WEBVTT - Davis Funds’ Chris Davis on the Earnings Yield 0:00:12.520 --> 0:00:15.760 Welcome to Inside Active, a podcast about active managers that 0:00:15.840 --> 0:00:19.119 goes beyond sound bites and headlines and looks deeper into 0:00:19.160 --> 0:00:24.360 their processes, challenges and philosophies and security selection. I'm David Cohne, 0:00:24.400 --> 0:00:27.400 i lead mutual fund and active research at Bloomberg Intelligence. 0:00:27.680 --> 0:00:30.920 Today my co host is Michael caspar Us, small cap 0:00:30.960 --> 0:00:34.320 and sector strategist at Bloomberg Intelligence. Mike, thank you for 0:00:34.400 --> 0:00:35.160 joining me today. 0:00:35.400 --> 0:00:36.680 Thanks David, So, you and. 0:00:36.680 --> 0:00:40.479 Gina recently published a note about the fair value model 0:00:41.280 --> 0:00:43.240 you know in the S and P five hundred is 0:00:43.280 --> 0:00:45.960 part of your twenty twenty five outlook. Can you give 0:00:46.040 --> 0:00:49.360 our listeners a brief overview of the fear value model? 0:00:49.520 --> 0:00:51.159 You know how the S and P five hundred is 0:00:51.159 --> 0:00:54.080 currently valued, and you know possibly how it's affected by 0:00:54.080 --> 0:00:54.760 the mag seven. 0:00:55.240 --> 0:00:57.800 Yeah. So our fair value model just for a bit 0:00:57.840 --> 0:01:02.880 of background on two different regressions trained on data between 0:01:03.600 --> 0:01:06.080 twenty twenty sixteen. We've been running it out of sample 0:01:06.120 --> 0:01:10.240 pretty much since we started here at Bloomberg. The left 0:01:10.240 --> 0:01:11.840 hand side of the model, or what I call the 0:01:11.880 --> 0:01:14.280 left hand side of the model, is a regression on 0:01:14.840 --> 0:01:18.600 estimated year ahead PE. The other side of the model 0:01:18.680 --> 0:01:21.920 is for next twelve month EPs growth. And what we 0:01:22.040 --> 0:01:25.640 do is we input consensus rate and macro expectations into 0:01:25.640 --> 0:01:28.480 the model and see what it spits out. Here at 0:01:28.520 --> 0:01:31.880 Bloomberg Intelligence, all of our models are data driven, so 0:01:32.680 --> 0:01:35.319 we're happy to use consensus in it, and it's available 0:01:35.319 --> 0:01:37.160 for clients on bi stocks Go if you'd like to 0:01:37.160 --> 0:01:39.440 download a copy yourself and enter in your own estimates. 0:01:39.440 --> 0:01:43.440 But nonetheless, with those macro own rate consensus estimates in there, 0:01:44.000 --> 0:01:46.480 you get about a nineteen point one times multiple on 0:01:46.520 --> 0:01:48.400 the S and P five hundred. You might be saying, well, 0:01:48.440 --> 0:01:52.680 that's well lower where we are today on the whole index, 0:01:52.800 --> 0:01:55.880 But what's really going on is the mag seven is 0:01:56.200 --> 0:01:58.240 driving a lot of the valuation premium in the S 0:01:58.280 --> 0:02:00.240 and P five hundred, And if you were at it instead, 0:02:01.360 --> 0:02:05.200 envision what the SMP equal weights multiple is. Back when 0:02:05.200 --> 0:02:08.160 we did it, the trailing PE was about twenty point 0:02:08.200 --> 0:02:12.080 three earnings and eighteen point four times forward earnings, So 0:02:12.240 --> 0:02:14.680 nineteen point one pretty much smack dab in the middle 0:02:14.720 --> 0:02:18.079 of those two. On the other side of the model 0:02:18.240 --> 0:02:21.640 next twelve month EPs growth, macro rate consensus would only 0:02:21.680 --> 0:02:24.120 imply about six percent EPs growth. That's well below what 0:02:24.160 --> 0:02:26.680 the bottoms up consensus is for the whole index. But again, 0:02:27.760 --> 0:02:32.320 just looking back at what the equal weighted index has 0:02:32.440 --> 0:02:36.959 forecast for itself, you're getting pretty close to that instead. 0:02:37.040 --> 0:02:39.839 So it's really been an outsized influence of the max 0:02:39.880 --> 0:02:42.160 seven on the S and P five hundred, driving the premium, 0:02:42.240 --> 0:02:45.640 driving the earnings growth at least of late, and consensus 0:02:45.639 --> 0:02:48.120 would expect that gap to narrow over twenty five and 0:02:48.160 --> 0:02:52.480 twenty six, driving a lot of the great rotation that 0:02:52.520 --> 0:02:56.320 we've seen since June at least. But I will note though, 0:02:56.360 --> 0:02:58.760 that we did a bit of a deeper dive into 0:02:58.840 --> 0:03:01.600 the economy and downloaded some of the tables from the 0:03:01.639 --> 0:03:04.640 BEA and combining pretty much all of the tech and 0:03:04.680 --> 0:03:09.560 tech related industries and comparing that to gross output. Those 0:03:09.639 --> 0:03:12.360 industries are only about fourteen point six percent of the 0:03:12.400 --> 0:03:14.639 whole economy, and this is really what's driving a lot 0:03:14.680 --> 0:03:18.480 of that issue or a detachment between our model and 0:03:18.560 --> 0:03:20.320 what's going on in the S and P five hundred, 0:03:20.400 --> 0:03:23.960 because our model is very macro based. Meanwhile, if you 0:03:24.000 --> 0:03:25.440 look at the S and P five hundred, and we 0:03:25.720 --> 0:03:28.400 did it on a BIX classification, which is Bloomberg's industry 0:03:28.440 --> 0:03:32.880 classification system SMP five hundred tech by itself is thirty 0:03:32.880 --> 0:03:35.680 percent of the S and P five hundred, So a 0:03:35.720 --> 0:03:38.800 lot of the reason why macro estimates and the rest 0:03:38.880 --> 0:03:41.600 is detaching from SMP reality right now. 0:03:42.520 --> 0:03:45.120 Nice interesting, So I think it's a great time to 0:03:45.160 --> 0:03:49.120 introduce our guest today. Christopher Davis is chairman and portfolio 0:03:49.240 --> 0:03:52.840 manager at Davis Advisors. He is manager of the Davis 0:03:52.920 --> 0:03:57.160 Large Cap and Financial portfolios. Welcome Chris, thanks for joining us. 0:03:57.320 --> 0:03:59.560 Thanks you so much, David. Mike, I'm glad to be here. 0:04:00.440 --> 0:04:03.520 So before we get into your background and investment philosophy, 0:04:03.960 --> 0:04:06.680 can you add your thoughts to what Mike said? You know, 0:04:06.720 --> 0:04:08.480 how are you seeing the S and P five hundred 0:04:08.520 --> 0:04:09.320 valued right now? 0:04:09.920 --> 0:04:14.880 Well, I think it surprises me. I think Michael's exactly 0:04:15.000 --> 0:04:17.680 right to break out, you know, sort of what is 0:04:17.720 --> 0:04:20.840 it like without the mag seven and so on? The 0:04:20.920 --> 0:04:24.920 median We sometimes think about the median stock and usually 0:04:25.000 --> 0:04:29.320 when you get this sort of very top heavy, concentrated, 0:04:29.440 --> 0:04:33.120 huge pe dispersion, that's sort of a signal that the 0:04:33.279 --> 0:04:36.240 average stock may be more attractive. But when you couple 0:04:36.640 --> 0:04:39.680 that market characteristic with what we would say is a 0:04:39.880 --> 0:04:45.080 very trans transformational time in the economy where a lot 0:04:45.080 --> 0:04:49.200 of traditional business models may be much more at risk 0:04:49.360 --> 0:04:52.200 than they used to be. We think the simple knee 0:04:52.279 --> 0:04:56.080 jerk reaction to rotate into value may be a little 0:04:56.120 --> 0:04:58.560 short sighted. You're going to have to be very specific 0:04:58.839 --> 0:05:02.520 when you look at all of the underlying transformation happening 0:05:02.560 --> 0:05:09.000 in the economy and monetary geopolitics, a high technological disruption. 0:05:09.560 --> 0:05:11.200 There are a lot of models that have been carved 0:05:11.200 --> 0:05:13.559 in stone for fifty or sixty years that are looking 0:05:13.600 --> 0:05:16.760 more and more fragile. So it's a very interesting time 0:05:16.800 --> 0:05:18.640 to invest, definitely. 0:05:19.160 --> 0:05:21.200 So you know, I'd like to take a step back, 0:05:21.279 --> 0:05:24.240 and you know, we'd love to hear your hear about 0:05:24.279 --> 0:05:25.839 the beginnings of your investment career. 0:05:27.080 --> 0:05:30.039 Well, I mean I was, you know, born on third base. 0:05:30.120 --> 0:05:32.520 I didn't hit a triple. You know, I was lucky 0:05:32.560 --> 0:05:37.280 that my grandfather was a spectacular investor. He started in 0:05:37.440 --> 0:05:40.200 about nineteen forty eight or forty nine with money that 0:05:40.240 --> 0:05:43.480 he had borrowed from his wife's family, So talk about pressure. 0:05:44.839 --> 0:05:47.040 And he turned that one hundred thousand dollars into eight 0:05:47.080 --> 0:05:51.080 hundred million by the time he died, all of which 0:05:51.120 --> 0:05:53.400 went to charity. By the way. He did not believe 0:05:53.440 --> 0:05:56.560 it inheritance. So you know when people talk about Warren's 0:05:56.640 --> 0:06:01.000 children or something like that, I know the feeling. He said, 0:06:01.200 --> 0:06:03.560 he didn't want to rob us of the opportunity of 0:06:03.600 --> 0:06:07.960 making an honest living. So and then my father was 0:06:08.000 --> 0:06:11.240 also a great investor, and he started at the Bank 0:06:11.279 --> 0:06:16.160 of New York and then started the Mutual Fund Company 0:06:16.240 --> 0:06:18.960 in the nineteen sixties in the Go go years, a 0:06:19.080 --> 0:06:22.640 time of hot tech and telecom, and he had sideburns, 0:06:22.680 --> 0:06:26.559 and you know, the seventies was such a humbling time 0:06:26.600 --> 0:06:30.080 that in a sense, we put together both of what 0:06:30.160 --> 0:06:32.560 I think of as the real sort of heart of 0:06:32.640 --> 0:06:35.039 each of their investment philosophies. I would say it was 0:06:35.040 --> 0:06:38.800 a similar investment philosophy but applied in two different eras. 0:06:39.320 --> 0:06:41.640 And that really has become the heart of what we do. 0:06:41.720 --> 0:06:44.240 So I grew up, you know, I used to say, 0:06:44.680 --> 0:06:47.080 I grew up at our table with advice like, oh, 0:06:47.360 --> 0:06:50.240 never trust a bear market rally on a Friday. So 0:06:50.320 --> 0:06:54.000 it's a very narrow family business sort of dynamic. But 0:06:54.480 --> 0:06:57.480 of course what really mattered the most, David is is 0:06:57.560 --> 0:07:00.840 both of them loved what they did. They just saw 0:07:01.160 --> 0:07:04.720 you know, this opportunity to study businesses, to study success, 0:07:04.800 --> 0:07:07.479 to look at the business as the people, to be 0:07:07.560 --> 0:07:11.840 able to co invest alongside into these great sort of 0:07:11.920 --> 0:07:16.280 growth companies, generational wealth builders. Was such an exciting way 0:07:16.280 --> 0:07:19.960 to live versus being a creditor, being a lender, being 0:07:20.000 --> 0:07:24.160 a banker. And so I just grew up lucky to 0:07:24.720 --> 0:07:26.760 have been sort of immersed in this from a young 0:07:26.800 --> 0:07:29.480 age by two people that loved what they did for 0:07:29.560 --> 0:07:32.440 a living, and that that has made an enormous business, 0:07:32.920 --> 0:07:35.920 enormous difference in sort of my own career path. 0:07:36.400 --> 0:07:39.120 That's great, kid. You know, if we talk about the 0:07:39.200 --> 0:07:44.000 Davis investment discipline, is I mean that's that's growth stocks. 0:07:44.560 --> 0:07:47.560 Well, it's funny you say that. I think we so 0:07:47.840 --> 0:07:52.680 predate this distinction between growth and value that we sort 0:07:52.680 --> 0:07:57.120 of rejected. Right. We think of ourselves as value investors. 0:07:57.160 --> 0:08:01.760 We never we never bought a business we thought was overvalued, right, 0:08:02.160 --> 0:08:06.760 And growth is a component of value. A business that 0:08:06.800 --> 0:08:11.320 can grow profitably is more valuable than one that doesn't grow. 0:08:11.600 --> 0:08:15.640 But there's no difference in the arithmetic, right, Any business 0:08:15.720 --> 0:08:19.080 is simply worth the present value of its future cash flows. 0:08:19.480 --> 0:08:22.160 And what we would say is the trouble is often 0:08:22.280 --> 0:08:27.160 growth investors are very complacent about the durability of a 0:08:27.200 --> 0:08:31.680 growth rate, and we're very skeptical because capitalism is vicious, 0:08:32.120 --> 0:08:35.040 and when somebody has high returns and high growth, it 0:08:35.080 --> 0:08:38.440 attracts competition. And if you need ten or twenty years 0:08:38.480 --> 0:08:42.600 of growth to get your money back, that can happen, 0:08:43.000 --> 0:08:45.720 but the probabilities are very low. So in that sense, 0:08:45.760 --> 0:08:50.560 we're very skeptical of the momentum style growth investing that 0:08:50.600 --> 0:08:54.719 has sort of characterized a lot of aggressive growth type managers. 0:08:55.160 --> 0:08:58.400 We think they're complacent about the durability of growth. They 0:08:58.600 --> 0:09:04.840 underappreciate the viciousness of competition and dislocations and disruptions. So 0:09:05.280 --> 0:09:08.200 in that sense we firmly in the value camp. But 0:09:09.040 --> 0:09:12.240 on the other hand, we also recognize that what Warren 0:09:12.640 --> 0:09:16.200 Buffett used to call cigar butt investing. You know, finding 0:09:16.240 --> 0:09:19.320 a net net something that's got a book value of 0:09:19.320 --> 0:09:21.360 one hundred and is selling at eighty and you think 0:09:21.400 --> 0:09:24.000 you can't lose money, Well, of course you can if 0:09:24.040 --> 0:09:26.920 the company's not liquid eating and if they continue to 0:09:27.000 --> 0:09:30.240 reinvest your earnings at three or four percent return on 0:09:30.320 --> 0:09:33.720 incremental capital, that's going to be a classic value trap. 0:09:34.200 --> 0:09:38.599 So we think that companies that have durability and resiliency 0:09:39.679 --> 0:09:43.240 are very valuable if they can grow over time, So 0:09:43.559 --> 0:09:46.240 we sort of land between the two. In our hearts, 0:09:46.520 --> 0:09:49.680 we think of ourselves as value investors, but I never 0:09:49.760 --> 0:09:51.600 bought a company that I thought was going to be 0:09:51.679 --> 0:09:54.160 earning a lot less five or ten years from now 0:09:54.320 --> 0:09:56.680 than it is today. So in that sense, we end 0:09:56.800 --> 0:09:57.920 up back in the growth camp. 0:09:58.440 --> 0:10:01.120 That makes sense. Actually you want to dig even a 0:10:01.120 --> 0:10:05.280 little deeper and specifically kind of focus on the Davis 0:10:05.280 --> 0:10:10.559 New York Venture Fund and the Davis Select Us Equity ETF. 0:10:10.720 --> 0:10:14.960 Tickers are n y vt X in d USA. For 0:10:15.040 --> 0:10:17.880 our listeners, can you kind of walk us through you 0:10:17.920 --> 0:10:20.240 know what happens when you're you know, in the investment 0:10:20.240 --> 0:10:21.640 process when you look for companies. 0:10:22.200 --> 0:10:25.280 Well, really our core strategies, which exactly as you say, 0:10:25.720 --> 0:10:30.280 our large cap approach has a certain characteristics that make 0:10:30.400 --> 0:10:33.640 sense given that background. We talked about about being in 0:10:33.679 --> 0:10:37.559 our heart value investors, but wanting that sort of durable 0:10:37.640 --> 0:10:41.040 growth as part of that equation, because what we would 0:10:41.080 --> 0:10:43.880 say when we put that all together is there very 0:10:43.920 --> 0:10:47.920 few companies that embody both of those characteristics. So we 0:10:48.040 --> 0:10:51.679 end up with a portfolio that is highly selective, right 0:10:51.760 --> 0:10:55.959 where we may have you know, thirty companies being you know, 0:10:56.080 --> 0:10:59.440 eighty percent, forty companies being eighty five percent or so 0:10:59.520 --> 0:11:04.440 of ninety percent of the assets of the funds. So 0:11:04.679 --> 0:11:08.800 a concentrated approach, because we really, in essence, we are 0:11:08.880 --> 0:11:13.000 rejecting sort of nine out of ten companies that we 0:11:13.040 --> 0:11:15.040 look at in the S and P. Five hundred and 0:11:15.080 --> 0:11:18.200 owning a portfolio of thirty to forty out of the 0:11:18.240 --> 0:11:21.760 five hundred. So it's a very selective approach. But the 0:11:21.800 --> 0:11:25.560 result of that selectivity is we own a portfolio of 0:11:25.600 --> 0:11:31.319 companies that today trades at about thirty five to say 0:11:31.400 --> 0:11:35.920 thirty five percent discount to the sorts of averages that 0:11:35.960 --> 0:11:39.200 Michael was talking about in the market today, so trading 0:11:39.240 --> 0:11:43.840 at fourteen fourteen and a half times earnings versus a 0:11:43.880 --> 0:11:48.360 market at let's say nineteen or twenty. And yet and 0:11:48.480 --> 0:11:52.120 yet our companies have grown their earnings over the last 0:11:52.160 --> 0:11:55.280 five years at a rate that is essentially the same, 0:11:55.360 --> 0:11:59.040 maybe even slightly higher than the averages. So we call 0:11:59.120 --> 0:12:02.600 that a value investor's dream when you're able to, in 0:12:02.600 --> 0:12:04.920 a sense, have both of those and that's what we 0:12:04.960 --> 0:12:08.079 see today, and that selectivity is sort of a core 0:12:08.240 --> 0:12:11.240 characteristic of what we do, and of course it reflects 0:12:11.240 --> 0:12:14.280 the fact that we're the largest investor in our own strategies. Right, 0:12:14.280 --> 0:12:16.760 we eat our own cooking, you know. This is we 0:12:16.800 --> 0:12:19.800 think of it as trying to build generational wealth. So 0:12:19.840 --> 0:12:23.280 we're not interested in some sub index how do we 0:12:23.360 --> 0:12:27.120 do versus We're interested in building wealth over time and 0:12:27.240 --> 0:12:32.000 so owning a relatively small number of durable businesses with 0:12:32.200 --> 0:12:36.560 resilient long term growth, purchased at attractive prices, run by 0:12:36.880 --> 0:12:39.920 managers that have sort of equal parts. We think of 0:12:39.960 --> 0:12:45.520 integrity and industry and intelligence. That's the sort of formula, 0:12:45.640 --> 0:12:48.840 and it's messy putting it into action. But we've been 0:12:48.920 --> 0:12:51.440 at it a long time. I guess I became the 0:12:51.840 --> 0:12:55.959 manager here in I think nineteen ninety four something like that, 0:12:56.160 --> 0:13:00.920 So it's been We've gone through some interesting markets in 0:13:00.960 --> 0:13:04.360 that time, and the fund itself having started in nineteen 0:13:04.559 --> 0:13:08.080 sixty eight or sixty nine, that's getting to be some 0:13:08.160 --> 0:13:09.040 real mileage. 0:13:10.480 --> 0:13:12.839 I got to ask about multiples a little bit, since 0:13:13.400 --> 0:13:15.439 large segments of the markets are concerned about it, do 0:13:15.520 --> 0:13:17.880 you share that concern? Are you more in the camp 0:13:17.920 --> 0:13:19.760 that productivity gains might make up for the. 0:13:20.240 --> 0:13:23.760 Well, no, I'm absolutely just you know, it's so funny 0:13:23.800 --> 0:13:27.679 because it's often, you know, the end investor is thinking 0:13:27.679 --> 0:13:30.680 about multiples in isolation, and I always think it's better 0:13:31.000 --> 0:13:34.559 if you invert the multiple, just turn it upside down 0:13:35.040 --> 0:13:38.000 and you get what we call the earnings yield. So 0:13:38.120 --> 0:13:40.120 what that means is just to make it easy, if 0:13:40.160 --> 0:13:43.760 you're paying twenty times earnings, you're getting a five percent 0:13:43.840 --> 0:13:46.600 earnings yield. Now you can buy a bond and get 0:13:46.640 --> 0:13:49.800 a five percent yield. So the question is, well, why 0:13:49.840 --> 0:13:53.240 the hell would you own inequity, which is riskier. You're 0:13:53.320 --> 0:13:57.280 the last call on the cash that the business produces, 0:13:57.360 --> 0:14:00.640 below all of the creditors, So why you take a 0:14:00.800 --> 0:14:04.120 comparable multiple. Well, the answer is because I think it's 0:14:04.160 --> 0:14:07.880 going to grow over time. But remember that five percent. 0:14:08.400 --> 0:14:11.839 If it grows ten percent a year, that sounds great, 0:14:11.880 --> 0:14:13.800 But you're only up at five and a half percent 0:14:13.920 --> 0:14:16.040 the next year. Now, depending what you use for a 0:14:16.080 --> 0:14:19.880 discount rate, you may be treading water. Now if you 0:14:19.960 --> 0:14:23.040 start in our portfolio at a fourteen or fifteen times 0:14:23.080 --> 0:14:25.120 or all of a sudden, you're starting with a seven 0:14:25.240 --> 0:14:28.160 or a seven and a half percent yield right now, 0:14:28.240 --> 0:14:32.920 that yield growing it. You know, let's say you know, seven, eight, nine, 0:14:33.080 --> 0:14:35.760 ten percent. All of a sudden, it's seven, it goes 0:14:35.800 --> 0:14:37.960 to seven, seven, it goes to eight and a half, 0:14:38.040 --> 0:14:40.920 it goes to nine point four. And you see the 0:14:41.160 --> 0:14:45.280 power of compounding over time. Now, because we're very low 0:14:45.360 --> 0:14:48.880 turnover investors, we tend to own these businesses a long time. 0:14:48.960 --> 0:14:52.600 That earnings yield over time is how we look to 0:14:52.720 --> 0:14:56.520 generate our return. We're not predicting changes in the multiple, 0:14:56.880 --> 0:14:59.040 but we do think when you start at a high 0:14:59.120 --> 0:15:02.880 multiple or a low earnings yield, you need a lot 0:15:02.920 --> 0:15:04.920 of growth just to get to the risk free rate. 0:15:05.000 --> 0:15:09.040 You started thirty times earnings, had three percent, you got 0:15:09.080 --> 0:15:11.920 to double it just to get to six. Right. So 0:15:12.560 --> 0:15:16.600 that is the mindset we have is instead of thinking pe, 0:15:16.760 --> 0:15:20.080 which is sort of an abstract idea, think about the 0:15:20.080 --> 0:15:22.440 earnings yield and then think about how long if you 0:15:22.560 --> 0:15:25.200 owned one hundred percent of that business, how long do 0:15:25.200 --> 0:15:26.840 you have to own it just to get to a 0:15:26.960 --> 0:15:31.080 ten percent return? Right? And then if it's a business 0:15:31.120 --> 0:15:35.280 where you're paying fifty sixty times earnings, so you're starting 0:15:35.280 --> 0:15:38.360 at one one and a half percent earnings yield, and 0:15:38.400 --> 0:15:40.840 you say boy that's got a double two or three 0:15:41.000 --> 0:15:45.440 times before I even get to a ten percent return. Well, 0:15:45.960 --> 0:15:49.760 that could happen. But once companies are quite large, you 0:15:49.800 --> 0:15:51.640 know a lot of people are gunning for them, and 0:15:51.680 --> 0:15:54.200 you could get a lot of competition. And you look 0:15:54.200 --> 0:15:56.040 at you know, as we look out at this world 0:15:56.120 --> 0:15:59.400 of AI, you know, look at all the obvious winners 0:15:59.440 --> 0:16:02.400 in the early days of the Internet. Most of them 0:16:02.440 --> 0:16:07.560 don't exist anymore. Yahoo, Netscape, I mean, Cisco's a shadow 0:16:07.640 --> 0:16:10.720 of what it was. I mean, those those were the 0:16:11.000 --> 0:16:16.280 absolute sure thing winners. You know, well into the dawn 0:16:16.360 --> 0:16:18.640 of the Internet. It wasn't like they it was still 0:16:18.640 --> 0:16:21.560 in a fort you know, you were about eight years, nine, 0:16:21.720 --> 0:16:25.640 ten years into the Internet, and those were the obvious 0:16:25.680 --> 0:16:29.680 winners to everybody. And of course no price was too high, 0:16:29.040 --> 0:16:32.200 and you were essentially, you know, if you had that 0:16:32.320 --> 0:16:36.360 portfolio pretty well wiped out. And so we think there's 0:16:36.400 --> 0:16:39.320 a lot of danger when people are trying to predict 0:16:39.360 --> 0:16:43.680 winners early, paying huge prices with an enormous amount of 0:16:43.680 --> 0:16:47.560 success booked in because that one percent errings yield, you know, 0:16:47.600 --> 0:16:49.680 to get it up to a ten percent errings yield, 0:16:50.200 --> 0:16:52.840 you need a lot to go right over a long 0:16:52.880 --> 0:16:58.480 period of time, and capitalism is vicious, so it's not 0:16:58.560 --> 0:17:01.920 quite so easy. So as I say that, I think 0:17:02.080 --> 0:17:05.120 is when I think about multiples, invert it, think about 0:17:05.160 --> 0:17:08.600 earnings yield, and then it starts making sense. When investors 0:17:08.600 --> 0:17:12.000 think about their returns going forward, the earnings yield is 0:17:12.040 --> 0:17:14.960 the right starting point, and then you've got to think about, well, 0:17:14.960 --> 0:17:18.280 why should it be higher a year, two, three, five, 0:17:18.640 --> 0:17:20.919 eight years from now. I mean, after all, there are 0:17:20.920 --> 0:17:23.679 some wonderful companies that are earning a fraction of what 0:17:23.760 --> 0:17:27.119 they earned ten years ago, and that sort of dislocation 0:17:27.359 --> 0:17:32.600 and disruption. You know, people underestimate, and you've seen some 0:17:33.040 --> 0:17:36.119 consumer stallwarts. I mean, we look at what's going through 0:17:36.200 --> 0:17:42.040 wonderful companies like Laughter or Anheuser Busch or or Diagio. 0:17:42.080 --> 0:17:45.800 I mean, these are great, durable companies, but you know, 0:17:45.840 --> 0:17:49.080 their earnings have been killed and their multiples have come 0:17:49.119 --> 0:17:52.480 way down. And so again we don't think the value 0:17:52.520 --> 0:17:55.639 side is a safe place in a tumultuous world, and 0:17:55.640 --> 0:17:58.480 within growth can be a very complacent place to be, 0:17:59.080 --> 0:18:02.960 and so you've got to navigate this tightrope that we 0:18:03.119 --> 0:18:05.200 think is what selectivity allows. 0:18:06.640 --> 0:18:09.840 You had mentioned management as one of the things you're 0:18:09.840 --> 0:18:12.600 looking at. And so you know you mentioned integrity, but 0:18:12.680 --> 0:18:16.719 are there other attributes that you look for in management teams? 0:18:17.200 --> 0:18:21.359 Well, the danger of we tend to lionize. Investors tend 0:18:21.359 --> 0:18:26.840 to lionize with the presses help you know, managements after 0:18:26.920 --> 0:18:29.240 their businesses have done very well, and there's what we 0:18:29.320 --> 0:18:32.879 call a halo effect, you know, where you retroactively say, oh, 0:18:32.880 --> 0:18:37.120 it must have been the great management. And so there's 0:18:37.119 --> 0:18:40.439 a lot of subjectivity. And what I would say is 0:18:40.480 --> 0:18:44.000 we try to create a mosaic to understand and I 0:18:44.040 --> 0:18:47.560 would expand the word management to say culture, to really 0:18:47.680 --> 0:18:51.119 understand what is the culture. Why is it that you 0:18:51.200 --> 0:18:57.360 could have two companies selling the same regulated product, headquartered 0:18:57.400 --> 0:19:00.840 almost in the same city, with the same market cap, 0:19:02.240 --> 0:19:05.600 where their product has to be filed with regulators so 0:19:05.640 --> 0:19:09.240 they can't have a secret sauce, and one of them, 0:19:09.400 --> 0:19:11.879 over a course of about twenty years, grew at twenty 0:19:11.920 --> 0:19:15.479 one percent a year and one of them grew at six. Now, 0:19:15.640 --> 0:19:19.879 the examples that I'm using are Ohio Casualty and Progressive. 0:19:20.520 --> 0:19:26.000 They both sell auto insurance. Essentially, they're both headquartered in Ohio, 0:19:26.160 --> 0:19:28.359 not far apart. I think one was in Columbus and 0:19:28.400 --> 0:19:30.919 one in Cleveland. But yeah, I'm a New Yorker, so 0:19:31.000 --> 0:19:35.679 it's close enough. And you know, and of course the 0:19:35.720 --> 0:19:40.399 difference was culture. Progressive had a totally different mindset as 0:19:40.400 --> 0:19:44.800 a company, a spectacular management, a culture of quantitative excellence, 0:19:44.800 --> 0:19:50.840 service excellence, urgency, discipline, creative thinking, I mean, amazing for decades. 0:19:51.359 --> 0:19:55.400 So when we try to evaluate management, I said, we want, 0:19:55.480 --> 0:20:01.159 you know, integrity, intelligence and intensity in a sense. But 0:20:01.320 --> 0:20:04.160 when we build that mosaic, what are we looking for, Well, 0:20:04.160 --> 0:20:08.040 we're looking for clues. Of course, we visit almost every 0:20:08.119 --> 0:20:10.720 company we own, you know, so we're trying to see 0:20:10.920 --> 0:20:14.159 do they keep a good team together. We're looking at 0:20:14.160 --> 0:20:18.399 their accounting choices. David Michael, that's an interesting one. You know. 0:20:18.520 --> 0:20:22.640 Gap is a very wide measure, and you just say, look, 0:20:22.680 --> 0:20:25.480 if somebody ran a private business and you're reporting your 0:20:25.520 --> 0:20:29.160 income to the tax authorities, I'm going to assume you're honest. 0:20:29.680 --> 0:20:32.439 But if you're honest and you're reporting your income to 0:20:32.480 --> 0:20:38.160 the tax authorities, you choose accounting policies that minimize current 0:20:38.200 --> 0:20:43.359 reportable income, right, So you expense things aggressively, use short 0:20:43.400 --> 0:20:49.080 amortization schedules and short depreciation accelerated depreciation schedules. You may 0:20:49.160 --> 0:20:51.960 defer revenue, you'll put up reserves. You know, you'll do 0:20:52.080 --> 0:20:54.240 everything you can to make it look like the company 0:20:54.320 --> 0:20:56.879 is not earning a lot of money. Now, if the 0:20:56.960 --> 0:21:01.640 same company reports its earnings to a perspective buyer, they 0:21:01.680 --> 0:21:07.639 may choose the opposite policies, again legal but very aggressive depreciations. 0:21:07.880 --> 0:21:11.480 They may start capitalizing a lot of software, R and 0:21:11.600 --> 0:21:14.840 D things that they could be expensing. The concept that 0:21:14.880 --> 0:21:16.879 we're trying to get at here was one that my 0:21:16.960 --> 0:21:20.439 grandfather talked a lot about. It was called owner earnings. Right, 0:21:20.560 --> 0:21:24.920 if you own the business, you reinvested enough to protect 0:21:25.040 --> 0:21:28.800 the core and maybe grow at the inflation rate. Everything 0:21:28.880 --> 0:21:32.800 else you have discretion over. You may choose to expand 0:21:32.840 --> 0:21:36.480 your business, but then what's your incremental return on that capital. 0:21:36.840 --> 0:21:39.480 You may choose to pay big dividends. You may take 0:21:39.480 --> 0:21:41.600 that money and say I'm going to go buy a competitor. 0:21:42.119 --> 0:21:44.400 But whatever it is, when we look at the business, 0:21:44.480 --> 0:21:48.960 that's the mindset we look at. So the capital allocation decisions, 0:21:49.240 --> 0:21:52.600 the accounting choices of the management, the ability to keep 0:21:52.640 --> 0:21:55.560 and retain good people, how do they communicate with us? 0:21:55.600 --> 0:21:59.600 I mentioned progressive Peter Lewis, the CEO of Progressive, wrote 0:21:59.640 --> 0:22:03.480 every in your report himself. You know who else writes 0:22:03.520 --> 0:22:06.080 their in your reports? Well, I mean, of course Berkshire 0:22:06.600 --> 0:22:11.400 marcl Let's see, Jeff Bezos did not many. You could 0:22:11.400 --> 0:22:15.240 probably count on two hands the fortune five hundred CEOs 0:22:15.280 --> 0:22:17.680 that take the time to write their own annual report. Well, 0:22:17.840 --> 0:22:21.560 that's a signal. That's a signal that they view their 0:22:21.560 --> 0:22:25.000 shareholders as a partner, They think of themselves as entrusted 0:22:25.000 --> 0:22:28.640 with shareholders' equity, and they're giving an accounting. So they're 0:22:28.640 --> 0:22:32.760 all these sorts of tiles that we build around evaluating 0:22:32.800 --> 0:22:35.800 a management. The proxy is a great place to look. 0:22:36.440 --> 0:22:38.959 You know. Is it an interesting that Exxon has a 0:22:39.040 --> 0:22:42.920 compackage as I recall, that vests something like ten years 0:22:42.960 --> 0:22:47.320 after retirement. Right, that's a very that tells you a 0:22:47.359 --> 0:22:51.119 lot about the culture of that company. There's not another 0:22:51.160 --> 0:22:55.600 company I've ever known that's done that. So we're building 0:22:55.640 --> 0:22:58.000 a mosaic to try to get a sense of culture, 0:22:58.119 --> 0:23:01.720 of the durability of a culture. Uh. You know, and 0:23:02.480 --> 0:23:04.520 the press is a terrible way to start that because 0:23:04.560 --> 0:23:07.679 the president almost always a halo effect. We're looking for 0:23:07.720 --> 0:23:13.240 those outsider type of CEOs. Understand capital allocation, understand excellence, 0:23:13.280 --> 0:23:17.240 don't fool themselves, keep the egos in check, keep great people, 0:23:17.760 --> 0:23:22.240 you know, value, have a stewardship gene. That's but it 0:23:22.359 --> 0:23:24.639 is the most fun part of the job. It is 0:23:24.680 --> 0:23:28.560 the most because in a market that's pretty damn efficient, 0:23:29.200 --> 0:23:31.880 you have to look for pockets of inefficiency, and one 0:23:31.920 --> 0:23:34.159 of them is crowd psychology. Obviously, when you get a 0:23:34.160 --> 0:23:38.520