Speaker 1: Hello, and welcome to The Australian's Money Puzzle podcast. I'm
Speaker 1: James Kirkby, the Wealth editor at The Australian, and welcome
Speaker 1: aboard everybody now. Issue Issue of the Week, Issue of
Speaker 1: certainly one of the biggest issues of the year. Hasn't
Speaker 1: happened for a long time. Chief executives behaving badly in
Speaker 1: many different ways. Does it matter to you as an investor?
Speaker 1: We want to look at that today. It does matter,
Speaker 1: by the way we can show you in many ways
Speaker 1: how it does matter.
Speaker 2: What if you had shares.
Speaker 1: In Quantus, for instance, and you would have paid a
Speaker 1: price for the reign of Alan Joyce, who was so
Speaker 1: good for so long. But in the end, of course
Speaker 1: it was ruling like an emperor in that airline and
Speaker 1: he was beyond question, it seems, and it's caused all
Speaker 1: sorts of problems, including political problems. But put that to
Speaker 1: one side. There were issues right across quantity after the
Speaker 1: nature if you like, and the sort of rain that
Speaker 1: he had where he was the king and the board
Speaker 1: really seemed to roll over for him. Chris Ellison at
Speaker 1: Mineral Resources Big Lithium Play. Lots of our listeners would
Speaker 1: have interest in lithium. He is under investigation for an
Speaker 1: alleged tax fraud. This is just like an old fashioned
Speaker 1: I would have called it a small time way of thinking,
Speaker 1: doing little deals on the side. We haven't seen that
Speaker 1: for a long time with in billion dollar companies, and
Speaker 1: there it is. And then of course of the spectacular
Speaker 1: case of Richard White of Voice Tech, where that stock
Speaker 1: lost billions of dollars because the CEO was invested in
Speaker 1: a sex scandal. Now these aren't typical CEOs. Keep in mind,
Speaker 1: these are larger than live CEOs, and they often create
Speaker 1: the company and run the company, and they completely How
Speaker 1: they behave is integral to how the company performs.
Speaker 2: You could eat on musk.
Speaker 1: Can we think of Tesla without eton musk mosque at
Speaker 1: the Trump Valleys? Do you think that matters as an investor?
Speaker 1: Is it relevant to you? So you can see how
Speaker 1: there's layers in this. Roger Montgomery is a regular on
Speaker 1: the show. He's also a regular contributor to The Australian's
Speaker 1: Wealth Section and indeed this week he has written on this.
Speaker 1: And when I saw the piece which he sends me
Speaker 1: earlier in the week, the minute I saw what I
Speaker 1: rang him and I said Roger, we have to do
Speaker 1: a podcast artist, and you are the person to do it.
Speaker 2: Oh are you, Roger.
Speaker 3: I'm really well, James. It's always great to be talking
Speaker 3: to in person.
Speaker 1: I'm trying to think of a period where we had CEOs.
Speaker 1: I mean, do we have to go back to do
Speaker 1: we have to go back to the nineteen eighties and
Speaker 1: the and the bonds and the cases and all that.
Speaker 1: And by the way, folks, their scandals were all financially
Speaker 1: right there, they were just financially really.
Speaker 3: We've had congo line examples of CEOs behaving unsatisfactorily or inadequately.
Speaker 3: And as we get into the talk today, we'll probably
Speaker 3: discover that boards have a lot of explaining to do.
Speaker 3: You could go all the way back to Enron and Worldcolm,
Speaker 3: as far back as you even further back to those
Speaker 3: that you mentioned. There's been ABC Learning Centers, We've had mfs,
Speaker 3: We've had all Co, Badcock and Brown.
Speaker 2: Credit Corp.
Speaker 3: I was the first fund manager in Australia to launch
Speaker 3: a class action against a public company because of failure
Speaker 3: to continuously disclose information that was happening in a company.
Speaker 3: In the Credit Corp case, Timber Corp. We've had great
Speaker 3: Southern plantations and most recently wise Teken before that quantus
Speaker 3: And in all of those situations, or in many of
Speaker 3: those situations, what happens is there's a personality in the business.
Speaker 3: They might be the founder of that business. In the
Speaker 3: cases where a founder has built a very successful business
Speaker 3: and they've brought directors underneath them, often the directors will
Speaker 3: fit a debt of gratitude to that founder, that chairman,
Speaker 3: or that CEO. Then, of course you have the examples
Speaker 3: where they've grown the business, or CEO comes in, they've
Speaker 3: grown the business. They might not be the owner, but
Speaker 3: they've done a phenomenal job of that business. And what
Speaker 3: happens is the media lavishes praise on that particular person.
Speaker 3: That particular person men starts to drink their own kool aid,
Speaker 3: so to speak, and then they become they become bigger
Speaker 3: than ben hers so to speak. And then the directors
Speaker 3: again fawn over these directors, and they're scared, they're scared
Speaker 3: to actually stand up to them. James, if you'll indulge me,
Speaker 3: there's a terrific quote from a University of San Francisco
Speaker 3: professor back in two thousand and one. Is named is
Speaker 3: Richard Pantillo, and he famously mourned the loss of the
Speaker 3: corporate moral compass. And if I can quote him, he said,
Speaker 3: in theory, publicly traded corporations have shareholders as their kings,
Speaker 3: boards of directors as their sword wielding knights who protect
Speaker 3: the shareholders, and managers as the vassal who carry out orders.
Speaker 3: In practice, in the past decade, and he wrote this,
Speaker 3: remember in two thousand and one, managers have become kings
Speaker 3: who lavish gold upon themselves. Boards of directors have become
Speaker 3: fawning courtiers who take coin in return for an uncritical
Speaker 3: yes man function, and shareholders have become peasants whose property
Speaker 3: may be seized at at management's when. And I think
Speaker 3: a lot of listeners today can relate to that. The
Speaker 3: shareholders are the owners of the business. But in many cases,
Speaker 3: when a founder decides to offer some shares to the market,
Speaker 3: those shareholders aren't considered at the same level of ownership
Speaker 3: as the founder of that business. And that's where the
Speaker 3: problems begin.
Speaker 1: Yes, and that's the problem, of course, that when these
Speaker 1: people and they are we have some I want to
Speaker 1: talk about some companies that are for listeners, that are
Speaker 1: very for the present is very important and by the way,
Speaker 1: there are no scandals that we are aware of, none, whatever.
Speaker 1: But they're marvelous companies, but they're also terribly linked with
Speaker 1: one person.
Speaker 2: We think of something like.
Speaker 1: The Goodman Group, which comes up all the time because
Speaker 1: not only is it a top class property trust her Reef,
Speaker 1: it's also a play on AI for many people, a
Speaker 1: company which isn't listed like Mecca Joe Horgen, she's she's
Speaker 1: completely personified that company's But the issue is when you
Speaker 1: have one person that personifies the company Richard Branson at
Speaker 1: Virgin marvelous example, Jerry Harvey at Harvey Norman, how does
Speaker 1: the board ever get around that, especially if these people
Speaker 1: are If these people are, they're they're charming, they're strong,
Speaker 1: they're brilliant, sometimes they're charismatic. You've made the point that
Speaker 1: with all these with this particular issues, the three issues
Speaker 1: we've listed in particular Quantus Minreis mineral resources, and also
Speaker 1: wise Tech. You mentioned the professor and he's talk about
Speaker 1: how it seems seemingly there's this structure, but in effect
Speaker 1: it's completely the other way around. Indeed, you mentioned in
Speaker 1: your piece which I was talking about earlier, that there's
Speaker 1: in recent there's this a big push for independent directors.
Speaker 1: So the theory was, bring in people who were really smart,
Speaker 1: really good, a really good lawyer, a really good account
Speaker 1: and someone who's already been through the hoops in another company.
Speaker 1: Put them around the board, and then the CEO is
Speaker 1: answerable to these people who dominate the board. That looks
Speaker 1: good from the outside. The problem is sometimes these people
Speaker 1: have no clue of what's going on in the company
Speaker 1: and their only window is the CEO who talks their
Speaker 1: own book. How do you get around that?
Speaker 3: Yeah, Look, most boards, despite the conger line of disasters
Speaker 3: that we've seen, despite that, most boards actually adopt conventional
Speaker 3: wisdom and sound practice when it comes to procedures and
Speaker 3: structures for their operations. They meet regularly. If you look
Speaker 3: at the best and worst companies, they or companies where
Speaker 3: nothing's gone wrong, and companies that have imployed, they held
Speaker 3: the same number of meetings. So it's not meetings that
Speaker 3: changes the outcome. There's an argument that you should have
Speaker 3: members on the board who are invested heavily in the business,
Speaker 3: but there are very famous examples. Ge as an example
Speaker 3: where there's been great success and the board of directors
Speaker 3: had little or no money invested. And then on the
Speaker 3: subject of independence, which you raised, James, the conventional wisdom
Speaker 3: says that you need plenty of independent directors. You don't
Speaker 3: want to have too many mates or insiders, because that
Speaker 3: muddy is the board's operations. It can also corrupt the
Speaker 3: decision making process. But then Warren Buffett once said, if
Speaker 3: you have too many people who are independent and their
Speaker 3: professional gig is being an independent director, then their bread
Speaker 3: is buttered by the fees that they receive for being
Speaker 3: independent directors, and so they don't want to rock the
Speaker 3: boat because they don't want to lose their income. And
Speaker 3: speaking of Buffett as an example today, Birkshire Hathaways eleven
Speaker 3: board members, but once upon a time it had seven.
Speaker 3: Three of them had the Buffet surname. Three of them
Speaker 3: were very related.
Speaker 2: Oh was that good or bad?
Speaker 3: We can have some incredibly admired companies that have done
Speaker 3: great things and there's very few independent directors.
Speaker 1: Your point is that the insiders.
Speaker 2: Define it. Berkshire Hathaway.
Speaker 3: Indeed, and I think this is the really important point.
Speaker 3: If following standard governance protocols doesn't protect investors from the
Speaker 3: sort of things that we've seen at Quantas and Minreres
Speaker 3: and at wise Tech. Then what is it what needs
Speaker 3: to change because those prescriptive tools haven't prevented people from
Speaker 3: losing a lot of money by being invested in businesses
Speaker 3: or companies where there's been a corporate failure or a scandal.
Speaker 3: And I think what needs to happen is you need
Speaker 3: to acknowledge. And we talked about it right at the start,
Speaker 3: or you mentioned it in your introduction, it's about personalities.
Speaker 3: Boards are social systems, and in so sociology, a social
Speaker 3: system is a group of people that combine sounds like
Speaker 3: a board to create a functioning society with goals that
Speaker 3: sounds very much like what a board does. So they're
Speaker 3: not just formal structures. They're a dynamic social system exactly
Speaker 3: the same and more mature version, but exactly the same
Speaker 3: as a sand pit in a kindergarten. And there's going
Speaker 3: to be interpersonal dynamics that greatly influence the effectiveness and
Speaker 3: the outcomes of what happens in that sandpit or board meeting.
Speaker 3: So the prescriptive stuff is vital, but really it comes
Speaker 3: down to the personalities and a couple of key ingredients
Speaker 3: that those personalities need to bring to those boards.
Speaker 1: You had an idea that the boards would run better
Speaker 1: if they all had a basically a performance review every
Speaker 1: year of personality.
Speaker 3: Let's talk about that for a minute.
Speaker 1: Yeah, I want to talk about it, because here's the thing.
Speaker 2: Who would do it? We do it.
Speaker 3: As I was writing the article for the Australian Wealth Section,
Speaker 3: I realized that the founders and the CEO, they should
Speaker 3: have publicly listed companies where there are lots and lots
Speaker 3: of investors who are depending that their superannuation is depending
Speaker 3: on their success or otherwise should be willing to submit
Speaker 3: to individual accountability and performance evaluations. Now, as I wrote that,
Speaker 3: I could hear CEOs, some of whom you've mentioned, saying, yeah,
Speaker 3: that's not going to happen. Stuff that I own them.
Speaker 3: I own the most shares. I am the CEO. I
Speaker 3: built this company, I listed it on the ASX, I've
Speaker 3: made it the great success that it is, and the
Speaker 3: rest of you can all go and get lost. There
Speaker 3: will be people who behave that way, which is precisely
Speaker 3: that treatment of shareholders as peasants that Richard Pontillo described earlier.
Speaker 3: That's that's where you will see really smart directors leave
Speaker 3: the board and arguably shareholder should probably do the same
Speaker 3: thing because eventually it's going to come a cropper.
Speaker 1: Yes, eventually you pay for this, don't you. Yes, that's right, okay,
Speaker 1: And just a quick word about the how important for
Speaker 1: you were you when you're assessing companies and you're putting money,
Speaker 1: a large lix of money often into companies.
Speaker 2: And obviously I know you.
Speaker 1: For a long time and I know that your quant
Speaker 1: quantitative analysis is always very important to you. But the
Speaker 1: chair and the CEO, now this is a thing the
Speaker 1: two companies come to mind. Tesla has an Australian chair,
Speaker 1: Robin Denim, and she she's been in all sorts of
Speaker 1: trouble for quite simply getting it on Muscowet's way. She's
Speaker 1: also in trouble because she's chaired the Czech Tech Council, yes,
Speaker 1: which should have been across the wise tech thing ages ago.
Speaker 1: That's one person. The other person is Richard Goider, who
Speaker 1: was greatly admired, had run West Farmers, was the chair
Speaker 1: of Quantus, while Joyce was particularly in the later not
Speaker 1: running that company in the optimum way for anybody. So
Speaker 1: how important is that dynamic and what can be done
Speaker 1: to improve that situation, but they they'll become chums.
Speaker 3: You mentioned there's a quantitative or a measurable aspect to
Speaker 3: investment analysis, and you're looking at the outputs of the
Speaker 3: company and the inputs as well the money that's going
Speaker 3: into that particular business to produce those outputs. But it's
Speaker 3: much harder to analyze that qualitative aspect, particularly if a
Speaker 3: great board has a culture of open descent and it
Speaker 3: values diverse perspectives to help avoid groupthink and to help
Speaker 3: enhance decision making. How do we as external shareholders actually
Speaker 3: assess that. It's really difficult. You can ask questions, you're
Speaker 3: probably always going to get the answer you want to hear,
Speaker 3: but ultimately that's what it comes down to. And unfortunately,
Speaker 3: sometimes the founder or the CEO has a personality or
Speaker 3: a celebrity status or a weld status at billionaires, and
Speaker 3: it makes challenging them almost impossible. But that's what you
Speaker 3: really want to find. You want to find a culture
Speaker 3: of open descent. Open descent, Yes, yeah, indeed, and I
Speaker 3: think if you can have that, then we wouldn't have
Speaker 3: the situation at Wise Tech, We wouldn't have the situation
Speaker 3: at Quantus. Nothing would have happened that merited headlines in
Speaker 3: newspapers that would have been nipped in the bud much
Speaker 3: much earlier.
Speaker 1: All Right, we'll take a short break and we'd be
Speaker 1: back in a moment with some of our listeners' questions. Hello,
Speaker 1: and welcome back to the Money Puzzled podcast. James Kirby
Speaker 1: with Roger Montgomery of Montgomery Investment Management, fund manager. I'm
Speaker 1: sure you all know him, though I should introduce him
Speaker 1: properly to you at this stage. Okay, lots of questions, Roger,
Speaker 1: and they're pretty interesting. I just quickly read this is
Speaker 1: not so much a question, but it was a comment
Speaker 1: we I had. I've been talking about a piece I
Speaker 1: had read in the Wall Street Journal which was so good,
Speaker 1: and it was by the chief scientist at Facebook, and he,
Speaker 1: of all people in the world, completely downgrades the excitement
Speaker 1: around AI and written, James, I know you have and so,
Speaker 1: and he says that where we're at the moment, that
Speaker 1: AI in terms of intelligence is at the same level
Speaker 1: as a household cat. In other words, he's saying, be
Speaker 1: very careful. It's highly developed advanced computing and retention, but
Speaker 1: it's not thinking. So Steven's question is I was thinking
Speaker 1: about your comment on and this was about yan Lecuon.
Speaker 1: By the way, yan l e c u N, who
Speaker 1: is the chief scientist that metas comparing the intelligence of
Speaker 1: AI and the cat. I just asked chat GPT to
Speaker 1: calculate the cash transfer value of a UK defined benefit
Speaker 1: scheme using the variables years worked, salary, etc. It gives
Speaker 1: me an approximate answer and second and showed the mathematical formula.
Speaker 1: I personally don't know any cats that could do this,
Speaker 1: said Steven.
Speaker 3: That's true, but both are right. Both are actually right.
Speaker 3: It's producing that answer, but it's producing it based on
Speaker 3: a probability analysis of what the next word should be,
Speaker 3: and it's looking at stuff that's already been written by
Speaker 3: humans and then pulling that in and consolidating it for
Speaker 3: the user. Look scouring the internet to find the answer,
Speaker 3: so to speak, and where it doesn't find the answer,
Speaker 3: where it adds libs. It's using probability to work out
Speaker 3: what the next word is likely to be. And it's
Speaker 3: not thinking and so it's not making a decision. It's
Speaker 3: just following a protocol and that is quite different to
Speaker 3: a cat. And with respect to hype around AI, look,
Speaker 3: I think I think that artificial intelligence there's a lot
Speaker 3: of use cases for it. I use it, most people
Speaker 3: I know use it, but we use it in a
Speaker 3: limited fashion. And more importantly, we don't pay a lot
Speaker 3: of money for it. So there's a couple of issues here.
Speaker 3: Share prices are currently reflecting the technology being transformational not
Speaker 3: only for life on Earth, which it may be, but
Speaker 3: transformational for all shareholders in all businesses that are related
Speaker 3: to AI. And what we know from past experience is
Speaker 3: that not all players are going to make money, not
Speaker 3: all players will survive, yet they're all being priced as
Speaker 3: if they're all going to be enormously successful. Now we've
Speaker 3: seen this in the past. We saw this with the
Speaker 3: advent of the motor car. If you'd been in Germany
Speaker 3: in eighteen eighty I think it was eighty eight, if
Speaker 3: you've been there when Carl Benz drove the first horseless
Speaker 3: carriage I think it was called the Benz patent Malta Vagan,
Speaker 3: and he drove that. You might have spotted that this
Speaker 3: was going to be transformational for life on Earth.
Speaker 2: But even if you.
Speaker 3: Had, and by the way, not everyone did. Famously, Henry
Speaker 3: Ford's lawyer told Henry Ford. We don't need a motor car.
Speaker 3: What we need a faster horses and so not everyone
Speaker 3: picked it, but let's say you did pick it. After
Speaker 3: that event, there's been something like sixteen hundred car manufacturers
Speaker 3: in the United States, of which four exist today, and
Speaker 3: two of those four were bailed out during the global
Speaker 3: financial crisis. So really there's only one or two that
Speaker 3: are profitable that still exists, and shareholders lost a ton
Speaker 3: of money. The same can be said for television. The
Speaker 3: same can be said for commercial air travel. Commercial airlines
Speaker 3: have now been running for something like eighty years, seventy
Speaker 3: nine years, and in those seventy nine years, the total
Speaker 3: aggregate and I did the calculation using the official data
Speaker 3: of the IOTA data, the total aggregate profit of all
Speaker 3: airlines that have ever operated commercially to transport people. The
Speaker 3: total profit today is twenty billion dollars. And that seems
Speaker 3: like a lot of money, but let's remember Microsoft does
Speaker 3: that in three months. This is eighty years.
Speaker 1: Their shareholders haven't made a lot of money, only a
Speaker 1: handful of winterers.
Speaker 3: Yeah, that's right, So it's really hard to pick the winners.
Speaker 1: Having said that, you like next TC, don't you and
Speaker 1: you like McQuary technology, and you're in them, aren't you.
Speaker 3: Am I right, we're in McQuary or have been in
Speaker 3: McQuary rather. And the reason for that is that we
Speaker 3: think that data centers are going to capture the line's
Speaker 3: share because they're upstream providers. So you got upstream and
Speaker 3: you got downstream downstreamer that people who try and adopt
Speaker 3: the technology to make products to then sell and upstream
Speaker 3: are the supplies of the picks and shovels. And we think,
Speaker 3: and the numbers bear this out that the upstreamers they're
Speaker 3: making the line's share of the money. At the moment
Speaker 3: in AI, the biggest use case, the biggest commercial use
Speaker 3: case or the most popular commercial use case for large
Speaker 3: language models, which is the chat GPTs and the perplexities
Speaker 3: of the world, is chatbots or companion bots. So these
Speaker 3: are people who might be lonely for various reasons or
Speaker 3: don't like talking to other real people, and so they
Speaker 3: keep they subscribe to a chatbot to keep them company.
Speaker 3: That's the biggest use case at the moment.
Speaker 1: At the moment, just on the investment side, then, is
Speaker 1: there any stock stocks that you think have a potential
Speaker 1: to be the long term winners.
Speaker 2: Well, I think all of.
Speaker 3: Them, at some point in the next few years are
Speaker 3: going to are going to have a valley through the
Speaker 3: sorry a shadow of the valley of death moment, and
Speaker 3: I think out of that will emerge there'll be some
Speaker 3: sort of correction. It's and I think that I'm guessing,
Speaker 3: completely guessing. I don't know, trying to predict these things
Speaker 3: as a fool's errand but if in the next couple
Speaker 3: of years we have some sort of correction, then out
Speaker 3: of that will emerge some winners, and those that are
Speaker 3: less likely to win won't receive ongoing funding and they'll
Speaker 3: they'll fall over and disappear. And it's then that you'll
Speaker 3: be able to, I think, be more certain of a
Speaker 3: great return on your money from AI.
Speaker 1: See the big superfones are certainly stopping large words of
Speaker 1: cash into data.
Speaker 3: The prices data centers are fine, but it's the AI,
Speaker 3: the LM producers perplexity. I mentioned a moment ago. It
Speaker 3: had a valuation earlier this year of about five hundred
Speaker 3: million US dollars. It did a funding round in March
Speaker 3: I think it was or April, and it was valued
Speaker 3: at four billion dollars, and it's now looking to raise
Speaker 3: some more money at eight billion dollars. So that's a
Speaker 3: big jump in value in less than twelve months. And
Speaker 3: its last official run rate for revenue was ten million dollars,
Speaker 3: So an eight billion dollar valuation for ten million dollars
Speaker 3: of revenue. Now there are that it's increased its revenue
Speaker 3: to fifty million, but eight billion for fifty million of revenue.
Speaker 3: There's a lot of optimism built into that price.
Speaker 2: There's a lot of optimism built into that price.
Speaker 1: Okay, So listeners, I think, I mean, look across this,
Speaker 1: it does seem well Roger's talking about the offstream and
Speaker 1: the difference between the language modular creators, but the data
Speaker 1: centers being something of an approximate for the pixel shows
Speaker 1: in the boom.
Speaker 2: Is that a fair thing to say that?
Speaker 3: I think that's fair, And it's worth remembering that there
Speaker 3: are people who believe that large language models are going
Speaker 3: to lead to artificial general intelligence, or what's called AGI.
Speaker 3: And there are other experts who say, you know what,
Speaker 3: for llms to turn into to evolve into AGI, there
Speaker 3: literally is not enough energy on Earth to produce the
Speaker 3: computing power for that to happen. So that's a widely
Speaker 3: debated point, and I think some of the optimism in
Speaker 3: share prices at the moment are bidding on large language
Speaker 3: models becoming AGI or becoming artificial general intelligence.
Speaker 1: That's why Google has bought directly into nuclear power, directly
Speaker 1: into the Three Mile Island, believe it or not, of
Speaker 1: all the plants, of all the nuclear plants in the
Speaker 1: world of the Harrisburg one.
Speaker 2: Yeah. Yeah.
Speaker 3: Google's purchase of nuclear nuclear power plant is an attempt,
Speaker 3: I think, to capture some of the energy that's needed
Speaker 3: to do that, and they're aware of it.
Speaker 1: Thank you, Stephen for that marvelous question. Could have been
Speaker 1: a whole show. We'd come back to it. We come
Speaker 1: back to it readily. Just a quick one from Sean
Speaker 1: on the show last week, so market the crashes and
Speaker 1: the crash of eighty seven. I saw no real info
Speaker 1: in this episode, just a lot of reminiscence about nineteen
Speaker 1: eighty seven, Okay, Sean, the idea I think of that, no,
Speaker 1: I know that. I think the show what we did, Sean,
Speaker 1: was to try and remind people what a crash is like,
Speaker 1: and most people have never really seen one.
Speaker 3: That.
Speaker 1: Of course, a ferocious downturn in COVID, but in many
Speaker 1: ways that was entirely explained by COVID and we recovered
Speaker 1: quite quickly. What a lot of our listeners on the
Speaker 1: show have never experienced is twenty five percent in a
Speaker 1: session or fifty percent Yeah, but we both have or
Speaker 1: fifty percent over two years that we got we got
Speaker 1: once upon a time in two oh nine, and I
Speaker 1: just wanted to have someone on the show to articulate
Speaker 1: what it's like, folks, because I'm just saying to you,
Speaker 1: as a shared investor, if you are really worried and
Speaker 1: you find it's double churning when you get up and
Speaker 1: find the market loses three percent in a night or four,
Speaker 1: just remember it can go ten, it can go twenty,
Speaker 1: and you should be able to accommodate that and know
Speaker 1: that it can happen. Okay, short break, will be back
Speaker 1: with the last three questions, which are very interesting from Tommy,
Speaker 1: Paul and Fred. Back at the moment. Hello, Welcome back
Speaker 1: to the Money Pozitle podcast. I'm James Kirby with Roger Montgomery,
Speaker 1: fund manager and author, regular guest on the show. Tommy says,
Speaker 1: longtime listener, first time caller, thank you, Tommy, do annual
Speaker 1: capital growth rates for Australian property accurately reflect the value
Speaker 1: appreciation of the land underneath the underlying land, rather distorted
Speaker 1: by the neglecting the cost of capital improvements.
Speaker 3: Great question.
Speaker 2: Yeah, yes, it's a.
Speaker 1: Really good question, isn't it The land out there isn't
Speaker 1: really going up in the same way, is it.
Speaker 2: What do you think, Roger Well?
Speaker 3: I think it raises an interesting and interesting discussion about
Speaker 3: where value in property lies. And we have to go back, James,
Speaker 3: We have to go back maybe ten or fifteen years,
Speaker 3: and I wrote an article for you talking about property
Speaker 3: in that light. And if you look at the very
Speaker 3: long term returns and one hundred year returns or eighty
Speaker 3: year returns for as CBD office tower, then you might
Speaker 3: be surprised to hear this, but pretty much all the
Speaker 3: rent that has ever received from owning one of those
Speaker 3: buildings is eventually poured back into its upgrade. In CBD buildings,
Speaker 3: we have A grade buildings, B grade, C grade, D
Speaker 3: grade and so on. And everyone with any kind of
Speaker 3: big brand wants to be in an A grade building,
Speaker 3: particularly if they're employing thousands of people. They want to
Speaker 3: be in the newest, latest, greatest building, and those buildings
Speaker 3: don't stay A grade forever because eventually technology changes and
Speaker 3: newer buildings that are constructed with newer technology that surpass
Speaker 3: the A grade building of ten years ago, fifteen years ago,
Speaker 3: or twenty years ago, and so they have a limited
Speaker 3: life where they're A grade buildings. Then they become B
Speaker 3: grade and then they don't earn as much, and so
Speaker 3: eventually the owners have to pour money back in and
Speaker 3: engage in what we call capital expenditure to upgrade the
Speaker 3: building to make it competitive again. And so with a
Speaker 3: CBD office Towler, you have a postage stamp of land
Speaker 3: that appreciates and you have a very large building that depreciates,
Speaker 3: and those economics aren't great over the very very long run. Now,
Speaker 3: people do make money out of office buildings, but they
Speaker 3: make it tactically rather than strategically. So they're saying, Okay,
Speaker 3: prices are really low. Now I'm going to buy one
Speaker 3: of these buildings. I'm going to do really well because
Speaker 3: I think prices are going to recover, and they make
Speaker 3: a tactical profit out of that. But if you owned
Speaker 3: a building for as long as the bricks and the
Speaker 3: cement lasted, you would find that over time you'd be
Speaker 3: pouring back pretty much all of your rent into upgrading
Speaker 3: that building. What you really want is a big piece
Speaker 3: of land and a tin shed on it, which is
Speaker 3: like a Bunning's building. That's what you want. You want
Speaker 3: Industrial industrial property, I think makes a lot more sense
Speaker 3: economically from a business economics perspective. Industrial properties make more
Speaker 3: sense than CBD office towers because you've got a lot
Speaker 3: of land that is appreciating and you have only a
Speaker 3: cheap shed that is depreciating.
Speaker 1: It's so interesting. And in residential that version, obviously is
Speaker 1: the landlords who have a row of pretty beaten noboard
Speaker 1: houses that never change and are rented for generations. And
Speaker 1: it's the same sort of thing in the middle of
Speaker 1: the city.
Speaker 2: Very interesting.
Speaker 1: Okay, we must get through the other questions, but thank
Speaker 1: you for that, Tommy's Paul. Are Australian and other share
Speaker 1: markets approach in long term pe value peaks?
Speaker 2: Don't they correct? At this point? What does history tell us?
Speaker 2: If only we.
Speaker 1: Could answer that in a reliable fashion, Paul, but Roger
Speaker 1: will have a goal.
Speaker 3: The short answer is no, it has nothing to do
Speaker 3: with the valuations by themselves. It will be a change
Speaker 3: in the PE ratio, which measures the willingness of people,
Speaker 3: the popularity or willingness of people to pay for a
Speaker 3: dollar of earnings. The more popular or the more willing
Speaker 3: investors are to pay for a dollar earnings, the PE expands.
Speaker 3: There is a relationship, a correlation between interest rates and PES,
Speaker 3: but there's also a correlation between sentiment and PES, and
Speaker 3: sentiment all else being equals, sentiment is going to drive
Speaker 3: what people are willing to pay for a dollar of
Speaker 3: earnings if interest rates remain constant. When interest rates go down,
Speaker 3: that acts like I think it was Warren Buffett who
Speaker 3: said that that interest rates are like gravity on prices
Speaker 3: or on pes, and so when interest rates go up,
Speaker 3: the gravitational force is much greater and the value the
Speaker 3: present value of future income goes down. PES go down
Speaker 3: because people leave the stock market to put their money
Speaker 3: into safer securities that are paying a higher interest rate,
Speaker 3: and so or what they perceive to be safer and
Speaker 3: paying a higher interest rate. So that process of moving
Speaker 3: money out of the stock market into interest bearing securities
Speaker 3: because interest rates have gone up, that reduces prices. That
Speaker 3: selling pushes prices down, and then prices follow the intrinsic value.
Speaker 3: The intrinsic values because the present value of future earnings
Speaker 3: goes down as interest rates go up.
Speaker 2: But to try and to.
Speaker 3: Say that old peas are very high at the moment,
Speaker 3: now there's going to be a correction, that's wrong. And
Speaker 3: you only need to look at Robert Schiller's cape chart.
Speaker 3: You can google that. Just type in Robert Schiller cape
Speaker 3: chart and it'll be the first it'll be the first
Speaker 3: entry on Google or the first listing you can pull
Speaker 3: up that chart, and what you'll find is that there
Speaker 3: have been lots of times in the past where the
Speaker 3: cape ratio has been high and it's just kept going higher.
Speaker 3: So no, you wouldn't say that just because peas are high,
Speaker 3: that the market is going to correct. That's a mistake
Speaker 3: that only young players keep making.
Speaker 2: Remember your young pups. But here's the thing.
Speaker 1: If there was a bell that rang at the top
Speaker 1: of them, I could pull, everybody would know, and we'd
Speaker 1: all be out, and we'd all be worthy and we'd
Speaker 1: go back in at the bottom.
Speaker 2: But it doesn't work like that.
Speaker 1: And as Roger says, when you see these headlines, and
Speaker 1: it's a great old trick, you see it in media
Speaker 1: all the time. This ratio, some ratio is gone high.
Speaker 1: Be careful the last time it happened to stop market crash. Yes,
Speaker 1: but there's no evidence proof whatsoever.
Speaker 2: It'll crash again because of one ratio or another.
Speaker 1: I think, as Roger alluded to, it's sentiment. Really all
Speaker 1: you can have all the ratios you like, it's sentiment
Speaker 1: that on the day that turns a market. I think
Speaker 1: the best one two for that is nineteen eighty seven.
Speaker 1: So one of the reasons I used that crash because
Speaker 1: it was the one that had no clear, outstanding explanation
Speaker 1: except for the fact that the market had run so high. Okay,
Speaker 1: and other crashes we knew why, COVID, GFC.
Speaker 2: Et cetera. Yeah, we might.
Speaker 3: I was just gonna say, James, it might be that
Speaker 3: there's a huge amount of global debt which hasn't worried
Speaker 3: anyone year for many years, and then suddenly everyone starts
Speaker 3: to worry about it because there's a refinancing of it.
Speaker 3: Or China decides to annex Taiwan, it decides to put
Speaker 3: all of its ships and all of its planes over
Speaker 3: the top, and suddenly sentiment changes. And that's more likely
Speaker 3: than just the fact that peas are high.
Speaker 1: Yes, exactly the sentiment rather than the actual numbers. Okay,
Speaker 1: final question from Fred. We'll try and do it quickly.
Speaker 1: It is impossible to see how my superfund is really
Speaker 1: doing against the market because tax is a distortion. Tax
Speaker 1: may exaggerate the returns if the tax rate is negative
Speaker 1: due to franking credits, for example. In addition, the tax
Speaker 1: on super can very lot, depending for example, if the
Speaker 1: fund is in accumulation or pension. Isn't it difficult and
Speaker 1: dangerous to discuss returns on investment without acknowledging the tax overlay? Yes, Fred,
Speaker 1: absolutely it is. Do you think it's in particular issue
Speaker 1: for super funds and their returns and their state? And
Speaker 1: those advertising panels we see on the highways telling us
Speaker 1: that such a funded nine percent for ten years in
Speaker 1: a row or whatever?
Speaker 2: Are they miss leading? Do you think, Roger?
Speaker 3: Look? I think, James. The reason why it's done that
Speaker 3: way is precisely because of the points that the question eraises,
Speaker 3: and that is that everyone's tax is different. Imagine an
Speaker 3: advertisement for a fund's returns that took into account everyone's
Speaker 3: different tax rates. The numbers would be so small you
Speaker 3: wouldn't be able to see the.
Speaker 2: Ad yeah, or even the bands.
Speaker 3: Yeah, absolutely, And so what we do is we take
Speaker 3: that out of the equation and we let people make
Speaker 3: their own assessment of what the return would be for
Speaker 3: them given their tax rate they deal with. Everyone deals
Speaker 3: with their own taxes, and we just present the numbers
Speaker 3: pre tax but after these but before personal tax rates,
Speaker 3: because we don't know people.
Speaker 2: If you're in.
Speaker 3: Pension phase in your superannuation fund, you're not paying any tax.
Speaker 3: So the advertised return is your return up to one.
Speaker 2: Point nine million.
Speaker 1: Okay, I thank you very much, fed So I hope
Speaker 1: that's useful to you. None of this was advice. It's
Speaker 1: all information. And the last piece of information there was
Speaker 1: that you want to see those returns before fees, but
Speaker 1: actually on taxes, it's just not feasible to do it
Speaker 1: after text because of the tax bands, because of the
Speaker 1: tax position, because of the fact that you don't pay
Speaker 1: TEXT when you're retired, and you pay half your income
Speaker 1: in tax if you make a good salary before you're retired,
Speaker 1: as all many of our listeners would be aware of. Okay,
Speaker 1: Roger Montgomery, thank you very much. Marvelous to have you
Speaker 1: on today or as a pleasure.
Speaker 3: Jame's glad to be with you again in.
Speaker 1: Person, and thank you very much for listening. Let's have
Speaker 1: some emails the money Puzzle at the Australian dot com
Speaker 1: dot au.
Speaker 2: Talk to you soon.