That's based on something else entirely. And that something else is the last refuge of governments, which is to debase the currency. In my opinion. That is what I think is going on here. What I think is going on is that, sure, the PayPal news is good. It's good for a little – I think it was good for about another 10% blip. Yay. It's good for bitcoin. It's good for cryptos. But overall I think we're getting close to seeing bitcoin double in 2020 versus where it started out at the beginning of the year because people – they don't like the U.S. dollar as much overall long term and they're starting to think, "I need to own some gold – I need to own some bitcoin."
And seeing another 300 million people get easy access to it within the next several months just underscores the usefulness of it and the acceptance of it. And it's got, what, just call it roughly a $250-billion market cap. It must be in that neighborhood by now. It was 240 or something, 236 or 237 recently. Whatever. It's in that neighborhood. And I think there's like 80 trillion of U.S. dollars in the world and there's tens of trillions of euros and yen and all these other fiat currencies. So if bitcoin just makes any kind of little dent in that – if there's any kind of acceptance as another currency alternative – there's 10 trillion of gold in the world. So if bitcoin just gets on par with any of these things, it's a major, major, major multi-bagger. It could be, whatever, 20, 40, 50, 100-bagger plus. And it's worth holding a little bit.
And I said I would tell you about my favorite election-related trades. The one I'm personally doing is: I chip away at bitcoin. Literally, I buy small amounts on a regular basis. Like almost weekly sometimes I'm just in there. And it's tiny amounts of money. Like I'll buy $1,000 at a time or $2,000 at a time. But I just keep doing it. It's sort of like I'm saving a little more money this week and I'm saving a little more and that's how I think of it. I think of it the same way I think of gold. It's savings. It gets me outside the financial system. You get the picture.
So, cannabis and bitcoin. Those are my two election-related trades. I actually have a third one. It's called "doing nothing." Because, like we said, the market goes up most of the time anyway. So an overall stock market-related trade is not necessary. The cannabis trade – we described that as speculative when we talked about it with Tom Carroll. I think bitcoin is frankly – I can't believe I'm going to say this – less speculative because it's like a form of savings... it's become so widely adopted. And in the scheme of things I understand: $250 billion is not widely adopted at all. But who knew it would be here already where it is, with just merchants all over the world using it as currency? You can buy things with it all over the world. It's amazing.
So, bitcoin, cannabis, and nothing are my options for election outcome trades. And really it's just getting past the election, I think, is the main thing. And bitcoin is an election-related trade because once we get past it, either candidate – both candidates are going to go heavy, heavy duty with as much fiscal stimulus as they can ram through, in my opinion. And that will have the effect at some point of weakening the currency. So you'll want to own more bitcoin.
All right. I said I wanted to talk a little bit too about the Melt Up. My colleague Steve Sjuggerud has been talking about this for like five years. He says we're going to get another one of these events kind of like what we got in the late '90s into early 2000, where stocks just melt up. So he's been talking about that. And other people like – we had Enrique Abeyta on the show a few episodes ago, episode 174. And Enrique called for a melt-up type of a thing earlier this year in March when it was a non-consensus viewpoint. Everybody's afraid the world was coming to an end and stocks were down 30% and Enrique was saying, "We're go going to have a Melt Up."
So now for the first time Steve is talking about preparing for the Melt Down. This is like some point in the next 12 months type of event. Starting maybe in the next 12 months. But he's starting to prepare his readers for it. I think that's interesting. Enrique is saying, "Well, I think it's still coming but it's going to be volatile and it's not a non-consensus viewpoint anymore." And even at Empire Financial Research – by the way, if you don't get Whitney Tilson's daily e-mail, you should get it. His one analyst, Berna Barshay – reading her stuff is just worth having that thing delivered in your inbox alone, let alone Whitney and Enrique and all this stuff that winds up. It's a great, mostly daily e-mail. I think it comes just about every day. And you can go to EmpireFinancialResearch.com and just put your e-mail in – you get a free e-mail.
Anyway, Berna Barshay, who works for Whitney also at Empire Financial Research, she also is saying: being bullish – that is not a non-consensus thing anymore. It's the consensus now. So all these folks are starting to realize that being bullish is the consensus overall. Despite a little bit of weakness recently in the stock market. And that the calls for – anybody who was early on that sort of melt-up bullishness – Porter was real bullish in late March, I got bullish in late April – we're all starting to get concerned now that this thing has really run hot. And at some point along the way here – of course I've been kind of mostly bearish for about three years. And at some point along the way here I think we're going to see an enormous top preceding an enormous bear market of like minus 50, 60%. So maybe we get that within the next, what, 6-to-12 months or something – we see that peak. We'll see. Stay tuned.
If we get a moment that looks really top-y from here, you'll probably hear me yammering to buy puts. "Buy puts, buy puts on anything." Right? At that moment. Not there yet. But it does bring up an interesting question. And this is what I want to finish the rant on this week. What asset do you not want to be caught without? Mostly we think, "Oh, what do I want to be in next? What's hot next? What's going to go up next?" But my mindset these days is: what asset do I not want the market to catch me not owning? I don't want the market to catch me not owning bitcoin. I don't want it to catch me not owning gold and silver. I don't want it to catch me not holding plenty of cash. And the same way, I don't want it to catch me not owning any equities, right? I don't want the market to catch me not owning a stake in the relentless innovation, the relentless ascent of man. So that's how I'm thinking of these things.
And, like I said, investing is really personal. I've said this a number of times. Investing is really personal. There's an asset out there probably that you know all about just because of how you've lived your life, right? Some people buy whiskey in casks in a warehouse in Scotland because they know about whiskey. Some people buy vintage guitars because they know about guitars and music and stuff. Some people buy wine, right? They buy wine as an investment. Some people buy collectable coins and art and all kinds of stuff. There's probably something you know something about – land, real estate maybe. I don't know. Whatever it is, there's probably an asset that you probably don't want to get caught not owning simply because you know a whole lot about it and it fits your personality and your style, right?
All right. That is all I have to say this week. Let's talk to Toby Carlisle. I love this guy. This is going to be a great conversation. I just know that. All right? Let's do it right now.
Hey, guys. If you haven't listened to our interview with Ron Paul on episode 156 and you're a Ron Paul fan, you're going to love that interview and I highly recommend it. Also: Ron has done an interview with us at Stansberry Research and he did a whole video presentation about it. And it's all about the 2020 election and what he thinks the 2020 election is really about, and who he think is going to win – which will probably surprise you – and what he thinks you should be doing to prepare right now. He thinks this is a really important election. And this video that he did – it's a warning. It's an urgent warning. And I think you need to take a look at it.
Now, if you want to see the presentation just go to Election2020Portfolio.com, and you can see the whole interview with Ron Paul. Election2020Portfolio.com. Check it out.
All right. It's time for our interview. Today's guest is Tobias Carlisle. Tobias Carlisle is founder and managing director of Acquirers Funds, LLC. He serves as portfolio manager of the firm's deep value strategy. Tobias is the creator of The Acquirer’s Multiple. He is also the author of the books: The Acquirer’s Multiple, Concentrated Investing, Deep Value, and Quantitative Value. Tobias has extensive experience in investment management, business valuation, public-company corporate governance, and corporate law. Toby Carlisle, welcome back to the program. Glad to have you again.
Tobias Carlisle: Thanks for the very kind intro, Dan. Always really fun to chat to you.
Dan Ferris: Yeah. We were just talking before we started up, and one reason we have to have you on the program is because you're still a value investor [laughs]. What sort of brain damage have you suffered that makes you – why are you still a value investor?
Tobias Carlisle: Well, you know, my mum tells everybody that I play a piano in a piano in a brothel [laughs]. Nobody likes to be known as a value investor there days. Why am I still a value investor? I started out as a corporate lawyer. I was an M&A attorney for a long time and I started out in April, 2000, which was the peak of the dot-com boom. And I literally saw the collapse and then I saw value have a really good run through that period.
And part of the law that I did was defense against activists, because we tended to work for bigger companies. So we didn't work for the activists – we worked for the companies defending the activists. Didn't know what they were at the time. They were the old-school corporate raiders from the '80s who'd come back. They sort of civilized over the early 2000s and changed their – Icahn is a good example of that. Originally brass-knuckle corporate raider restyled as sort of shareholder activist looking out for the little guy. I just thought it was fascinating. And the returns in the early 2000s were spectacular to value.
And the logic of it appealed to me... that you could identify a value, an intrinsic value that was separate from the share price that you could see in the stock market so you had some guardrail for what you were doing. You weren't just looking at the stock price running up and thinking, "Do I just hold onto this thing forever or is there a price at which it doesn't make sense anymore?"
It's funny. It's one of those things where probably the best returns I ever got were right at the beginning when I didn't know anything. And the more that I've learned, the worse my returns have got. There's something about that. But part of it is also that values had this shocking run. So I have a friend, Mikhail Samonov. He runs a firm called Two Centuries. And the reason it's called Two Centuries is they have this very – they've managed to stitch together these different data series going back to 1825. It starts with the French data, which folks might be familiar with. That's Ken French of Fama/French who sort of came up with the value factor, factor investing.
And then there was the Cals Commission, which was like 1875 to 1925, which is the very famous study where Alfred Cals wondered whether there were any investors who had any skill. And so this was the very early computers. They had it on punch cards. And so he collected all of these returns and be basically showed that there was very little skill out there. Most of it was sort of random chance. Benjamin Graham got hold of that study, and Graham was able to do a test where he looked at: what if we had just bought low price-to-book value stocks, which is Graham's kind of approach? And he, of course, found that it outperformed pretty materially from 1875 to 1925, which was the point that he was interested in.
And then there's another gentleman who's done this very deep research collecting the annual reports of companies going back to 1825 and looking at the dividend yields. Because that was the only – they didn't have to disclose much early on so the only way that you could determine whether something was cheap or not was if it had a bigger dividend yield for the price that you were paying, it was assumed to be a cheaper company. They found the same thing. Basically the higher the dividend yield, the better the performance of the stock. Now, it's incomplete data but it's still very interesting and it's fascinating that it goes all the way back to 1825.
What was happening in 1825 was the beginning of the Industrial Revolution in the States. And so that was Commodore Vanderbilt with his steam ships plying his trade around New York. And he was sort of the big man of the day. And then the telegraph gets invented in 1841 and you can see that's one of the early tech booms. Because until that point in time, information had traveled at the speed of the wind. It was how fast a ship was blown across the ocean from England to New York or vice versa. That was how long it took information to get here. And so they laid a subsea cable and so all of a sudden information becomes almost instantaneous. And it kicks off one of the first information technology booms in the States. And that was a bad time for value.
And so looking back over this 200-year period, you can see there are all of these – one thing: there are lots and lots of forgotten depressions. That was one thing that – I sort of thought if you were only familiar with the data running from the 1920s to today, which is basically what the French data is, you see one great depression. And it's shockingly – it's outsized relative to everything else that we have in the data. But if you go back 200 years, there have been three. And the first great depression is now known as the forgotten depression, and the second one is known as the long depression. And the long depression ended in 1904. And that was coincidentally the last time that value performed as badly as it currently is. So value has performed really badly on three different occasions. There's one in the early 1800s, there's one through to 1904, and there's one today. So we're living in truly historic times for value.
That's why it's been a very long period of underperformance. Depending on how you're measuring it. Price-to-book value – nobody really uses that anymore but the data's very good. So that's the thing we tend to look at. It's the longest period of underperformance in the data for that. And it starts in sort of 2005. Fifteen years is a big chunk of most people's careers. So it's understandable why folks have sort of drifted away from value. If you use the real ways that people are valuing companies, looking at the cash flows and those sort of things, you would've kept up until about 2018. But 2018, 2019, 2020 have been absolute misery for value investors. But it's not without precedent.
And so I think that there's a reasonable chance that at some stage we get some mean reversion and value goes back to working. Because it's been a very good strategy over the full 200-year data set. It's way, way ahead. It just has these periods of underperformance like we're going through now.
Dan Ferris: I love the way you characterized that first information age revolution when we went from steam ships to the telegraph. That is really cool. I've never heard anyone characterize it quite that way before. But it's worth noticing. I know a lot of people look at the data from – they say, "Well, the data before about 2000 or so," basically before the age of the almighty infallible central bank, they kind of dismiss it as not being really relevant. How do you feel about that?
Tobias Carlisle: It's a great question and it's one of those things that: the more you underperform, the more you reach around for answers for why you're underperforming. Why does this thing that I'm doing that seems logical and has a long history of working – why does it feel like it's not working now? Who's to blame for it not working now? So there's some interesting – I've given a great deal of thought to it and it's entirely possible that the central bank does have some influence on it. It seems to me that if you print a whole lot of money and you bail out a whole lot of companies – which is not necessarily central banks. That's a fiscal step as well. But if you do those things you get that – I forget who said it now but "Capitalism without bankruptcy is like Christianity without hell." Something like that.
There's got to be some consequences for borrowing too much and running businesses that are basically cash-flow-negative all the time. And at the moment there are none. So as a value guy that makes it hard for me to find things that are good and undervalued. It's easy to find stuff that's really terrible and undervalued. And it's really easy to find stuff that's good but is massively overvalued. The trick is to find stuff that's worth owning and is undervalued.
The interesting phenomenon I think is that it's pretty well known – there's lots of research around this area that as humans get sort of bad feedback – so there's an interesting study where they get two guys and they sit them down in front of slides of cells, like the cells that you find in a human body, blown up under magnification. And they're untrained. And they're shown a slide and they're asked to identify: is this cell sick or is it healthy? Is it pathological or is it healthy? With no sort of training beforehand. They're not doctors or anything like that. And they just click a button that says "sick" or "healthy" and they get instant feedback: wrong or right.
And so after a period of time one guy gets very good at identifying, with no pretraining, and the other guy is unable to identify sick and healthy cells. And the reason is that the second guy doesn't get real feedback. He gets this sort of scrambled, randomized feedback. They ask them, "How did you know that this cell was sick? How did you know that this cell was healthy?" The first guy – he's got these really simple, concrete rules for identifying sick and healthy cells, and they make sense. You can train any reasonably intelligent person to make these determinations for the vast majority of cells. The second guy has these really elaborate, amorphous, complex, complicated rules for identifying this stuff because he's not getting the right feedback.
So I sort of think something like that is happening in the market. When you pump in a whole lot of money, either fiscally or monetarily, you destroy the information in the market. And so guys who have been previously trained on this, have reasonably concrete rules for making these decisions, all of a sudden it becomes hard for them to make decisions and so they come up with increasingly elaborate reasons for why what they're doing's not working. It's probably just because the price signal has been destroyed by central banking.
It happens periodically though. So, Cliff Asness at AQR has done a study where he looks at – let's assume that we can give a program some – the forward earnings from a year in the future. So it's explicitly cheating. We're saying we're going to make this system cheat. Because what we're trying to figure out is how closely the price tracks the forward earnings. And so what you find is that, as you can imagine, over the vast majority of the years in which you do this, you get spectacular results. Because if you can see the future, find out what the earnings are going to be in the future, I'm going to heavily buy those things that are going to go up and I'm going to not buy those things, or short those things, that are going down.
And the years when that doesn't work are '99 and 2000. In those years it actually hurt you. It was inverted. If you were using those forward earnings estimates in '99 and 2000, you did worse than someone who was basically reversing the decision. The only other time where that's happened in the data is 2019 and 2020. So I think we're in this very odd period of time where, if you rely on fundamentals like a lot of value guys do, looking at what's going on under the hood, your price information's being destroyed by central banking and there's a little bit of a boom bubble going on. And the fundamentals have been reversed. Happens regularly in the data. Happens for short-ish periods of time, two or three years, and then it goes back to where it was. So I think it'll go back to where it was eventually.
Dan Ferris: Makes sense to me, man. You know, you remind me, talking about market signals, of another Australian guy named Daniel Want, whose letters I like to read. They're at a firm called Prerequisite Capital. And their latest letter that landed in my inbox not too long ago – he starts out talking about the exact same thing, about how market signals can become confused, and that the whole apparatus of monetary fiscal regulatory policy has been focused on disengaging market mechanisms. And he says: when market mechanisms are unable to do their job, basically, counterbalance and address the issues in the financial system and in the business world, then the political mechanisms take over. And he says this is why we have civil unrest and populist politics. And other developments.
Tobias Carlisle: Well, he sounds like a very intelligent man.
Dan Ferris: [Laughs]. That's right. He's another smart Australian guy. He's a smart guy. But I have to say: in our annual conference, which we had to hold virtually this year a couple weeks ago, Porter Stansberry was talking about a very similar thing. Basically the ongoing degradation of the currency doesn't just screw up market mechanisms, it kind of screws up our whole lives. But we bottom-up value guys – we tend not to focus on these issues, don't we? We tend to think more about company fundamentals and other bottom-up type considerations. Do you think that's a mistake? Where does the macro come in for you?
Tobias Carlisle: It's not a mistake at all. And the reason is – I think it's a point of some confusion for other folks when value guys say, "I don't pay attention to macro." They just think you're a lunatic. Like how could you not pay attention to macro? The only reason that you don't pay attention to macro is: it's impossible to forecast. There's just no one out there who can do it consistently. George Soros maybe. Stanley Druckenmiller maybe. But it's not that it's not important. It is extremely important. It's that it's not forecastable. It's not predictable.
And I forget who said it but it's so hard to figure out – because there's political dimensions to what central banks do. They're not rational actors. There are political dimensions to what governments do. They're not rational actors either. You have to sort of figure out this long daisy chain of sequences for why they might do or not do something. And then at the end of that sequence you have to come up with the decision for what you're going to do. I just think it's too hard to do that.
So instead what I do is I just focus on: this company that I'm looking at right now. It pays a little dividend, it's got some yield, and it's got some growth, and it looks like it's reinvesting at – it's earning more on its reinvested money than we can get certainly from any bank account anywhere. And probably it's better than most of the companies that we might look at. So it's good that it reinvests. It's going to grow at a pretty good rate, and the market should reward it for its reinvestment at this rate. Eventually. Not necessarily now.
And so with those two things, the yield and the growth, I can see what the future for this company could potentially look like over the next, say three-to-five years. I've got some rough idea what it's going to do over that period of time. Now, I could be wrong, but I think that that's a much easier kind of decision to make: will the next three-to-five years look roughly like the last three-to-five years? And if they will then I'll do okay. In the interim, what do I care what multiple the market puts on those earnings? I don't. Because I've already figured out what my return is likely to be. I've got my yield and I've got what I think the growth is worth for this business.
And so when you think about what a market price is, it's just the marginal seller and the marginal buyer getting together at some price. And they might be a forced seller. They might be an index buyer. There's lots of rational and irrational reasons for buying and selling. So I take advantage of the irrational ones. If the price gets too low because there's a forced seller – or it might not even be a forced seller. It might just be – this happens all the time. I haven't seen this recently, but sort of over the last decade, first five years of the last decade particularly, there were a lot of companies around that were absolutely spectacular businesses that ran up so high in the 1990s that the valuation just got so far ahead of them that they did nothing for a decade.
And so folks would just say, "This company's just dead money. It doesn't do anything." But really what's been happening is the underlying business didn't change at all. The underlying business was still a phenomenal business. It was still growing very rapidly, maintaining its high returns on invested capital. It's just that it took it 10 years to work off the overvaluation.
And so I would find these things. And there's no volatility in the options because they haven't done anything for a decade. It's massively undervalued because the underlying business is so good that it's worked off that overvaluation that it had in say 2000 and it's now become a cheap company. And so that's an ideal kind of company to find. It really is a spectacular business underneath the hood but it's available cheaply. Not because of any forced selling – just because people get bored and it hasn't done anything for a long time. A lot of people on the market are just action junkies. They're like Robinhood traders; they just want something to happen.
So I hunt around for these kind of things that I can estimate what the return is going to be over the next three-to-five years. I don't have to worry really about the macro picture unless it influences that company. But then that would be a negative for that company. If it got a commodity input that I can't guess at where it's going to be, or it's got a commodity output that I can't guess where it's going to be, or it's heavily influenced by interest rates or something like that. Those are going to be too hard for the most part. So that's sort of my attitude to macro: I don't ignore it because it's not important – I ignore it because I can't do anything with the information.
Dan Ferris: That answer resonates with me because there's an echo of Warren Buffett in there, right? Because he has commented on this many times. He says, "Well, the best way we handle inflation is by buying good businesses. Because if you're getting 20, 30% returns on the capital that you invest, then you just want to keep your money in the equity of that business and let it compound over time at these higher rates. And let the market do what it will in the short term with the stock price. That result that you get, which is" – it's similar to what you described – the market will eventually have to recognize that something great is happening there and the return will beat what most of us think of as the likely nearer-term outcomes for inflation. So I feel you on this. I do.
Tobias Carlisle: I appreciate that. Naturally, I'm a huge fan of Buffett's because I read his letters – that's how I became a value investor. And then I went and read Security Analysis. That was very rough. That was like eating gravel to get through that one. But the letters really taught me more than anything else.
I have to say that I diverge slightly from Buffett. So I manage two funds. I've got ZIG – that's the ticker –
Dan Ferris: I knew you would say that.
Tobias Carlisle: [Laughs]. That's a long-short value fund but it's a deep value fund. And I manage another one that has been a large cap but is going to be small and micro on Monday, October 26, and that's DEEP, D-E-E-P. The strategy in both is the same. It's just, DEEP is small and micro and ZIG is large cap long-short. The approach that I take is this deep value approach. And the difference between what Buffett does and what I do is that Buffett says he likes wonderful companies at fair prices. I actually don't think that's actually what Buffett does. I think what Buffett likes his wonderful companies at wonderful prices.
And I have to sort of distinguish myself a little bit from what he does. So I tend to like fair companies at wonderful prices. And I hope that in my fair companies I get some things that eventually turn out to be wonderful companies. But the idea is this: I want to buy something that has a great balance sheet, generates lots of cash flow, and it's undervalued and management is doing the right thing, which means that they're buying back stock. You notice that in that I haven't had – there's no sort of requirement that it is what Buffett would call a wonderful business. And the reason for that is I've done a lot of – so my first book is Quantitative Value, came out in 2012. Did some research with a gentleman from the Booth School of Business who was doing his PhD.
We went and found everybody of industry and academic research we could find and tested, and we had some stuff that was from the 1920s, some ideas from the 1920s about finding credit risk in manufacturing companies and stuff that had – as we'd gone along, identifying frauds, identifying distress, identifying good businesses, identifying cheap businesses, all these sort of things. And we tested those ideas again to see: were they originally the product of data mining? Were they just sort of a fluke in the data? If you test data enough, you're going to find some false positives in there. And we found all the stuff that had continued to work. And we built it into a model.
And the idea is that it buys these things that are undervalued but may potentially have some mean reversion in the underlying business. So the business might look more beaten up than it actually is. And it's just at a cyclical low. Every business – most businesses, not every business – about 4% percent of businesses don't have a cycle. They sort of seem to be able to avoid the cycle. But 96% of businesses do tend to cycle. And they offer incredible returns if you can buy them at the bottom of their business cycle at a depressed valuation.
So that's basically what I'm trying to do. They're not Buffett's wonderful companies. Buffett's only trying to buy the 4%. I'm trying to buy, in the 96%, stuff that's cheap and beaten up. And I'm hoping that, as there's a recovery in the business and there's also a removal of the discount in the price, that we'll get a good return that way.
Dan Ferris: There was a question that I wanted to ask you about because there's a article by this guy John Authers who writes for Bloomberg. I don't know if you read him every now and then. And he was writing about value and citing a bunch of fairly recent studies like the folks from Research Affiliates and Andrew Lapthorne from SocGen. And he pointed out that Lapthorne's study indicated that value, he says, correlates very well, negatively, with the 10-year Treasury. And I thought: that's kind of interesting to me because in general we've seen negative correlation of all equities and treasuries basically in the era of the central bank in the past two decades.
So for Lapthorne to kind of dig in and point out, "Well, the real issue is the value" – he says it's the only major equity style negatively correlated with 10-year bonds. And I thought: that's kind of interesting because he's actually trying to say that if you want to hedge against a turnaround in the bond market – if you think interest rates are going to go up that you ought to buy the cheapest stocks in the market. Does that sound right to you?
Tobias Carlisle: Earlier I was saying that everybody's reaching around for the different explanations and this is another one of the explanations. I find this one very compelling, very appealing. I understand though that there's not a lot of – the difficulty is that the old causation/correlation conundrum. So, AQR, Cliff Asness' shop, have done some research looking at the interest rates and value. Because everybody's trying to figure out: why's value not working? What's happened here? [Are] its interest rates pinned too low? So the theory is – you've got two types of stocks, right? You've got value stocks, which are basically cheap against their cash flows. Now they've got big cash flow yields.
And then you have growth stocks, which don't earn much now but presumably will earn more in the future. So all of their cash flows are back-end loaded. Value cash flows are front-end loaded. You're getting them right now. Growth cash flows are back-end loaded. You might have to wait 20 or 30 years to get them. So if you're familiar with the bond market, the 10-year, or the nearer-term, treasuries tend to be less sensitive to interest rates than the 30-year. So it sort of makes a little bit of intuitive sense. Interest rates that are – if you have to hold a bond for 30 years, any small movement in interest rate has an outsized movement on the 30-year. Nearer-term bonds have less of a sensitivity to interest rates.
So basically what that means is: if you think about the growth stock as a 30-year and the value stock as a nearer-term treasury – so the 10-year – they're less sensitive to movements in interest rates. So what we have seen, as interest rates have been going down very rapidly, is the 30-year, the growth stocks, have been exploding up. And value stocks, which are closer to maturity, because they're already getting the cash flows, have been less sensitive but they've been at the other end of that. They've been suffering as a result of the interest rates going down. And the idea is that if that reverses then the growth stocks are going to get beaten up along with the 30-year when interest rates go up. And value stocks, which are nearer-term, will do better. That's the duration argument.
The problem with it is: there are lots of different ways of assessing interest rates. We can just look at the yield on different maturities or we can look at the term structure, which is the shape of: what is the 10-year relative to the 30-year, and the 10-year relative to the 1-year T-Bill? Or something like that? So that shape of that curve is another thing – is that curve very steep? Is that curve very flat? There are lots of different ways of thinking about interest rates.
And so what AQR did is they said, "Let's not pick any one. Let's just brute force every single permutation of this that we can think of. Let's look at near-term interest rates, long-term interest rates, the shape of the curve, changes in the shape of the curve, changes in interest rates." And then they back tested that against value and growth stocks. And they were unable to find a relationship. So it's a difficult thing where I find the idea of it really compelling – I just can't see logically how it's not the case that an increase in interest rates should help. And I've noticed it. I watched the 10-year. I've watched it as it's crept back up. Value stocks have started doing a little bit better. It's very appealing to me. Intuitively, I love the story. The problem is that I have to respect the fact that there's this paper out there by AQR, who are very smart guys, that seems to show that there's no relationship.
So that's kind of where I am. Basically I'm confused but hopeful.
Dan Ferris: Right. And I believe there's an intuitive sense to it too. Because we have seen evidence from some of these papers – and, again, it's intuitive: the value stocks really get beat up in a really bad economy, a really bad recession. So it would make sense that if the economy is kind of heating up enough to push the demand for money and the interest rates back up that the value stocks would respond rather disproportionately given how badly beat up they are at the moment, right?
Tobias Carlisle: And when you look at the growth stocks, they tend to need to be financed too by the market. So they're still raising capital all the time. So they're reliant on the market being open for capital raising. Whereas value stocks tend to be self-financed, so they're not relying on that. So they should do better in a worse economy.
Dan Ferris: That's a great point. A lot of these things: they're growing revenues like crazy but they're not making any money. They're eating up cash. They need to finance. Yeah. Excellent point.
I kind of wanted to go back though and talk about this fund that you're taking over, DEEP, D-E-E-P. The holdings right now that I just pulled up real quick on my screen – the thing owns Best Buy and AmerisourceBergen, pharmaceutical distributor, HP, BorgWarner, Allstate. That ain't gonna look that way when you get done with it, right?
Tobias Carlisle: No. We've been managing it since June. So that long portfolio there is very similar to what you'll find in ZIG. Because that's a larger-cap portfolio. When we took it over it was a large-cap ETF. But we took it over explicitly with the intention of making it a small and micro ETF for the reason that small and micro value is so beaten up. It's been a decade or more of just having the stuffing taken out of it. And it's really hard for small and micro-value strategy – small and micro-value managers to even have survived this period of time. So there's really not that many small and micro funds available. What they tend to be is they're index-type funds where they've got hundreds and hundreds of holdings.
What we are doing – it's just like any managed account. We're just going to be wrapping it in an ETF. It's what I think are the best opportunities in small and micro in the U.S. And as I go through the names – I know what names are going to be in there because that's already been handed over and that'll be traded in on Friday, available on Monday, 26. I know what names are going in there now. I'm astonished at the names that have fallen into the small and micro basket. Because what has happened with value – it's been so beaten up. They've all shrunk.
So all these companies that – I used to think of these companies as being pretty big enterprises. And now they haven't gone anywhere for 10 years – the market's grown around them. In some cases they've shrunk. And they're very high-quality names that have fallen into the small and micro-value bucket. And so I'm more than happy to be the one who scoops them up. And I think if you look at – just going back to the way that I was thinking about valuation before, if you look at the yield, which is dividend and buyback, and the growth, which is basically what they're earning on what they've got invested in them, and project that forward, I think that small and micro value and large-cap value are now primed to deliver better returns whether they get the multiple rerating or not.
So we don't need the market to recognize how good these businesses are. We're at a point now where the yield is so good and the growth is so good that even if they stay depressed at these multiples, they're still going to deliver better returns in the market. I realize that's a very bold call but I think that, over a period of three-to-five years, that will become obvious that that is the case.
And then, of course once that becomes obvious, then you get the multiple expansion as well. But they're now so compressed, they're so beaten up that it's not going to require multiple expansion for them to work.
Dan Ferris: That's really cool. You know, you pointed out that basically the small and value managers – many of them have disappeared and gotten just too badly beaten up to stay in business. How are you still around? You remind me of people I know in the equity business who manage gold and mining equities who are still around. And I know how they did it. They ran their balance sheets 10 times better than other people. How are you still around?
Tobias Carlisle: [Laughs]. Well, I'm a value guy to the absolute core. And that just means that I try to keep my own personal expenses low. Which, I've got to say it's tough. I live in California and I've got three kids. It's not easy. But it's achievable. I live the philosophy. We're reasonably frugal. I've got a little business. And I don't have any great needs. I get all of my – the fun for me – my avocation is value. My hobby is value as well as it being my day job. So it's easy to sort of do both. Having said that, a tailwind for value would be very welcome. It's been a rough decade running value with everything going backwards. It would be much easier if I had the tailwind behind me.
Dan Ferris: Yeah. I'll tell you: if I could just get the hurricane I'm walking into to stop, that'd be a great start.
Tobias Carlisle: That's it. That's all I need. I'm sick of tacking into the wind. I want it behind me. I want to put up the spinnaker and then I want to show everybody what it can do.
Dan Ferris: That's right. Well, we're coming to the end of our time, which I even hate saying it because I feel like I could just talk to you for a couple hours. It's really a pleasure. But I'm going to ask you what I ask all my guests. If you could leave our listeners with just one idea – and since you're a value guy, maybe I'll ask you to see if you can make it an upbeat idea [laughs]. If you could leave our listeners with just one idea today, what would that be?
Tobias Carlisle: An investment idea or sort of a philosophical idea?
Dan Ferris: Your choice. Either one.
Tobias Carlisle: Let me do both. The funds that I manage are ZIG – that's the ticker: Z-I-G, you can just buy it from your brokerage account – and DEEP, D-E-E-P. One is a large-cap long-short. The other one is small and micro. Of course, I'm going to talk my book and suggest those ones.
The other thing that I would like to suggest is value as a philosophy. The reason that I think that value is a good philosophy: it's an evergreen philosophy. Most years it does work. But it has gone through this very long period of underperformance. It's worth understanding why that is. It probably got too expensive. It was very popular in the early 2000s. Most value stocks paradoxically got more expensive than what you'd call growth stocks between sort of 2010 and 2015. And that's why we've seen the bad performance over the last sort of three-to-five years.
We're now at a stage where it's so compressed, it's so beaten up, and the businesses that are in there are still pretty good businesses – in many cases they're much, much better than the stuff that's getting very high multiples. They're now at a point where, as I was just saying – this is the really mind-bending thing I think – the dividend yield and the underlying growth are now so much better than the market and the growth-y stocks that you're going to get better growth out of the value stocks, whether the multiple rerates or not. It does not require multiple rerate. They don't need to get more expensive. They just need to keep on doing what they've been doing.
As a value guy – that's sort of why I'm a value investor – because I like buying things where it doesn't really matter to me what the market does. I buy them, I can see the return I'm going to get, and I'm comfortable with the return I'm going to get. And right at the moment it's going to be better than the market whether the multiple rerates or not.
What I think is likely to happen though is that the multiple is going to rerate – upmarket multiple is going to rerate down, and they're going to massively outperform. But it doesn't require any of that multiple movement for that to happen.
Dan Ferris: Nice. Wow. I like the sound of that. All right, man. It's great to talk to you. And we're going to be checking in with you again in the next 6 or 12 months or something. And I hope you'll come back and talk with us.
Tobias Carlisle: I hope so. It's always a pleasure chatting to the great Dan Ferris. So I'd love to come back. Thanks so much, Dan.
Dan Ferris: All right, Toby. Thanks a lot. All right. Listen, Toby and I are like brothers from another mother and I just love talking with him. And I love just hearing him talk. It's almost like a pep talk for value. But it's not just a pep talk. It's obviously – as you just heard, it's based on lots and lots of research and deep understanding of just the whole proposition of investing in equities, period, let alone the proposition of being a value investor. And I love what he had to say at the end there about how counterintuitive – it's crazy, you wouldn't expect it, but just from a growth perspective, value looks better than growth today. It's crazy, isn't it? I think I actually did know that, but I didn't expect him to say that. Really great answer. All right. Let's look at the mail bag.
Hey, guys. I get a lot of e-mails asking, "What happened to Buck Sexton?" Well, Buck Sexton is not on the podcast anymore but he's doing a lot of other things. And you know he's a former CIA guy and he knows all the ins and outs of what's going on in Washington, DC. And he's written a brand-new book called The Socialism Survival Guide to help investors and other people navigate the political trends, the disturbing political trends that we've talked about on the podcast fairly recently that're ongoing today in our country. And Stansberry Research wants to give you a free digital copy of this book. Yeah. Free. Buck Sexton's new book, free of charge. I kind of had to do a double take when I heard it myself.
And to get it you just go to www.InvestorHourBook.com. You don't need a credit card or a subscription or anything. Just get a free copy of the book by going to www.InvestorHourBook.com. That's Buck Sexton's brand-new book, The Socialism Survival Guide. Check it out.
In the mail bag each week you and I have an honest conversation about investing or whatever is on your mind. You send your questions, comments, and politely-worded criticisms to me at [email protected], and I read every word of every e-mail you send me and I respond to as many as possible each week.
Mail bag was a little light this week. I don't know what's going on out there. Maybe you're watching too much election news or something. The first one though is a question from Charles B. about THC. And I e-mailed Tom Carroll, our guest from last week, our cannabis guru at Stansberry, and he sent me a really thoughtful answer to this that I'm just going to read exactly as he sent it to me.
So here's the question from Charles B. He says, "Hi, Dan. You're doing a great job of presenting interesting and potentially profitable themes to your listeners. Some comments on cannabis. I think THC will be legalized in the U.S. very soon. I also agree that big pharma does not oppose the legalization. But do you know that THC can be made synthetically? Big advantage is consistent and uniform quality. Pharma have the resources and technology to make it very cheaply. The feds will love it because far fewer producers to regulate. Farmers are likely to be a small part of the market. Some consumers will want to buy the natural product. Your thoughts? Regards, Charles B."
Okay. Now here's Tom Carroll's response. Tom Carroll says, "Excellent question. Yes, I'm aware that cannabis compounds are being created in the lab, so to speak. I was just talking about this on a board call with the senior management of a private cannabis company I am personally invested in. A handful of firms are trying to perfect this. Probably most well-known in cannabis is Cronos, ticker symbol CRON, a Canadian cannabis company. It is working with a firm called Ginkgo Bioworks on this exact thing. They've been working on it for over a year. This will happen and it will eventually happen at scale. And pharma will dominate it. Isolating specific compounds is what pharma and biotech do to build medicine.
"However, it might be harder to make the transition when it comes to consumers and personal taste. My current opinion," Tom says, "is that there won't be a rapid move to synthetic cannabinoids in the consumer world. People won't want synthetic cannabis any more than people want synthetic wine or synthetic beer. Moreover, there is something called the entourage effect. This refers to many cannabinoids interacting in a specific way to produce a specific effect. That may not be replicated in the lab. We just don't know yet.
"In my view, a bigger competitive threat is cannabis grown in South America, Colombia in particular. The light and weather conditions are perfect for growing a plant like cannabis or hemp. And labor costs are minimal. There are some players that already have a toehold there. Once the U.S. opens up, this biomass may begin to come into the U.S. at a fraction of the cost of current indoor grow facilities in the U.S. Stay tuned for my favorite one of these companies. I will be recommending it soon. - Tom Carroll."
Thank you, Tom. And I'm going to let that answer stand on its own because I certainly don't know as much about it as Tom.
Next comes Greg S. Greg says, "Hi, Dan. Long-time listener, first-time writer. I really enjoy listening to you every week. While I agree with the potential growth in good cannabis company stocks, especially in the long term, until it's legal on the federal level, folks who have a security clearance shouldn't or can't own these stocks right now. We've been told by the security folks that people who hold security clearances cannot have any association with illegal drugs. Owning these stocks can put your clearance in jeopardy. Thanks again for your show. - Greg S."
I just included that because I thought it was interesting. People with security clearance is not something I ever think about. And you can see: there's all kinds of ramifications for legality at the state level but still the illegality at the federal level. And once that gets cleared up, I bet there are probably implications that nobody is even talking about right now that will develop and that will be made very clear after cannabis is made legal – marijuana or whatever they call it in the laws is made legal at the federal level. And I think after the election, that process starts cooking along. Because candidates don't have to worry about campaigning anymore.
Okay. Next is Mike K. Just a quick comment here from Mike K. He says, "Hi, Dan. Totally agree on comments of the Fed and big banks. There's definitely collusion. To keep it short, I would love to see a debate with you and Jamie Dimon with the subject of him being a criminal. No mute buttons allowed. Thanks, Mike K." We're going to get right on that, Mike. We'll contact Jamie Dimon's people this week [laughing]. I'm sure he'll be thrilled to go on some podcast he's never heard of and talk to some guy he doesn't care about who called him a criminal in public with a straight face [laughs]. Good suggestion. I wish we could actually do it.
And you know something? I would listen to him. If I actually spoke to him, I would listen. I would say, "Jamie, this looks really bad on you. It looks criminal to me. And I'd explain my position as I did before. And he'd probably chuckle and say, "Oh, Dan, I'm still a billionaire, you putz."
So last question this week is Mark S. Mark S. is a regular correspondent and I interact with him on Twitter quite a bit. Very thoughtful guy. Mark S.: "Hi, Dan. I could hear your hesitation when you read the word taxes in my note in last week's podcast. I wrote that because some MMT folks I've listened to seem to believe that taxes should be used as a way to prevent inflation, not to pay for government, which is backwards. I've been thinking on this more. I can see the logic in this argument but obviously it is also fraught with risk. If the government can use taxes to suck up excess cash from general circulation, that gives the government a lot of power to decide who is taxed more and who is taxed less. They get to pick the winners and losers. Let's just hope you are not a loser.
"Also, when does the government stop taxing? Would they actually get the right level? They set tax rates once a year and then let the economy run for a year. A lot can go wrong in that time. And will the changes to taxes actually fix it?" By that I think he means actually fix inflation. He continues: "Can both parties even agree on what the right path is with taxes to control inflation? It all sounds like a crock," Mark S. says.
And he finishes up: "Better to have the government stick with living within their means, keeping debt at reasonable levels and keeping the government small enough that it stays out of our way so we can get to work building products and services that will enhance our lives, create jobs, and build our wealth the real way, without fear of some bureaucrat destroying everything by fiddling with the money system. Best, Mark S."
Preach it, brother. You are so right. And the whole idea that these jackasses in Washington are smart enough to stand there on top of the whole economy pulling these two levers – "Oh, we just need a little bit more taxes. Oh, a little bit less taxes. Oh, a little bit more money printing. A lot more money printing. A lot more taxes." Not to mention the god-awful effect that it would have on humanity, on our souls when the government came out and said, "Hey, inflation's getting out of control – we need to raise the income tax to 50% for everybody" or something like that. It's ridiculous. Anyone who trusts these people – anyone who thinks MMT would work – they've got a lot of hard work to do to convince me that it's not, like you say, Mark, a total crock. You are spot on. I totally agree. Thank you for writing in. Yes, yes, yes, Mark. You're right. I agree.
All right. That's the mail bag and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as I did, especially Mark S's e-mail. 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. You can also follow us on Facebook and Instagram. Our handle is @InvestorHour. Also follow us on Twitter where our handle is @Investor_Hour. If you have a guest you want me to interview, drop us a note at [email protected] Till next week, I'm Dan Ferris. Thanks for listening.
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