Value Investing with Options: Selling Puts to Buy Wonderful Businesses at Better Prices | S08 E18

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Value: After Hours is a podcast about value investing, Fintwit, and all things finance and investment by investors Tobias Carlisle, …

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We're live. This is Value After Hours. I'm Tobias Carlisle joined as always by my co-host Jake Taylor. Special guest today, Tim Travis, CEO Value Options Letter. How are you, Tim? I'm doing well. How are you guys doing? Really well. Good to have you back, Tim. When we When we Good to have you back. Oh, thank you. Thank you. When we have uh When we're talking value options, uh just in case folks don't know, do you want to give us a little explanation? Yeah, so basically uh we're value investors. Uh so naturally, so we're looking to buy businesses that are trading at large discounts to intrinsic value uh based on extensive fundamental analysis. And then when we're talking about value options, it's using simple strategies such as covered calls or cash-secured puts to generate income and reduce risk. And we're limiting ourselves to stocks that are already undervalued. Uh and so that's kind of the critical element of this is that it's it's value investing. That's the strategy. The way that we utilize options are just tactics. For instance, if you like a stock and you you would be willing to buy it here, but maybe you're kind of concerned about the overall market or you just like to make it a little safer even, you might sell a put a cash-secured put on that stock. And that creates a situation where there's two outcomes, heads or tails. Heads, if the stock's above that strike price where you sold the put at expiration, you make your return. We target over 10% uh annualized almost always. Uh tails, you end up buying the stock if the stock's below your strike price where you sold the put at, you end up owning it and now you have all the upside, the dividends, you could sell covered calls on it. Uh you know, how however you want to deal with it from there, but that's that's kind of the the basis of uh value options. There are two things that I like about it. One is that you can choose your entry and exit price for stocks. You're not necessarily guaranteed to get that entry or exit price, but that's the other side of the equation that you can make sure you're getting a sufficient return on cuz when they're cash secured, so if you take if you want to go long a stock, you sell a put, which I know is a little bit like inside out the way that people think about it. You buy a put for protection for downside protection, and so you sell a put, so you're underwriting the stock if it falls below that particular strike. But the nice thing is and there's an example of Buffett doing it with Coca-Cola in the early 1990s after he had established his position, it's trading at $39. [snorts] Um he buys a strike at 35, and he gets a $1.50 per contract. So his if he gets the stock put to him, it's $33.50 against the $39 stock price. And in that instance, uh I guess he thought that $33.50 was a good price to take the stock because the premium that he got was only enough to uh give him about a 6% annualized return, which uh is pretty thin for um for the cash that he had to put up. So he may not have done it cash secured, but he would recommend doing it cash secured. So you got to put the money into your account, and the premium gives you a little discount, and basically that's that's your return for the period of time you have it there. Correct. Correct. Exactly. So uh it just it's it's a attractive way to layer into a stock. Everyone wants to buy when stocks they want to buy stocks at cheaper prices, right? Uh and and it's hard to do that mechanically. Sometimes people will dollar cost average. Uh just, you know, they'll have like certain limit prices that they're willing to buy the stock at. But when you're selling puts, you're kind of manufacturing that in a way where if that stock doesn't drop to your level, you're still able to profit. Because sometimes you'll you'll be buying, let's say Google or or meta or something like that, and the stock runs away from you where you can't buy that full position that maybe you wanted. Maybe maybe it had already run up. You get in, you you establish a foothold in the stock, but you you haven't built the full one. You're just a little cautious on it and you're kind of expecting it to drop at some point. But you might not get that chance. And so when you sell puts, you're able to create a heads you win, tails you win situation as long as you're willing to own the stock. That's the key difference. It's not necessarily heads you win, tails you win. You've got to make sure that you win on both sides before you put the the trade on, right? Like that's part of >> in the sense that you want to buy the stock cheaper. You know what I mean? So it's a stock you want to own, so you're able to manufacture that cheaper entry price into it. But 100% it all it all ultimately comes down to the the is the stock that you're buying good? You you still have similar loss dynamics. I mean if a stock goes to zero on you, of course. And it's true on the other side, too. If you own the stock and you want to sell, you sell it's just the reverse process. You sell the call, you're not necessarily getting hit, but you generate income in the event that you don't trade all the way up. Right. What's Why do you think that these securities get mispriced in the in the option market? And is it more likely to be mispriced than the underlying? Uh I think that yeah, at times that is the case. I I think it's because just like there's the efficient market theory where uh you know, volatility equa- is equated to to risk in some academic circles. Uh and I know that someone like Buffett or Charlie Munger would totally agree with that disagree with that, and so would I uh personally. Same thing with options. I mean options are priced off a bunch of mathematical algorithms, including volatility as being a a big component of that. So, if a stock drops a lot, the the price of that option might be very, very high, but that doesn't necessarily mean that the that the underlying stock is extremely risky or that the option position that you're building is risky. I mean, we see things where you you might have like a real estate investment trust that's trading at 50% of its net asset value. And it's got a a good balance sheet. Obviously, there's headwinds, right? Cuz why is it trading so cheaply? But even now, I mean, even in high-quality ones are trading at 15, 20, 25% discounts uh to NAV just because real estate's out of favor with with rates going up. Uh and then you're you're you know, they've they've taken a big hit, so volatility's pretty high. You're able to sell puts way way out of the money. So, creating a a much, much, much larger margin of safety to what you already see is a pretty big margin of safety. Uh so, you're you're kind of benefiting two ways. You have the the mispriced stock, and then you have the option that's just really based on the mathematical principles of of how far the stock's dropped in what amount of time, uh and the perceptions of of short-term movements with options. And I think it gives the advantage to someone that's patient, that's willing to own the underlying. And that's one of the things that that we do uh at at Value Options Letter is that we we break down the mathematics for subscribers so that they can see, "Okay, we're targeting 13% on this trade. Worst case, you're going to manufacture an entry price 25% below the current price. This is why this stock looks attractive. These are the fundamentals behind it." And then the the uh subscribers also get um get input on when good exiting opportunities would be. So, it's easier to track the options. Tim, can you >> what you're saying there, then basically the if people are using math to value something and they're using the inputs of volatility as one of the primary drivers, that can become disconnected from the fundamentals of the business, which allows you to take a different view on the security then. Precisely. I would agree. I think you summarized it much more eloquently than I did. Well, I had time to think while you were talking. >> [laughter] >> Can you give us a worked example? I know you've done that you've done that previously, but we can work through you you gave us Blue Owl last time. I think Blue Owl's kind of interesting cuz it's in the news, lots of headline risk, lots of people feel strongly about it one way or another. >> People selling their sports franchises. >> [laughter] >> It's a good It is a good example because when you're talking about OWL, the asset management company that has the vast majority of their assets under management are are permanent capital. And and so, there's a certain stability to the fees that they're bringing in. And they have a variety of different verticals where they're raising assets, whether it's real estate, whether you know, they're they're in the data center type stuff that's being built. They also have the the private capital. They have the publicly traded private capital, which is different uh and and so, they're in the headlines for all the wrong reasons, but the reality is the business isn't that risky at all. It's an asset management business. Uh so, so I I don't think that I mean, it's an investment grade credit for a reason. They generate a ton of free cash flow. They're paying a really big dividend, but that's one of those where because the stock's dropped a lot, the options are really volatile on the put side and the call side. So, you could sell puts at really high returns way out of the money. You could sell calls uh really really high returns way out of the money, while also collecting the dividend, which is like 9 and 1/2% or something like that. It's very high. So, but we gave that last time. But, where we found some opportunities lately are on some of these software as a service uh stocks. So, it's interesting. I mean, that's not the normal uh purview of some value investors, but we we look at growth and value as being intertwined. And so, uh stocks that have just gotten demolished, but their underlying fundamentals are are pretty strong. Like, ServiceNow, for instance, was one uh that that has done pretty well lately, but it got absolutely demolished from its 52-week highs. But, their their we actually look at them as being a beneficiary of AI uh because of where they sit in the IT infrastructure and and helping companies kind of bridge that gap and and navigate things and get the appropriate permissions and all of that stuff. And they're they're still growing their revenues. They've got a really good balance sheet. Management seems to finally want to start taking some medicine on the stock-based compensation, which is a big problem for them. But, you're buying it at multiples that that it's never been available for uh and the options are are priced very attractively as well as well. But, but of course, we're willing to own the underlying stock. So, some of those are are really good. I mean, even even Amazon, when Amazon dipped to to 200, that was a great opportunity. We we look at Amazon as as good of a business as there is in terms of the future and and the assets that they have, if you think about it. You have You have uh obviously the retail operations, but AWS is the crown jewel. You have the advertising business, which is bigger than YouTube, uh and growing rapidly and is perfectly situated with where it is. You have them now entering logistics, third-party logistics, uh competing with UPS and and uh FedEx. Uh and and there's so many different ways for them to win and you look at the valuation. Yes, free cash flow is getting crushed. So, on a price to free cash flow, it's going to look horrendous. But, this is this is money that they're going to earn a fantastic return on in our estimation. I mean, if I was CEO of Amazon, I'd want to be throwing a lot into this because the reality is is is the AI is that good. It is that powerful. And I was I was skeptical, uh but but the more you engage with it and the more you see what you can do with it, it it really is. I mean, there's very very high limits to to how much computing power and stuff like that that they're going to be able to sell. So, so I thought that was attractive. So, you're able to, you know, sell puts on really high-quality companies like that and manufacture attractive entry prices into the stock or if it runs away, then you made a really nice profit, too. Tim, couple of good questions from the crowd. What's the expected return on this approach? Uh that's difficult to quantify, but how do you measure the risk in this method? Well, I mean, how do you measure the risk uh when you buy a stock, right? So, I mean, the number one risk we're concerned with is is mitigating permanent losses of capital. Uh so so, that's the big difference in how we use options versus many people is that a lot of people use options where either they're buying options and they have unlimited potential, but limited risk, but the odds are stacked against them. Or they'll do things like technical trading and they're doing spreads where if if it goes against you, yes, once again, your your risk is limited, but you're you're locking in permanent losses of capital and you might have been just been wrong on like the timing. You You have just gotten the timing wrong, but but ultimately that's the issue. With this, you know, we're we're targeting double-digit returns on on the option trades that are that are that are put out and published on the site. And then if you end up owning the stocks, it also lists the target price. So all a lot of these are 40, 50% below the target prices for the stock. So I would say this, I think it's a safer strategy than owning stocks outright. It's a risk reduction strategy. There's different types of risks. So like as you mentioned earlier Toby, if you own a stock and you sell a call 25% above where the price is at current price is at. And let's say that option's a year out, which sometimes we'll do. If that stock doubles, well, you still made a great profit, but you didn't double your money. So that's another risk where you're you're capping the upside on some of these. So you want to sell calls, covered calls, at prices that you'd be willing to sell the stock at. And conversely, you want to sell puts on prices that you're willing to uh acquire the stock at. But I would say it's this is a risk reduction income enhancement strategy. I think it it it once you understand how to do it and that's that's really the the genesis of the Value Options Letter. This was a concept I've wanted to build for 20 years. And obviously I have other businesses that that I'm involved in that that I'm not really talking about that are related to investing of course. Uh but but trying to keep those separate. But the idea is options are such a valuable tool when you know how to use them in an intelligent business-like manner. And so I want to democratize that and make that easy for people to understand and incorporate it into what they're doing with their investments because you can have a lot more wins when you're when you're doing something like this. Uh but you're going to losers, too. I mean, of course. There's There's pros and cons to any strategy, but I think there's huge value the more educated people become on this on this subject. So, if you >> It's a couple two questions, I guess. One, uh um are you then in this strategy rooting for choppy markets? [snorts] Is that Is that good for for this? It's definitely not bad. Like if if you were to do a relative performance type thing versus like the S&P, that's a very good scenario. Uh really any scenario, I think this you you know, it all depends on the stock selection and whatnot. But even if you're doing this on like an S&P index, which we don't we don't do, but but if you were doing it then, the the the the markets that run away to the upside where it's up 25, 30%, those are the ones where you're going to underperform the most. Uh if the market's down a lot, you'll still lose money, uh but you'll you should lose less, right? Because we're building that that bigger margin of safety with the options. And yeah, choppy So, so yeah, I mean, so there was periods like uh after the tech crash and then going into the financial crisis where there was a lot of stability, a lot of range-bound trading, and a lot of these types of strategies did quite well, but but they weren't They're honestly like other than Buffett, there's not a lot of people that you see talking about and he doesn't talk about it a lot, either, and it's not in the news that much. But but talking about using the options as a tool to manufacture a cheaper entry price into the stock. It's not just an options, it's a value options where the key part is the value investing principles, the research behind it, and then just using the tools like a hammer and wrench. You know, you're just using Okay, I want to create a situation Let's say you own a thousand shares of a stock. Maybe you want to layer out of that at different prices, so you could sell calls 20% above, 10% above, that sort of thing. And And if it if if somebody gets exercised, great, you're reducing your position like you wanted to. If none of it gets exercised, well, you just made a lot of money that you wouldn't have made anyways. A lot of people that work at companies that have a ton of one stock, I see that all of the time. What a great tool to reduce that risk uh without just blowing it all out at once. There might be tax con- consequences uh if you just blow it all out at once. So, a lot of a lot of value there. I guess the other thing, too, to think about. Sorry. Sorry, Tim. If you are trafficking in names that are very power law driven, it seems like that this would not be good for that because it's the you know, the big winners are carrying most of the weight in in that type of portfolio. But, if you're looking more to do singles and doubles and not trying to hit home runs, so you're focused more on batting average than slugging percentage, let's say, then this would be a good way of of focusing on that. Yeah, I would agree. I would agree with that. I mean I mean there's there's definitely stocks that will run away from you. Uh but but I think that yeah, there's a lot there's a lot it's a lot easier to find opportunities to get those targeting double-digit annualized returns. And And if you're in a market, and we've talked about this before, but I remember in in 2010, 2011, after we had had two major bear markets in 10 years, buy and hold was considered dead, right? Like annuity sales were up, gold coins were up. I bet people wish they would have held onto those nowadays. Uh and and and it it was buy and hold was dead. That was the thing. And now, we were talking about it before the show, in my career, I've never seen more optimism on buy and hold, where it's just like set it and forget it, very little risk, valuations, who cares, you know, Nvidia at five and a half trillion, like it doesn't matter. Uh and so, you know, the the pendulum swing both ways. And so, as you get more range-bound markets or more negative markets or just not as robust markets, adding some of these additional tools to generate income and reduce risk in your portfolio can make a lot of sense. And most of the people that gravitate it, from my experience, and I've been doing this for a very long time, are like engineers, uh business owners, lawyers, doctors, educated people that are like, well, that makes a lot of sense. Like, why why wouldn't I do that, you know? And it's the reason why people don't is their advisors might not know how to do it. It you have to keep track of a lot of stuff. You still have to you or or someone else has to understand the businesses that you're investing in. Uh but those are kind of uh the solutions that we tried to solve uh with the valueoptionsletter.com. If you're if you're short a put, um if you sell a put, it's sometimes called a ball put. The way to think about that is it's your downside is like being long the equity because you've underwritten it, but you've got a little bit of a discount already with the strike. And you get a little bit of additional padding with the premium that you take on. So, that's that's your downside risk for a sold put. But there's also this sort of other risk on the other side where you sell the put and you get the premium, and then it's on a stock that goes on this incredible run. So, you miss out on the upside of that of that stock. So, how do you quantify the benefit of a cash secured put versus buying more stock? I think position sizing has a lot to do with it. Uh so, so if you think that a stock is going to double, I would suggest owning the stock. And then >> Zero-day expiration, that's what I would say. Yeah, right. [laughter] Right. Uh but but I would suggest owning the stock. I mean, so that's why that's why it's important to have things like target prices and that's stuff that we provide. So, if we think a stock's going to double, you definitely want to own some some shares in it, but maybe you're also saying, "Well, if it drops 10%, I want to buy more." And so, that's where you could sell puts or you say, "All right, if it rallies 25%, I want to lighten 25% of my stock up." Uh so so, the idea is, you know, if a stock doubles, there's going to be so many different times when as an investor, we've all been through this, uh where okay, should I hold or should I sell? Should I sell some? The exact same principles apply, right? Because I mean I mean, we've all had stocks that that oh, meta is a great buy at 100 100 and then it gets to 200 and it's like, "Oh, I mean, we just doubled our money. Let's take profits." And now it's at 600, right? So, so it happens if you own the stock, it can happen with options. It's just being disciplined and and understanding that that you're taking you're making business-like decisions with your investment portfolios. That's something that I'm a firm believer in, knowing that not every business decision is the correct one, but there's the the strong rationale and logic behind it will lead to good outcomes. It's a sound process that that can lead to good outcomes and I I think less risk overall if if you're implementing it uh in the way that that's kind of suggested by the by the >> like operationally, cuz I've never really tried this before, but like how much of your bankroll do you keep available versus written? Uh you know, let's say especially like on the put side. So, the benefit with the cash-secured puts is that is that you have to allocate the capital for the full amount. So, if you're selling uh a $50 put, that's 100 shares, you're going to collect a $500 premium. The the capital required would be be about $4,500. So, you're not going to get a margin call if you're doing cash-secured puts. You're going to do it like you're doing it stock. So, that means that you should expect stock-like returns, and that's why at the Value Options Letter, we just sell uh puts that generally target that double-digit threshold. Uh so, so it can be It also kind of depends on just the outlook. I mean, if you have a lot of If it's 2009 and you've got just really fertile grounds for investment, buying stock is is fantastic. And and the website does make recommendations of just buying stock when it makes sense to do so. But, maybe maybe you're looking at the current investment climate, and it's not that attractive to you. Maybe you want to overweight towards some of these more conservative strategies where you're still targeting double-digit returns. And what's nice is even if the market's kind of flat, uh you can you can still uh potentially generate returns uh with that. When you say you're targeting double-digit returns, what you mean is that the premium that you're getting relative to the cash that you put up that is secured on an annualized basis works out to a double-digit IRR. Correct. Exactly. So, so the the target profit So, if you sell a put, you're going to collect a premium up front, and let's just say in that example, 500, uh and on a on a $50 stock, your maximum risk is 5,000 minus the 500 you collected, so it's 4,500. So, that's your return. Low low double digits, and it just depends on the time frame. You know, I mean, the the the website has stock uh or option trades that are targeting 40% annualized returns and it has some that are targeting 10 and even on some if it's like a super safe stock the hurdle gets lowered a little bit to like nine but you know I'll I'll pose this question like I think it's interesting if you look at like Berkshire Hathaway. Because it's it's all well we're not buying back stock at like let's say 1.6 times book value but at 1.4 times book value we're buying stock and at 1.3 we're really backing up the truck or 1.2 whatever. But what I like about using these types of strategies is that you can create that. Where look you're backing up the truck at 1.2 times book value it's not hard to figure out what price that would be at you set the strike to that level and then over time if you're investing in good companies it's going to be worth more over time the Amazons the Google the Metas the Microsofts uh you know so we want to focus we're focusing on on on high quality balance sheets undervalued stocks this is not like a get rich quick uh method it's it's a tactical business-like approach uh and a very educational approach to help people navigate the options uh market. Uh Tim do you want to just discuss um a wheel give folks an idea of a wheel? >> Yes yeah yeah so a wheel is a really cool strategy and it it it's great way to kind of articulate the value of the site. So let's say that you want to acquire uh let's just say Amazon stock let's use that we've talked about it a few times and and so Amazon right now is trading around 260 as we record this uh let's say that that you want to buy it at 200 okay? And so you're going to sell a put at 200 and you're going to you're going to target a a double-digit return. Now now this is just type totally hypothetical. Realistically, Amazon is so high quality, there's I'm I'm sure that there's not a $200 put that's that's targeting 10% but I just want to use it as an example of a stock that everyone knows. Uh so, basically, you're in a situation where if the stock's above 200, you're making 10%. If the stock's below 200, you're buying it at a discount a sizable discount to the current price and a discount to your strike price cuz you collected the premium. Now, let's assume that Amazon just tanks and now you own the stock. Well, your option's probably underwater a little bit just depending on how far the stock dropped, but now you own the stock at at whatever the break even is, maybe it's it's 180 or whatever whatever it is. Uh and now you have all the upside or downside with the stock. What you can do with this strategy is then you can start selling calls. So, maybe you sell a call at 240. Uh and and it expires and you sell another call. Or if you want to if if you're like, "Oh, I kind of don't really want to own Amazon as much as I thought I did. Maybe something changed fundamentally." Maybe you just want to sell that call kind of at at the strike you sold the put at 200, you can do that and you're making money on both sides. You're making money from Uh you're you're you're reducing your cost basis by selling the put and then you're making money on the calls that you sell. So, once you get exercised, as long as it's a stock you want to own, it's really the beginning of the game and so that's what the wheel is. It's continued uh covered calls on existing positions and that's the value. So, if you're trying to do this on your own, it's hard. There's a lot of layers to it. You've got to analyze companies, you've got to analyze option chains, and then you've got to track all these things. So, it's very very very hard and that's why I've tried building this website for 20 years. I've hired two developers, I've paid over $60,000, and none of it just came out clunky. It wasn't the right user experience. But, we finally got it right. And and so, that's the beautiful thing of it is it attracts the trades, users place the trades with their own brokerage. Uh it's not an advisory, it's a publication, a research publication. Uh but but it had it issues it publishes uh suggestions on on when to exit and stuff like that, and when to sell additional calls on the wheel strategy and things like that. So, what's the what's the website Tim Tim? Yeah, it's www.valueoptionsletter.com. And there's right now it's it's priced 50% off, so it's just $100 a month, $99 a month. Uh and there's a a sale where it's $9.99 for the full year. So, very cheap, that price will double uh soon because it's new. Uh we really look at kind of founding subscribers as partners in this because they're they're putting trust in us and and in the method and in the process. Uh but I think it's I think it's a great value and we're excited about it. There's also a free 7-day trial. So, if you're interested, try the free 7-day trial and see if you like it, and I I think you will. Uh but three to five trades come out every week on average. Lately, there's actually been more than that. Uh and uh especially cuz we have new subscribers, and we really want them to get the full uh multitude of of what the site does. So, Tim and I have partnered together on this. We've also written a book together uh called Value Options. It's really short, easy to read, just discusses everything that we've said here. All of the stuff that is in the book is free on the site, too. So, you don't need to buy the book, you can just go and read the stuff that's on the site, or buy the book if you prefer to do it that way through Amazon. Um JT, let me do some Do you have some veggies? Let me Let me do a quick shout-out around the horn, and then we'll do some veggies. Gothenburg, Sweden first in the house. What's up? Valparaiso, Indiana. Lausanne, Switzerland. Philly, Beaune, France. Welcome. Petah Tikva, Israel. Tallahassee. The Market Rates Woodshed, I hope you're okay. Boise, Toronto, Snohomish. Helsinki, Finland. Limerick City. His favorite saint St. Patrick. His favorite poems are limerick. Oregon City, Oregon. Bethesda, London. Chicago, Cincinnati, Beaverton. Thanks for joining us, folks. We appreciate it. JT with some veggies. All right. So, we are going to attempt something never before tried, which is connecting railroads and everyone's favorite, the octopus. So, stay with me on this. Yeah. So, one of one of them [clears throat] is thought commonly as a repulsive, conniving creature with no soul, slippery, hard to pin down, will strangle you if it gets a chance, and the other one is an octopus. Uh All right. But, underneath the jokes, uh they're solving the same problem often, which is how do you keep flow moving through a complex system without the whole thing falling apart? So, let's start a little bit with what railroad railroads used to look like. And for most of their history, North American railroads were less like factories and more like a jazz band. Local managers would make these judgment calls. Trains would would leave when they were just full enough, basically, in the opinion of that person. Rail yards acted like these giant buffers, where they would soak up a lot of uncertainty and delay. And it was organized in a very improvisational way. And for a long time, that worked because competitive pressures just weren't really that intense. Uh but then trucking got better, deregulation finally arrived, uh and and investors started demanding higher returns. And and that's And then we come to this guy, Hunter Harrison. And you know, he's one of the most divisive operators in transportation history. He ran four Class 1 railroads in his career, and unfortunately, he died 3 weeks after taking over CSX in 2017. But, the basic story with him was he would come in and take over, and all of a sudden the operating ratios, which is basically just like profit margin, the term that they use in railroads, uh would just continue to keep improving. And he would take a company or a railroad that was earning like 2%, two pennies on every dollar of revenue, and bring it down to like, you know, 40 cents of of profit margin, like just absolutely huge. He did it like four different times in different locations. Uh and this philosophy that he implemented was called precision scheduled railroading, PSR. Uh and you probably you might have heard Buffett talk about this at different points, and it's it's a pretty common uh there's a common argument about this. So, what PSR actually does is it takes what the traditional railroads used to do was wait for the demand to show up and then ship something. PSR forces the customer to adapt to the schedule of the train is leaving, get your stuff on there, otherwise sorry. Uh you know, the train leaves on a clock, whether it's full or not, and they try to run fewer trains, they run longer trains, and the whole point is that less idle equipment, less dwell time is what it's called, you know, where a rail car is just sitting motionless in the yard. And this whole network is then tuned for one continuous thing, which is just flow. Uh and the railroad stops behaving like a freight company, it really starts looking like a circulatory system, which is where we're going to go back to the octopus. Uh and believe it or not, an octopus has three hearts. Two pump blood to the gills, one pumps oxygenated blood throughout the body. And more importantly, an octopus is is this profoundly decentralized organism. No rigid skeleton, eight arms that are operating semi-independently. A huge percentage of the neurons live in the arms themselves, not in some central brain. And each arm can then solve problems and react locally on its own. Um but there's this famous problem in anything decentralized, which is like how do you coordinate? And the octopus solved this by building a circulatory architecture that keeps this flow synchronized across the whole organism. Multiple hearts are managing pressure and the body functions then as one system, even though the intelligence is kind of spread out. So, this is kind of what PSR is trying to do for a railroad. Decentralize assets, but centralize circulation. And the network is is this organism. Uh it's you know, it's the flow is the point. So, but there's a trade-off here. And the octopus, when it swims really hard, its main systemic heart actually struggles under that load, and which is why you octo- octopuses prefer to crawl typically rather than like swim. It's very expensive metabolically to swim, and they weren't really built for it. Um So, that that same trade-off sits inside of PSR. Traditional railroads actually carried a lot of slack. They had extra crews, extra locomotives, extra yard capacity. And on paper, that slack looks like waste, of course. But in practice, it's a bit like biological fat reserves. Like it absorbs shocks. And PSR strips most of that out. The financial results are amazing, and the operating ratios drop to be attractive, assets get more productive, free cash flow gushes. But you also have removed this buffer, and one delayed train then can pressure into the next. One congested yard creates, you know, downstream choke points. Um and >> [clears throat] >> the same synchronization that produces uh that it produces efficiency can also then amplify fragility. So, the kind of the investing version of this that we've seen, you know, relatively recently was um in Japanese auto parts in 2011 with the 9.0, you know, magnitude earthquake hitting Japan. It it a triple disaster because yeah, the quake, the tsunami, and Fukushima meltdown. And these manufacturing companies in Japan were really like the gold standard of just-in-time delivery. They you know, like Toyota basically invented this. And the average Japanese manufacturer at the time held only 3 weeks of material inventory. So, really lean balance sheets, lean warehouses, single-source suppliers looked like this super efficient industrial system. And of course, MBAs rejoice at how well they were taking working capital out of it. But but then it stopped and production fell 78% year-over-year in April of 2011 because of this earthquake. And it wasn't that Toyota's own plants were even destroyed. It was actually their suppliers, suppliers, suppliers were destroyed. And that's then chokes the whole system. Um >> [clears throat] >> so manufacturing actually dropped across Japan completely 15% in March. It didn't recover for like 6 months. So, after that, Toyota rewrote their their business continuity plans and they now require key suppliers to hold anywhere from 2 to 6 months of inventory minimum. And they moved away from single-sourcing many other things. And you know, it's there's some irony in the fact that the firm that invented just-in-time voluntarily put slack back into the system. Um and their slack they sacrificed efficiency on purpose. Uh so, try to wrap this up here. There's this kind of uncomfortable point, which is that all this efficiency in PSR is visible, uh but that the resilience is often invisible. And you know, you see these lower operating margins or better operating margins I should say in in PSR. And you get all this working capital that's released. And you can count fewer locomotives being used, fewer crews. But what you can't see is the train that that doesn't get delayed because the crew was available. The factory that doesn't shut down because inventory was available. Uh the portfolio that doesn't have to sell at the bottom because cash that looked lazy for 5 years is available to do the things that you want to do. Uh and so uh mother nature's octopus understood all these trade-offs long before we did. This have this distributed intelligence that's useful and then this circulated uh centralized circulation system. But the organism survives because it has more than one way to keep the blood moving. And the real underwriting question in any business or supply chain, railroad, whatever is not how efficient is this under normal conditions, but what happens when one of the hearts stops. Good one. Have you seen the the conspiracy theory that octopus octopi octopuses uh um octopods uh aliens because they don't fit into any of the uh other Like normal schema. families, yes. >> Phylum, yeah. Yeah. You know, I might My teacher the octopus, the movie? I've purposefully not watched it. I've avoided it. Yeah. >> That's a little uncomfortable. >> I like the taste too much. I know. You fall in love with the octopus and the guy is great, too. And then he doesn't defend the octopus while it's getting like eaten by sharks. It's hard to watch, for sure. I think globalization though. I think similar I remember reading uh and I remember it was actually Bill Gates of all people that recommended it, but it was like a book by like Vaclav Smil or something. Jake you might know him. >> Smil, yeah. Yeah, yeah. And uh and it talked about uh globalization, but just how vulnerable we were because we had outsourced so much of our manufacturing. And so you get to war times or now you see it with rare earth minerals and things like that where obviously, you know, when when when there's peace, globalization is very efficient. Uh but you know, we've seen that collapse multiple times now. Uh so it's interesting. It works in in smaller scale like I mean, railroads are still big or or even on the global economy. It is surprising that so many countries kind of willingly ceded their energy independence and military independence uh so easily. It's crazy to think about. It's a really is. Years of peace, years of like no conflict, no huge global conflict. Two two generations, nobody nobody remembers. Can't happen here. >> [laughter] >> I saw a YouTube documentary on uh BYD and the level I clearly clearly cleverly run and the guys uh you know, Munger says he's a visionary on the level of Benjamin Franklin, but they've also been enormously subsidized by uh by China along the way. Like China subsidized a lot of those industries. And so I just you know, cuz we you and I have visited China. We we looked at those EVs. Like they're beautiful EVs. They're much cheaper than EVs in the states. And we were concerned that you know, you unleash these EVs on the US and then how does someone like Tesla compete with these guys. But it seems like they are pretty heavily subsidized. Yeah, subsidized a lot of different industries. So I think that probably tariffs are a reasonable response to that. I hate yeah, yeah. Anybody want to jump in on >> Acorn night? Yeah. Yeah. Touch that third rail. I mean I mean pretty >> pretty popular topic, but World War II, what happened? Like they we had to convert the auto manufacturing into, you know, war production uh and war equipment like tanks and stuff like that. So there's huge disadvantages from allowing all these countries to to uh you know, have all the manufacturing of key things. So uh I think that there is logic behind that, but it's obviously super painful and not easy and communication and whatnot. I mean, it goes to optimization, right? Because Yeah, you get the consumer wins over most of that time period. Mhm. Until they get enslaved by the other Right. >> [laughter] >> Is that bad? Is that Yes, it's Was that right? >> menu. And overloads. Yeah. Um what do you guys make of this massive rally that we've seen since March 31? It's a barn burner. Yeah, it is. I mean, a lot of it seems like it's Nvidia and and some of those some of those other like Microns and the Sandisk of the world. It doesn't seem like it's that broad of a rally overall. Uh so, you know, it's interesting. I just think that when I have a stock screener that I I look at a stock ticker thing with Schwab and it's hundreds of names and I feel like through most of the rally probably 60s 5% have been red most of the time, whereas but then you have like Nvidia gapping up five bucks, which is a huge market cap number. I mean, last I looked it was a five and a half trillion dollar market capitalization. So, I think people are rightfully looking at AI and the more you engage with it on the more sophisticated things, it's very clear that it's going to dramatically transform a ton of industries. It's It can be fantastic or devastating for small and big businesses both. Uh but you could see why the demand for the chips is as high as it is. Uh and but it's interesting cuz you have Nvidia I feel like there's even more competition getting getting in now with Google's chips and Amazon's chips that that might be a little more energy-efficient than than Nvidia's chips, but but uh right now it's uh it's a tailwind for for all of them, it seems. Never been a better time to be a solo entrepreneur, cuz the the Claude or ChatGPT just so powerful. Efficiency is insane. I mean, you can just you can have it working overnight on a project and exactly. I mean, I mean, even things like like accounting and you really can automate so much, but more and more you're hearing kind of the horror stories where people that thought they had job stability are realizing that they absolutely do not. And I'm sure it's going to create a ton of new jobs, a ton of new businesses, but it it's I mean, right on par with the internet, if not exceeding it as far as impact, in my opinion. I I see it Having used it a lot, I see I see that, in my opinion. To what extent do you think companies are going to how much DIY vibe coding do you think is going to happen in most companies? I guess that Do you think that that's a real You don't think that's a big threat for maybe, you know, VMS? Mission-critical kind of >> it'll be individual I think it'll be solo >> providers. solo guys, cuz there's no incentive in a big company to go and build something. Yeah, I mean, yeah. And how how expensive is it? You know, I mean, I I I I was reading something where the Constellation Software guys were talking about when they lose clients, when they lose customers, and it wasn't cost that was the issue, it was the customers go out of business or or they get bought by someone that's not uh a customer of of one of Constellation Software's divisions. And and so, you know, if you can create a cheaper CRM, for instance, or ERP, is that really going to drive you away from using Salesforce or um or Workday? You know, maybe if you're a small business, if you're a big business, that's that's a lot. You've already invested so much time training these people. You know, everyone's familiar with the system. So, I do think that the fears are a little bit overblown on on some of them. Clearly, you know, some smaller companies will be impacted and everyone's going to be impacted in some way, but most of them are embracing AI, creating their own agents so that so that they can enhance their user experience. Cuz I mean, I I use HubSpot for instance as my CRM. And I've been tempted by other things. I don't love all of it, but it's a big project like to to to move that to something else. You have a lot of integrations built into it. Everyone's comfortable with it. It's It's not like something that's really a high priority for me. Do you think that that puts pricing pressure though on like knowing that you could do it yourself if you wanted means that they can kind of only charge you so much before you squeal and defect. Do you Do you think that's true in software in general? I I don't know I don't know. There's always competition though, right? There's always been other competitors out there. There are other options and the the the same problem has always existed that you have to switch from one to the other and it's a massive time-consuming project to get that done. I think they have to invest more into R&D cuz I mean, if if you're not I'm sure that these these big Salesforce software companies their customers are asking, "Okay, like how are how are you the best solution in this new age of AI?" And so, you need to have that AI formula. Well, we're using it in these ways to make your life easier. This is why you wouldn't want to just try to create this on your own. And it's not that easy. I mean, you can you can create some pretty cool things, but I mean, these companies have phenomenal software developers and they know what their their customers want. So, I don't know. I just I think now some of them are attractively priced. I mean, even like a you look at a stock like Adobe, I mean, it's a very very cheap, you know, it's a low low low double-digit multiple when it used to trade at 35, 40. And you could see why there'd be more competition and why but but it's not directly you're not seeing that in the financial results yet. And there are a lot of reasons why it it's easier just to maintain them uh as part of the infrastructure for for what they do. So, it we'll see. We're seeing increasing numbers of layoffs. I mean, I don't know if we're seeing increa- I just see the I see the headlines and so and they're always big numbers. Like Meta comes out and says it's 8,000 and then Block comes out with like 7,000. Like they're big numbers whenever they come out. I wonder to what extent it is AI causing them or if that's just a convenient scapegoat for what really happened was that they massively overhired through 2020, 2025. And there were lots of articles about you know, they used to what happened to all those TikTok girls who'd do the day in the life where it was basically just them getting matcha green tea and a Yeah, a smooth- like just showing up late and eating and like there was no sign of any work being done at any stage of the day. Maybe like crack that laptop open and type an email or something and then close and it looked like a great day, but hard to imagine that they were there was much value for money there. Yeah. AI is probably reducing those jobs, I think. I I think I mean, all right, you have you have the big hyperscalers investing hundreds of billions of dollars of CapEx. Where's that money going? Data centers, right? I mean, I mean, like I have friends and uh clients that that are involved in that business and and I mean, there's so many different facets, so many different companies that that are benefiting in from So, a lot of the job growth is is related to where all of that money is going to. Uh but yeah, I mean it's a K-shaped or whatever you want to call it economy where there's haves and have nots and and especially with oil prices where they are, there's there seems like there's a lot more have nots. It feels like the top end of that K has been white collar, though, and the bottom end has been blue collar, but it feels to me like that's going to switch pretty hard here if AI comes in. Like, you know, where in 2020 we said it's a shame that it's like all the all the blue collar guys got to go out and actually risk their lives while white collar guys are on their computers at home and fine, but the reverse is about to happen with AI. Like, now AI maybe can do all those jobs. But you know, to wire a data center, you actually got to go to the data center and wire it. Like, to grade the land like to do all the work that it requires to build a data center, you need to be physically present to do it. Maybe it's a blue collar on top of the K for a while. Well, and imagine if stocks drop, you know, for a prolonged period of time. >> Tim. Yeah, yeah, you're right. >> That's impossible. Yeah. >> that's But we're so we're so reliant. I mean, remember the Buffett indicator? Like, what is that at right now? >> looked at that today. It's actually you know Is it 200 or something? Where are we at? Higher than that. The numbers I looked at I went to the DShort cuz they have the value they they track all of them like Chris Mont. They track that indicator to its own number. They track Schiller PE, Tobin's Q. And then they lump them all together and then they look at it on an arithmetic basis and a geometric basis and basically Is it just smoke coming out of your computer at that point? Or what was what It's it's off the scale. Like, the chart cuts off and you can't see the top of it. They couldn't imagine that it could get this high. But it definitely came off a little bit from Q4 last year, but it there's been this violent rally. I think one of the things that's really interesting, I track two series that to get an idea of to what extent it is the top end of town that is driving all of this or if it's more broad-based. And one is just equal weight versus market capitalization weight. And that one in particular went to has gone to new all-time highs as of like last week. Maybe it's come off a little bit over the last couple of days. But that one surprised me a little bit because the other one I look at is OEF, which is the S&P 100. So, that's the biggest 100 versus the 500. So, in that instance, if you think of RSP as being the more broadly based one and 500 as being the big end of town, in this one it makes the 500 the more broadly based indicator and the 100 is the big end of town. What's interesting is that 100 hasn't bounced as hard relative to the 500 as the 500 did to the equal weight. And I've been I've I've noticed that for the last few weeks. I I don't really know what that means, but it doesn't seem to me that it really is the very biggest of the big that's driving it and it's the average biggest stock. I I I don't really know how to articulate it and I don't know the reason why, but I've just seen it and I think it's an interesting little phenomenon. Like the the 100 hasn't bounced as much as the 500 relative to its more broadly based uh comparison. I mean, other than Nvidia, the other ones haven't bounced as much. Like like Amazon and and I mean, they had a big rally like a little bit a little bit earlier. Uh and but Meta and Microsoft, they they have bounced a little bit from their lows, but but they it's really like the last couple weeks it's Nvidia going from 195 to 225. I mean, that's $30 move on the largest company in the world. It's probably pretty big. And then you have the the memory ones uh like the Microns and the SanDisks and all that. Those are value stocks every now and again. You wait long enough, the cycle turns. So, uh stocks that couldn't get a bid. Yeah. >> Yeah. Yeah. The multiples still aren't high. You know, if you if if if earnings are are uh stable. I know that I think they're like so I think Micron's like sold out till like 2028 or something like that is what I I heard something like that but don't quote me on it. >> I track I track bag man which is like mag seven plus a few others. Um I guess Broadcom's the B. I was going to say what's the B? Broadcom AVGO the ticker is Yeah. Broadcom Amazon Google Microsoft Apple Nvidia maybe Netflix as well in there. And that rally uh since the start of the year is in the order of like 22% last time I looked anyway so it's definitely run up more than the rest of the index. It's just been a violent every day it's up a few percent. Until the last couple of days. >> guys finally winning a little bit. >> is it's nice to see them win a little bit. It's like George Clooney selling Casamigos for a billion. Good to see that bloke have a win. Finally catch a break. >> [laughter] >> Yeah Apple's had a big move too actually. Apple Apple's gone up to like >> near 300 and that was at 260 not long ago. So I mean that's another just some of the biggest are huge. The big end of town is running. Yeah. Well I think the funniest thing is uh Running to where? To the moon. Yeah okay. Make it to the moon if you have to crawl. I think the funniest thing is uh energy stocks have come in since the since the war. Yeah multiples cheaper. Oh and the multiples you're saying on the multiples yeah Yeah. Well they haven't reported yet so I mean there hasn't been much report haven't they haven't all reported yet. Right. Yeah I mean I I know the pipelines have had a big run. It's it's it just seems like this war is dragging on a lot longer so it's a pretty good environment for energy generally of course but similar things like to get to the next two weeks and then I thought that was supposed to hit long duration. I thought higher rates hit long duration. Actually that's one interesting thing that I've I've been track you know, I track the 10-year and the 3-month. Um that's at a that's a that spreads at an all-time not a sorry, sorry. Not an all-time high. A a high for this cycle. It's like 93 at the moment. Um having been negative like not that long ago. >> We're not inverted. We're We're back to normal. >> no longer We've been uninverted for about six like if there was anything that happened like Well, where's the recession? They're supposed to be here. >> not it's not here. It's it probably going to fight that that uh little metric in the future. The 10-year has been running up a lot. I think the 10-year is as high as it's been since 2007. The front month which the Fed the 3-month which the Fed controls has been falling down. You know, they pinned it ran it all the way up. They've dropped it back down. 10-year is now high since 2007. And that's not unusual around all of the developed countries in the world. All of those rates have run up to as high as they've been since the mid-2000s. High as they've been in 20 years. That might be more impactful than anything else. Although nothing nothing stops the mag seven train. Well, I mean think about the housing. It's housing. It's huge. It's huge. Mortgages are priced off that. So, you have a ton of people that were waiting out the market trying to get lower rates to be able to buy or or sell their homes. And a lot of homes are just sitting on the market for a very long time. And so that's definitely going to exacerbate the situation there. Uh but but yeah, it's a big it's a big deal. It's a big deal. Median house >> this is so rosy though. Let me ask you this. Why why are we still running trillion dollar plus deficits then? Where's it going? Oh well, oh that's that's that's assuming that you're doing that uh Keynesian priming the pump when I don't think it's as thoughtful as that. Is it like that was the you run >> No, we just gave them a license to spend on whatever they want basically. And gave them gave them an economic intellectual cover to spend as much as they want. And then when it didn't when it didn't help anymore, they just dropped that quietly, dropped that policy. Doesn't matter anymore. Yep. I don't know. If we're we're like grumpy old men at this point. People are tired of hearing it at this point from us, I think. We're going to be proven uh one out of We'll predicted nine of the last one uh you know, hard patches. True. I find that I find the 10-3 one kind of interesting because it's it's such a funny run. Like you it's probably if something is to happen and to to like validate that, it has to happen pretty soon, I would think. But it doesn't seem to me like there's any unless rates are the thing that just strangles the whole Well, eight out of nine's not bad, right? Isn't that where what it would be at? That's true. It shows how dynamic our economy is, though, cuz I mean [clears throat] we've been through, you know, housing housing bubbles and busts, and we've been through uh oil booms, and but but then you have, you know, other areas picking up steam. Uh but this this one's so big. I mean, these tech companies are so big now that it has such a disproportionate impact. Yeah, that's a massive >> know I'd be curious to know where this ranks in terms of like the concentration of the economic impact between other I mean, but you had railroads before. It's It's probably similar Yeah, it's private stimulus. Private stimulus. Mhm. And this is probably the only other version is like or maybe it was the optic fiber buildout in the early 2000s. Definitely. As a percentage of GDP, we're still pretty far south of railroads, but That's what That's good good work, JT. That's why we got you here. Fellas, we made it. We we hit the we hit the time. Tim, give us a give us a where do folks find Value Options Letter? Yeah, yeah, www.valueoptionsletter.com and and hit that trial. Give it a try and I I think you'll like it. JT. Be good to each other. That's all I got. Uh folks, we're off next week. Uh I'm in Australia for my 30-year high school reunion. It's terrifying. >> Let's go. Yeah. And then I'll be back uh the week after that. We appreciate you being here. >> your crypto for a value run heading into that just so you feel good when you show. >> [laughter] >> I can separate my personal and my professional. Talk about the kids a lot. >> [laughter] >> Yeah. But thanks, guys. It was Enjoy. Safe travels. Thanks for having me. Pleasure.