This week, Dan brings a fresh voice to the show: seasoned value investor Gary Mishuris.
Gary is currently the managing partner and chief investment officer of Silver Ring Value Partners, an investment firm that focuses on long-term intrinsic value investing. He has more than two decades of portfolio and asset-management experience plus degrees in computer science and economics from the Massachusetts Institute of Technology ("MIT")... which is where he received the advice that shaped his career.
Gary used to make rookie investor mistakes – like losing his shirt after putting all his money into a hot stock that tanked. But when Warren Buffett came to speak at Gary's alma mater, his words put the ambitious young man on a path to learn value investing instead of "gambling around with tech stocks."
Today, Gary has his own priceless advice to share with our listeners, such as keeping a well-diversified and allocated portfolio. He warns against blindly chasing the price action and stubbornly allocating half of one's portfolio to the biggest position...
I would say the goal there is to make sure that no one position can really sink the ship... It's good to have conviction, but you need to make sure that your process over time – which drives the outcome – is not in any one position.
But having conviction isn't entirely a terrible thing. As he explains, it's all about maintaining the "delicate balance"...
You have to be sufficiently flexible to adjust to the reality of the changes but have sufficient conviction... [so] you don't fall to the market's pressure.
During their conversation, Dan and Gary delve deep into the common psychological pitfalls that can come with investing. Gary also discusses the importance of exercising caution by playing "behavioral defense" amid a sea of folks who too often rely on "behavioral offense." He even shares his proprietary "thesis tracker" – a unique way to evaluate the performance of every investment in your portfolio.
Finally, Gary leaves us with the No. 1 trait he says every investor should have: humility...
You want to be humble in this business... Base your approach on humility and then work really hard from a position that you can be wrong a lot, and then build that being wrong into everything.
CEO of Silver Ring Value Partners
Gary Mishuris is the managing partner and chief investment officer of Silver Ring Value Partners, an investment firm with a concentrated long-term intrinsic value strategy.
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 Gary Mishuris. Gary is a value investor. I see him once a year, we have a great time together, he's a very thoughtful investor, can't wait for you to meet him. In the mailbag today, gold, gold, and more gold... plus, a longtime listener rants back. And remember, you can call our listener feedback line at 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my opening rant this week, investors are too comfortable. I know it sounds crazy, but we'll talk about that and more, right now, on the Stansberry Investor Hour.
"So we're in a bear market, and Dan is saying that investors are too comfortable." Like how could that possibly be, right? With stocks down, bonds down, inflation up, how could it be that investors are too comfortable, too complacent, not concerned enough? That's usually the sort of thing you say at the top when stocks are trading for exorbitant multiples and bonds are at 0.5% in a 10-year bond. Here's why I say this. I found an indicator, a statistic that – it's an indicator that was created in the 1990s by Jeremy Grantham and Ben Inker. Jeremy Grantham is one of the co-founders of a firm called GMO, and you can go online at GMO and read their research. They had a little piece about this indicator, and it's called the Comfort Model.
It's just a way of looking at price-to-earnings ratios of the overall stock market, and it tells you how comfortable investors are with current market conditions. And then you can sort of extrapolate and say, "Well, should they be this comfortable or shouldn't they?" And if you read their little article on the Comfort Model, they sort of explain it to you. They say the model is based on the simple premise that the conditions which make investors comfortable are high profits, stable economic growth, and inflation of around 2%. So the higher the profits, they say, the more stable the economic growth. And the closer inflation is to 2%, the more comfortable investors are. With greater comfort, investors are more likely to pay a higher multiple on the market and vice versa. So when they're less comfortable, they're only willing to pay a lower P/E for stocks, right? Now, it's important to note that they're using the cyclically adjusted P/E ratio of the S&P 500. It's called the CAPE ratio, and it's adjusted for inflation among other things.
So the point at this moment in history is that today's reading on the GMO Comfort Model just suggests that investors are too comfortable, like they should not be willing to pay a CAPE ratio of 30 times – or 29 or 30 times is where it is these days. They should, according to GMO's reading of their model, the current conditions like profits are down, economic stability is not great, and inflation is 9%, not 2%. Those should not be comfortable conditions, and according to them, investors shouldn't be paying more than 19 times CAPE ratio for the S&P 500 but they're willing to pay 29, 30 times. So they're still too complacent. Like we've had this brutal record-breaking first half – literally the worst – well, worst first half for the S&P 500 Index since 1970 but the worst first half – the worst six months for the 10-year U.S. Treasury since 1788. Not kidding. You know, it's been horrendous.
And you know, of course some people, they want to point to the popular sentiment indicators. The AAII, the American Association of Individual Investors, is one of them. That's one of the popular ones, but that's a sentiment survey. They're just asking people how they feel. "Are you bearish, are you bullish?" And of course, they're more bearish now. They're more-than-average bearish now, and they're less-than-average bullish. So people say, "Wow, people are scared." And if you look at the – who is it? I guess CNN has that Fear & Greed indicator. It's in the fear mode, right? So a contrarian would look at all this and say, "Well, investors are fearful. Stocks must be cheap, let's buy them." I think that's too glib. I also think the sentiment indicators are too volatile. They're relatively worthless most of the time. I've looked at them and looked at them and watched them over the years, and I've quoted them, and I've offered them as contrarian evidence, and it just never seems to work out. They're just not that great. Every now and then, I'll see a really, really serious extreme, but other than that, I stopped following them like last year. I just don't look at them anymore.
But this Comfort Model is different because it's based on the price-to-earnings ratio of the market. So it's how much people are willing to pay for stocks. That means a lot more to me. That's in the market. That's not just what somebody says in response to a survey. It's what they're doing with real money, right? So that means a lot more to me, and I think it's true. I think people are too comfortable and complacent. And a recent thing I saw that sort of backed this viewpoint up is that the CEO of the National Association of Home Builders went on TV. His last name's Howard. I think it's Jerry Howard. And he was talking about the simple fact that housing is one of the best leading indicators, and he didn't say that, but he said housing has led us into every recession since World War II, and it's led us out of every recession since World War II. So it has been a pretty powerful leading indicator of recession, and you know, the prices are starting to fall, and he cited a bunch of statistics that say unless something changes, we are headed into a recession, basically. That's what housing is telling the National Association of Home Builders CEO these days.
So you know, I think that if investors are willing to pay a lot, we're headed into a recession... interest rates are up, inflation is up. I mean, maybe I'm just being too simple-minded about all this because everybody knows housing is the leading indicator, and everybody knows about inflation and everybody knows all the things I'm telling you. The only thing I would say everybody doesn't know is that stocks aren't really cheap. I think a lot of people think they are cheap, and I don't think they are. So, you know, be careful.
I wrote about all this in my latest Stansberry Digest if you're a Stansberry subscriber. It was the first part of my Stansberry Digest, and then I went on to talk about a bunch of stuff that maybe we'll talk about next week that's a lot more complicated. But just put this thought in your mind and keep it there. I think investors really are too complacent right now, they're paying too much still. The CAPE ratio, it peaked three times before three enormous bubbles in the last century – 1929, 2000, 2007. And it's now just back down to the third-highest one, 1929. And I don't think the fact that 1929 is nearly 100 years ago is a problem. Some people say, "Ah, you can't compare that market to today." I think you can. I think you can compare all the massive bubbles to one another because we go into them, everybody's optimistic, they run stocks up to unseen heights, and then they plunge and we get a bear market of two years. Well, put it this way, we've never come out of a massive bubble with a little six-month 20%, 30% drawdown like we've seen in the S&P 500 and Nasdaq. I've said that before. I'll say it again and again and again until the message comes across, but you know, I don't think this is half over, and I think we need to be real, real careful about what we're buying nowadays.
I'm going to leave it right there, and I'm really, really excited about this week's guest. I've known him for years but I'm finally getting him on the show. Let's talk with Gary Mishuris. Let's do it right now.
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It's time, once again, for our interview. Today's guest is Gary Mishuris. Gary is the managing partner and chief investment officer of Silver Ring Value Partners, an investment firm with a concentrated long-term intrinsic value strategy. Prior to founding the firm in 2016, Mr. Mishuris was a managing director at Manulife Asset Management, where he was the lead portfolio manager of the U.S. Focused Value strategy. From 2004 through 2010, Mr. Mishuris was a vice president at Evergreen Investments, where he started as an equity analyst and assumed roles with increasing responsibilities. He received an S.B. in computer sciences and an S.B. in economics from the Massachusetts Institute of Technology. Wow, I didn't know you went to MIT. That's cool. Maybe we'll talk. Gary, welcome to the show.
Gary Mishuris: Well, thank you so much for having me. I really appreciate it.
Dan Ferris: So, you went to MIT?
Gary Mishuris: I did. I did. I really enjoyed it.
Dan Ferris: Oh you bet, you bet. So I mean, does one study, you know, value investing and economics at MIT, or what did you study there?
Gary Mishuris: Yeah. No, I think MIT is actually another end of the spectrum. It's quite quantitative. I think what I learned from MIT is very rigorous systems-level thinking because as an engineer, you can't wing it. As a fundamental value investor, you can make whatever you want up and time will tell, but if you don't do it right, your code will not compile and the program will not run. So you have to do it systematically and rigorously... Otherwise, it just won't work.
Dan Ferris: All right. Yeah, we've had a few folks on the show who started out in scientific disciplines and said much the same. It's the rigor and the fact that, as you say, in the sciences, things either work or they don't... and there's a lot more leeway in finance. So how did you make your way to finance from MIT?
Gary Mishuris: Sure. So you know, I was – this was during the tech bubble in that circa 1999, and I was dabbling in tech stocks, thinking, "Oh, I'm smart... I'm studying economics and computer science and I can figure it out." And I think I was lucky to have invested my meager savings in the only tech stock in that period that went down. And I say that because had I actually made money together with 99.99% of other people, I would have gotten the wrong lesson that you do no work but you guess a little bit, and you get a lot of money. And then right around that time, Warren Buffett came and spoke on campus at the Sloan School of Management, and I'd heard the name. I didn't know much about him. And he wasn't in favor back then. You know, 1999 wasn't his peak year of popularity, let's just say. And so I went to listen to him speak, and here was a guy talking about long-term intrinsic value, competitive advantage, and stuff that's second nature now but back then was kind of new. It immediately took, and I stopped fooling around and gambling in tech stocks, and I started reading about value investing. That was kind of the origin story, if you will, of my passion for investing.
Dan Ferris: OK, so let's fast-forward to 2016, and now you've founded your own value-investing fund. How big of an organization is it? Is it just you? Are you a solo guy, or do you employ a large staff, or somewhere in-between?
Gary Mishuris: You are looking at the organization right now. I'm right here, it's me. I do have an outsourced CFO for like administrative, operations stuff. I have some remote interns that help me out occasionally, but I've never set out – look, I started my career at Fidelity, I worked at very large firms, and I've just come to the conclusion that for me and the way I practice concentrated value investing, I don't want a big team. There are pros and cons. We can get into it, but what I realize is these committees or these kind of hiring the Harvard MBA who wants to make decisions three years out of business school, never seeing a down cycle... that is not to me the best way to manage money. So given what I do, I don't envision there's going to be much of a team. Maybe a couple of junior analysts down the road, but I believe that this fits very well with my approach.
Dan Ferris: All right. It sounds like you found your spot. How concentrated are we talking here? Let's get into it a little bit.
Gary Mishuris: Yeah, so I would say 10 to 15 positions would be typical. My position size ranges from 5% for a small position, 10% for a medium, and then 15% for a large position. I would say that ladder sizing is unusual. Like a lot of things need to line up, not just valuation. It would need to be business quality and people quality as well, and balance-sheet quality. So I would say the goal there is to make sure that no one decision can really sink the ship. And I know there are people who disagree and they say, "Ah, a dozen investments, that's not that concentrated. I have half my portfolio in my biggest position because I have conviction." Well, I've been humbled many times. I've done this for over two decades, and I've always seen people – it's good to have conviction, but you also need to make sure that your process over time – which drives the outcome – is not in any one position, which, no matter how good you are, you're going to get it wrong some of the time.
Dan Ferris: Yeah. Yeah, when I hear that, I do cringe a little bit when people say they've got half or even like 25%, 30%. I just start thinking, "Man." I'm thinking about a particular fellow whose name I won't mention but, you know, it was some massive position in an oil and gas stock when oil prices were way up. Of course he blew up and had to liquidate and everything, but it doesn't sound like you're going to allow that to happen.
Gary Mishuris: I try not to, that's for sure. But I mean, one of the reasons I have this mentality is when I was at Fidelity, there was a very senior analyst on the verge of promotion to portfolio manager who sent out a research note to the whole department, and the note basically said – I think it actually verbatim – said this, "If you don't buy this stock, you don't deserve to be a portfolio manager"... which is a pretty bold statement, right? And of course, you know, the punch line, or I'm sure you're guessing the punch line, it turned out to be a fraud, right? So it's not that he was wrong. It looked so amazingly good – it was so good that it was just not true. I mean, obviously he didn't become portfolio manager and no one has ever heard of him again, but that was just a very vivid early example where conviction's good. Stupidity and overconfidence on the massive scale... not as good.
Dan Ferris: Right. And I think the other point deserves to be made too, right? he could have survived that if he had sort of operated in a more measured risk-aware fashion, if he had just said, "Well, maybe if you buy – if you don't buy this stock, you know, you don't deserve to be a portfolio manager," but maybe he also could have said, "I think there's something here. This might warrant a small position." Right? So in other words, you can buy frauds, and they don't have to blow you up.
Gary Mishuris: No, and I think that's right. I think – you know, we can get into it later, but I'm a big fan of behavioral finance and just being aware of the various biases that we have. And I just think that there was just sheer arrogance oozing from his note that it wasn't that he was wrong. It was just the misjudgment of not knowing the limits of your insight. That was the big, I think, issue.
Dan Ferris: Yeah, it's a lack of risk awareness. It's bitten a lot of people. It's bitten me at various times in my – you had your 1999 moment of being wrong, and I've had my moments as well. So I want to get into the behavioral stuff before we get into the kind of companies you like to buy and all that because you've spoken about this before in that part of what you do. The other stuff, it tends to sound very similar. Even though everybody's very proud of how they've chosen which companies they buy and everything, but I think this sort of makes you stand out in my mind as an investor. That's one of the main reasons I wanted to have you on the show. So let's talk about that. Is there an important list of principles that you've learned from studying behavioral investing, for example?
Gary Mishuris: Well, at a high level, a lot of investors are very eager to play behavioral offense. Because if you think about active investing, it very much says the market is wrong at least some of the time and we can take advantage of it. Now, why is the market wrong? Well, people make mistakes, the mistakes are systematic enough for me to find. That's offense. We are trying to take advantage of the mistakes others are making. And I think too little time is spent on behavioral defense, and that's kind of being – saying, "OK, the market makes mistakes, sure, but I also make mistakes." And unfortunately they're also systematic, so it's not like "Oh, I just once in a blue moon make a mistake." So you have to have systems in place to guard you against the very same things that you're trying to take advantage of on the other side.
So I'll give you an example. You know, very common mistakes might be anchoring and confirmation bias, which is a deadly pair. You buy a stock, stock XYZ, you have a thesis, you think it's worth $200, you buy it for $100, so you bought it for half of what you think it's worth, and you have a thesis. Now your mind is going to make sure to sweep under the rug any evidence that your thesis is wrong, and it's going to anchor on that $200 number, right? You want that $200. And very frequently, people in value investing talk about value traps. Jean-Marie Vallet once told me there's really no such thing as value traps – it's just you getting it wrong. And I think he's right in the sense that you will latch onto "Oh, this is a business worth $200, and we'll latch onto our thesis," and so the question is how do we – here's why, by the way.
So if you think about you starting as a beginning value investor and you observe sell-side analysts who whiplash their price targets willy-nilly. I think of a sell-side price target as a carrot in front of a donkey that's on a stick, right? it moves as the donkey moves, so they basically say, "Well, I'm going to recommend – my boss wants me to recommend this stock or whatever, so the price target will be 25% or what not of the current price. And I'm just going to adjust it for frivolous reasons no matter what happens." So that's like the behavior that the value investor rebels against, and they say, "Oh no, I'm not going to be like that guy. I'm going to have conviction and I'm going to stick to my guns," right? And that's good, but only good if you're right. If you're sticking to the wrong things, then that's not good. So then the challenge is how do you not become like the sell-side analyst who's going over all over the place based on whether the stock is going up or down. How do you actually make sure that you still are open to opposing points of view?
So here are a few things as an example. So I have a thesis tracker that I color code in my spreadsheet. And this is very simply every quarter for each investment, I code each cell from bright red to bright green, so there's five levels – bright red, orange, white, light green, and bright green. And the bright red means that quarter was strongly disconfirming relative to the thesis. No excuses. Doesn't matter if it's a recession, doesn't matter if it's COVID, so there's no judgment. And the reason to not allow judgment, even for one-time charges, one-time charge still going to get penalized. And by the way, this is not against quarterly estimates, but it's against kind of my base case trajectory for the business.
So if I think this business should have 10% operating margins and grow at 5% organically, let's hypothetically say, and now this company comes at minus 5% organically, it's going to get a red box for that quarter. Now, there might be a perfectly sound reason for why that one quarter is not representative of the long term, but I still get to watch – look at that red box. And I have certain triggers. For instance, if you get a single red box, I get to rebuild the model and start from scratch. If I get three orange boxes, meaning mild under performance in a row, I get to rebuild the model. And in each of those scenarios, I'm not allowed to add to the position.
So this is kind of like tying yourself to the mast in the Odysseus story, where I know my tendency as a value investor is to double down, right? "Oh, Mr. Market, you're going to argue with me. Well, you're going to take my stock from $100 to $50... I'm going to put more money in to show you." That's a dangerous mentality because the idea isn't to win. The idea is to be right on average over time. And so I've put these kind of checks and balances to guard against what I know are my own tendencies which I have just like anyone else. And I think the advantage of that is if I have hypothetically the same tendencies but I'm more aware of them and they have more systems to prevent me from damaging my portfolio through the behavioral mistakes I might make, I'm not going to catch all the mistakes, but if I catch a good percentage of them, I'm going to have an edge in that area.
Dan Ferris: Interesting. So just to be clear, you could put a red box on there, and the stock could be up, let's say. Or you could put a green box in there and the stock could be down. It's not about the performance of the shares... it's about the performance of the business as revealed by quarterly reporting.
Gary Mishuris: Right. And I think a lot of value, and like you said, all value investors sound the same. I'm sure you talk to a lot of them, and I'm sure one of the favorite things that you've been told is, "Hey, we're not worried about volatility, we're not worried about market risk. The values in our portfolios have not changed." I read a lot of letters. I read that all the time. And I think that's true if they haven't changed for real. The danger is if the manager, someone like in my shoes, is sitting on a bunch of unrealized losses, their loss aversion – which is another well-known behavioral bias – is preventing them from realizing those losses. So they're, you know, as Peter Lynch used to say, cutting the flowers and watering the weeds... they're selling their winners because it feels good to lock in a win, and they're nurturing their losses, waiting for them to come back. And so what they're saying to themselves and to their clients is like "Hey, don't worry. It's just market to market. The values haven't changed."
But I think the reality is the values change all the time. It's not like the value is not a certain thing because people like the certainty, like this pen is worth $100. But the reality is it's both uncertain, meaning it's a range, and it changes over time. Like think of a mine. You have 10 potential mines – either it has $100 of gold or not, and there's a 50% probability of each mine. As you explore the mines and you realize that the gold is there or not in each mine, the value of that 10-mine enterprise will change because what started as an expected value becomes an actual value based on how much gold is in the mines. So I think that you have to be sufficiently flexible to adjust the reality as it changes but have sufficient conviction that when the evidence is there but the market disagrees, you don't fold to the market's pressure. And that's a delicate balance.
Dan Ferris: Right, and it's tough, isn't it, for a fundamental investor because let's face it, it always turns out like the market knows before you do, and then, you know, the market knows, it sends the price of your stock down 30%, 40%, and now you're having to look at the information that has been revealed and make a decision after that decline. It's not easy. It's not easy.
Gary Mishuris: No, and I have a great story from early in my career at Fidelity where I was an arrogant little punk, a 23-year-old whatever who thought he knew something about value investing because he read a few books. And I kind of – now, there was a company called PolyOne. The ticker was POL. And it was a plastics compounder, and I covered specialty chemicals as my first assignment. And I remember we owned like $100 million of this thing at Fidelity, which was nothing for Fidelity, by the way, but for a young kid with a negative $10,000 net worth out of the school, college loans, that was kind of a lot of money. And so I remember I recommended that we buy at like $S12. I visited them. The CEO at the time was a very nice Harvard Business School-educated man, sharp suit, everything terrific. He told me this cross-selling strategy, how they were going to grow the business. It was awesome, right? And then the stock started to slide.. went from $12 to $10. And then I'm like, "Ah, great, volatility is our friend, let's go." I went to all the portfolio managers because that's what we were supposed to do. Analysts would go to the portfolio managers, try to convince them to listen to their recommendations internally.
So I said, "We should buy more," and some people listened, and some people didn't. And it went to $8. I'm getting a little nervous... going from $100 million to like $70 million or so isn't pleasant. But I'm like, "Oh, let's buy more." And one grizzled veteran, the guy who ran the value fund said, "Let's call them. Gary, let's call them." The stock at that point was like at $7. So we called them, and you know, from the questions, from the answers, and the body language, it's very clear they're going to miss the quarter... that the quarter is weak. But there goes Gary again. It's like, "Guys, we're not playing the quarterly game. We're long term. We should be focused on the value. The value is $20. Now this is a great bargain." Like I'm sure you read a lot of this stuff, right? And I didn't realize at the time how awful I sounded to others but – and you know, for them, this is Fidelity so they're not concentrated. They have like 30-basis-point positions, so like "Fine, we'll humor this guy, whatever." But most of them held on.
And then I remember this vividly. This was December 23, the day before Christmas Eve. Now, it didn't miss the quarter. They preannounced like the day before Christmas Eve, which by the way, if anyone preannounces the day before Christmas Eve, you know it's for real. It's not because they're missing it by a penny, right? They hugely caught guidance, eliminated the dividend, the stock was down 50% in a single day. So I wanted to hide under my desk and cry, but I made it around to the portfolio managers, and one guy who wasn't particularly nice about it said, "You know, Gary, are you sure you know what you're doing? Why don't you go home and reread Warren Buffett? Take the rest of the day off."
And I actually listened to him because I literally felt sick to my stomach. By the way, there's a corollary, eventually, that we bought back more. At that point, it was trading at such a distressed level that it was overreaction. We did OK in the end, but that was a very serious early lesson that, first of all, arrogance can be deadly, but the other thing is there are times when the market – I'm not a technical analyst, and I never will be, but to basically assume that price action means nothing is essentially saying that you have all the knowledge in the world and nobody else could possibly know anything you don't know. And that's just not the case.
Dan Ferris: And all that price action after you do all your fundamental work. That all happens in the future, and you don't have any control over it. And you know, you can know the business inside-out and upside-down, backward. By the way, as I recall, being involved with PolyOne, I was writing a newsletter about – I think it was about small-cap stocks a long time ago, so I feel your pain on that one is the message there. And you know, on cyclical stocks in general, I've learned a huge lesson. I've learned it probably too many times, but I believe that I have finally learned it. And so my question then for you today, running a concentrated portfolio is, is there a place for cyclical stocks in what you're doing today, with 10 to 15 positions?
Gary Mishuris: Oh, absolutely. I mean, I think those are my favorite. I guess the way I think about it is if you're a value investor, you have to think about what are the patterns of mispricing that you're trying to exploit and why are they going to reoccur. And cyclicals – so what's happening with a cyclical? Like let's take a deep cyclical. There's no growth cycle to cycle, and let's say it loses $1 at the trough, it makes $1 on average through the cycle, and maybe makes, whatever, $2 at the peak. So what happens? Well, when we're near the peak, people kind of realize we're near the peak, but they still overvalue it. So maybe they'll value it at – I don't know, so let's say the business should be worth $10 times $1 of midcycle earnings. And they will overvalue it and say pay $18 or whatever it is based on peak earnings.
Then the cycle will unfold and here's how this is going to play out. A bunch of sell-siders will say, "Well, let's wait for the inflection point." So they're trying to time the inflection point. We want to have visibility, which by the way, most managements will do that as well as far as suspending the share buybacks, and then they'll say, "Well, you know, there's a little visibility, guys. We'll wait for a little bit more visibility." Well, when you get to visibility, you'll have a different price, but that's a different conversation. So the stock goes to $5. It goes to $5 because right now, the company's earning between $0 and minus $1. It's losing money or maybe just not making any money, and people are just waiting for the turn. So this business that's worth $10 you can buy for $5 if – and this is an "if" – you're willing to buy before there's evidence of an upturn.
Now, the whole key here is the correct diagnosis of the problem. So if it's truly a cyclical problem, it's a matter of if not when – sorry, when not if. Because by definition, the cycle will turn, and the only other corollary is that you can't have what I call something that's a path-dependent cyclical. And that usually arises when the balance sheet is just not strong enough to withstand a particularly prolonged or deep cycle. So it means that in a benign cycle that's shallow or quick to recover, we are going to do OK. But if there's a deep or long cycle, you're going to go bankrupt or need to raise dilutive capital. So as long as that's not the case, we're talking about when not if, and if you buy something for half of what it's worth, even if it takes five years, it's going to be a 15% CAGR. But again, this is predicated if you diagnosed the problem correctly, and this is not an internal problem, but this is a cycle which will definitely turn. And this pattern reoccurs every single time because people want to wait for the inflection point of the catalyst. And sure, by the time you get the catalyst, you might get a price of $9 or $8. And so I think that you can make very good money, and it's a very basic pattern they teach because it's very simple to analyze it because there's less work required and some more advanced concepts we can talk about later.
Dan Ferris: So just to be clear, Gary, I think you're in the same camp as I am on this issue. It is simply – you don't wait for catalysts, in other words.
Gary Mishuris: Well, not with a cyclical. Because the reason with a cyclical – you don't wait with a cyclical is you know if it's a cyclical, it's going to turn, whether their cycle ends in 18 months or in six months or in 36 months. That will affect your CAGR, but if you buy based on the price-to-value relationship and that margin of safety is sufficiently big, your CAGR, which is the ultimate goal, is going to be fine. Now, if someone buys late – let's say they buy at $8 in that example for a company that's worth $10, and then they sell early. Let's say they sell at $10 or $11, and it takes them a few years to realize that that's a problem because their CAGR now is not that good. But if you buy at the deep – at the point of maximum pessimism as I like to call it, or close to it, you will do very well with no catalyst in a cyclical.
Dan Ferris: And just for our listeners, when Gary's saying CAGR, he means your annual return, cumulative annual –
Gary Mishuris: Yeah, your IRR or your annualized rate of return. Obviously, the two determinants are your total return over the period and how long it takes. And the longer it takes you to realize the same rate of return, the worse you are. I mean, my wife's grandfather who recently passed away at the tender age of 105, used to tell us a story of – all his wealth was in Disney stock, and he would say, "Gary, do you know what my cost basis is on this thing?" And I would say, "No, tell me, Grandpa." And he'd say, "Well, it's $8 per share," or something like that. And then, as I said, he was 105 so we – at one point I did the math offline from when he bought it, and the compounded annual growth rate was like some high single-digit number. But look, I didn't have the heart to tell him. It's not like next time I saw him at a family gathering I didn't tell him, "Well, Grandpa Sam, nope, you didn't do so well, as well as you thought." I kept that to myself, but I think the point of the story is it's not just the total return... it's how long did it take to achieve it.
Dan Ferris: Right. So you have been in business since 2016. What is your average hold since then?
Gary Mishuris: My average holding period?
Dan Ferris: Yes, your average holding period, sorry, yes.
Gary Mishuris: Yeah. No, sure. I mean, I don't have the actual number. The last time – that's current. Last time I checked, it was about a 25% annual turnover, which means a 4% – four-year holding period. And that's about right, meaning that if you think about – I think it was Seth Klarman or someone similar who came up with the idea of the yield curve for equities, the idea being that the short term of the curve or the six- to 12-month time horizon stuff is fairly efficient in the arbitrage when most market participants. And as you go beyond that 18-to-24 mark, very few people are willing to take the short-term pain. Like if you were to take some average portfolio manager at a big institution and you came up to them and said, "Here's a proposition for you. You're going to have a compound annual return on your investment of 20%, but the first two years will be negative. Would you like it?" Many will say no. And they'll say, "Well, Gary, I'm just going to wait for the third year. I'm no fool." And the problem is that in the markets, you don't always – it's not as clear cut as that. The point is their bonuses might be in jeopardy, their jobs might be in jeopardy, they might lose clients, whatever the case might be. So people want the returns this year, or at least in the next 18 months. And so I think that by going out beyond that, you get to a much more inefficient part of the market. But the other kind of thing I want to kind of maybe push back on a little bit is that there's some value investors running around saying, "Well, I'm a buy-and-hold investor. I'm going to buy this amazing company and I'm going to own it forever." Well, that's not value investing anymore because the refutation is simple. Well, if it were $1 million per share tomorrow, would you still own it? "Well, not $1 million." Well, then it's not forever. So it's either you're holding it forever or it's price dependent. And so my decisions of whether to own something or not are a function of the fundamentals, business quality, the earnings and cash flows, management quality, balance sheet, and the price. And if at any point while my average holding period is three to four years, at any point someone offers me what I consider to be an attractive price or if there were a much better opportunity in terms of opportunity cost that came about, I might make the switch. It just so happens that given my approach, a few years is my typical holding period.
Dan Ferris: I see. So this aspect of your style that you've described sounds like very classic value. It almost – I seem to remember Ben Graham saying something like two to three years is pretty typical for a position for him, and you're at about four, so just a little bit more than that. But you're concentrated, and that – doesn't that make for more stress on you to concentrate a position?
Gary Mishuris: Well, I think that's exactly right. That's exactly right. So look, I know we started this conversation with kind of you jokingly saying all us value guys sound alike... let's talk about behavioral stuff, which I get it. I'm not teasing you at all. I read some people's letters, I'm like, "Wait, I could have written that." So what is the difference? I think part of the difference is temperament. Warren Buffett always talks about that you can't teach temperament. It's like, you know, think you wouldn't know some other famous basketball coach said, "I can't coach height." So there's – I can teach almost anyone how to model in Excel. That's not hard. There are many ways to over a few years learn how to analyze the business qualitatively by forces, frameworks, and so forth. And some people are going to be better, some people are going to be worse, but it's teachable. Temperament I believe is not teachable.
So I'll give you an example. I used to have a boss at one of the big firms I worked for, and he supposedly was a value investor who ran a value fund, and every time a stock sold off, his natural inclination was to sell. Now, sometimes he was able to get a grip on himself and not do that, but that was his natural tendency, which by the way, is very common. And every time a stock was going up, his tendency was to add to it. There's nothing wrong with doing either in selected instances, but if you're wired to be afraid and act afraid when everyone else is as well, it's very hard to have an independent view that's not a function of the opinion and the action of the herd. And that's a temperament. And by the way, temperament gets tested at intermittent intervals, but those are very important. Like we're in one of those periods right now where we had a lot of investors who, for a decade, who were picking stocks from a universe that had a 20% to 25% annualized rate of return.
And some of these investors are extremely skilled and good. I don't want to paint with overly broad brushstrokes, but a lot of these investors frankly were just gamblers that were picking from a highly biased universe, but they convinced themselves and others that they're amazing stock pickers. And they ran around and talked about their fancy mental models and how they buy compounders irrespective of price, and they're that good, and look at Costco, point to other successful practitioners of that style... and there are some that are very successful. But a lot of people have basically just – gambling on garbage bubble stocks, and they got lucky. And then the luck kind of ended so far this year. We'll see where things go. And some of these folks are staring at 30%, 40%, 50% losses. And that's when the temperament gets tested because it doesn't get tested when you're telling your LPs, your partners, or your clients, "Oh, I had another 30% year, look at me, I'm great." It gets tested when you have your minus 50% year.
Now, as a deep-value investor, I hopefully shouldn't have minus 50% years, but sometimes, who knows. It's not 100% within your control what people price securities at, but I think tolerance for pain is – and also just combined with behavior models to be very process oriented as opposed to outcome oriented is one of my big competitive advantages for sure. And it does allow me to have concentration because I know myself, from my two-plus decades of investing that when the pain comes, I'm going to stick to my process. That's what I pride myself on, not whether one stock went up or down, or even if I made a mistake or not because I am going to make mistakes. So will everyone else. the point is, over time, what's the net balance, the magnitude, and the frequency of your mistakes versus your good decisions.
Dan Ferris: Amen to that. I think enough folks don't – especially early on, even if – especially if they're not professional investors, they get a mindset where they think there's a system out there that's going to pick winners every time. We know that doesn't exist.
Gary Mishuris: Sure it does. I think the name was Bernie Madoff. I mean, he had a system like that, right?
Dan Ferris: Yes, the system that picks winners every time is a fraud. That's right. All right, so we're actually – we're near the end of our time here, and I want to thank you for being here, but I do have my final question that I want to ask you, and it is the same final question for every guest on the podcast no matter what the topic is. Even sometimes we deal with a nonfinancial guest every now and then. Same exact final question, and that is simply if you could leave our listeners with a single thought or a single idea today, what would it be?
Gary Mishuris: I would say humility. I think that you want to be humble in this business, and if you – one of my mentors, a gentleman by the name of Joel Tillinghast at Fidelity, who I learned a lot from in my early days, I remember going to lunch with him and asking him, you know, "Joel, how did you pick your style?" And Joel was hired by Peter Lynch, and so – and he went on to have an extremely successful career. I think he's beaten the market by 4% by year over a quarter century managing tens of billions of dollars, so extremely impressive. And he told me something that really surprised me at the time as a young analyst. He said, "I didn't know if I could be a good stock picker, so I picked an approach that didn't rely very much on predicting the future." And I kind of didn't get that because it was like, well, isn't stock picking what we do? What do you mean not sure if you're a good stock picker? And what he meant is he wasn't sure he was going to be good at predicting when businesses are going to achieve drastically new and better things than they've ever done. And he's based his approach on being humble and just finding situations where things were predictable and steady Eddie and maybe they weren't the most glamorous companies, but the prices were really cheap and the businesses were good. They might not have been great, but they were good, and the people were honest... and he made a killing. Now, if he had 4% of excess return per year managing tens of billions, you can only imagine what he would do with a much smaller sum. And I think that was an approach based on humility. And so I try to do the same thing, and I would advise the listeners to do so as well is to – if it turns out that you're Michael Jordan of investing, that's great. Maybe you can pick the compounders that you price, but very few people can do that. So that's an approach that kind of is the opposite, based a little bit on arrogance. Sometimes deserved arrogance, but still arrogance, meaning "I'm going to take something which very few people can do well, and I'm going to be one of the few people to do it." So I think investing is hard enough. So I would say base your approach on humility and then work really hard from a position that you're going to be wrong a lot, and build that being wrong into everything... into securities selection, portfolio construction, into how you build the structure we affirm and to which clients you choose or not choose to partner with. So, humble... but confident. Humility is not the opposite of confidence. So I think you can be humble and confident at the same time.
Dan Ferris: Humility and confidence. That's a good combo. Thanks. That's a good answer, man. So listen, thanks very much for being here. I really enjoyed talking with you, and I know our listeners enjoyed it as well, so thanks again, and I hope you'll come back in six or 12 months and talk with us again.
Gary Mishuris: Would love to, and thank you again for having me on, and hope everyone out there is enjoying themselves and staying safe both in the world and in this crazy market.
Dan Ferris: All right. Well, I enjoyed that very much. I hope you did too. The reason why I invited Gary here is because I've heard him speak. We see each other every year at an investment conference that I just got back from in Vail, Colorado, and I see him speak most years, and he is obviously very, very thoughtful on the topic of behavioral investing. And I was really excited and interested to hear how he turns that into a tangible sort of doable quarterly process for assessing whether or not his thesis is correct or not. I think that's really quite a bit of self-wisdom being exercised there. You know, you know yourself well enough that you need a system just to make sure that you are or are not on thesis with your investment. I thought it was quite brilliant. And you tell me. Write in to [email protected] what you think, but I just feel like we've heard so many times people say I like high-quality businesses, we like plenty of free cash flow and good balance sheets and good margins, and we buy at a discount. We've talked about all of those things many, many times. We have not talked about anything quite like this very often at all, and certainly I can't remember hearing a rigorous process to work the behavioral aspects into the investment process like we did today. So really valuable. Wow, that was great. All right, let's take a look at the mailbag. Let's do it right now.
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Dan Ferris: 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 our listener feedback line at 800-381-2357. Tell us what's on your mind and hear your voice on the show.
Lots of stuff about gold this week. Let's dive in with Michael L. And Michael L. says, "With the high level of inflation driven by increasing the money supply relative to goods and services available and probably understated substantially according to ShadowStats, does this distort any of the metrics that lead us to conclude the market is overpriced? How did markets and extreme examples of inflation respond? Czech Republic, Zimbabwe, Argentina, etc., relative to their non-super-hyperinflation historical averages. What about periods of very high inflation in the U.S. or other advanced economies? Did these metrics work as a valid measuring stick when something fundamental like this occurs? This is important to ask and challenge, especially at Stansberry... when to buy, not overpaying is critical to long-term investing success and the recommendations. I ask this also in the backdrop of understanding the value of a commodity. I look at gold right now. For years, I've heard this is important to understand how gold is priced. You can look at it in comparison to the S&P, silver, dollar, euro, etc. With the dollar having strengthened significantly over the last six months, is gold really down in value? I think it is – or I don't think it is, he says. Inexplicably, we seem to have an opportunity to buy more of it with the dollars we have. Hope you stuck with me to the end. Love the show and the work you do. Keep it coming. Regards, Michael L."
Michael L., first things first. Those hyperinflation examples don't apply. Hyperinflation is a totally different phenomenon than the 9% or greater CPI-type inflation that we're living through now. Hyperinflation is a societal breakdown. It's not just more currency relative to goods and services. It's much worse. I mean, if hyperinflation is happening, you've got bigger problems than whether or not stocks are a good buy, and that's when you want to own plenty of guns and ammo and maybe even a place up in the hills or something. So let's just get rid of all that and replace it with the main example of the past 50, 60 years, which was the '70s. So if you look at a long-term chart of the S&P 500 P/E ratio, you can see a dip in the '70s, and it makes sense. I mean, if you got a phenomenal business and it reliably generates like 30% returns on equity year after year and inflation is 10%, that's 20% on equity. And if at 30% ROE, the thing is worth – just keep the numbers simple. These are just hypotheticals. They mean nothing. It's just for example purposes. But if at a 30% ROE, people say, well, this business is worth 30 times earnings, at a 20% ROE, maybe it's worth 20. Maybe it's worth even less because people are just worried in general.
So yes, inflation means multiples darn well ought to be lower, and that's one important reason why they have come down, but as I said in my rant, I don't think they've come down enough. So as far as – you know, is gold really down in value? Well, yeah, it is. But over the long term, it's done a brilliant job. It's still going to do a brilliant job. It's crushed everything else in the past six, eight months, and I agree we do have an opportunity to buy more of it right now. And gold stocks too.
Next comes Drew, and Drew said, "I enjoyed your recent interview with Doug Casey, albeit sobering. That said, one of the concepts that you discussed was the redefining of the word inflation, essentially the increase in the supply of dollars. That led me to two questions. Gold is not a fixed supply commodity. I watch all those gold shows, and people are digging up new supplies all the time. As the gold is extracted, isn't that like inflation for gold? Wouldn't the doubling of supply essentially lower the value of gold over time? No. 2, we continue to quote gold in relation to fiat currency, most often USD. What is the relation to the buying power of the USD to gold over time? Is the price of gold really outpacing the destruction of the USD? Really enjoy your show each week. Keep up the good work. Drew."
You'd think these questions had really objective answers, but they kind of don't. As far as your first question, is gold being – can we say that gold is undergoing inflation the way the dollar is? I don't think so because gold is in relation to everything else, so we still have a lot less of that than we do of dollars, and we have a lot less of it than we do of just about everything else. It's a good thing that gold – the supply of gold can grow with the economy. We talked about this when George Gilder was on the program, and he said that's one of the problems with bitcoin is that it behaves like a closely held tech stock and the price is all over the place because it is basically less liquid. Most bitcoin is kind of closely held, and the rest of it trades like a meme stock. It's crazy. And it doesn't behave like a currency at all. And it doesn't behave like a store of value at all. That's objective. You can't argue with that. it absolutely has been the way it has been.
And as for gold, it's beaten stocks in the 20th century, it's a 50-bagger since it was divorced from the U.S. dollar in 1971. So over the long term, it's done a brilliant job, and people right now are going to say, "Well, look at bitcoin. Since its inception, it's up 30,000% or whatever it is." I don't know what it is. So that's the same thing, isn't it? Well, all I'll point out to you is things that go up 30,000% tend to fall 90%, you know, as bitcoin has done in the past. And I think it'll do it again. I think that it peaked at around $69,000, and I think the bottom is somewhere between $3,000 and $12,000 still. And it has yet to be proven. Gold is proven over 5,000 years. Bitcoin hasn't even had 15 years to prove itself, so let's just not get ahead of ourselves with bitcoin as a store of value or currency.
Your second question was we continue to quote gold in relation to fiat currency. Is the price of gold really outpacing the destruction of the USD and what's it like over time? I think I answered that already. Good questions. We should question these things. Thank you, Drew.
Next comes Zach R. Zach R. says, "Hi, Dan. One of the things I've been wanting to see this year is a capitulation day. I don't expect to see a 12% down day like we had during COVID but maybe something 6%, 7% on the S&P. The worst we've seen is just under 4%. Bank of America's fund manager survey shows equity allocations at the lowest level since the great financial crisis. Survey also has cash positions at the highest level since 2001. Growth peaked more than a year ago, and many speculative names have seen 70% to 90% declines. Have we already seen capitulation? I would love to hear your thoughts. Thanks, Zach R."
Well, the final capitulation, no, I don't think we have. I don't think you come out of one of the three most massive bubbles ever of the last century and by a couple of measures the most massive bubble ever, you know, certainly the most massive bubble in bonds with the 10-year was 0.5% a couple years ago. So wow. Crazy, right? And that was basically a 5,000-year high in bond prices, you know, if you read the yield books, Sidney Homer's yield book. So yeah, most massive bubble ever, and we're going to get out of it with a little 30%, 40% – or 20%, 30% drawdown in the S&P and Nasdaq. Yeah, I don't think so. So I don't think we've seen the ultimate capitulation. What happens in-between the top and the bottom is going to be a wild ride. We will get major, major rallies. So yeah, that's my thought, Zach.
We also have Elsa G. asking about gold. She said, "Would it not be more correct to say that gold has done very well this year compared to stocks despite the rising dollar? In other words, would gold not do even better when/if the dollar rolls over?" Well, yeah. Absolutely. I agree because that strong dollar is in relation to other currencies. That's how it's being measured. And somewhat in relation to gold, but gold's held its own. It's done pretty well relative to stocks and bonds and other things.
Finally, we have Al M. Al M. is a longtime listener, frequent correspondent, very thoughtful, intelligent guy. He sends longer e-mails so I tend not to read them, but this one is good because he's basically ranting back at me a little bit. I don't think he's really sort of taking a dig at me, but I like the tone of it. Al, like this. I like when you're on fire here. It says, "Dan, it seems to me that you two" meaning Doug Casey and I, "give the current Fed chairman and current politicians way too much credit for being stupid or just plain dumb economically. It seems you do this on every issue. Really?" he says. "Why do they have open borders? Why do they kill millions of businesses? Why do they supposedly believe in some professor, Stephanie Kelton, who claims that you can print money to no end with no consequences until inflation? Oops. Why do they lower rates and keep them there for years? Why do they hate energy companies and energy for everyone? They want energy only for their personal jets so they can fly to big climate change meetings and conjure up new tax schemes even though their own scientists claim they're distorting all the data for their narrative."
And then he refers to Steve Koonin's book Unsettled, which I agree you should refer to it. It's all in the title. The science is unsettled. Science is never settled ever. He continues, "I think they know exactly what they are doing and understand exactly the economic consequences. They want to kill capitalism. They want a new world order based upon a few elite choosing everything for everyone, and they think they will be part of that team and the billionaires club. They think they're already controlling everything. They are already killing capitalism as sure as I have a nose on my face. Al M." Al, you rock, buddy. I like the way you're thinking. They couldn't be this stupid. I hate to be a conspiracy theorist, but the problem is they keep coming true, these conspiracy theories. Yeah. Let's hear more of that, Al. I like it. I like getting you fired up.
All right, 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 like this episode and know anybody else who might like it, 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. Have a guest you want me to interview? Drop me a note at [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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