Grahamian Value Week in Review ― March 19, 2021
“A single conversation across the table with a wise [person] is better than ten years mere study of books.”
— Chinese Proverb
WEEK IN REVIEW
There have been no changes to our Grahamian Value Classic list.
We showcase highlights from the inaugural Grahamian Value Fireside Conversation with Nicholas E. Radice, which took place on Thursday, March 11, 2021.
I. WEEK IN REVIEW
This marks our twenty-third consecutive week with no new additions to the Grahamian Value Classic list of companies.
Join us in an upcoming Grahamian Value Fireside Conversation — featuring Murray Stahl on Tuesday, March 30, 2021; please see the complete details here.
II. HIGHLIGHTS FROM LAST WEEK’S FIRESIDE CONVERSATION FEATURING NICHOLAS E. RADICE
Warren Buffett often cites that “investing is most intelligent when it is most business-like”, and he’s clearly paraphrasing Graham there. On my personal journey, things have shifted more toward operations and business.
This gets to the distinction between financial markets and economic markets. We all look at financial markets; electronic quotations on a Bloomberg terminal or similar resource. Economic markets trade goods and services. The gap between them is the widest that it has been; you can see this through metrics such as the size of the total stock market, relative to GDP — at the highest that it has been.
Viscerally, and in our daily life, we find the disconnect all over. GameStop and similar situations almost have an entertainment factor; it is detached from the real world. This is not good. And it will not end well.
— Nicholas E. Radice (Thursday, March 11, 2021)
GV: Have you noticed any commonalities among your most successful investments?
NR: Yes, real assets and distress. The top four best investments, measured by total return — they all involved extreme distress. Each of the companies went into bankruptcy. It’s the lowest point at which you can buy, the bottom tick. That’s been lost nowadays, when everyone is buying high with the hope of a greater fool.
And each involved real estate as a margin of safety. That’s my signature concept: substituting real estate as an equivalent to inventory in the Graham net-net calculation. I don’t see any reason why those things aren’t equivalent. Is retail inventory — if you have a declining retailer, which would fit under Graham’s definition — is that inventory somehow more valid than prime real estate? If you own a bunch of retail inventory, it doesn’t have a huge value. You’re liquidating it at pennies on the dollar.
GV: You describe yourself as a protégé of Ian Cumming. What did you learn from the Leucadia experience?
NR: It is critical not only to focus and specialize, but also to iterate. You’ve got to keep iterating; Leucadia did that with its transactions. The first was Talcott National, which was renamed as Leucadia. Talcott had a rich history in the factoring industry, and Leucadia’s founders sold that name. I was running a small factoring business in 2010 — which is how, and when, I connected with Ian Cumming.
Ian executed the Talcott takeover and restructuring. And he realized, essentially, “We’ve got a process here, we can repeat this process, we can iterate this to a large scale” — and that’s the lesson. The fact is that if you don’t specialize, if you don’t focus, and if you don’t think about iterating — you’re simply not going to stumble into it; it just won’t happen.
GV: In your view, how have newer businesses adapted to get access to “float” or wholesale capital?
NR: Amazon essentially doesn’t make money on retail. Their signature strategy is a negative cash conversion cycle — they want very positive cash flow. Retail is almost like float, in a sense. It’s financing more valuable assets. So, they sell at breakeven — or sell at a loss — to get momentum — to get that cash flow, with a negative cash conversion cycle. And what asset did they finance? AWS. That’s why, in some respects, “the next Buffett” was Jeff Bezos.
Similarly, a situation like Facebook — does adding users, de facto, function as float? It is an interesting question. And it hits on some lessons that I learned from Peter Thiel. He’s said, “If you want to get results — find a way to compound daily. Find daily compounding.” How do you get that? Well, by adding users. That’s a common theme with PayPal and Facebook — if you sign people up, in effect, you’re compounding your business on a daily basis and it has a network effect, as value increases with more people.
And when I say, essentially, a “next Buffett,” they’re even doing deals. Look at Instagram, it’s one of the best deals of all time; a 100-bagger — off a $1 billion base.
GV: You’ve shared a thesis that the next twenty years may exhibit parallels to the 1940s and 1950s, please explain.
NR: The 1940s is by analogy — and of course it’s never going to be exactly the same. But I don’t think we’re going back to the 1980s and 1990s, certainly not a dramatic decline in interest rates. I would start with the two economic engines from roughly 1980 to 2020: interest rates and Moore’s Law. Many of the investments that have done well, they’re just linked to those. The lever is Moore’s Law. The lever is interest rates. We had double digit interest rates drop to zero, driving economic activity and a wealth transfer that were a function of interest rates.
The boom that began in the 1980s would not have been viable in the 1970s. People need to be cognizant of that. And again, it’s fundamentally business-like investing; thinking about the real world. So, those two engines — Moore’s Law and interest rates — they’re either at diminishing marginal returns or they are tapped out. And there’s evidence that they’re pretty tapped, because we’re seeing crazier and crazier behavior. What is considered “tech” also gets to differences between the 1990s and today. In the 1990s, it was actual tech; Cisco was tech, JDS Uniphase. They were technology companies.
WeWork is not a technology company. We’re seeing real estate schemes, and almost toy type companies. Snapchat — it’s an amusement; it’s entertainment. It’s not technology. But it’s valued almost equally to Goldman Sachs. Is that realistic? It’s a lot crazier this time. And I think the reason is partly that we’re no longer getting the brute-force gain from Moore’s Law. We’re also not seeing the bottom line. In the 1990s, what was Bill Gates earning, a billion dollars a month? He was making a fortune in profit. By contrast, many “tech” companies nowadays, they’re losing money. What that tells me is not only the proximate cause — they’re schemes, we can short them, whatever. But the deeper, actual driver is that we’re not getting the gains out of Moore’s Law that we were in the 1990s — when you had low-hanging fruit, when there was a tremendous tailwind.
That’s what the past forty years looked like. And when we look at the next twenty, I think they could be quite optimistic. We’ve obviously been in a dark place over the past year, but the next twenty years could be a golden age — it just depends on what you’re talking about.
Economically, a question I often ask is, when was the last time that U.S. real GDP grew at 3% or above per annum? That is trend growth, what Kuznets called Modern Economic Growth; three percent is what the economy should grow at — when is the last time we saw that? It was actually 2005. Of course, we may have a good quarter, but it’s telling that since the financial crisis, annual growth has been poor. That helps to explain a lot of what’s gone on since then; second order effects, like trying to compensate by reaching for yield, or bidding up growth companies — because GDP growth has been poor.
So, what does it mean to get back to a 1940s-like period? It means a return to trend GDP growth. The economy would feel more normal; people would get back to work. Real jobs — not Uber, not speculation. That era was a big infrastructure cycle. Infrastructure is now becoming a buzzword; which is correct, we need it. The last infrastructure cycle was during the 1940s, 1950s, 1960s. And that’s an optimistic thing; you just want to invest accordingly.
What else does it mean to get back to a postwar-type cycle: interest rates begin rising. And inflation: we had double-digit inflation in the 1940s. The Depression was analogous to this past decade, with very low interest rates during the 1930s. And then inflation started rising in the 1940s. Also, it could mean twenty years of low P/E ratios. It shouldn’t be that controversial of an expectation, over the next twenty years, that we could see multiple compression. Invest accordingly.
I had a similar conversation with someone whose family ran a large lending business in my area. During the 1970s, they were essentially shadow billionaires. They weren’t listed on Forbes, but should have been. We talked about that postwar period, the Greatest Generation. Back then, many people weren’t raging bulls on stocks. Many saved through other instruments. Why? Because — and this is critically important — stocks in real terms were a dead end throughout much of the 20th century. Stocks peaked in 1929, and we had a horrible situation in the 1930s and 1940s. Stocks came back in the 1950s, and we had a good run in the late 1960s — the Go-Go Years — but then crashed right back down in the 1970s.
By 1982, in real terms, stocks lost just as much as during the Great Depression. The inflation-adjusted S&P 500 was still at 1920s levels without including dividends. That doesn’t get talked about nowadays; that by the early 1980s, stocks were unbelievably cheap. They took a long trip to nowhere from the late 1920s until the early 1980s — for over fifty years.
That was also true of urban real estate. In the 1970s, you could buy apartments on Park Avenue, Fifth Avenue, in the hundreds of thousands of dollars. The place today where Stephen Schwarzman lives in Manhattan; it’s probably a nine-figure residence. Three floors on Park Avenue. It traded hands in 1971 for a reported $285,000. So, the urbanization we’ve seen, the takeoff of that type of real estate, throughout much of the 20th century was a dead end. It peaked in the late 1920s and then we got into a period when America suburbanized, and had very different investments that did well. During the 20th century, a lot of people saved through fixed-income instruments; they weren’t excessively exposed to equities, the way they are today.
The problem is multiple compression and inflation. It can’t be overstated how dangerous those two factors are, especially when combined. If you combine multiple compression with inflation, it is going to devastate your wealth.
In Berkshire Hathaway’s recent shareholder letter, Warren Buffett talks about Berkshire Hathaway Energy and Burlington Northern. If this 1940s and 1950s analogy is correct, it means that Buffett’s actions are visionary — and it means that Berkshire Hathaway could evolve into a trillion-dollar company. The fixed assets and infrastructure investment in America — if you read between the lines a little, there’s almost an implicit forecast there — that may be right or wrong; we’ll see. But it certainly looks like, in the case of Buffett, he’s placed his chips and there’s a view that one cannot inflate away the railroad. Those entities borrow at extremely low rates, Berkshire has been borrowing at very low rates — and they’ll be deeply negative real rates with a pickup in inflation. And that’s the classic Buffett move: a negative cost of capital; the insurance companies funded him at a negative cost of capital for decades. It is brilliant and hard to replicate.
11 Days Away —
UPCOMING FIRESIDE CONVERSATION FEATURING MURRAY STAHL
Following a wonderful discussion last week with Nicholas E. Radice, we are proud to announce our second Grahamian Value Fireside Conversation — featuring Murray Stahl of Horizon Kinetics, scheduled for Tuesday, March 30, 2021 at 11:00 AM Eastern Standard Time (UTC-5). Advanced registration is required to participate.
As a complement to our weekly electronic dispatches, we are excited to introduce Grahamian Value Fireside Conversations — a series of live online events featuring prominent thought leaders we respect and admire, exploring the application of Grahamian values adapted to present circumstances, rooted in a margin of safety.
Our Grahamian Value Fireside Conversations series is intended to add further context and commentary, layered on top of quality pre-existing research that has piqued our interest. Importantly, Grahamian Value Fireside Conversations are solely educational explorations that are not intended to provide individual stock pitches or be regarded as investment advice. In our view, with frictionless data, there’s an abundance of information and a scarcity of knowledge; we hope, with these conversations, to add to a marketplace of knowledge.
Important Message for All Readers:
The editorial team of Grahamian Value does not maintain accounts with, or receive compensation from Horizon Kinetics or any affiliated entities thereof. We are not brokers or investment advisors, and do not presently manage outside capital. Any information herein should not be regarded as a promotion or endorsement of Horizon Kinetics or its products or services. We do, however, independently believe that Horizon Kinetics’ thought process and approach to certain market opportunities are intriguing and (on merit alone) deserve deliberate, focused attention.
(Full Disclosure: The co-editors personally own LEAPS on Berkshire Hathaway Inc.)
III. WEEKEND WATCHING
Courtesy of Pzena Investment Management: Legendary investors and long-time friends Joel Greenblatt (Gotham Funds) and Rich Pzena (Pzena Investment Management) recently sat down with investment strategist Steve Galbraith for a masterclass in value investing. The three long-time friends discussed a host of topics – including quality, momentum, interest rates, financials, ESG, disruption, parallels to the internet bubble, and their current positioning — along with the basics of how they define value. (Uploaded March 11, 2021)
IV. WEEKEND LISTENING
Courtesy of Riches in the Niches Investor Podcast (hosted by Richard Sosa of thinkAEN): Today’s master class is with James Dinsmore, portfolio manager at GAMCO Asset Management. James is focused on convertible securities. For those of you that don’t know, GAMCO is a large money management firm run by legendary investor, Mario Gabelli. On this episode, James will go over his thoughts on convertibles as well as how GAMCO adds value to clients in this niche asset class. (February 18, 2021 episode date)
Direct Download: “A Review Of The Convertible Securities Market”
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Harry Sauers and Shai Dardashti are co-editors of Grahamian Value and, as of the date of this communication, may individually own shares of companies mentioned herein. The publishers do not receive compensation from the companies and people covered in Grahamian Value for such coverage. This communication is for informational purposes only. This is not intended to be investment advice. Seek a duly licensed professional for investment advice.