Asset-Earnings Equivalence, Cyclical Downturns, and Thoughts on NVDA
Summary
Valuation Framework: The guest emphasizes triangulating assets, earnings, and NPV rather than relying on a single method, with NPV as most important but most uncertain.
Financials Insight: For banks and insurers, franchise value and low-cost deposits justify premiums (e.g., 2x tangible book), while commodity-like lenders deserve discounts.
Nvidia (NVDA): Extensive caution on Semiconductors leader due to 70x earnings, ~54% operating margins viewed as unsustainably high, and insider selling; any margin normalization could compress valuation.
NACCO Industries (NC): Used as a case study where long-term earnings and contracts built cash and assets post-spin, now appearing cheaper on an asset basis despite earlier earnings-driven appeal.
Market Themes: The market’s love of AI and so-called Compounders is highlighted, with a warning against box-labeling and paying extreme multiples (e.g., >10x sales).
Time Horizon: Focus on what a business looks like in 2–3 years, not near-term earnings; temporary losses (e.g., in insurers or airlines like Southwest) are acceptable if long-term relative advantages persist.
Risk/Reward: Asset plays require meaningful upside, not just small discounts to appraised value; cyclical upside can be strong when industry supply-demand tightens.
Transcript
welcome welcome welcome how's everybody doing hope you are doing well my name is Andrew with Focus compounding on air live with Jeff gon Jeff how goes it today uh it is going very well with me how is it going with you it's going great we hope it's going great with everybody else as well if this is the first time you are tuning in thank you so much for joining us be sure to check out all of our content that we push out into the investing Universe uh the best way to do that is to follow me on X forly known as Twitter at Focus compound uh if you would like to get access to investment right up from Jeff going all the way back to 2005 go to focus compound.com and you'll get all of that for free at our website all the information is in the description below so today's podcast Chef we are going to be going over a question um and uh if you're listening and you would like to send in questions email them to me at Android Focus compound.com uh in the subject line just put question for the podcast or something and we'll queue it and we will pull it for the podcast so this question says when it comes to valuing a business do you believe more in asset valuations or earnings earnings aren't guaranteed to be there in the future depending on the industry of course but assets are only worth what you can sell them to somebody else do you think a pizza shop should be analyzed based on how much pizza they sell with the value of its real estate and bank account should they all be assessed when determining a value for the business this is the question I've been thinking about in trying to understand valuation so we could run with that get your thoughts on that I don't know if there's a difference in companies or how you think about it but yeah let's go from there so asset valuation vers earnings valuation right so here I think that this is a great question but it's also a it's a great great question but it's also really dumb idea which is that you would value something one way or the other I wrote a blog post a long time ago about assets earnings equivalence and one of my points about that was ultimately if you're appraising things correctly you should be able to convert one side of a company um entirely into the other in the sense that you should either be able to come up with a with a um estimate of what the market value of everything would be um or you should be able to come up with an estimate of what all the earnings would be if everything was put to say it's highest and best use or something like that so this comes up all the time in in Banks insurance companies Etc where interest rates were near zero you would say okay well let's take the balance sheet and let's apply different r rates to it that it will earn more in the future so you convert those assets into earnings this is the biggest problem with Burkshire people want to do it one calculation or the other they're both really the same thing you know assets are things that produce earnings and earnings really turn into retained earnings they can be paid out or other things but they just turn back into those assets in terms of that's the form that they take and I tried to mention that way in terms of like you know with physics you know um the same idea in terms of the equivalence there I wanted to give that same idea with earnings and assets and I think it's really dangerous for people to focus on them as one or the other through time they're the same thing right you can take earnings and turn them into assets you can take assets and turn them into earnings you can either take the earning the assets and make them more productive and everything they generate earnings or you can sell them invest them in other things that have earnings right so in the case of some companies it may be that you know that they're stuck in a mindset that is going to be harmful to the company over time because they have other concerns besides you know Financial ones and then maybe it's a family run thing maybe this thing's been around forever and they're stuck in this industry that will never get better whatever and they won't follow a path that would be the highest and best use of the things that you see there with the assets then you could say okay well then I have to Value it based only on these meager earnings that it has and uh it'll never sell but usually even then it does sell you know someone will die it will sell one day so there's three ways to look at a business right you can look at what the assets look like right now and you can change them to the market value and everything that's sort of the Marty Whitman way of doing it you can look at the earnings and say okay these are the current earnings and I'll use that as it or you can use the basically the net present value of the future cash flows which assumes all the capital allocation decisions the company makes and all that of all the way so this is sort of a triangle and using this you can kind of triangulate for Value the most AC the most important one to know is the npv it's also the one you have the least confidence in the hardest and has the most uncertainty yeah but it's by far the most important the second most important is the earnings which also is less certain even in terms of the way that people just take reported earnings as if they mean something but even in terms of you have to go through the earnings and adjust them for all sorts of things to get an idea of what earnings really are earnings are actually quite more complicated concept than assets or cash flows usually at a company um they're much easier to to to um they have a high subjective element and timing element to them and then um assets is the one you would be most uh um able to come up with a number for but it is the number that would mean the least so that's the problem that you have the one you can have the most confidence in today is what it looks like is what the assets look like what they could be liquidated for ETC today but it's the least important number to know usually and then the one that's by far the most important is the npv number right so if you're looking at Burkshire haway when Buffett takes over you know the asset number very well it's actually kind of inaccurate in that it would turn out that you wouldn't be able to liquidate as well as you had hoped or any of those things but you have confidence that it's not too expensive but the number that you really need to know that this company's going to do 20 30% a year for for decades is to know that MPV number but that depends on Capital allocation and what they do with everything which is much trickier for people to figure out and includes things above the business level and really what the the corporation is doing and how they approach things so you use all three of those things to try to see what could be the case and I always use all three of those always when looking at companies um but you then have the question of like margin of safety and how certain are you of some things happening and sometimes it also creates a difference in terms of valuations and maybe how quickly people recognize things in the market and whether you should invest in something or not so if you take an example like Naco I would have invested that on the basis of the idea that you're going to have earnings over time and that will either turn into assets or as we said like an MPV type thing to a large extent I was not off on any of those estimates over five six seven years whatever so it has followed since the spin-off much the same path that I would have expected in terms of what it's generated and how those things have kind of aifi on the balance sheet and everything so now it looks cheaper on like an asset basis whereas when it started it didn't look cheap on an asset basis so it it migrated from that perspective from being something that maybe look cheap if you read the contracts and tried to understand the business to something that now looks cheap on stuff like priced a tangible book but all of those things that you see there came from buildup in some case there was contract termin and they got things from that in some case they actually you know um minerals were used up over time you know natural gas was brought out of the ground and sold and everything and they collected um their royalties on that and that turned into cash and in other cases just earnings that piled up on the balance sheet because they have some dividends and they've only recently started buying back but it followed the path that I would expect from the time of the the spin-off um and yet at times some people would focus there there's different people who send things in and they would say oh well here's on the cash flow thing why I like it or why I don't and then they change at different times whether they like the stock or not then there's other people say well on the balance sheet it's not cheap enough at first right because has these contracts that that don't have the same value in terms of what you're seeing versus say cash just sitting there on the balance sheet but it also has has dumb things on the balance sheet too and they've written some of those off but they just have like you know loads of coal inventory in places that probably you know you couldn't be so sure that they ever get used and they're counting that as if that's an asset that's good but they're maybe not paying as much attention to the fact you have a contract that as long as this plant keeps operating you're going to keep making money now the plant could shut down any day but the cold could be worthless any day too um so you want things that are um attractive in the way that you look at them but you do have to be aware that most people are not going to take that kind of view of all the different ways you can value a company assets earnings and this MPV type thinking Some People your growth type investors um VC whatever type people who think of the videos and stuff today are only looking at the MPV type stuff they don't care what the earnings are today or what the assets are then you have your hard Bend gram types which might be looking at the assets even in cases where that doesn't necessarily make much sense because we know things about the future um and there are some cases where this becomes dramatically different the big ones are in cases of like insurance and banking I side with Buffett on that I'm very happy to buy a bank at two times tangal book or more without any hesitation if I like the the the actual value of the bank that way and yet I also won't buy other Banks as 0.9 times tangible book because some banks have a an insurance companies but some of them have a real business with a real franchise to it that's based on relationships that they have and you know lower cost deposits than others and advantages in different ways on fee businesses whatever but it's a it's a service business that way that actually has a lot of built-up Goodwill in it and then others basically are paying competitive savings rate type things and then like you know investing in the equivalent of just what would be like a portfolio of mortgages or something you know what I mean that what they say they do might be a little different from that but it's awfully close to commodity on this side commodity on that side and so that business might be something that earns 6% return on Equity at a reasonable leverage ratio and someone else earns 20% and and it's it's not a risk-based thing it's that there's real um economic assets that aren't captured on the books in one case and not in the other um it would be most noticeable if you were buying something that was started out from scratch that way if it acquired its way to all that then there' be intangibles and things that you could look at that would look different but it becomes especially different that way so it's the same as like with c's you know there's nothing wrong with paying a high price for something um on an asset basis so I have no problem that way uh of something that has no I I've invested in companies that have essentially negative equity probably I literally I don't remember if IMS Health had negative equity when I invest in it but it probably may have it was buying back stock so I probably had no tangible equity no no Book value mhm what do you think generates better returns in the short to medium to long term buying on the balance sheet selling on the earnings or buying based on a cheap earnings multiple well I I think the thing that tends to make money is something where the effect is really really big so I don't think that you make a lot of money in earnings or assets or any of those by buying at things that are close to the uh amount that it actually is worth right so when people say does assets work better than than earnings or something with a lot of people thinking today that assets don't work as well I would disagree with that I think that assets work really well if there's a huge discount right so I still think that they would work in a really big way if you're getting a huge discount I think that people tend to be overly aggressive in writeups on the asset portion of it um a good thing we talked about the movie business and one thing to keep in mind with that cuz this applies to investing here is if you have movies that you're now making and putting out not in theaters but just to streaming and all that you could make small amounts of money on everything you make you could have a well-controlled budget you know what you're going to get paid for putting on these different Services whatever but you don't have any possibility for these big windfall profits from a surprise run in theaters there's not much of a cap on how much you could make if you happen to have something that everyone loves and if you don't have that then you can't make it this huge upside what I think the problem is with many of these asset things that I see in writeups is there's not enough upside to be honest so you may be able to prove that there is some strong protection on the downside right or that it's at 80% but I don't think you want to buy something at 80% that's going to go to 100 but that can't go to 200 you know it's much better to buy something on an asset basis that something could go really right with it and you can make a lot of money MH um so we talked about you know Encore Wire right if that cheap on a price to book or something at some point well in a short supply for the industry it actually makes a ton of money and it has a strong position in not a good industry really or um we talked about AAR precious metals right or even if we talk about things like um where people have low hopes of it being exploited anytime soon so Mau land and pineapple right it's all about oh is there Catalyst soon or not so sometimes the trades at a big discount to what it might be worth because people are going I got to wait 10 20 years or they're thinking this is going to happen at 10 or 20 months you know so there's a big possibility for a big payoff a lot of times you're capping your upside on the asset things today I don't think that was the case 50 years ago but I think that that um the upsides that I see are really small on things that are bought on the assets usually mhmh do you think if you're investing in so you had mentioned AAR precious metals oncore wire those are more cyclical Industries and if you're investing in them cheap on an asset basis perhaps you're at the point in the cycle where there star for Capital maybe supplies coming out you could hope that the cycle May you know the pendulum would swing back the other way right if you're buying it on a cheap to asset basis you could sort of have that that uh Tailwind you know well you're investig situation I don't look at current period earnings at all really when I buy a stock I'm saying what will it earn in three years or something I'm using like what's the long-term sales what's the constant things that way and then looking at kind of what that could mean so you could be using Book value could be using sales and then you're applying some sort of multiple to it but I would have no hesitation to buy something that's in a period where it's making nothing you know uh a insurance company that has made had a you know a combined ratio below 100 for the last 20 years and now it's uh uh 101 this year you know um or let's say 107 or something so that it's investment stuff wouldn't offset the loss so it actually reported a loss it wouldn't bother me I'd be happy to buy an insurance company making a loss I I bought other I mean I think I literally bought Nintendo when the one time it made a loss um we talked about Airlines I'd be happy to buy Southwest when it made a loss it wouldn't bother me uhhuh is that because of the brand of Southwest it's such a dominant business that's been around forever they have M shares staying power I mean this is a company that you know is is uh a very high quality business no it's it's like would you look at would you think differently about that if it was not a Southwest if it was like a micro cap or a company that isn't yet proven or haven't been around has not been around as long as Southwest has been no it's just trying to to not be stupid to use your mind here there's no reason why having a 12-month period where something had a loss should matter it just doesn't make any sense I mean C's candies I'm sure reports losses for quarters during the year because it's a seasonal business um you know the question is did it outperform all the other companies in that industry or something it would be much more alarming if if a company and we showed this with Southwest over time the major Legacy carriers have closed the Gap with Southwest there's no doubt that's the thing I'd be worried about that happened even in years where Southwest had good margins and everything um so it's that relative Advantage the same thing with insurers if you posted 101 combin ratio when everyone else had a 93 in your industry yeah I'd be worried that something happened and hopefully it's a one-time event um but it wouldn't bother me if you were still keeping much of your relative advantage over others so it's you focus on the things that are you know I've said this before constant consequential and calculable so one of the things that I the calculable reason is because otherwise you just get people who write two pages of all the things that could happen with uncertainty and uncertainty isn't risk yes there'll be problems every business is going to have a lot of problems and just saying them ahead of time doesn't help we talked about a company if you remember that we bought stock in that had to do with loyalty points in Airlines and we bought it before covid yeah we thought of some other the things that happened that did happen during covid yeah didn't help us Co still happened the airlin still shut down it doesn't matter if you said what would happen in a pandemic what would happen in war you have to ultimately make a decision and are you just going to avoid anything that would be devastating in that kind of situation so yeah there's always lot of uncertainty and everything but um you have to look at the the long-term value of the company the most stocks today B basically all stocks are long very long duration assets the actual amount they earn this year and even pay out this year is is not highly consequential um it just isn't usually enough to move the needle between a really good idea and a so so one even so it does not matter uh I mean even if you couldn't predict as long as you knew that a company wanted would have the same number of shares out and the balance sheet wouldn't look that much different in three years it's not really that important that you know what they're going to earn this year or next year maybe it matters to the stock but even then it's arguable because if the stock is so focused on short-term earnings that it moves ahead of those times then it's also moving on guidance and on expectations for the industry so it could move anyway for reasons that don't make sense to you so it can still a stock can still work out really well for you one to three years even if you're just focused on what it looks like in year three or something if I'm buying a stock in 2024 I'm really asking what's this going to look like in 2026 because I don't want to be thinking well will there be recession this year or not while you own stocks or while the next person who buys it from you and decides what to pay for this owns the stock there'll be recessions some years there won't be in other years it whether there's a recession this year or something isn't something we should focus too much on you know so I don't think that current period earnings either trailing 12 months or forward 12 months is ever a particularly good idea to look at stocks I don't think statistically it's ever been proven that that's helpful like the Schiller PE might have value price to sales might have value but I don't think that PE would have value that doesn't really make sense to me how different does it feel to you investing like at least since we started Focus compounding valuations have been very high versus different parts in your career where you're buying FICO at you know single digit pees there investing has a lot of a fashion aspect to it right so it changes over time what people are really into and it happens to be that the FICO type thing um is really what everyone wants to be in right now um they love the Compounders you know we named our our our whole everything that we do Focus compounding uh I don't know if we were naming it today would do that because although that word was out there a little bit that is a word that now if I go to Valley Investor's club or something they just designate something this is a compounder as if that's that means something yeah that's a category of stock that's not really what happens you know it's a thing that happens to some and um I I I wouldn't put things in categories like that I would say look most of the time does it do this or something is maybe a better way of thinking about it don't just put companies in boxes where you say this is a great company this is a compound or whatever but more often than not does it tend to be better at controlling expenses than other companies yes so that maybe sometimes is a better way to think of it yourself than this is a um you know uh Cost Cutter this is a compounder or whatever yeah um I mean we've talked about over-the-counter markets is over- the- counter markets a compounder over time maybe it's it's not a compounder that every year it's going to happen I don't think it's a good idea to put it in that sort of category that way I think it's better to think it in in different terms but um yeah there's there's no doubt the market is quite excited about these kinds of companies that grow a lot and it's excited um you know you have Nvidia up there to me that's hard to make any sense of that that doesn't mean it I don't know mathematically we're getting to points where it pretty much does mean it it can't make money over time from here but you know I mean I think let's take insiders no Insider ever Buys in video stock right it's all sells no buys I believe that that's true that if we looked at the last six months last year there can't be anyone inside the company buying it they have to all be selling and that doesn't mean they're selling a lot or something but I'm pretty sure it's like totally all one-sided um and they're not wrong that they should turn a little of it into cash for themselves because what is the operating margin at Nvidia in 2024 and this is not updated for the current I mean this probably is updated for the current quarter but we're doing a trailing number here mhm mhm 54% yeah okay do you think the margin will be 54% in the future I don't think do it does anyone think that is that what people think well there's an issue because if something trades at 70 times earnings and the margins are twice what they're supposed to be then you're active trading at 150 times I mean what's likely to happen is that there will come a point where earnings don't grow as fast as revenue or to put it in another way earnings fall faster than revenue and that may be a point where people are unhappy now they should notice that point beforehand but it's not like you should look at Revenue growth as being an accurate number of what's going to happen I I um you know so that's the difficulty in doing these mpvs and all that is that you can but but I do like them because you if you just write down your assumptions about something you do realize that oh you're assuming 50% operating margins which is probably crazy I mean what's fico's operating margins because Nvidia is not going to be as good as FICO but the expectation is that it's going to be really close about the same as the expectation right now right 43% I mean it's consistently gotten better but yeah I mean we're talking 10year medium margins on EIT 21 and a half% but you know for operating margin it's it's 26% 31% 39% 42% yeah I mean ver sign I think probably has margins that are a bit higher than that probably but like we you could look at company after company which is Moody's you know which are things where you have to almost legally you have to do this for some companies it's it's not literally legally but there are companies where realistically they kind of need to have FICO scores there's Alternatives they could try to use them and stuff but basically you're going to need to use a sign you know indirectly you're going to need to use FICO you're going to need Moody you could do S&P and Fitch or something but these are like taxes that are imposed upon you by Monopoly type things basically they're kind of things that you do need Nvidia could have that position in a huge Market I just don't think that it'll ever have margins that are much harder than that and that's why I'd say using things like sales MH there's also a physical aspect to the Nvidia thing where you actually will pile up inventory and everything so um but look I don't know you're assuming that they it grows very fast that other people can't get into the business right um so I think the it's just something that I just don't worry about you know I don't just mean I don't worry about Nvidia but I don't worry about the fact that some companies have crazy multiples and does that mean the world's changed we talked about a little bit I don't think it means it it's just something that people are into now and other points they're really into value stuff or they're really into you know what ever else don't know that yeah I mean I don't know that the exact multiple on some stocks is really all that more thought out than whether Bitcoin is the price it is or half the price it is you know there's an element that's thought about that way but but you know Charlie merer said that where he said you know that stocks are sometimes like REM Brands you know to some extent and I think that's true um the I mean Nvidia is simple in the way that why it's happening is that everyone wants to be in um AI stuff and they can only think of one name and they only see one name in The Press and everything so it's the huge awareness and that happens but barbon Heimer happened why did it happen why did Nvidia happen I mean it just was a thing it was put in front of everybody it caught their eye they didn't know of other choices they knew of that and they bought that mhm um there's underlying reasons why Nvidia is great but I doubt that's the only reason why the multiple is incredibly High cuz they're great businesses in the past where the multiple for some reason isn't very high you know um but this is one where obviously you can't use either earnings it it fails that test is the current earnings is too expensive on that basis and then also it fails to test obviously on assets so it's all about npv it's all about npv and but we should keep in mind and I don't want to Discount this everything you know about a stock a business you know is the past all that matters matters about it is the future for you as investor today the past does not matter so we can look at that chart and see that in nvidia's past it certainly has never performed as a business in any way that would justify this the Returns on Capital here are off the charts and they have 20 some years of history that is all consistently below that and quite cyclical and everything it doesn't mean that it will return to being that because it could be quite a different business now um so I I don't want to just say you have to focus on those numbers and worry about it I would never say the PE is too high The Price to Book is too high so I'm betting against it or something even when I said earlier in the year the U magnificent 7 you know that is a group of stocks and so I would say that if you wanted to if you know that if you're worried and I don't think there is I I think you should just ignore it but if you were worried that even if you buy stocks that are great they are going to go down over time because everything's going to go down you know the only way to hedge that is basically the Magnificent 7 um it's a realistic fear I think that even if you buy relatively good stocks they they might still be absolutely not that cheap but it's just something that we have to deal with we you know especially managing money for other people you kind of are putting the money to use in the best things that you can do you try to make sure that you think it's double digit things but um you know let's see from from 1999 to 2009 I would guess the inflation adjusted return in stocks was probably somewhat negative I don't know if it was one or two% negative or something but like the real return was negative obviously in Japan it was negative for a long time so you know it could happen and that's just something that you have to accept you hopefully you run on a um uh you know like a relative basis enough points ahead of the market that you still have a positive return but you know it's not always that easy I would just steer very clear of these sorts of things I mean what I would say is like we've said you know you can have a very good success in life in investing never buying anything more than 10 times sales so why add that to your thing to buy things that are 10 times sales or more you can just ignore them it's really not a big deal um and the same thing is true with all sorts of other kinds of businesses I think people do that with other things they ignore entire categories if they're under litigation risk or something they're just like I won't buy it environmental things I won't buy it but if it's incredibly expensive they they don't just say okay the company may be wonderful I can learn about it but no matter what I'm not buying it over a certain multiple because that has a huge kind of catastrophic risk to it that I don't want to take got it cool well I want to thank everybody so much for tuning in with the both of us on the focus compounding podcast if you have a question you would like featured on the podcast email to me Andrew at Focus compounding dcom I than every so much for tuning in with the both of us U the focus compound podcast if you're interested in learning about our Money Management Services you can reach out to me at Android focus comp.com and be sure to hit the Subscribe button wherever you are listening or watching us here today I don't thank every always so much for all the support and we will see you in the next podcast take care
Asset-Earnings Equivalence, Cyclical Downturns, and Thoughts on NVDA
Summary
Transcript
welcome welcome welcome how's everybody doing hope you are doing well my name is Andrew with Focus compounding on air live with Jeff gon Jeff how goes it today uh it is going very well with me how is it going with you it's going great we hope it's going great with everybody else as well if this is the first time you are tuning in thank you so much for joining us be sure to check out all of our content that we push out into the investing Universe uh the best way to do that is to follow me on X forly known as Twitter at Focus compound uh if you would like to get access to investment right up from Jeff going all the way back to 2005 go to focus compound.com and you'll get all of that for free at our website all the information is in the description below so today's podcast Chef we are going to be going over a question um and uh if you're listening and you would like to send in questions email them to me at Android Focus compound.com uh in the subject line just put question for the podcast or something and we'll queue it and we will pull it for the podcast so this question says when it comes to valuing a business do you believe more in asset valuations or earnings earnings aren't guaranteed to be there in the future depending on the industry of course but assets are only worth what you can sell them to somebody else do you think a pizza shop should be analyzed based on how much pizza they sell with the value of its real estate and bank account should they all be assessed when determining a value for the business this is the question I've been thinking about in trying to understand valuation so we could run with that get your thoughts on that I don't know if there's a difference in companies or how you think about it but yeah let's go from there so asset valuation vers earnings valuation right so here I think that this is a great question but it's also a it's a great great question but it's also really dumb idea which is that you would value something one way or the other I wrote a blog post a long time ago about assets earnings equivalence and one of my points about that was ultimately if you're appraising things correctly you should be able to convert one side of a company um entirely into the other in the sense that you should either be able to come up with a with a um estimate of what the market value of everything would be um or you should be able to come up with an estimate of what all the earnings would be if everything was put to say it's highest and best use or something like that so this comes up all the time in in Banks insurance companies Etc where interest rates were near zero you would say okay well let's take the balance sheet and let's apply different r rates to it that it will earn more in the future so you convert those assets into earnings this is the biggest problem with Burkshire people want to do it one calculation or the other they're both really the same thing you know assets are things that produce earnings and earnings really turn into retained earnings they can be paid out or other things but they just turn back into those assets in terms of that's the form that they take and I tried to mention that way in terms of like you know with physics you know um the same idea in terms of the equivalence there I wanted to give that same idea with earnings and assets and I think it's really dangerous for people to focus on them as one or the other through time they're the same thing right you can take earnings and turn them into assets you can take assets and turn them into earnings you can either take the earning the assets and make them more productive and everything they generate earnings or you can sell them invest them in other things that have earnings right so in the case of some companies it may be that you know that they're stuck in a mindset that is going to be harmful to the company over time because they have other concerns besides you know Financial ones and then maybe it's a family run thing maybe this thing's been around forever and they're stuck in this industry that will never get better whatever and they won't follow a path that would be the highest and best use of the things that you see there with the assets then you could say okay well then I have to Value it based only on these meager earnings that it has and uh it'll never sell but usually even then it does sell you know someone will die it will sell one day so there's three ways to look at a business right you can look at what the assets look like right now and you can change them to the market value and everything that's sort of the Marty Whitman way of doing it you can look at the earnings and say okay these are the current earnings and I'll use that as it or you can use the basically the net present value of the future cash flows which assumes all the capital allocation decisions the company makes and all that of all the way so this is sort of a triangle and using this you can kind of triangulate for Value the most AC the most important one to know is the npv it's also the one you have the least confidence in the hardest and has the most uncertainty yeah but it's by far the most important the second most important is the earnings which also is less certain even in terms of the way that people just take reported earnings as if they mean something but even in terms of you have to go through the earnings and adjust them for all sorts of things to get an idea of what earnings really are earnings are actually quite more complicated concept than assets or cash flows usually at a company um they're much easier to to to um they have a high subjective element and timing element to them and then um assets is the one you would be most uh um able to come up with a number for but it is the number that would mean the least so that's the problem that you have the one you can have the most confidence in today is what it looks like is what the assets look like what they could be liquidated for ETC today but it's the least important number to know usually and then the one that's by far the most important is the npv number right so if you're looking at Burkshire haway when Buffett takes over you know the asset number very well it's actually kind of inaccurate in that it would turn out that you wouldn't be able to liquidate as well as you had hoped or any of those things but you have confidence that it's not too expensive but the number that you really need to know that this company's going to do 20 30% a year for for decades is to know that MPV number but that depends on Capital allocation and what they do with everything which is much trickier for people to figure out and includes things above the business level and really what the the corporation is doing and how they approach things so you use all three of those things to try to see what could be the case and I always use all three of those always when looking at companies um but you then have the question of like margin of safety and how certain are you of some things happening and sometimes it also creates a difference in terms of valuations and maybe how quickly people recognize things in the market and whether you should invest in something or not so if you take an example like Naco I would have invested that on the basis of the idea that you're going to have earnings over time and that will either turn into assets or as we said like an MPV type thing to a large extent I was not off on any of those estimates over five six seven years whatever so it has followed since the spin-off much the same path that I would have expected in terms of what it's generated and how those things have kind of aifi on the balance sheet and everything so now it looks cheaper on like an asset basis whereas when it started it didn't look cheap on an asset basis so it it migrated from that perspective from being something that maybe look cheap if you read the contracts and tried to understand the business to something that now looks cheap on stuff like priced a tangible book but all of those things that you see there came from buildup in some case there was contract termin and they got things from that in some case they actually you know um minerals were used up over time you know natural gas was brought out of the ground and sold and everything and they collected um their royalties on that and that turned into cash and in other cases just earnings that piled up on the balance sheet because they have some dividends and they've only recently started buying back but it followed the path that I would expect from the time of the the spin-off um and yet at times some people would focus there there's different people who send things in and they would say oh well here's on the cash flow thing why I like it or why I don't and then they change at different times whether they like the stock or not then there's other people say well on the balance sheet it's not cheap enough at first right because has these contracts that that don't have the same value in terms of what you're seeing versus say cash just sitting there on the balance sheet but it also has has dumb things on the balance sheet too and they've written some of those off but they just have like you know loads of coal inventory in places that probably you know you couldn't be so sure that they ever get used and they're counting that as if that's an asset that's good but they're maybe not paying as much attention to the fact you have a contract that as long as this plant keeps operating you're going to keep making money now the plant could shut down any day but the cold could be worthless any day too um so you want things that are um attractive in the way that you look at them but you do have to be aware that most people are not going to take that kind of view of all the different ways you can value a company assets earnings and this MPV type thinking Some People your growth type investors um VC whatever type people who think of the videos and stuff today are only looking at the MPV type stuff they don't care what the earnings are today or what the assets are then you have your hard Bend gram types which might be looking at the assets even in cases where that doesn't necessarily make much sense because we know things about the future um and there are some cases where this becomes dramatically different the big ones are in cases of like insurance and banking I side with Buffett on that I'm very happy to buy a bank at two times tangal book or more without any hesitation if I like the the the actual value of the bank that way and yet I also won't buy other Banks as 0.9 times tangible book because some banks have a an insurance companies but some of them have a real business with a real franchise to it that's based on relationships that they have and you know lower cost deposits than others and advantages in different ways on fee businesses whatever but it's a it's a service business that way that actually has a lot of built-up Goodwill in it and then others basically are paying competitive savings rate type things and then like you know investing in the equivalent of just what would be like a portfolio of mortgages or something you know what I mean that what they say they do might be a little different from that but it's awfully close to commodity on this side commodity on that side and so that business might be something that earns 6% return on Equity at a reasonable leverage ratio and someone else earns 20% and and it's it's not a risk-based thing it's that there's real um economic assets that aren't captured on the books in one case and not in the other um it would be most noticeable if you were buying something that was started out from scratch that way if it acquired its way to all that then there' be intangibles and things that you could look at that would look different but it becomes especially different that way so it's the same as like with c's you know there's nothing wrong with paying a high price for something um on an asset basis so I have no problem that way uh of something that has no I I've invested in companies that have essentially negative equity probably I literally I don't remember if IMS Health had negative equity when I invest in it but it probably may have it was buying back stock so I probably had no tangible equity no no Book value mhm what do you think generates better returns in the short to medium to long term buying on the balance sheet selling on the earnings or buying based on a cheap earnings multiple well I I think the thing that tends to make money is something where the effect is really really big so I don't think that you make a lot of money in earnings or assets or any of those by buying at things that are close to the uh amount that it actually is worth right so when people say does assets work better than than earnings or something with a lot of people thinking today that assets don't work as well I would disagree with that I think that assets work really well if there's a huge discount right so I still think that they would work in a really big way if you're getting a huge discount I think that people tend to be overly aggressive in writeups on the asset portion of it um a good thing we talked about the movie business and one thing to keep in mind with that cuz this applies to investing here is if you have movies that you're now making and putting out not in theaters but just to streaming and all that you could make small amounts of money on everything you make you could have a well-controlled budget you know what you're going to get paid for putting on these different Services whatever but you don't have any possibility for these big windfall profits from a surprise run in theaters there's not much of a cap on how much you could make if you happen to have something that everyone loves and if you don't have that then you can't make it this huge upside what I think the problem is with many of these asset things that I see in writeups is there's not enough upside to be honest so you may be able to prove that there is some strong protection on the downside right or that it's at 80% but I don't think you want to buy something at 80% that's going to go to 100 but that can't go to 200 you know it's much better to buy something on an asset basis that something could go really right with it and you can make a lot of money MH um so we talked about you know Encore Wire right if that cheap on a price to book or something at some point well in a short supply for the industry it actually makes a ton of money and it has a strong position in not a good industry really or um we talked about AAR precious metals right or even if we talk about things like um where people have low hopes of it being exploited anytime soon so Mau land and pineapple right it's all about oh is there Catalyst soon or not so sometimes the trades at a big discount to what it might be worth because people are going I got to wait 10 20 years or they're thinking this is going to happen at 10 or 20 months you know so there's a big possibility for a big payoff a lot of times you're capping your upside on the asset things today I don't think that was the case 50 years ago but I think that that um the upsides that I see are really small on things that are bought on the assets usually mhmh do you think if you're investing in so you had mentioned AAR precious metals oncore wire those are more cyclical Industries and if you're investing in them cheap on an asset basis perhaps you're at the point in the cycle where there star for Capital maybe supplies coming out you could hope that the cycle May you know the pendulum would swing back the other way right if you're buying it on a cheap to asset basis you could sort of have that that uh Tailwind you know well you're investig situation I don't look at current period earnings at all really when I buy a stock I'm saying what will it earn in three years or something I'm using like what's the long-term sales what's the constant things that way and then looking at kind of what that could mean so you could be using Book value could be using sales and then you're applying some sort of multiple to it but I would have no hesitation to buy something that's in a period where it's making nothing you know uh a insurance company that has made had a you know a combined ratio below 100 for the last 20 years and now it's uh uh 101 this year you know um or let's say 107 or something so that it's investment stuff wouldn't offset the loss so it actually reported a loss it wouldn't bother me I'd be happy to buy an insurance company making a loss I I bought other I mean I think I literally bought Nintendo when the one time it made a loss um we talked about Airlines I'd be happy to buy Southwest when it made a loss it wouldn't bother me uhhuh is that because of the brand of Southwest it's such a dominant business that's been around forever they have M shares staying power I mean this is a company that you know is is uh a very high quality business no it's it's like would you look at would you think differently about that if it was not a Southwest if it was like a micro cap or a company that isn't yet proven or haven't been around has not been around as long as Southwest has been no it's just trying to to not be stupid to use your mind here there's no reason why having a 12-month period where something had a loss should matter it just doesn't make any sense I mean C's candies I'm sure reports losses for quarters during the year because it's a seasonal business um you know the question is did it outperform all the other companies in that industry or something it would be much more alarming if if a company and we showed this with Southwest over time the major Legacy carriers have closed the Gap with Southwest there's no doubt that's the thing I'd be worried about that happened even in years where Southwest had good margins and everything um so it's that relative Advantage the same thing with insurers if you posted 101 combin ratio when everyone else had a 93 in your industry yeah I'd be worried that something happened and hopefully it's a one-time event um but it wouldn't bother me if you were still keeping much of your relative advantage over others so it's you focus on the things that are you know I've said this before constant consequential and calculable so one of the things that I the calculable reason is because otherwise you just get people who write two pages of all the things that could happen with uncertainty and uncertainty isn't risk yes there'll be problems every business is going to have a lot of problems and just saying them ahead of time doesn't help we talked about a company if you remember that we bought stock in that had to do with loyalty points in Airlines and we bought it before covid yeah we thought of some other the things that happened that did happen during covid yeah didn't help us Co still happened the airlin still shut down it doesn't matter if you said what would happen in a pandemic what would happen in war you have to ultimately make a decision and are you just going to avoid anything that would be devastating in that kind of situation so yeah there's always lot of uncertainty and everything but um you have to look at the the long-term value of the company the most stocks today B basically all stocks are long very long duration assets the actual amount they earn this year and even pay out this year is is not highly consequential um it just isn't usually enough to move the needle between a really good idea and a so so one even so it does not matter uh I mean even if you couldn't predict as long as you knew that a company wanted would have the same number of shares out and the balance sheet wouldn't look that much different in three years it's not really that important that you know what they're going to earn this year or next year maybe it matters to the stock but even then it's arguable because if the stock is so focused on short-term earnings that it moves ahead of those times then it's also moving on guidance and on expectations for the industry so it could move anyway for reasons that don't make sense to you so it can still a stock can still work out really well for you one to three years even if you're just focused on what it looks like in year three or something if I'm buying a stock in 2024 I'm really asking what's this going to look like in 2026 because I don't want to be thinking well will there be recession this year or not while you own stocks or while the next person who buys it from you and decides what to pay for this owns the stock there'll be recessions some years there won't be in other years it whether there's a recession this year or something isn't something we should focus too much on you know so I don't think that current period earnings either trailing 12 months or forward 12 months is ever a particularly good idea to look at stocks I don't think statistically it's ever been proven that that's helpful like the Schiller PE might have value price to sales might have value but I don't think that PE would have value that doesn't really make sense to me how different does it feel to you investing like at least since we started Focus compounding valuations have been very high versus different parts in your career where you're buying FICO at you know single digit pees there investing has a lot of a fashion aspect to it right so it changes over time what people are really into and it happens to be that the FICO type thing um is really what everyone wants to be in right now um they love the Compounders you know we named our our our whole everything that we do Focus compounding uh I don't know if we were naming it today would do that because although that word was out there a little bit that is a word that now if I go to Valley Investor's club or something they just designate something this is a compounder as if that's that means something yeah that's a category of stock that's not really what happens you know it's a thing that happens to some and um I I I wouldn't put things in categories like that I would say look most of the time does it do this or something is maybe a better way of thinking about it don't just put companies in boxes where you say this is a great company this is a compound or whatever but more often than not does it tend to be better at controlling expenses than other companies yes so that maybe sometimes is a better way to think of it yourself than this is a um you know uh Cost Cutter this is a compounder or whatever yeah um I mean we've talked about over-the-counter markets is over- the- counter markets a compounder over time maybe it's it's not a compounder that every year it's going to happen I don't think it's a good idea to put it in that sort of category that way I think it's better to think it in in different terms but um yeah there's there's no doubt the market is quite excited about these kinds of companies that grow a lot and it's excited um you know you have Nvidia up there to me that's hard to make any sense of that that doesn't mean it I don't know mathematically we're getting to points where it pretty much does mean it it can't make money over time from here but you know I mean I think let's take insiders no Insider ever Buys in video stock right it's all sells no buys I believe that that's true that if we looked at the last six months last year there can't be anyone inside the company buying it they have to all be selling and that doesn't mean they're selling a lot or something but I'm pretty sure it's like totally all one-sided um and they're not wrong that they should turn a little of it into cash for themselves because what is the operating margin at Nvidia in 2024 and this is not updated for the current I mean this probably is updated for the current quarter but we're doing a trailing number here mhm mhm 54% yeah okay do you think the margin will be 54% in the future I don't think do it does anyone think that is that what people think well there's an issue because if something trades at 70 times earnings and the margins are twice what they're supposed to be then you're active trading at 150 times I mean what's likely to happen is that there will come a point where earnings don't grow as fast as revenue or to put it in another way earnings fall faster than revenue and that may be a point where people are unhappy now they should notice that point beforehand but it's not like you should look at Revenue growth as being an accurate number of what's going to happen I I um you know so that's the difficulty in doing these mpvs and all that is that you can but but I do like them because you if you just write down your assumptions about something you do realize that oh you're assuming 50% operating margins which is probably crazy I mean what's fico's operating margins because Nvidia is not going to be as good as FICO but the expectation is that it's going to be really close about the same as the expectation right now right 43% I mean it's consistently gotten better but yeah I mean we're talking 10year medium margins on EIT 21 and a half% but you know for operating margin it's it's 26% 31% 39% 42% yeah I mean ver sign I think probably has margins that are a bit higher than that probably but like we you could look at company after company which is Moody's you know which are things where you have to almost legally you have to do this for some companies it's it's not literally legally but there are companies where realistically they kind of need to have FICO scores there's Alternatives they could try to use them and stuff but basically you're going to need to use a sign you know indirectly you're going to need to use FICO you're going to need Moody you could do S&P and Fitch or something but these are like taxes that are imposed upon you by Monopoly type things basically they're kind of things that you do need Nvidia could have that position in a huge Market I just don't think that it'll ever have margins that are much harder than that and that's why I'd say using things like sales MH there's also a physical aspect to the Nvidia thing where you actually will pile up inventory and everything so um but look I don't know you're assuming that they it grows very fast that other people can't get into the business right um so I think the it's just something that I just don't worry about you know I don't just mean I don't worry about Nvidia but I don't worry about the fact that some companies have crazy multiples and does that mean the world's changed we talked about a little bit I don't think it means it it's just something that people are into now and other points they're really into value stuff or they're really into you know what ever else don't know that yeah I mean I don't know that the exact multiple on some stocks is really all that more thought out than whether Bitcoin is the price it is or half the price it is you know there's an element that's thought about that way but but you know Charlie merer said that where he said you know that stocks are sometimes like REM Brands you know to some extent and I think that's true um the I mean Nvidia is simple in the way that why it's happening is that everyone wants to be in um AI stuff and they can only think of one name and they only see one name in The Press and everything so it's the huge awareness and that happens but barbon Heimer happened why did it happen why did Nvidia happen I mean it just was a thing it was put in front of everybody it caught their eye they didn't know of other choices they knew of that and they bought that mhm um there's underlying reasons why Nvidia is great but I doubt that's the only reason why the multiple is incredibly High cuz they're great businesses in the past where the multiple for some reason isn't very high you know um but this is one where obviously you can't use either earnings it it fails that test is the current earnings is too expensive on that basis and then also it fails to test obviously on assets so it's all about npv it's all about npv and but we should keep in mind and I don't want to Discount this everything you know about a stock a business you know is the past all that matters matters about it is the future for you as investor today the past does not matter so we can look at that chart and see that in nvidia's past it certainly has never performed as a business in any way that would justify this the Returns on Capital here are off the charts and they have 20 some years of history that is all consistently below that and quite cyclical and everything it doesn't mean that it will return to being that because it could be quite a different business now um so I I don't want to just say you have to focus on those numbers and worry about it I would never say the PE is too high The Price to Book is too high so I'm betting against it or something even when I said earlier in the year the U magnificent 7 you know that is a group of stocks and so I would say that if you wanted to if you know that if you're worried and I don't think there is I I think you should just ignore it but if you were worried that even if you buy stocks that are great they are going to go down over time because everything's going to go down you know the only way to hedge that is basically the Magnificent 7 um it's a realistic fear I think that even if you buy relatively good stocks they they might still be absolutely not that cheap but it's just something that we have to deal with we you know especially managing money for other people you kind of are putting the money to use in the best things that you can do you try to make sure that you think it's double digit things but um you know let's see from from 1999 to 2009 I would guess the inflation adjusted return in stocks was probably somewhat negative I don't know if it was one or two% negative or something but like the real return was negative obviously in Japan it was negative for a long time so you know it could happen and that's just something that you have to accept you hopefully you run on a um uh you know like a relative basis enough points ahead of the market that you still have a positive return but you know it's not always that easy I would just steer very clear of these sorts of things I mean what I would say is like we've said you know you can have a very good success in life in investing never buying anything more than 10 times sales so why add that to your thing to buy things that are 10 times sales or more you can just ignore them it's really not a big deal um and the same thing is true with all sorts of other kinds of businesses I think people do that with other things they ignore entire categories if they're under litigation risk or something they're just like I won't buy it environmental things I won't buy it but if it's incredibly expensive they they don't just say okay the company may be wonderful I can learn about it but no matter what I'm not buying it over a certain multiple because that has a huge kind of catastrophic risk to it that I don't want to take got it cool well I want to thank everybody so much for tuning in with the both of us on the focus compounding podcast if you have a question you would like featured on the podcast email to me Andrew at Focus compounding dcom I than every so much for tuning in with the both of us U the focus compound podcast if you're interested in learning about our Money Management Services you can reach out to me at Android focus comp.com and be sure to hit the Subscribe button wherever you are listening or watching us here today I don't thank every always so much for all the support and we will see you in the next podcast take care