WEBVTT - John Hempton on What's Ailing Bank Stocks 0:00:06.400 --> 0:00:09.719 Hello, Odd Lots listeners, It's Tracy Allaway. Before we get 0:00:09.720 --> 0:00:12.760 to today's show, I have a bit of news. It's 0:00:12.800 --> 0:00:16.239 something I'm really excited about. Odd Lots is hosting its 0:00:16.320 --> 0:00:20.280 first ever live event on Thursday, September nine in New 0:00:20.360 --> 0:00:23.880 York City. Join me and Joe Wisenthal as we host 0:00:23.920 --> 0:00:27.200 an all star lineup of guests to talk about everything 0:00:27.280 --> 0:00:31.200 from white collar fraud to sovereign debt and much much more. 0:00:31.760 --> 0:00:34.440 This will be a group of new Odd Lots guests 0:00:34.479 --> 0:00:38.680 plus a few old favorites. Will also have live finance, 0:00:38.760 --> 0:00:43.280 the music, as well as drinks and just overall great conversation. 0:00:43.840 --> 0:00:46.320 Details of the lineup are going to come out very soon, 0:00:46.600 --> 0:00:48.879 so keep listening to add blots to learn how to 0:00:48.920 --> 0:00:53.560 sign up to see us live on Thursday September in NYC. 0:00:53.960 --> 0:01:13.800 Joe and I both hope to see you there. Hello 0:01:13.880 --> 0:01:16.920 and welcome to another episode of the Odd Lots podcast. 0:01:17.040 --> 0:01:20.560 I'm Tracy Alloway. My co host Joe Wisenthal is away 0:01:20.600 --> 0:01:23.399 this week. I happened to be on a work trip 0:01:23.480 --> 0:01:27.360 to Australia. I've never been before. It's fascinating. I have 0:01:27.520 --> 0:01:30.920 big plans to meet a koala, but beyond that I 0:01:31.000 --> 0:01:34.160 also happened to be in the country for a momentous 0:01:34.240 --> 0:01:38.440 historic occasion, which is the benchmark Australian bond deald dipping 0:01:38.440 --> 0:01:41.400 below one percent for the first time. I was also 0:01:41.480 --> 0:01:43.760 there when the Reserve Bank of New Zealand opted to 0:01:43.840 --> 0:01:46.760 cut rates by fifty basis points, which was something that 0:01:46.880 --> 0:01:49.520 shocked the market. And just a couple of hours later 0:01:49.720 --> 0:01:52.120 we had rate cuts from the Central Bank of India 0:01:52.400 --> 0:01:55.120 and also the Central Bank of Thailand as well. So 0:01:55.360 --> 0:01:59.120 clearly we are in another cycle of fresh monetary easing. 0:01:59.480 --> 0:02:03.040 And along with these lower yields and interest rates around 0:02:03.080 --> 0:02:08.040 the world come lower bank stocks. Bank valuations are trading 0:02:08.080 --> 0:02:12.720 at historic lows, partly because of concern about bank's ability 0:02:12.800 --> 0:02:16.000 to make profits on lending when rates are this low. 0:02:16.560 --> 0:02:19.120 And who better to talk about all of this than 0:02:19.520 --> 0:02:23.160 John Hampton of Bronte Capital, someone who's been writing about 0:02:23.200 --> 0:02:25.840 the financial markets for a very long time on his 0:02:25.919 --> 0:02:29.280 blog and also invests in them through a long and 0:02:29.360 --> 0:02:36.560 short hedge fund. John, it's so nice to meet you 0:02:36.600 --> 0:02:40.839 in person. Finally, thank you. I'm a little a bit 0:02:40.840 --> 0:02:43.720 in ore of that requirement to speak about it generally 0:02:43.760 --> 0:02:46.600 because I like to speak about these things rather specifically. 0:02:47.440 --> 0:02:50.320 Um I started my career in financial markets as a 0:02:50.360 --> 0:02:53.840 bank analyst. So once upon a time I read more 0:02:53.919 --> 0:02:56.600 or less every bank account for every major bank in 0:02:56.639 --> 0:02:59.800 the world, and along the way I decided that they 0:03:00.120 --> 0:03:04.560 largely not very good businesses. There are exceptions. There are 0:03:04.840 --> 0:03:10.679 extremely good oligopolies in some countries Canada, Australia, Scandinavia. There 0:03:10.720 --> 0:03:15.160 are a few banks that have large captive businesses that 0:03:15.240 --> 0:03:18.280 should be very cheap to run. The trust banks come out. 0:03:19.200 --> 0:03:22.679 But as a general rule, most banks are not very 0:03:22.680 --> 0:03:26.320 good businesses, but they mask themselves as pretty good businesses 0:03:26.360 --> 0:03:29.919 most of the time. How do they do that Well, Firstly, 0:03:31.000 --> 0:03:34.360 they're very powerful because they have access to large amounts 0:03:34.360 --> 0:03:38.360 of money, and being powerful means that you just get 0:03:38.400 --> 0:03:41.920 a lot of press. Journalists seem to be too interested 0:03:41.920 --> 0:03:45.360 in bankers. The world seems to be too interested in bankers. 0:03:45.520 --> 0:03:49.600 The second reason is that you can deceive yourself for 0:03:49.600 --> 0:03:53.640 a very long time running a bank. Banks are quintessentially 0:03:53.760 --> 0:03:57.520 estimate machines. And thirdly, every now and again they really 0:03:57.520 --> 0:04:01.960 are very profitable. We're looking at the moment it banks 0:04:02.080 --> 0:04:06.920 across the world except in the United States, basically at 0:04:06.960 --> 0:04:10.360 thirty yellows a lot of the European banks. And it's 0:04:10.360 --> 0:04:12.840 not just Deutscher thirty year lows. If you look at 0:04:12.880 --> 0:04:14.760 sock Jan it's at a thirty year low. If you 0:04:14.800 --> 0:04:18.960 look at credit agricol ubs, the English banks, they're all 0:04:19.000 --> 0:04:22.400 at thirty year lows. And I live in a world 0:04:22.400 --> 0:04:26.680 of extremely expensive stocks, and so suddenly I feel like 0:04:26.760 --> 0:04:29.159 I want to be a bank analyst to give just 0:04:29.440 --> 0:04:34.240 because you know, these things look cheap. So I've been 0:04:34.240 --> 0:04:37.560 puzzling myself a bit about bank margins for a while. 0:04:38.520 --> 0:04:40.560 Now I'm going to lead you back to an article 0:04:40.640 --> 0:04:46.919 that was appeared in The Economist on January and the 0:04:47.040 --> 0:04:49.640 article is just comical when you read it now. It's 0:04:49.680 --> 0:04:53.920 called the Lloyd's Money Machine. And at the time, Lloyd's TSP, 0:04:54.160 --> 0:04:57.800 as it then was, was the thirty five biggest bank 0:04:57.839 --> 0:05:01.240 in the world by assets and the biggest bank in 0:05:01.279 --> 0:05:04.919 the world by market cap. Ten years later Lloyd's was 0:05:05.000 --> 0:05:09.880 essentially UK government property. But this was it wasn't ordinary profitable, 0:05:09.920 --> 0:05:14.640 it was ferociously profitable. To pick an example, if you 0:05:14.640 --> 0:05:16.760 look at the banks in the world at the moment 0:05:16.920 --> 0:05:20.240 and do say revenue to risk weighted assets, you see 0:05:20.279 --> 0:05:23.400 the Japanese banks at the lowest end and revenue is 0:05:23.440 --> 0:05:26.600 sub one percent of risk weighted assets. Then there are 0:05:26.600 --> 0:05:30.040 the German and Italian banks, and the English banks get 0:05:30.120 --> 0:05:32.599 up to about two and a bit descent. And the 0:05:32.600 --> 0:05:34.760 English banks are in the order that you would expect, 0:05:34.880 --> 0:05:38.919 with Royal Bank of Scotland being the thinnest and Barclays 0:05:38.960 --> 0:05:43.920 being the fattest margin and the margin actually just matches 0:05:44.000 --> 0:05:47.599 the stock prices, right, And then sitting in the middle 0:05:47.680 --> 0:05:50.400 is sort of these American banks at about four and 0:05:50.400 --> 0:05:54.039 a half five percent, and then with an outlier, and 0:05:54.080 --> 0:05:56.240 the outlier is the one you'd expect, which is the 0:05:56.279 --> 0:06:00.080 most revenue focused retail bank in America, the one it 0:06:00.240 --> 0:06:04.680 would do anything to, including steal from you, to get 0:06:04.720 --> 0:06:09.840 more revenue, and that's which is just the fattest margin bank, 0:06:10.200 --> 0:06:12.279 and at about the same sort of revenue to risk 0:06:12.320 --> 0:06:16.599 weighted assets you see the Canadian banks is about six percent. 0:06:16.720 --> 0:06:19.120 And then the fattest margin banks in the world are 0:06:19.160 --> 0:06:22.400 the ones that speak in my accent, right, and it's 0:06:22.480 --> 0:06:24.960 just this really good oligopolic. But if I go back 0:06:24.960 --> 0:06:31.520 to this article, Lloyd's revenue to risk weighted assets at 0:06:31.560 --> 0:06:36.320 that time was eight c Lloyd's in the UK made 0:06:36.360 --> 0:06:40.839 more money than the Australian banks do now. It was 0:06:41.000 --> 0:06:48.000 just astonishingly profitable. And over the next ten years, English 0:06:48.000 --> 0:06:50.480 bank margins went down, and then they went down a 0:06:50.520 --> 0:06:52.280 little bit more, and then they went down a little 0:06:52.320 --> 0:06:58.000 bit more, and eventually you had the wonderful institution called 0:06:58.040 --> 0:07:01.760 Northern Rock which was the protagonist in all of this. 0:07:02.600 --> 0:07:06.920 And Northern Rock ran mortgages at about sixty bits of 0:07:06.960 --> 0:07:11.720 margin and about twenty five bits of cost, and eventually 0:07:11.760 --> 0:07:13.960 they got down to twenty bits of knit margin leave 0:07:14.000 --> 0:07:17.760 at sixty times to produce an eighteen centirow it. But 0:07:17.800 --> 0:07:20.760 they managed to do this in a low but positive 0:07:20.760 --> 0:07:26.520 interest rate environment. I understand why English bank margins collapsed 0:07:26.520 --> 0:07:31.440 and why Lloyd's collapsed in the answer was, well, there 0:07:31.480 --> 0:07:34.440 was a large whack of competition. The banks will blame 0:07:34.440 --> 0:07:36.600 it on new regulation, right and the fact they have 0:07:36.680 --> 0:07:38.760 to hold more capital and they can't eke out that 0:07:38.840 --> 0:07:43.440 much money per capital plus low interest rates predated that, right. 0:07:43.560 --> 0:07:49.520 This was pre crisis lloyd Lloyd's was ferociously profitable in 0:07:50.560 --> 0:07:53.480 its revenue to risk weighted assets was north of eight 0:07:54.360 --> 0:07:56.800 by two thousand and eight. It's revenue to risk weighted 0:07:56.800 --> 0:07:59.960 assets was sub you're talking the beginning of two thousand. 0:08:00.040 --> 0:08:03.960 It that night after September two, two thousand and eight, 0:08:03.960 --> 0:08:06.960 it was subject. And the problem is that when your 0:08:06.960 --> 0:08:10.400 revenue to risk weighted assets went down that far, even 0:08:10.520 --> 0:08:14.760 small credit losses blew you up. Right Now, the beauty 0:08:14.800 --> 0:08:18.320 of the American banking system was that the revenue to 0:08:18.400 --> 0:08:21.040 risk weighted assets never went below about four and a half. 0:08:21.960 --> 0:08:25.280 During the crisis, there was the banking sector had three 0:08:25.800 --> 0:08:28.320 thirty billion, I think was the number of pre tax 0:08:28.360 --> 0:08:31.320 pre provision income. And if you've got a trillion dollars 0:08:31.320 --> 0:08:33.640 of losses, you can write that off over three years, 0:08:33.679 --> 0:08:36.200 and as long as you can extend and pretend enough, 0:08:36.240 --> 0:08:39.040 you never actually go sub profitable. And they raised a 0:08:39.040 --> 0:08:41.360 lot of money, and they sort of came through the 0:08:41.400 --> 0:08:44.600 English banks didn't have enough revenue, and the German banks 0:08:45.000 --> 0:08:48.760 spectacularly didn't have enough revenue, right because that the German 0:08:48.760 --> 0:08:51.200 banks are the thinnest in the world. But all of 0:08:51.240 --> 0:08:58.599 this margin collapse happened in a positive interest rate environment. Recently, 0:08:58.640 --> 0:09:01.600 the most interesting thing I've seen is by a guy 0:09:01.640 --> 0:09:05.439 called Shannon mcgonachy who runs a fund for Horseman Capital 0:09:05.679 --> 0:09:08.920 and japan focused fund. He's an Australian. I've never heard 0:09:08.920 --> 0:09:12.160 of him before this interview, but he was running through 0:09:12.280 --> 0:09:15.920 Japanese regional banks, which are the lowest margin banks in 0:09:15.960 --> 0:09:20.120 the world. And he says, and I haven't verified the number, 0:09:20.120 --> 0:09:22.080 but I believe him because it sort of matches my 0:09:22.720 --> 0:09:26.880 on the ground observations that the average interest rate achieved 0:09:27.000 --> 0:09:30.520 on a new loan in a Japanese regional bank this 0:09:30.640 --> 0:09:34.360 year so far has been sixty eight basis points, and 0:09:34.400 --> 0:09:37.319 it costs more than sixty eight basis points to administer 0:09:37.400 --> 0:09:40.280 the bank. You've got to have branches, you've gotta have staff, etcetera, 0:09:40.920 --> 0:09:45.439 and so on increment on current business. The Japanese banks 0:09:45.520 --> 0:09:49.840 are loss making before credit losses. They don't even need 0:09:49.880 --> 0:09:52.440 a credit loss to lose money, right If they have 0:09:52.480 --> 0:09:57.920 credit losses, that's just extroduced to the capital destruction that 0:09:57.920 --> 0:10:00.320 it doesn't show in their accounts and Lorea's and is 0:10:00.400 --> 0:10:04.240 that they have a bunch of reason the ways of 0:10:04.640 --> 0:10:08.400 turning capital gains into interest income, the most obvious of 0:10:08.440 --> 0:10:10.800 which is that they've held a lot of jgbs because 0:10:10.800 --> 0:10:13.520 they have loan deposit ratios of sort of point six 0:10:13.559 --> 0:10:17.080 point seven they've held a huge number of jgbs. As 0:10:17.160 --> 0:10:20.200 rates have come down, they've got huge capital gains. They've 0:10:20.240 --> 0:10:23.840 been clipping those capital gains all the time and calling 0:10:23.840 --> 0:10:27.480 it interest income, so they look like they're marginally profitable 0:10:27.520 --> 0:10:30.040 at the moment that they're in fact marginally loss making 0:10:30.160 --> 0:10:33.440 before credit losses. So instead of making money on actually 0:10:33.520 --> 0:10:36.960 extending loans to customers or corporates in the way that 0:10:37.040 --> 0:10:39.640 they used to, they're making most of their money through 0:10:40.120 --> 0:10:44.360 asset price increases that then get booked as interest income 0:10:44.600 --> 0:10:47.800 that will run out, and then they will make losses 0:10:47.840 --> 0:10:51.559 on extending lines. His simple view is there's no price 0:10:51.600 --> 0:10:53.520 that you can buy these at their point to book, 0:10:53.559 --> 0:10:56.760 and that's a value trap. So is the banking business 0:10:56.920 --> 0:11:01.040 just broken at interest rates that low. That's what is 0:11:01.160 --> 0:11:06.000 clearly the case in Japan, and is what the market 0:11:06.120 --> 0:11:08.760 is telling you about the big mega banks in Europe. 0:11:10.400 --> 0:11:13.240 The flip side is that you know there are banks 0:11:13.280 --> 0:11:17.920 in Europe in oligo baalistic markets that are still got 0:11:18.040 --> 0:11:24.040 fairly fat margins which have also come down. So you know, 0:11:24.080 --> 0:11:26.760 if I'm going to beat myself up the stock on 0:11:26.800 --> 0:11:30.800 the portfolio, the two stocks that I own that have 0:11:30.960 --> 0:11:35.640 bugged me. Most have been Spensker Hundle's Bank, which is 0:11:35.760 --> 0:11:40.920 a very well run, highly oligobalistic Swedish bank, and Allied 0:11:40.960 --> 0:11:44.480 Irish and Allied Irish is a less well run but 0:11:44.520 --> 0:11:49.560 even more oligo ballistic Irish bank. And Irish banking margins 0:11:49.559 --> 0:11:53.080 are very nice right there, about the same as US 0:11:53.120 --> 0:11:56.720 banking margins. They're not as rich as Australian banking margins, 0:11:56.800 --> 0:12:00.320 but there are many times you know a big French 0:12:00.920 --> 0:12:03.600 or a big German bank, or even a big English 0:12:03.679 --> 0:12:07.040 bank yet that they're still drowned to trading. At point 0:12:07.120 --> 0:12:10.280 six book, I'm trying to work out why I'm wrong. 0:12:10.720 --> 0:12:14.000 We've we've had a demonstration of margins collapsing even in 0:12:14.000 --> 0:12:17.120 a positive interest rate environment, and that's called English banks. 0:12:18.480 --> 0:12:21.520 And we have a demonstration of margins completely and utterly 0:12:21.520 --> 0:12:24.280 collapsing in a negative interest rate environment, and that's good 0:12:24.280 --> 0:12:28.760 in Japanese regional banks. And I'm wondering whether I'm just 0:12:28.840 --> 0:12:32.000 insane or not. But that's my little frustration at the moment. Well, 0:12:32.960 --> 0:12:35.080 so how would you explain it? Then? Is the is 0:12:35.120 --> 0:12:37.960 the market wrong? That would seem to be the simple explanation. 0:12:39.080 --> 0:12:41.920 Every time I've been confident that the market is wrong, 0:12:41.960 --> 0:12:45.400 it tends to beat me in the head I think 0:12:45.440 --> 0:12:50.840 it's wrong. I rang up Shannon mcgonicky after this, and 0:12:50.920 --> 0:12:54.080 I tried to go through right just because I wanted 0:12:54.120 --> 0:12:57.400 to work out whether any of the margin collapse that 0:12:57.640 --> 0:13:00.480 and the methods of hiding it that he could see 0:13:00.480 --> 0:13:05.560 in Japan we're applicable to my Irish banks. And the 0:13:05.600 --> 0:13:08.720 answer was no. But that doesn't mean that I'm not wrong. 0:13:09.600 --> 0:13:11.560 I am enough of a stock picker to know I 0:13:11.600 --> 0:13:14.440 can be wrong any day of the week, and believe 0:13:14.480 --> 0:13:17.120 me the moment I think I'm wrong, And if any 0:13:17.160 --> 0:13:21.320 of your dear listeners will tell me why, then I'll sell. 0:13:21.320 --> 0:13:24.480 These positions. Are not allergic to them, but they are 0:13:24.600 --> 0:13:26.840 very tempting. And the reason they're very tempting is that 0:13:26.880 --> 0:13:30.520 almost everywhere you look in this world, particularly in North America, 0:13:30.600 --> 0:13:35.480 you see assets at extreme prices. Right that we have 0:13:35.559 --> 0:13:41.160 a situation where the market really does believe that low 0:13:41.240 --> 0:13:44.360 interest rates are here here to stay, and that economies 0:13:44.400 --> 0:13:47.800 are relatively are going to be relatively weak. So things 0:13:47.880 --> 0:13:52.720 that have highly deterministic cash flows that you can value 0:13:52.920 --> 0:13:57.120 off the low interest rates are priced at very high levels. 0:13:58.120 --> 0:14:02.240 My favorite example of this is Visa. Visa trades that 0:14:02.400 --> 0:14:05.079 last time I looked at seventeen times revenue. I think 0:14:05.120 --> 0:14:06.960 the markets down a bit this week, so it might 0:14:07.000 --> 0:14:11.520 be only sixteen times revenue or fifteen times revenues. Yeah, 0:14:11.559 --> 0:14:14.600 there's a famous quote from Scott McNally at the end 0:14:14.679 --> 0:14:17.080 of the It's one of the quotes that I almost 0:14:17.320 --> 0:14:19.800 pin on my wall at the end of the of 0:14:19.920 --> 0:14:23.440 the tech bubble, which said that, you know, at the 0:14:23.440 --> 0:14:25.720 height of the tech bubble, Sun was trading at ten 0:14:25.720 --> 0:14:31.280 times revenue, And dear readers, what were you thinking, you know, 0:14:31.880 --> 0:14:34.080 at ten times revenue. In order to get a ten 0:14:34.120 --> 0:14:36.800 percent return, I've got to return a hundred percent of 0:14:36.960 --> 0:14:40.840 revenue to you in cash, which means that I don't 0:14:40.840 --> 0:14:42.760 have any staff, which is kind of hard when you're 0:14:42.840 --> 0:14:44.960 running a tech company and they don't have any inputs, 0:14:44.960 --> 0:14:47.360 which is kind of hard when you're selling computer boxes. 0:14:48.040 --> 0:14:50.720 And I don't pay any taxes, which is kind of illegal. 0:14:51.880 --> 0:14:54.240 And that I can maintain all the revenue without any 0:14:54.400 --> 0:14:57.320 R and D expense, which seems a little improbable. What 0:14:57.360 --> 0:15:00.520 were you thinking that ten times revenue was the sort 0:15:00.520 --> 0:15:05.440 of number that said this is insane. Now Here, I 0:15:05.480 --> 0:15:08.520 have Visa, which is a very fat margin business. I'll 0:15:08.560 --> 0:15:10.920 admit it's a very fat march in business, trading at 0:15:11.320 --> 0:15:15.640 sixteen or seventeen times revenue, and yeah, it's got two 0:15:15.760 --> 0:15:20.000 thirds margin. Half half of Visa's revenue drops to the 0:15:20.040 --> 0:15:22.480 P and L, and all of that is spent on 0:15:22.520 --> 0:15:27.440 either dividends or buybacks. It's an incredibly cash generative machine. 0:15:28.440 --> 0:15:31.120 But it is one point seven times the price that 0:15:31.160 --> 0:15:35.080 Scott McNelly said was insane. Is the difference between now 0:15:35.240 --> 0:15:39.320 and past markets That in past markets, valuations used to 0:15:39.360 --> 0:15:43.640 be self limiting. At some point someone would go, you 0:15:43.680 --> 0:15:46.280 know what, the stock is far too expensive and I'm 0:15:46.280 --> 0:15:48.840 not going to buy it. Whereas now because so so 0:15:49.000 --> 0:15:51.840 much of the profit that you make by investing is 0:15:51.880 --> 0:15:55.600 basically momentum and a price increase. No, nothing, that's just 0:15:55.680 --> 0:15:59.240 got to be wrong. Nothing is as as expensive as 0:15:59.320 --> 0:16:03.400 the worst as second tier tech stocks were during the 0:16:03.400 --> 0:16:05.640 tech bubble. If you go have a look at the 0:16:05.640 --> 0:16:09.600 biggest five or six tech names during the tech bubble, 0:16:09.600 --> 0:16:11.400 and you brought them now and you held them to now, 0:16:11.440 --> 0:16:16.000 you've actually made an acceptable return. If you went and 0:16:16.160 --> 0:16:21.800 looked at names twenty to thirty in March two thousand 0:16:22.800 --> 0:16:26.360 and you held them to now the result is an unbelievable, 0:16:26.440 --> 0:16:33.040 spectacular wipeout. Right, there are names that were hugely important 0:16:33.120 --> 0:16:35.920 then that don't mean anything to you now, Like I 0:16:36.120 --> 0:16:40.120 two Technologies. There was a period where the too hottest 0:16:40.120 --> 0:16:42.600 tech names in the world, where I too Technology and 0:16:42.720 --> 0:16:47.760 JDS Uniphase and I two Technologies had a market cap 0:16:47.800 --> 0:16:50.800 of two hundred and twenty billion and j D s 0:16:50.920 --> 0:16:54.880 Uniphase was to eighty billion. Now, the various parts of 0:16:54.960 --> 0:16:58.480 j DS you are still available and if you actually 0:16:58.480 --> 0:17:00.960 add them up, there's probably went to your thirty billion 0:17:01.000 --> 0:17:04.080 market kept there, so it's not the complete insane way about. 0:17:04.800 --> 0:17:07.320 I think I two Technologies were sold at the end 0:17:07.400 --> 0:17:13.000 for seven million. If you go back to the second 0:17:13.119 --> 0:17:17.200 tier tech names, they were just insane, right, That is, 0:17:18.600 --> 0:17:22.080 if you actually had revenue, like Cisco. Cisco was one 0:17:22.119 --> 0:17:24.080 of the first ones to break, and the reason it 0:17:24.119 --> 0:17:25.720 was one of the first ones to break is that 0:17:25.800 --> 0:17:27.879 it actually had revenue and it told you the world 0:17:27.960 --> 0:17:29.919 wasn't quite as good as you thought, and so they 0:17:29.960 --> 0:17:33.040 stop went down a lot. Right, There was that period 0:17:33.200 --> 0:17:36.480 where profits were about you in a really good bubble. 0:17:36.520 --> 0:17:38.439 Profits are a bad idea because then you have a 0:17:38.440 --> 0:17:41.800 fantasy about it. But the tech bubble got to the 0:17:41.840 --> 0:17:44.879 point where revenue was a bad idea, right, because then 0:17:44.920 --> 0:17:47.720 you'd have a fantasy. You couldn't write what you really 0:17:47.760 --> 0:17:52.639 wanted to measure with something like eyeballs, potential growth, potential growth, 0:17:52.800 --> 0:17:56.280 And if you bought the stuff that was the second tier, 0:17:56.359 --> 0:18:00.400 then the wipeout was far more spectacular. That was much 0:18:00.440 --> 0:18:05.280 more overvalued than anything i'm seeing now. That said, all 0:18:05.640 --> 0:18:08.640 the old economy was priced at seven or eight times earnings. 0:18:08.800 --> 0:18:12.719 There the years two thousand to say two thousand and 0:18:12.800 --> 0:18:17.200 six were the years in which the naive champion bearded 0:18:17.280 --> 0:18:21.440 self righteous value investorout the FORMT. I know a few 0:18:21.440 --> 0:18:24.960 of them. I'm sorry, the bearded self righteous value investor. 0:18:25.400 --> 0:18:28.200 Is that their official name? No, but that's what they are. 0:18:28.480 --> 0:18:32.560 You see them. They were they're just cheap and they 0:18:32.600 --> 0:18:36.400 liked buy cheap stocks, right, and they're very obsessed by 0:18:36.480 --> 0:18:41.240 pe ratios. Several of them owned things that looked cheap, 0:18:41.320 --> 0:18:44.639 like Jase Bank and right. They also wear cheap suits. 0:18:45.400 --> 0:18:47.920 They'd like to be buffet acolytes, and they all meet 0:18:48.000 --> 0:18:51.320 up at the Berkshire Meeting. I've been been to this 0:18:51.400 --> 0:18:54.800 Berkshire meeting. Several of these people are my friends. Right, 0:18:55.119 --> 0:18:58.840 they're almost the cliche of they start with the valuation 0:18:59.600 --> 0:19:03.080 and they'd buy almost any old economy stock at seven 0:19:03.160 --> 0:19:05.919 or eight times earnings, and for the next five to 0:19:06.000 --> 0:19:11.480 seven years they just did wonderful, right, They outperformed like crazy. 0:19:11.880 --> 0:19:14.600 And a lot of the things that they owned were 0:19:14.760 --> 0:19:19.960 cheap and bad. So the same people often. You know, 0:19:20.000 --> 0:19:21.920 if I take a look at long Leaf, which is 0:19:21.920 --> 0:19:25.919 a fairly decent, well known mutual fund, I don't think 0:19:26.000 --> 0:19:28.399 they have beards, but it falls into the same camp. 0:19:29.359 --> 0:19:32.280 Long Leaf owned a whole lot of things that look 0:19:32.400 --> 0:19:35.119 cheap and went to zero, right, the sort of general 0:19:35.160 --> 0:19:39.560 motors stuff, and you know, sometimes cheap as cheap for 0:19:39.600 --> 0:19:42.560 a reason. But at that time, the whole old economy 0:19:42.680 --> 0:19:45.920 was cheap, and if you just bought the old economy, 0:19:46.240 --> 0:19:48.560 you did really well. And you know, some of the 0:19:48.640 --> 0:19:52.399 misvaluations in were crazy. You go have a look at 0:19:52.440 --> 0:19:56.360 the New York Times or any other newspaper. And newspapers 0:19:56.440 --> 0:20:00.439 hit their highest valuation ever in two thousands, just as 0:20:00.480 --> 0:20:04.280 their business model was about to dismantle. And I actually 0:20:04.280 --> 0:20:07.119 asked somebody at one stage, a sort of check analyst, 0:20:07.359 --> 0:20:11.439 why all these newspapers were valued so highly. And the 0:20:11.520 --> 0:20:14.720 answer came back, looking at me weirdly, is it? Well, 0:20:14.760 --> 0:20:18.760 they have websites, don't they? People look at their websites. Right, 0:20:18.760 --> 0:20:21.560 There were tech plates at that time because they all 0:20:21.600 --> 0:20:23.840 of them were going big on the internet in some 0:20:23.880 --> 0:20:27.080 way or each other. The overvaluation this time is not 0:20:27.200 --> 0:20:31.720 as bad as that time. It's just broader. Right in 0:20:31.880 --> 0:20:35.840 that time, if you just did the naive thing and 0:20:35.880 --> 0:20:38.960 bought the ten times earnings or nine times earnings old 0:20:38.960 --> 0:20:43.439 economy stocks including there, I say at Wells Fargo, you 0:20:43.680 --> 0:20:49.720 just did fabulous, right. And the most naive, self righteous 0:20:49.800 --> 0:20:53.160 value investor, the one that seems to think that any 0:20:53.160 --> 0:20:56.680 growth stock is risky but value stocks are not, right, 0:20:56.960 --> 0:21:02.479 did great guns for five kids? Mhm this time? You 0:21:02.520 --> 0:21:05.480 know I want to be a self righteous beard and 0:21:05.600 --> 0:21:08.800 value investor, I really do. But the only things that 0:21:08.840 --> 0:21:12.840 look cheap, thanks, And I've just given you you know 0:21:12.920 --> 0:21:16.800 my angst feeling about them, my own two banks. I 0:21:16.840 --> 0:21:20.080 also earn a little slither of a company called Power 0:21:20.119 --> 0:21:24.760 Corps Corporation of Canada. None of this I've ever disclosed. 0:21:24.920 --> 0:21:29.760 For that they they look really cheap, and I don't 0:21:29.880 --> 0:21:34.520 think they're problematic. The problem with cheek stocks is cheap 0:21:34.520 --> 0:21:37.760 stocks are often problematic, and you can get yourself very trapped, 0:21:37.800 --> 0:21:42.080 as every beard and value investor is once discovered. Okay, 0:21:42.119 --> 0:21:44.600 so talk to me about how you actually go about 0:21:45.240 --> 0:21:50.440 selecting companies in an environment of ultra low interest rates 0:21:50.480 --> 0:21:55.480 as we've discussed, but also generally broad high expensive valuations. 0:21:56.200 --> 0:21:58.880 Actually I tend not to start with the valuation at 0:21:58.920 --> 0:22:04.040 all my general view, as I start with the business. 0:22:04.240 --> 0:22:07.480 And there are some business models that you just want 0:22:07.480 --> 0:22:09.879 to own at some stage. The best business model in 0:22:09.880 --> 0:22:14.080 the world is will develop global scale, will share the 0:22:14.119 --> 0:22:18.199 better scale scale with their consumers. And it's also the 0:22:18.240 --> 0:22:20.840 hardest business model in the world twine, especially as a 0:22:20.920 --> 0:22:24.840 hit as a bearded value investor. And the reason is well, 0:22:25.160 --> 0:22:29.240 the iconic example is, of course Amazon. But if you 0:22:29.280 --> 0:22:32.520 look at Amazon in two thousand and two, it just 0:22:32.640 --> 0:22:38.040 sold books, It made small losses, it was growing very fast, 0:22:38.800 --> 0:22:42.399 and if Jeff Bezos had told you where he was going, 0:22:42.800 --> 0:22:47.800 he would have sounded insane. Right now, it wasn't in 0:22:47.880 --> 0:22:50.520 Jeff Bezos's interest to tell you where he was going, 0:22:50.720 --> 0:22:55.760 because if he told you, he sounded insane. People and 0:22:55.800 --> 0:22:59.440 to some weirdo out there, they might think, oh my god, 0:22:59.480 --> 0:23:02.399 I want to get there too, and so he'd induced competition. 0:23:03.280 --> 0:23:06.840 If you're Jeff Bezos in two thousand and two, the 0:23:06.960 --> 0:23:09.520 job is to grow as fast as possible, subject to 0:23:09.560 --> 0:23:11.439 the constraint you don't run out of cash, and you 0:23:11.480 --> 0:23:14.000 want to get big before or your competition get there. 0:23:15.680 --> 0:23:18.240 And the problem with that from a value investors perspective 0:23:18.320 --> 0:23:21.879 is the optimal profitability is zero. So what you have 0:23:21.960 --> 0:23:25.360 to do is buy a high growth, zero profit company 0:23:25.480 --> 0:23:28.879 that doesn't tell you what it's directions. This is the 0:23:28.920 --> 0:23:31.720 hardest thing in the world to do, but I'm always 0:23:31.720 --> 0:23:35.200 on the lookout. Right. Problem is I don't have any 0:23:35.840 --> 0:23:38.639 right um that that. Well, I have a few, but 0:23:38.680 --> 0:23:40.640 I don't want to talk about them. And the other 0:23:40.680 --> 0:23:42.200 thing is if I told you what I thought about 0:23:42.240 --> 0:23:45.000 them might sound insane. The other thing is that if 0:23:45.000 --> 0:23:46.800 they don't not go in that direction, I want to 0:23:46.800 --> 0:23:51.359 sell them before the d rate. So it's not in 0:23:51.400 --> 0:23:53.600 my interest to tell anybody for the same reasons it 0:23:53.720 --> 0:23:57.080 wasn't in Jeff bezos Is interest to tell anybody. The 0:23:57.240 --> 0:23:59.560 second sort of model that I look at all the 0:23:59.680 --> 0:24:04.680 time is what we call the trifecta. If you are 0:24:04.800 --> 0:24:09.760 a small but important part of the big thing, you're consumable, 0:24:09.880 --> 0:24:12.320 and you have a high switching cost, you make a 0:24:12.400 --> 0:24:15.880 packet of money. The problem with these trifectors, and I'll 0:24:15.920 --> 0:24:18.200 give you a nice example, is an English one called 0:24:18.320 --> 0:24:24.959 Crowda right, which we own and Croda makes active ingredients 0:24:24.960 --> 0:24:26.960 for cosmetics. It does a lot of other things, but 0:24:27.000 --> 0:24:31.359 the original ingredient product was active ingredients for cosmetics. It 0:24:31.440 --> 0:24:36.280 turns out there are recipes almost every face cream that 0:24:36.400 --> 0:24:41.159 can answer the medical question visibly reduces the appearance of wrinkles, 0:24:41.840 --> 0:24:45.639 has it in it ingredients that are extracted from war Greace. 0:24:47.400 --> 0:24:53.000 Now there are Egyptian recipes for war Greace makeups or cosmetics. 0:24:53.640 --> 0:24:57.200 And they were stuck, and so the woman would put 0:24:57.320 --> 0:25:00.439