WEBVTT - Michael Mauboussin on How to Read Stock Prices (Podcast) 0:00:02.040 --> 0:00:07.160 This is Mesters in Business with very Results on Blueberg Radio. 0:00:08.200 --> 0:00:11.400 This week on the podcast, I have an extra special guest, 0:00:11.760 --> 0:00:15.280 returning Champion, Michael Mobison. He is on the buy side 0:00:15.320 --> 0:00:18.360 people thinking. When I say that Michael is at Counterpoint 0:00:18.360 --> 0:00:22.479 Global at Morgan Stanley Investment Management, it's not Morgan Stanley, 0:00:22.520 --> 0:00:25.959 the big seal side broker dealer. It's a totally different division, 0:00:26.000 --> 0:00:29.000 their asset management division. We really spend a lot of 0:00:29.000 --> 0:00:32.159 time talking about UH the new edition of his book, 0:00:32.360 --> 0:00:37.080 Expectations Investing. What I love about Michael is how thoughtful 0:00:37.159 --> 0:00:43.200 he is, how interesting his approach to investing, thinking about markets, 0:00:43.360 --> 0:00:47.839 individual companies value UH and basically the approach he brings 0:00:47.880 --> 0:00:52.080 to research to the investment community. He's been writing and 0:00:52.120 --> 0:00:57.960 publishing about markets for literally decades, not just his many books, 0:00:57.960 --> 0:01:02.440 which I'll include in my notes, but the research papers 0:01:02.480 --> 0:01:05.680 he puts out and shares with the public. They're always 0:01:05.720 --> 0:01:11.080 interesting and thoughtful, and I frequently find myself looking at these, 0:01:11.120 --> 0:01:13.720 reading these and going huh cock in my head, I 0:01:14.000 --> 0:01:17.000 hadn't thought about that. That's a really interesting take on 0:01:17.240 --> 0:01:20.800 a very fundamental idea, and I'm I'm glad I had 0:01:20.840 --> 0:01:23.600 the opportunity to give this a thought. I found this 0:01:23.680 --> 0:01:28.000 to be a master class in valuation and how to 0:01:28.080 --> 0:01:33.920 think about what a company's proper potential value is, what 0:01:34.160 --> 0:01:38.160 your expectation for investing in that company should be. Uh, 0:01:38.200 --> 0:01:41.360 it's no surprise he's been teaching at Columbia for I 0:01:41.360 --> 0:01:43.640 don't know twenty years as an adjunct professor in the 0:01:43.720 --> 0:01:46.640 Business School. I'm gonna stop babbling and say, with no 0:01:46.720 --> 0:01:54.000 further ado, my conversation with Morgan Stanley's Michael Mobison. This 0:01:54.480 --> 0:01:58.920 is Mesters in Business with very Results on Bloomberg Radio. 0:02:00.280 --> 0:02:03.920 My very extra special guest this week is Michael Mobisan. 0:02:04.280 --> 0:02:08.359 He is the head of Concealing It Research at Counterpoint Global, 0:02:08.680 --> 0:02:12.760 which is part of Morgan Stanley's investment management group. It's 0:02:12.840 --> 0:02:16.160 the bye side part, not the sell side part of 0:02:16.200 --> 0:02:20.400 Morgan Stanley. Previously, he was head of Global financial Strategies 0:02:20.400 --> 0:02:24.240 at Credit Swiss and before that, chief investment strategist at 0:02:24.320 --> 0:02:29.200 leg Mason Capital Management, working with the famed investor Bill 0:02:29.240 --> 0:02:33.680 Miller during his incredible streak. He is also a professor 0:02:33.680 --> 0:02:36.880 of finance at Columbia Business School and Chairman of the 0:02:36.919 --> 0:02:41.000 Board of Trustees at the Santa Fe Institute. Michael Mobisan, 0:02:41.280 --> 0:02:44.520 Welcome back to Bloomberg. Awesome to be with you, Barry. 0:02:44.560 --> 0:02:47.240 Always a blast, and it's so good to be with you. 0:02:47.240 --> 0:02:49.600 You know, I don't do this. I don't throw my 0:02:49.760 --> 0:02:52.800 arms up when I'm doing it at home remote using 0:02:52.800 --> 0:02:57.200 a Comrex machine to jack into the Bloomberg machinery. It's 0:02:57.280 --> 0:02:59.840 nice to be in the studio and look at you. 0:03:00.280 --> 0:03:03.760 I I have four hours worth the questions for you, 0:03:03.960 --> 0:03:06.360 so we'll we'll see if we can get through some 0:03:06.560 --> 0:03:10.840 of them. But let's start talking about your most recent book, 0:03:10.880 --> 0:03:15.320 which I hold in my hands, Expectations investing, reading stock 0:03:15.360 --> 0:03:19.720 prices for better returns. So you first wrote this twenty 0:03:19.840 --> 0:03:24.240 years ago with your co author is Alfred Rappaport. What 0:03:24.440 --> 0:03:28.200 made you decide to um revisit this and reissue this 0:03:28.520 --> 0:03:31.359 twenty something years later? Yeah? Why should first tell you 0:03:31.360 --> 0:03:33.160 a little bit about the background of the first book? 0:03:33.320 --> 0:03:36.080 And and I was, you know, I was a someone 0:03:36.240 --> 0:03:39.520 had no business experience, coming onto Wall Street and read 0:03:39.560 --> 0:03:43.680 a copy of Owl's book Creating Shoulder Value in the 0:03:43.760 --> 0:03:46.720 late nineteen eighties, and it was for me a professional epiphany. 0:03:46.760 --> 0:03:50.760 And I say that because it really everything I've done 0:03:50.800 --> 0:03:53.280 professionally has come and rift off of this, so it's 0:03:53.320 --> 0:03:55.760 really standing on the shoulder of giants. And so al 0:03:55.840 --> 0:03:59.320 Rapaport has been an incredible mentor and collaborator for me. 0:04:00.160 --> 0:04:02.400 So that book, by the way, it was aimed at 0:04:02.400 --> 0:04:05.040 corporate executives about building value. And there were three lessons 0:04:05.080 --> 0:04:07.160 in there that I always have taken with me. One 0:04:07.280 --> 0:04:11.120 is it's about cash flows and not accounting numbers, you know. 0:04:11.160 --> 0:04:13.280 And it's funny, Barry that we seem to relearn this 0:04:13.400 --> 0:04:16.080 lesson from time and time, but we'll probably get into 0:04:16.120 --> 0:04:17.800 it in some degree. But I think today we're at 0:04:17.800 --> 0:04:21.120 a particularly interesting time and markets where because of the 0:04:21.120 --> 0:04:23.120 way the accounting works and because of the way the 0:04:23.120 --> 0:04:26.599 economy is moving, uh, you have to really follow the 0:04:26.800 --> 0:04:30.039 cash trail more than ever. The second thing is he said, 0:04:30.080 --> 0:04:33.039 you know, to do intelligent valuation work, you have to 0:04:33.120 --> 0:04:36.919 understand both finance and strategy. And I think this is 0:04:36.960 --> 0:04:41.120 something else people feel very free throwing multiples around and 0:04:41.160 --> 0:04:44.200 so on and so forth without really doing the proper 0:04:44.240 --> 0:04:47.039 strategy analysis. And I think that was a second lesson. 0:04:47.040 --> 0:04:48.920 And then the third thing, this is my build up 0:04:48.920 --> 0:04:51.440 to your answer your question. The third thing was the 0:04:51.440 --> 0:04:53.880 original book catch chapter seven was called stock market signals 0:04:53.880 --> 0:04:57.120 to managers, and the argument was, hey, executive, if you 0:04:57.120 --> 0:05:00.360 want to understand how to allocate capital judiciously, even set 0:05:00.480 --> 0:05:03.000 up incentives, you need to understand what the markets pricing 0:05:03.040 --> 0:05:07.680 into your stock. So that obviously has direct implications for investors. 0:05:07.800 --> 0:05:10.120 And that ended up, you know, we end up collaborating 0:05:10.120 --> 0:05:13.080 on the original version aimed at investors called Expectations Investing. 0:05:13.160 --> 0:05:15.760 Now I'm glad you're sitting down because the original version 0:05:15.839 --> 0:05:22.240 came out September two thousand and one, like literally twenty 0:05:22.320 --> 0:05:26.760 years ago, the day before the Greatest that the greatest 0:05:26.800 --> 0:05:29.880 not natural tragedy, and by the way, much less significantly 0:05:30.160 --> 0:05:32.760 in the midst of a three bear three year bear market. Right. 0:05:33.120 --> 0:05:35.560 So um, And by the way, I thought, you know, 0:05:35.560 --> 0:05:37.760 many of the ideas and the books stood up over time. 0:05:37.800 --> 0:05:40.120 But I had been teaching from this these principles for 0:05:40.160 --> 0:05:42.479 a long time and so you know, and part of 0:05:42.600 --> 0:05:44.240 was COVID induced, but I was, you know, and I'm 0:05:44.279 --> 0:05:46.600 in constant conversation with with Al, and I said to him, 0:05:46.600 --> 0:05:48.880 you know, there's enough that's gone on in the world, 0:05:49.240 --> 0:05:51.400 uh that I think we it's time for us to 0:05:51.400 --> 0:05:54.159 take another swing at this, which is bring in what 0:05:54.400 --> 0:05:58.480 is new, freshen up our case studies and uh like, 0:05:58.600 --> 0:06:01.640 let's focus on what worked still and what's still is good, 0:06:01.640 --> 0:06:03.720 but let's bring it in and make it more contemporary. 0:06:03.760 --> 0:06:05.640 So I just thought it was and and and and 0:06:05.640 --> 0:06:08.200 and in teaching it, what lessons have I learned? And 0:06:08.279 --> 0:06:10.839 how to communicate some of the ideas effectively, what matters 0:06:10.839 --> 0:06:12.800 and what. So we ended up only getting rid of 0:06:12.839 --> 0:06:16.000 one chapter, replacing one chapter altogether. But there's so much 0:06:16.040 --> 0:06:17.919 about it. So the bones are basically the same, but 0:06:17.960 --> 0:06:20.000 there's so much about it that's brand new in terms 0:06:20.040 --> 0:06:23.120 of the case studies and again reflecting how the world 0:06:23.160 --> 0:06:25.520 has changed in the last twenty years. And for people 0:06:25.520 --> 0:06:28.440 who may not be familiar with Alfred Rappaport, he's a 0:06:28.480 --> 0:06:31.720 professor professor at Kellogg and and he's done a ton 0:06:31.760 --> 0:06:35.720 of work on how to create long term value and 0:06:35.839 --> 0:06:40.719 overcome short term is um amongst investors and corporate managers. 0:06:40.720 --> 0:06:43.040 Tell us a little bit about that background. Yeah, I 0:06:43.080 --> 0:06:44.880 mean that's it. I mean, look, I think that he 0:06:45.240 --> 0:06:49.039 um is gonna he is one of the great sort 0:06:49.080 --> 0:06:52.920 of academics, uh in this whole area in the last 0:06:52.960 --> 0:06:56.720 half century. Um. His PhD is in accounting, by the way, 0:06:56.760 --> 0:07:01.039 I should mention, but he's made very important contra usians 0:07:01.080 --> 0:07:05.240 in accounting, in finance, and as I mentioned, was one 0:07:05.240 --> 0:07:08.960 of the great synthesizers of bringing together strategy and finance. 0:07:09.320 --> 0:07:11.240 He by the way, did a lot of the executive 0:07:11.240 --> 0:07:15.280 programs a Kellogg and had a literally a world famous 0:07:15.320 --> 0:07:18.520 program called Merger Week. And if you were anybody in 0:07:18.560 --> 0:07:21.800 the mergers and acquisitions world, in the corporate world in 0:07:21.840 --> 0:07:25.000 the eighties and nineties, you the mecca was to go 0:07:25.040 --> 0:07:27.520 to Kellogg to do Merger Week and learn about this. 0:07:28.040 --> 0:07:31.640 And so yeah, I mean, he's just a tremendous a 0:07:31.640 --> 0:07:34.640 tremendous resource. Now he's in he is in his late eighties. Now, 0:07:34.760 --> 0:07:36.400 he by the way, could not be better. I mean 0:07:36.400 --> 0:07:39.240 I talked to him almost every single day and sharpened 0:07:39.480 --> 0:07:44.760 and you know, just intellectually, so curious, a very avid reader. 0:07:45.200 --> 0:07:48.000 I mean, so really going, still going, really really strong. 0:07:48.120 --> 0:07:50.240 But um, and it's by the way, total delight. Is 0:07:50.280 --> 0:07:53.360 always total delight working with him, in part for for 0:07:53.360 --> 0:07:55.520 for the joint learning that goes on, but also to 0:07:55.600 --> 0:07:57.800 have someone to be a reality check when you're sort 0:07:57.800 --> 0:08:00.000 of going off a little bit and need a little 0:08:00.080 --> 0:08:02.920 of course, correction. He's the old professor that sort of 0:08:02.920 --> 0:08:05.320 brings you back into line, which is powerful. That's great. 0:08:05.480 --> 0:08:08.360 Everybody needs a Jimney Cricket on their shoulder to make 0:08:08.400 --> 0:08:10.520 sure they're not, you know, they're not going off to 0:08:10.600 --> 0:08:13.520 never Neverland. So there are a bunch of quotes from 0:08:13.520 --> 0:08:16.480 the book I want to get into, but I have 0:08:16.560 --> 0:08:21.640 to start with one that that's so macro and all encompassing. 0:08:22.160 --> 0:08:24.520 It really talks to the theme of the book, which 0:08:24.560 --> 0:08:29.920 is when investors talk about expectations, they're usually talking about 0:08:29.960 --> 0:08:35.360 the wrong expectations. Explain, well, I think that, Um, it's 0:08:35.440 --> 0:08:40.280 interesting that when people talk about what a stock is worth, 0:08:40.559 --> 0:08:42.600 and you should you should correct me if you hear 0:08:42.679 --> 0:08:48.880 something differently, it's almost always some multiple of some sort 0:08:48.920 --> 0:08:52.720 of earnings metric PE to say, the very least and 0:08:52.760 --> 0:08:55.920 then a million variations r P E or e VD 0:08:56.679 --> 0:08:59.800 or something like that. Right, And so the basic argument is, 0:09:00.000 --> 0:09:04.800 at um, multiples are shorthand for what is a broader 0:09:04.880 --> 0:09:10.720 valuation process, and multiples embedding them lots of assumptions about 0:09:10.760 --> 0:09:14.600 how the world works, including assumptions about returns on capital 0:09:14.640 --> 0:09:17.400 and growth and so forth. And then as we'll talk 0:09:17.440 --> 0:09:20.480 about and probably more detail. Measures like earnings or even 0:09:20.520 --> 0:09:25.240 even daw themselves um can be very unreliable measures or 0:09:25.360 --> 0:09:29.080 metrics of value creation. So so when they say, oh, 0:09:29.160 --> 0:09:32.719 at at X multiple, that it looks like low expectations, 0:09:32.800 --> 0:09:35.960 or it's cheap in quotation marks, or it's expensive in 0:09:36.040 --> 0:09:39.360 quotation marks, they're really they really don't know exactly. They 0:09:39.360 --> 0:09:42.839 haven't unpacked exactly what the story is. Whereas I think 0:09:42.840 --> 0:09:44.720 we'd all agree a lease in theory that the value 0:09:44.760 --> 0:09:46.880 of the business is the present value the cash flows. 0:09:47.520 --> 0:09:49.520 The argument I always like to make is, let's let's 0:09:49.600 --> 0:09:52.680 lay the lay bare on the table what those assumptions are, 0:09:52.800 --> 0:09:56.400 what the underlying economic assumptions are, and then debate them. Right, 0:09:56.400 --> 0:09:58.680 we may not agree or come down in the same 0:09:58.679 --> 0:10:01.040 place on these things, but at least we note we're 0:10:01.040 --> 0:10:05.880 dealing with versus uh, these these these using putting together 0:10:05.920 --> 0:10:08.599 a multiple, these two things that are neither which on 0:10:08.960 --> 0:10:10.719 their own are very helpful. So so let me take 0:10:10.760 --> 0:10:13.120 a swing at this and you tell me if I'm 0:10:13.559 --> 0:10:16.079 on the money or or off. So when we look 0:10:16.120 --> 0:10:19.480 at earnings, a lot of different things go into making 0:10:19.559 --> 0:10:22.880 earnings high or low, cheaper, expensive, And if you're just 0:10:22.960 --> 0:10:26.160 looking at that net number, you're blind to all the 0:10:26.200 --> 0:10:30.560 moving parts that might be temporary one offs or potentially 0:10:30.640 --> 0:10:35.240 reflect fast future growth. Just looking at the number itself 0:10:35.320 --> 0:10:38.240 relative to price doesn't give you a complete picture. Is 0:10:38.240 --> 0:10:40.679 that a fair? That? That for sure is true? And 0:10:40.720 --> 0:10:43.520 then there's another component of it that's probably even more compelling, 0:10:43.559 --> 0:10:47.520 which is growing earnings is not synonymous with growing value. 0:10:48.000 --> 0:10:50.760 So saying that differently, if you invest in your business 0:10:50.760 --> 0:10:53.840 and your earning exactly your cost to capital, growth doesn't 0:10:53.880 --> 0:10:57.960 make any doesn't add any value whatsoever. And so uh 0:10:58.000 --> 0:11:01.160 so so so earnings growth be good, it can be bad, 0:11:01.320 --> 0:11:03.520 it can be indifferent, and so you just don't know that. 0:11:03.640 --> 0:11:06.520 So saying this differently, company A and company be same 0:11:06.640 --> 0:11:10.400 earnings growth rates, but the very different value creation prospects 0:11:11.160 --> 0:11:13.760 you can't tell. You know, the multiples are going to 0:11:13.800 --> 0:11:15.960 be different, and they should be different, but the earning 0:11:16.280 --> 0:11:18.480 the earning number in and of itself doesn't tell you 0:11:18.520 --> 0:11:20.920 the answer. And then the other question that comes out 0:11:20.920 --> 0:11:23.560 of this that I felt was really fascinating, what sort 0:11:23.559 --> 0:11:28.560 of expectations should investors have from reading stock prices? And 0:11:28.640 --> 0:11:33.000 how can the ordinary investor read stock prices? Yeah? So 0:11:33.160 --> 0:11:34.760 this I mean this gets to the heart of it. 0:11:34.880 --> 0:11:36.199 And you know, Barry, I was trying to do a 0:11:36.240 --> 0:11:38.480 little bit even and working on this book, I was 0:11:38.520 --> 0:11:40.360 trying to get a little bit of the psychology of 0:11:40.360 --> 0:11:43.240 this because it seems fascinating to me that people love 0:11:43.360 --> 0:11:47.160 to think that they can figure out the value and 0:11:47.160 --> 0:11:49.160 then they're going to compare the value to the price. Right, 0:11:49.200 --> 0:11:51.640 So there they feel like their job is to figure 0:11:51.640 --> 0:11:56.760 out why identifying intrinsic value sided discounts premium and what 0:11:56.960 --> 0:11:59.240 this The premise of this book is obviously just to 0:11:59.320 --> 0:12:01.920 reverse the whole process and just say, like, there's only 0:12:02.000 --> 0:12:07.000 one thing we know for sure, and that's the stock price. Right. Again, 0:12:07.200 --> 0:12:09.080 you may not may like it or not, like it 0:12:09.080 --> 0:12:11.280 doesn't matter. It is something we know for sure. It's 0:12:11.280 --> 0:12:14.679 an objective number versus what's essentially an opinion. So then 0:12:14.720 --> 0:12:17.560 we say we're going to reverse engineer what has to 0:12:17.600 --> 0:12:20.200 happen for that thing to make sense, and then try 0:12:20.240 --> 0:12:23.679 to judge whether that is sensible. Now that to me, 0:12:23.800 --> 0:12:27.400 the most powerful and vivid metaphor is the handicapper. So 0:12:27.559 --> 0:12:29.720 you go off to the horse races to figure out 0:12:29.880 --> 0:12:32.319 and and presuming you'd like to make money, there are 0:12:32.320 --> 0:12:34.920 two things that are really important, right. One is the 0:12:34.960 --> 0:12:37.120 odds on the toe board, which is telling you which 0:12:37.160 --> 0:12:39.960 horse or horses are likely to win. The second is 0:12:39.960 --> 0:12:42.000 how fast the horse is going to run, right, And 0:12:42.040 --> 0:12:44.520 so it's the combination of these two things that it's important. 0:12:44.520 --> 0:12:46.840 But often starting with the toe boards a very sensible 0:12:46.840 --> 0:12:48.480 thing because you say, all right, well, you know, is 0:12:48.520 --> 0:12:50.600 this a favorite or is this a long shot whatever 0:12:50.640 --> 0:12:54.560 whatever it is. So this is basically saying, let's do 0:12:54.600 --> 0:12:57.000 these things backwards. And by the way, there's a there's 0:12:57.000 --> 0:12:58.720 a fascinating guy who you by the way, you should 0:12:58.720 --> 0:13:00.840 get him on sometime. He's really interesting and a kind 0:13:00.880 --> 0:13:03.960 of Stephen Christ. Do you know Steve? Do you know 0:13:04.000 --> 0:13:06.880 Stephen Christ? And the way he's a he's an interesting guy, 0:13:07.280 --> 0:13:09.679 um he and he's written a lot. By the way. 0:13:09.679 --> 0:13:11.800 He wrote a chapter in a book called It's called 0:13:11.880 --> 0:13:14.280 kristin Value is a thirteen page chapter which is one 0:13:14.320 --> 0:13:17.679 of the best chapters about investing I've ever read, even 0:13:17.720 --> 0:13:20.680 though it's about handicapping and Chris sort of talks about 0:13:20.800 --> 0:13:23.120 you know, it's it's about this miss pricing between odds 0:13:23.120 --> 0:13:26.400 and and and performance and so forth. But one of 0:13:26.400 --> 0:13:28.040 the one of the lines in there he loves. He 0:13:28.080 --> 0:13:29.960 says that I love. He says, you know, everybody thinks 0:13:29.960 --> 0:13:32.760 that they're doing this thing, but very few people actually do. 0:13:32.840 --> 0:13:35.080 And I think that's the same thing for for investing. 0:13:35.120 --> 0:13:38.280 So when when you explain expectations investing the basic principle, 0:13:38.320 --> 0:13:40.840 people go, yeah, well, it's kind of what I'm doing, 0:13:40.920 --> 0:13:42.920 and isn't it And and the answer is that's known 0:13:42.920 --> 0:13:45.200 and not really what you're doing. Right. So so there 0:13:45.200 --> 0:13:47.680 are really three steps in the process, which you'll probably 0:13:47.720 --> 0:13:49.520 get to you. But one is to say what has 0:13:49.559 --> 0:13:52.079 to happen for today's stock price to make sense, right, 0:13:52.080 --> 0:13:55.280 So that's just basically where is the bar set? And 0:13:55.320 --> 0:13:57.640 then step two is introducing you know, sort of more 0:13:57.720 --> 0:14:01.880 high falutin strategic and financial now to determine whether company's 0:14:01.880 --> 0:14:05.160 gonna outperform, that expectations underperform, or g it's going to 0:14:05.240 --> 0:14:07.800 be I have no strong opinion one or another. And 0:14:07.840 --> 0:14:10.160 then step three is to make by cell and hold 0:14:10.320 --> 0:14:14.959 uh uh decisions as a consequence. So in the book 0:14:15.040 --> 0:14:17.240 you we're going to talk about earnings now, but I 0:14:17.320 --> 0:14:21.240 have to bring up the broad changes you identify in 0:14:21.280 --> 0:14:24.280 the market, and and we're going to circle back to 0:14:24.320 --> 0:14:27.680 these but I want to reference these relative to earnings. 0:14:28.080 --> 0:14:32.040 The shift from active to passive, the rise of intangibles, 0:14:32.200 --> 0:14:35.640 the move from public investing to private investing, and then 0:14:35.640 --> 0:14:39.520 the major changes in accounting rules. All four of those 0:14:39.560 --> 0:14:43.080 things have changed since the first version of this book. 0:14:43.520 --> 0:14:48.480 How significant are they to how earnings are accounted for 0:14:48.800 --> 0:14:52.240 and valued by investors? So, I mean, maybe we can 0:14:52.280 --> 0:14:54.360 part these a little bit because I think the active 0:14:54.720 --> 0:14:58.800 too passive thing would affect you know, if it affects anything, 0:14:58.840 --> 0:15:01.760 would be things like markets more or less efficient and 0:15:01.840 --> 0:15:03.960 things like that. So I don't know that that's a 0:15:04.000 --> 0:15:06.400 big thing for what we're talking about in terms of earnings. 0:15:07.000 --> 0:15:09.960 And the other one is public to private And you know, 0:15:10.000 --> 0:15:11.720 even since we wrote this book there I think there 0:15:11.720 --> 0:15:15.000 are a third fewer public companies than there were twenty 0:15:15.080 --> 0:15:18.160 years ago. But on that point, keep in minds someone 0:15:18.240 --> 0:15:21.960 there's been some studies done and a huge swath of 0:15:21.960 --> 0:15:25.200 those were penny stocks that got kicked off the nas 0:15:25.240 --> 0:15:28.520 deck and onto the paint and nobody really cares about them. Yeah, 0:15:28.560 --> 0:15:31.720 that's that is absolutely correct, and so but the nature 0:15:31.720 --> 0:15:33.920 of these companies have changed, it in the market caps 0:15:33.920 --> 0:15:35.640 and so forth. But again that I'm not sure that's 0:15:35.640 --> 0:15:38.360 a big story for earnings. I think the one that 0:15:38.480 --> 0:15:40.800 I mean accounting changes, but I think the really big 0:15:40.840 --> 0:15:43.880 one is this rise of intangibles that you pointed out, 0:15:43.960 --> 0:15:46.720 And just to give well, first of all, let's go 0:15:46.760 --> 0:15:48.720 back a little bit even further in history. Back in 0:15:48.760 --> 0:15:53.760 the nineteen seventies, tangible investment, so tangible physical things, think 0:15:53.880 --> 0:15:58.760 tractor factories and truck machines, drills, all that, right, those 0:15:58.800 --> 0:16:02.720 were twice the level of intangible investments and intangible by 0:16:02.760 --> 0:16:09.200 definition non physical, so think now branding, software, code, all 0:16:09.240 --> 0:16:13.160 these kinds. Okay, right, So two to one tangible to intangible. 0:16:13.240 --> 0:16:15.640 At the time we wrote the book so called two 0:16:15.680 --> 0:16:18.520 thousand and one, twenty years ago, they were the first 0:16:18.600 --> 0:16:22.360 version of the book. They were at parody. And our 0:16:22.520 --> 0:16:27.120 estimate is, for one that intangibles will be more than 0:16:27.160 --> 0:16:30.920 two times tangible. So in the last twenty years alone, 0:16:30.920 --> 0:16:32.640 they you could sort of say they started the race 0:16:32.960 --> 0:16:36.240 basically neck and neck, and now it's much much more intangible. 0:16:36.480 --> 0:16:38.440 So why why is that important? Like why do we 0:16:38.480 --> 0:16:42.520 care about that? That's important because tangible assets, the way 0:16:42.560 --> 0:16:46.320 the accounts record them is they're capitalized on the balance sheet, right, 0:16:46.320 --> 0:16:48.640 it's a it's property, plant, and equipment, which we then 0:16:48.680 --> 0:16:51.400 depreciate over time, so it does show up in the 0:16:51.400 --> 0:16:54.960 income statement, but primarily in the form of depreciation. By contrast, 0:16:55.480 --> 0:16:59.680 intangible investments are fully expensed. Now. The most famous of 0:16:59.720 --> 0:17:02.040 these research and development, and we've known that since the 0:17:02.080 --> 0:17:04.879 nineteen seventies, the fast we decided that that R and 0:17:04.960 --> 0:17:07.439 D should be expensed, and there's debate about there's been 0:17:07.480 --> 0:17:10.040 builby about that for a very long time. But now 0:17:10.200 --> 0:17:12.719 R and D is only a quarter of total intangible investment. 0:17:12.800 --> 0:17:15.160 So there's lots of other stuff that's going on that's 0:17:15.200 --> 0:17:17.639 all expensed. So what does that mean, all things being equal, 0:17:17.720 --> 0:17:20.000 The answer is earnings are a lot lower than they 0:17:20.080 --> 0:17:23.800 would otherwise be. I always like to point out that, uh, 0:17:23.840 --> 0:17:29.200 you know, great companies like Walmart, great companies like home Depot, 0:17:29.280 --> 0:17:31.439 for the first ten or fifteen years, they republic had 0:17:31.520 --> 0:17:34.760 negative free cash flow, right, which their investments were bigger 0:17:34.760 --> 0:17:37.879 than their earnings. That they had positive earnings. Was that 0:17:38.000 --> 0:17:41.200 a problem, No, it's fantastic, right, because their investments had 0:17:41.359 --> 0:17:44.639 very high returns on on capital and so and by 0:17:44.640 --> 0:17:47.160 the way, Walmart, for example, it's first fifte years tripled 0:17:47.160 --> 0:17:49.359 the performance of the stock market. Right, it crushed it. 0:17:49.840 --> 0:17:53.120 And when you do the that's a substantial compounding advantage. Right. 0:17:54.040 --> 0:17:58.040 But the problem is now where we're conflating investments and 0:17:58.200 --> 0:18:00.679 expenses on the income statement and don't see that. We 0:18:00.760 --> 0:18:03.280 can't unpack those things and just to just to jump 0:18:03.320 --> 0:18:07.320 in places like Walmart and Home Depot and those just 0:18:07.600 --> 0:18:10.439 they're buying land, they're putting up new stores, they're expanding, 0:18:10.760 --> 0:18:13.840 so that sort of tangibles does show up on the 0:18:13.840 --> 0:18:15.760 balance sheet, that's right, and that's the whole point. So 0:18:15.800 --> 0:18:18.720 they're there. And by the way, even Walmart, Walmart for 0:18:18.760 --> 0:18:20.840 sure was an early user of technology. Right. If you 0:18:20.880 --> 0:18:23.439 read Sam Walton's book, which probably everybody should, it's a 0:18:23.480 --> 0:18:27.000 fantastic I reread that memoir just last year. It's just awesome. 0:18:27.280 --> 0:18:29.800 You know, they were early users of technology, so they 0:18:29.800 --> 0:18:32.800 were early intangible users as well. But you're exactly right. 0:18:32.840 --> 0:18:36.359 The vast majority of their investments were physical you can 0:18:36.400 --> 0:18:38.560 you can kick it and so and so forth, whereas 0:18:38.560 --> 0:18:41.760 other other companies that is not the case. So yes, 0:18:41.960 --> 0:18:44.040 so that to me is a that's a watershed change, 0:18:44.040 --> 0:18:48.240 and that's why earnings Again, if you're focusing on cash flow, 0:18:48.640 --> 0:18:51.840 these things become much less important because we're getting to 0:18:51.880 --> 0:18:55.440 the ultimate route. Answer. Uh, but if you're simply using 0:18:55.520 --> 0:18:57.920 multiples or some sort of shorthands, you're gonna just miss 0:18:58.000 --> 0:19:01.359 this very significant development. So so people love to point 0:19:01.400 --> 0:19:05.280 out how expensive the stock market is and how pricey 0:19:05.320 --> 0:19:08.040 that we used to call them fang but now with Facebook, 0:19:08.240 --> 0:19:10.800 I don't know what the alt call it anymore. But um, 0:19:10.840 --> 0:19:14.680 if we look at the top ten or twenty technology companies, 0:19:15.960 --> 0:19:18.600 or or the top of the S and P five 0:19:18.680 --> 0:19:23.040 hundred by market cap, those appear to be pricey. But 0:19:23.200 --> 0:19:27.959 these are all companies that have massive investments and intangibles. 0:19:27.960 --> 0:19:32.000 So it's Google, it's Apple, it's Netflix, it's Microsoft, it's Facebook. 0:19:32.280 --> 0:19:35.600 Go down the list, it's in Vidio. All these companies 0:19:35.680 --> 0:19:39.400 are They own software, they own patents, they own processes. 0:19:40.680 --> 0:19:45.240 Does this imply that these pricey technology companies I left 0:19:45.240 --> 0:19:48.560 out Tesla from the list. Are are these so called 0:19:48.600 --> 0:19:54.280 pricey tech companies that have so much sunk into intangibles? 0:19:54.320 --> 0:19:58.400 Are these perhaps less pricey than the average stock analysts 0:19:58.400 --> 0:20:01.119 believes if you're using additional multiple as, you get a 0:20:01.160 --> 0:20:03.200 very different picture. And you know, we recently wrote a 0:20:03.200 --> 0:20:06.960 report called uh, it's called classifying for clarity, where we 0:20:07.040 --> 0:20:09.560 talked about argue. We argued that certain things should be 0:20:09.600 --> 0:20:12.280 restated in the statement of cash flows. And we use 0:20:12.320 --> 0:20:14.480 as our case study Amazon dot Com. Right, so, one 0:20:14.480 --> 0:20:18.880 of these companies and Amazon back, our calculation or our 0:20:19.080 --> 0:20:23.400 estimate is at Amazon's intangible investments in or forty four 0:20:23.600 --> 0:20:28.800 billion dollars and you, uh, they're if you amortize, if 0:20:28.800 --> 0:20:30.800 you build old schedule and advertise it, it it still comes 0:20:30.800 --> 0:20:34.000 out to nineteen billion dollars of net profit increase. Now, 0:20:34.280 --> 0:20:37.920 Amazon's profits last year about twenty billion. So so just 0:20:38.480 --> 0:20:40.760 if you accept as you doubled the profits right now, 0:20:40.800 --> 0:20:43.040 if you know you we could quibble about the details 0:20:43.080 --> 0:20:46.000 of that so and so worth, but basically that is no, 0:20:46.080 --> 0:20:50.159 that's exactly right. And the IBADAT numbers don't quite double, 0:20:50.280 --> 0:20:53.200 but they close to double. And so now the flip 0:20:53.240 --> 0:20:55.480 side of all that, that's you know, the earnings are better, 0:20:55.520 --> 0:20:58.720 but let's also recognize the investments are a lot higher 0:20:58.720 --> 0:21:02.120 than what is reported to And so I always say 0:21:02.160 --> 0:21:04.760 the job of an investors to understand the magnitude of 0:21:04.800 --> 0:21:07.800 investments and the return on investments, to understand future profits 0:21:07.880 --> 0:21:10.639 and so for a company like Amazon, they're earning a 0:21:10.680 --> 0:21:13.199 lot more than people, at least what they seem to report, 0:21:13.240 --> 0:21:15.200 but they're also investing a lot more. So you know, 0:21:15.240 --> 0:21:17.320 there's still lots of judgment as to what those investments 0:21:17.320 --> 0:21:19.320 will pay off and so and so forth. But you're 0:21:19.359 --> 0:21:24.320 exactly right, it's a very distorted picture, you know, without commentary. 0:21:24.359 --> 0:21:25.800 So this is the whole thing about you know, the 0:21:25.840 --> 0:21:28.800 market used to trade at this multiple. You know, it's 0:21:28.920 --> 0:21:34.320 just the underlying uh nature of our markets. Our businesses 0:21:34.320 --> 0:21:37.879 are enterprises are so different today that I think that 0:21:37.920 --> 0:21:40.800 those sort of comparisons seem to be very simplistic. And 0:21:40.840 --> 0:21:43.520 then just throw in the whole interest rate thing as 0:21:43.560 --> 0:21:47.399