Christopher Bloomstran on Warren Buffett, Berkshire Hathaway $BRK.B, $BLDR, $DECK, $ALK, | S08 E14
Summary
Value: After Hours is a podcast about value investing, Fintwit, and all things finance and investment by investors Tobias Carlisle, …
Transcript
Well, I've this is Value After Hours. I'm Tobias Carlisle joined as always by my co-host Jake Taylor. Our special guest today uh he's a regular. He's back again. We love to have him. Christopher Bloomstrand. Simple Augustus. How are [snorts] you Chris? Good good good to see you. I'm doing great. How are you guys? It's good to always good to be on with you. The two of you. You've uh you've completed your annual opus. Um it was uh as good as you've as good as you've done. We I enjoyed it. New record on length. It was thanks thanks for that. >> [laughter] >> It was indeed. I I I thoroughly intended to not do that lengthwise. Um What happened? Uh well, I added a section on AI that I thought uh I I would try to tackle not being an expert on it. Um and then I was going to cut uh some of it is you know, I up I update the portfolio each year and that's a little bit repetitive and then some of my Berkshire um subsidiary work and and various of the valuation tools that I use are are updating. And I you know, with new text and kind of an update on with the subsidiaries you're doing. And I was going to cut about 30 pages from that and you know, Lincoln edits and ran it by a couple friends and they said, "Man, if anybody thinks it's too long at 150 pages, who cares if it's 180? It's your letter." >> [laughter] >> That's right. I carry it around in my briefcase and I'll pull it out in meetings and just >> circle back. Just just to remind me of what's happening with some of the numbers and what I thought at year end. So one of these days I'll shrink it. Um hopefully next year. But I thought it was a good one. I've I've had some great feedback and there were some fun things in it that were pretty interesting. In fact, some of the things on uh little tribute to Warren Buffett on his retirement and his performance record that were astonishing. Um Yeah, give it a Let me take you through it, Chris, cuz I got I got a few questions. So, uh let's talk about let's just talk about Let's start with the overall valuation of the market and the play of Magnificent Seven, margins. Let's talk about that. What What's your What's your view? Where are we? Well, you know, I wrote I modified my note my notion that we were at a secular peak to a secular plateau. Yeah, I like that. I saw that. Going back to Irving Fisher because I thought we were at a peak in 2021, which on the whatever the S&P declined for the year 18 or 19% and the Nasdaq down 35 looked fairly prescient, but then you snap back with back-to-back 25% years. And so, valuations essentially at the end of 25 were either back to '21 levels and in some cases slightly beyond. So, uh I think for the cap-weighted large-cap US investor, uh prospects are pretty grim for a long-term horizon, 10 or 15 years. And I go through my five factors, and we can get into that. Yeah, let's do that. Uh well, huh Okay, so [clears throat] just just get right into it. Yeah. >> Um So, in '21, No foreplay. in 2021, you had a 10-year period where the S&P earned 16.6%. And you had just an explosion in profit margins and in multiples. Not much top-line growth, but you had the market trading at 22.something, 22.8 times a record profit margin of 13.3% and you know, we've talked about Warren Buffett having been wrong in his '99 Fortune article. You had a various various combination confluence of factors that that drove margins higher over time um a lower corporate tax rate certainly lower interest rates mean allowed very high amount of leverage on the corporate balance sheet to not be financed at much of an interest burden and that added about three full percentage points to the margin. Then you had the cap light businesses uh the big tech companies that sit atop the market now that they have been properly rewarded for a lot of revenue growth very high margins much more growth than you can get anywhere else and so I don't think the market got those wrong but they're very fully valued so um at at 22.8 on a 13.3 margin you didn't leave a lot for future return and so in the interim you had a big decline in margins in 21 and then a recovery so you're back up to 12.8% at year end so you're not back to the 13.3 but you're close but the the multiple is even higher. You're 26 times. um and you you can go through any combination of of the factors revenue growth what might happen with the share count which is actually rising in the last few years and stunningly for 25 years the share count's higher than it was despite an enormous amount of cash from operations going to share repurchases and so you know I've got a uh I've got scenarios by which you'll have margin compression and multiple compression and you get to a best case 10-year return of 5% and if it gets a little more grim you can make a case that you'd have negative returns much like you had after the stock market peaked in 1999 which >> You mean 5% compound or 5% over the entire Oh annual annual returns. Okay. annual returns and so you can play around with all those numbers but I ran scenarios to to get to the Ibbotson long-term stock market return of 10 and 1/2% so you know you're starting at a record profit or near record profit margin and a 26 multiple which is really at levels never before seen on high margins. I mean you can have a really high multiple under depressed earnings. If you're in a recession and earnings drop to nothing like they did in '08-'09, the market can trade at 40 or 50 or 60 times or can trade at an infinite multiple if you have losses which you had for a couple quarters. Mhm. But [clears throat] if you run a 10-year let me find this cuz I it'd be fun to get the numbers right. Um So if you take an expectation of earning 10 and 1/2 you're going to get there through some combination of margin expansion or multiple expansion. So if you hold the margin over the next 10 years constant at 12.8% it's going to require a 43 PE on a 12.8 margin and then you basically get your sales growth and what what what starts as a 1.2% dividend yield. So the prices are so high the dividend yield's low. If you do it at the other extreme um uh getting it all through multiple expansion uh or margin expansion you've got to take the margin from 12.8 to 20.7% holding the multiple at 26. And if you just simply do a 50/50 uh and combine your multiple and margin expansion you take the you take the margin up to 16.4 and the multiple to 33.3. So all you get is your sales growth and your dividends and then just an enormous amount of margin and multiple expansion which isn't going to happen. So there's there's just to me there's no way to make 10 and 1/2% unless you're in a hyperinflation and you just own tangible assets because you've got incredibly high inflation. but otherwise, if you have a rational economy, there's no way to make 10 and 1/2 in the cap-weighted S&P 500. Just to play devil's advocate because we're all in the choir here, but isn't isn't the thesis would be something like AI spurs top-line growth the likes of which we've never seen before. Or takes cost out in a way we've never seen before. That's true. How do you feel about that? >> Yeah. Um plausibly Um but I would take the counterargument and I in my AI section simply take the amount of CapEx that's now being spent by these formerly capital-light businesses and the dollars are so great that you're you've introduced trailing growing depreciation expense which begins as a fraction of your CapEx depending on your depreciation schedule. And who would have thought that Microsoft would no longer have net cash on the balance sheet? I mean Right. These guys have gone from CapEx being 12% of cash from operations to what's going to be darn near 100% this year from '23 to '26. For four years, you're going to spend all of your cash from operations on CapEx. That crowds out share repurchases. You It's It's requiring leverage and so you're already starting to see declining margins and because you're introducing capital intensity to these capital-light balance sheets, you're already starting to see declining returns on equity and returns on capital. So this may be the classic capital cycle where the dollars wind up being spent redundant redundantly by I mean, everybody doesn't need to be building their own LLMs. I mean, we didn't need we didn't need as many fiber optic networks as we're being built in 1999. You didn't need the number of track miles that we built in railroads 100 plus years ago, 150 years ago. Um So you'll have beneficiaries of of the tool we're a beneficiary of the tool. You guys are beneficiaries of the tool, but I don't know that the revenues and the profits uh will can can even plausibly catch up with what was $400 in CapEx last year by the hyperscalers, which is going to be north of $700 this year. And three trillion, let's say, cumulatively or higher by 2030. I mean, just last year's CapEx. For $400 Depending on who you listen to, the revenues that are being produced on AI are somewhere around 30 or 40 billion. So less or equal to the CapEx. Well if you're spending the CapEx, you want to make a return on the CapEx. And so if you're going to make a 15% return on capital you need 60 billion in profit and your revenues are half that. You extrapolate that out to three trillion dollars in CapEx, which is being depreciated and depreciated over somewhere between six, seven, eight years. And there's an argument as to whether the the scaler should have whether it was reasonable or conservative to extend the depreciable lives of chips from three or four years to five or six years. Well, that to me that's not the argument. It's the argument is the depreciation expense is coming, the CapEx is there. So on three trillion dollars to make a 15% return you have $450 billion. I mean, of of profit. I mean, Microsoft's revenues are $300. Each of the hyperscalers, you know, you take Microsoft, you take Amazon, you take Google, you take Meta, they've all just got somewhat north of $100 in cash from operations, which roughly equates to net income. So, the numbers in a four-year period of time, at least for those that are spending the money, don't make sense. So, I have a hard time thinking that you're going to get margin expansion from here. I think rather to the contrary, you're already seeing front and center margin contraction. And I think if if they really do spend the amounts that are suggested over the next three or four years, I don't think there's any way in aggregate society or the aggregate of the S&P 500 benefits enough to offset what's going to happen to these handful of tech companies that are spending enormous sums of capital. I guess the bulls would say that the uptake is still fairly low for ChatGPT subscriptions and so on, and probably there, you know, there are super users who are paying hundreds of dollars a month, so you transition the $20 plan to a $50 plan, and $100 to or hundreds of dollars to $1,000, and you get some more growth, and that's how they And then you look at Anthropic's been growing very quickly, too. They've like doubled their went from four to eight billion dollars over 12 months or something like that, which is I think they're like 30 billion, right? >> 30 billion. Yeah, it's been >> Yeah, it's it's in the enterprise world, it's in the business world where where you really generate revenues. And then on the offset of your Google or your meta, and you've already got an enormous advertising platform, the retail side of your business, the individual subscriber will will pay subscriptions. I mean, it's coming. They're giving it away at first. It's the it's the crack cocaine dealer. Uh but they're they're eventually going to charge you for it. Um but it'll be augmented with advertising revenues. I mean, Sam A Sam Altman said, "We're never going to advertise." And guess what? They're advertising. Um you you you just can't recover the capital without without trying to push the top line. But the numbers are stunning. I mean the the the numbers are already 1 and 1/2% of GDP on CapEx, and they're going to be close to 3% this year. They're enormous amounts of money. So, you think this looks something more like a a railway build-out or a um fiber optic cable build-out, both of which had very long lives, and chips have a much shorter life. So, I guess that's a that's a problem. I think that there are a lot of parallels. Um all of those prior capital booms from canals to railroads um to the auto and infrastructure and electricity. Um a lot of that was debt-financed or it was financed by the government {slash} the taxpayer. Uh the fiber boom was financed with leverage. I mean, it was the pipeline companies. It was anybody that had rights-of-way. But, the leverage that was introduced was enormous. So far, the leverage isn't that big. But, unlike a railroad that was building 100-year assets, these these things depreciate. Uh I was having a conversation the other day. I think what I what I haven't got my mind around, and maybe some that are a lot smarter in this space have, but will be the transition from from training to inference. And so, once you've built the models, and once you've essentially uh appropriated all of the all of the the the the knowledge in the world, um does does the does the chip in the data center cost of simply using the LLMs is is it materially lower? In other words, is maintenance CapEx a thing on the CapEx being spent now, or having built the railroad, does it become somewhat less expensive to maintain it? I mean, Warren Buffett talk talks about the trillions of dollars that would be that would be required today if you were to build the railroads from scratch in today's dollars and many of the assets are very, very old and fully depreciated. You you wouldn't do that, of course. And so, I what I don't what I have no idea what the capital intensity winds up being 5 years from now or 10 years from now. If it winds up being cap light and you just have a short period of time where you spend a whole bunch of capital, then I think you can you can lean more into and the scenario you just talked about, but the dollars are so large, I'm still I'm very skeptical. Yeah, I think I mean, one way [snorts] to maybe think about it is the the sources of data that are being used for the training. And so, right now, you know, it's been this the corpus of all of written history, basically, and you know, IP rights be damned, sounds like in a lot of cases, but you know, at some point we kind of run out of raw materials of original words that were put in orders for it to train on. And then, we need to have something else for it to look at. And that's where I think it's a little bit interesting when you think about other forms of intelligence, like language is one form, but there's also you know, a squirrel has a certain type of intelligence from just being out in the real world and experiencing data as it comes in of I put this I plant this nut here and then I can find it later. Well, it the modern equivalent of that might be robots who have all these sensors that can then learn in the real world like how things work, like a a real-world model of things, not just not just language-based. In which case, the training may be for as long as you I can see to incorporate these new data sets over time as they get built out. Um So, who knows? I mean, it's obviously starting to get into sci-fi stuff, but but it is interesting. Yeah, and I'm as an investor, I'm going to go back to the capital and the dollars being spent. And so you had the enormous sums that were spent on fiber. And massively redundant, massively overbuilt. You'd lit something like 4% of the fiber that was that was laid was actually lit by 2001, and then everybody went bankrupt. But had you not laid the fiber, you wouldn't have had YouTube, you wouldn't have had Netflix, you wouldn't have had all the streaming. And so there was an end user that benefited from it, but it was not the ones that spent the money. Mhm. Um Microsoft can spend I mean Google's going to outspend everybody on this. And they can do it. I mean I don't think there's unless Sam is continues to be um uh as apparently impressive as he is when he's raising money. Uh and he actually can spend 1.4 trillion dollars. Google's going to spend to make sure they're the ones that win this thing. But all the CEOs have said, "Look, we don't we probably don't all need to be doing this. We don't need five of these things. We don't need seven or whatever it is." Um so clearly portions of society are going to win. And because they're they're they generate so much money and they're already so big, they will grow and they'll have revenues that grow out of this thing. But I think it comes in the case of the tech companies at at a decline at at at at at at at a harming their profitability, harming the returns on capital. And Wall Street does not generally like paying 35 times for declining returns on capital. Um >> [snorts] >> so we'll see. I mean it's it's a hard thing and we don't have direct investments trying to benefit from it. We don't have direct investments other than a really tiny short on Nvidia, which is really just valuation um and the notion that I don't think they can maintain a 58% net margin, especially as this thing evolves, but um you know, as a user >> Also, probably a little under appreciated that, you know, when these guys were cap light and making all that money, they kind of ceded territory of different things to each other and didn't compete all that hard where they were inter- overlapping. But, it seems like this, you know, the LLM world is lots of overlapping use cases, lots of competition potentially, and and it's like you know what competition does to profit margins, right? Well, and and capital spending uh forces competition. Um especially when the sums are so enormous that you get redundancy. So, they will compete on price. Right. The enterprise user is going to negotiate and and play one against the other for capacity. And again, much like the fiber, you just don't you you didn't need it all immediately. So, we'll see. There's There's >> free there's free models around, and it seems like the the new model sort of makes the the old model obsolete in that the old model's probably pretty useful. So, I think there's going to be plenty of people using older models for specific tasks that won't need to update all the time. Plus, the Chinese free models that seem to be popping up. Right. Yeah, they're going to have to charge, but um you know, OpenAI, and I've got a I I went through and looked up all of their funding rounds and and where the source of their capital came from. Well, I mean, they by year end, before this last funding round, they'd they'd raised something like 73 billion, had already burned through 50 billion of it. And you listen to Sam A on an interview last year, and they were trying to tease out what his revenues were, and he said, "Well, they're they're 20 billion." And somebody said, "I I what Sam, it can't be that high." And uh essentially, what he's done in his mind is taking the current minute or the current quarter's run rate, multiplying it by four. Well, that's that's Kenny that's the stuff out of Kenny Lay when Enron was telling you that their revenues were the largest in the world and he wouldn't commit to the dollar revenue amount. Um Well, if your revenues were 12.7 and they've increased their funding rounds. I mean, they just raised over 100 billion at an 800 something funding round. Microsoft is only in on the first couple three funding rounds. It's something like 13 billion. Um Revenues [clears throat] need to come from somewhere. Uh If I had to bet at this stage who wins and who loses, Open AI probably loses this thing and in that case Microsoft wins because if Open AI doesn't make it, they own the IP. But Microsoft does. What do you think about the this potentially big IPOs that that might be coming down the pike? Is this good or bad for the average person? SpaceX Oh, I just can't wait. I I cannot wait to read the S-1s. Uh This is going to be the the entertainment value of the year. Uh particularly SpaceX's. To see what has happened with the shareholders the Twitter buyout with the leverage, Morgan Stanley being able to get out of their debt. I mean, I think you're going to wind up reading and and maybe they'll maybe they'll figure out a way to to not detail it in the footnotes. But you know, let's go let's just go Twitter. Um It pays whatever 44 billion for it. Put all the leverage in it. Um Elon's got equity. Uh Larry Ellison's got some equity. Well, the revenues immediately got cut in half from whatever it was, 4 billion to 2 billion and with the debt in the business, I think they had 1.2 billion dollars of interest expense. And so, they were burning through a whole bunch of cash. So, my understanding is and I couldn't get verification of this because I couldn't get the summary. Presumably, there were some summary financials, maybe not fully audited, but summary financials. But when Morgan Stanley and the others sold their debt, Elon said, "Well, we're making money." Thinking, "Well, how are you making money?" Well, my understanding is XAI paid a billion or a billion two as a royalty payment to Twitter, which get gets booked above the line, so it gets booked as revenue, not as a capital infusion. And so, you can say, "Well, we're generating a billion two of EBITDA because there's no cost associated with a with a royalty payment." Well, shortly after that, the the the the the guys with the debt got out of all of it. And immediately, the equity owners of of Twitter {slash} X lined up merging and owning XAI, and then they're going to roll XI into SpaceX. It's going to be really interesting. I've got a friend who's one of the largest investors in SpaceX. It's his largest holding. It's a big investor in terms of dollars under management, and he was in at one of the early funding rounds. Um Starlink is flex. I mean, it's Starlink is now started to generate an enormous amount of cash flow. Um but, if we're going to do this valuation at two trillion, I mean, this is going to just get into the the the the Elon stuff of pixie dust where there's to me, there's just no way to support it and data centers in space, and I guess we've backed off from data centers and populating Mars, having just sent astronauts around the moon. Uh the time it took, you do the miles to the moon and the miles to Mars. And I I think I think between uh these big techs, the the the the the offering documents are going to be interesting at a minimum. One of the things that Jake and I have talked about a little bit has been the strength of the S&P 500 last year because of the uh Magnificent Seven. And then Magnificent Seven seems to have fallen off, but not the S&P 500. It's managed to be The other 493 companies are now pulling their weight in the S&P 500, but um how do you think about the uh How do you think about that interplay between the concentration, dispersion? What's keeping the S&P 500 up? If if you If you continue with the cap-weighted and you and you pull out the Mag Seven from the S&P 493, the 493 were still trading at 22 plus to earnings. I mean, they're on a cap-weighted basis, they're still expensive. There's There's a There are a bunch of companies from Costco to Walmart to some of the drug companies that are still very very expensive, 40 plus times earnings that don't have the revenue growth or the potential the potential to expand margins to support it. Um under the hood though, when you drill down into uh and I hate doing um sectors, and I don't like doing market caps, and I don't like doing uh international jurisdictions, but there are a whole bunch of companies that are I mean, very very reasonably priced if not give away cheap. Um International markets had a big year last year for the first time in a long time. The The MSCI XUS was way ahead of the S&P. Uh and you've still got an enormous small cap versus large cap valuation disparity. The reality is, there aren't that many companies left. I mean, the Wilshire 5000 has something like 3600 components in it. Um and over all these years, a lot of the great businesses either grew to be mid-cap or large-cap companies uh or they were acquired. And so you've you've got an awful lot of mediocre companies, both smaller cap in the US and abroad, that just aren't great businesses. So again, I don't think the market's got it wrong, but the multiples being paid today uh for where the the money in the US stock market is concentrated, things are still pretty expensive, but from an active investor's perspective where you can buy differing sizes and not constrained by the the Berkshire Hathaway type enormous amount of capital where the pond you can swim in is pretty limited. There's an awful lot to do with money. Uh I think Semper's historical portfolio right now is probably as maybe attractive even on an absolute basis as it's been even not even relative basis. Do you do you agree with that? Well, we I mean we we made a a bunch of money last year. We were up 40 whatever percent, 42%. Um February of this year uh we were up something like 12 for the year, and then we were down every day for 3 weeks. So the minute my letter was out, I mean That's what cured the Every single day lost money, but then So I I think we wind up the quarter up about three for the year. But we've been very active. Um and by very active, this is not 100 150% turnover, but taking advantage of the tariffs last year, uh having invested a a big chunk of money in various um corners of the energy patch. In 2020, we bought a couple of refiners in the fall of 2020 for 1 and 1/2 times cash flow, Valero and what's now HF Sinclair, the old Holly Frontier. Numerous international energy assets, some of the integrateds. Um Well, we've taken advantage of A early um especially in the case of Valero, we trimmed it way back on the Maduro extraction, but then um Here with I would have predicted a run, uh but we've shaved big big chunks of our energy holdings. And And to me, they're cyclical assets that you can't own for 30 years. You buy them when nobody wants them. And when you get oil tight like it is and uh it it's pretty good time to trim those. But we've peeled back big chunk of the gains we had in Dollar General. We've been using gold as a source of capital. And so we're finding places at the moment that are really really attractive and really cheap. And so Yeah, I think we we probably ended the year at about 12 to earnings on the portfolio versus 26 for the S&P. And that's about where we've been historically. At the end of the prior year, we were 10x. And so you wouldn't have predicted a 42% return. But we also didn't grow the multiple from 10 to 14 because of portfolio activity plus ongoing earnings progression of the things that we own have things pretty reasonably valued. And uh we've really concentrated capital with the proceeds from the the not uh not small sales into six or seven companies that are very very very cheap. Um And so I I I like how we're positioned. We're we're generally pretty tax efficient with our taxable clients. But we are distributing capital gains this year. And And you know, like I I I don't hope that we have uh before year-end some unrealized losses. But we just don't have unrealized losses in the portfolio to offset gains where, you know, typically you do. Um But at the mo at the at the prices that that we're getting uh harvesting some of the profits that we've made on assets that you don't want to own for 30 years. Yeah. Uh it has to your point and to your question, um yeah, I portfolio is still pretty darn cheap. Do you feel like you've been able to move up in quality a little bit out of some of the more cyclical things that have started to work the last couple years? Yeah, if you would Yeah, I think if you'd say, "Well, energy is cyclical and it's not high quality just because it's cyclical." then yes, uh but we still have some cyclical things. And, you know, at some point the construction world is going to turn and even the housing market's going to turn. So, we're doing some things there that that would still be cyclical assets, but you're on the front end of the cycle instead of the back end of the cycle. Right. Um There was this There was this notion that we talked about in the fall, Jake, and it was just the whole concept of value investing. And there's a a bunch of our world that defines value investing as uh Warren Buffett's notion that you buy something and the the ideal holding period is forever. Well, that's Yeah, that's been the case at Berkshire with the wholly owned businesses, but his portfolio over the years has been very actively turned. You know, if you go through the list of holdings, uh which used to appear in the chairman's letter for years and years and years, you'd see wholesale changes and he tended to own various cyclical things. And then I think the other thing is the concept of 100 baggers and buying a business and owning it forever. Those are hard. There there aren't that many you can get. Uh and even where Warren screwed up with Coca-Cola uh having made a mountain of money buying it in '98 and '99 or or '88 and '89, got $1.3 billion invested by June of '98, he had the high-class problem where that was 30% of assets. 60% of equity was just Coca-Cola. And it went from trading from 15 times earnings to 58 times earnings. They had grown sales at 9% a year for that first decade that he owned it. And the margin went from 12% to something like 19%. But then the stock traded at 58X. So, he he later acknowledged he should have sold it, but he did essentially double Berkshire's assets nearly by buying Gen Re, which cut the Coke position in half. And got a I've got one of my five factors in the letter that showed Berkshire's Coke position compounding at something like 36% a year for the first decade. Well, what do you think the compound return has been for the last since '98? 27 years. per year annual Uh not much, low. four and a half >> four and a half, yeah. And the S&P was expensive. The S&P has only done eight or eight and a half, but Coke did four and a half. Like 60, 65% of the returns come from the dividends. Mhm. And so, you didn't have ongoing 8, 9% sales growth. Sales growth slowed. Margins no longer expanded, but the multiples come back down to the mid-20s from 58. And so, That That's what generally happens with the Everybody's got a list of the great compounders that have been phenomenal businesses in the last whatever period. Some of the the beverage companies, Pernod Ricard, Brown-Forman Yeah, Monster. And for years they would trade at 40, 50 times earnings. And once the growth is obviously and apparently slowed or you get some disruption in your industry or you overbuild, they just shoot these things and the valuations just get crushed. And so, in the ashes of some of that you'll find some great assets, but to me you've got to be willing to sell things when they're either on the back end of a cycle or if you've got a a business that's still going to grow, but the price is just wrong, you have to be willing to sell. I I you cannot have an infinite permanent holding period, I think. It's been really interesting to see a lot of the CPG companies, which were almost bond proxies five years ago. If you remember when everyone was like, "There is no alternative. Why would I want 1% T-bills? I'm going to own Campbell Soup instead." Like you heard that all the time. And now that whole CPG complex has really been taken to the woodshed. It's I find it very interesting how the narratives change on these things. You weren't going to get much more than nominal GDP growth and in some cases you don't even have that because taste change and Yeah, direct to consumers hurt a lot of that. Dollar brands. But a nominal GDP growing business that's already max profitable that's introduced leverage upon leverage upon leverage onto the balance sheet to finance share repurchases uh to finance incremental bolt-on deals they're not worth nominal GDP growing business that's got a lot of leverage is not worth 40 times. Yeah, you shouldn't do a 2% earnings yield on that. No, Costco's one of the best business in the world and it traded at almost 60 times earnings a year ago. It's still trading at 50. I mean, and I love the company. It's it's the probably the best run business I've ever encountered. We've owned it. I still own little stubs in taxable accounts where my basis is $19 a share. But you are not going to make money owning Costco. You're not going to make much money owning Costco at prices above or at where they are today. I mean, there's and there's just a number of those companies that have been the best businesses in the world. But price matters. I guess Let me let me do a quick shout-out around the horn. And then J say you get some veggies for today. We I do. Okay. Pit a tick for Israel. What's up? Pittsburgh, Tampa, Florida, Philly, Valparaiso, Boise. Wasan, Switzerland, Breckenridge, Bethesda Fredericton, Canada Toronto, Wagga Wagga, Australia. What's up? Tallahassee Zagreb, Madeira, Ireland That's in Portugal. You've already won. Skip ahead. Uh Moss Feldspar, Iceland. How did I go with that pronunciation? Let me know. Vancouver, Bologna, Italy. What's up? Jamaica. Nice. What's up, Monique? Uh JT Veggies, let's go market folks, 6 minutes past the hour. Cincinnati, Ohio, last one. Okay. So, uh you know, Iran war happening. We're going to be talking about war. Uh but actually there's a little twist to this cuz I know Chris is also a sports fan. So, we're going to be talking about war and baseball. Uh so, Babe Ruth hit 714 home runs. And by this modern measure of war, you know, he wasn't maybe even the most valuable position player of his era. It might have been Rogers Hornsby. Uh that probably sounds wrong, right? Cuz Ruth is sort of the patron saint of home runs. You're the Babe Ruth of XYZ, uh you know, it's the best of all time kind of thing. But but war says otherwise. And war stands in baseball for wins above replacement. Uh and it's it's asking a different question. How many wins did this player produce that the next guy in line wouldn't have done? And what does this like next guy in line really mean? Uh this is actually more like a bench player, AAA call-up, a minor league veteran on a one-year deal. Every team in baseball has access to this uh replacement player at a minimum cost. Uh he's not average. Average is actually pretty good in the league. Replacement is the floor. Uh you know, what can you get if your starter goes down and you have to grab someone off the waiver wire on a random Tuesday afternoon? This is the baseline that war is built on. And and it changes really kind of how you think about the value of things. So, this uh >> [clears throat] >> war puts a number to all of this. And once you have this baseline, you you need a unit of measurement. And and for baseball, this is it's runs. And every action on the field either creates a runs or prevents the other team from scoring runs. So, a single, a walk, a stolen base, a diving catch in the gap, like all of it gets translated into runs. So, a home run is worth more than a double. A double's worth more than a single. A walk has value because it doesn't make an out. That And this last point sounds kind of boring, but it sits at the center of the modern game right now. You know, Bill James spent decades arguing that avoiding outs was undervalued. And Billy Beane read about this, and he built a playoff team in the Oakland A's in 2002 that was, you know, now Moneyball. And And every front office now in baseball understands this. So, but then let's let's add in base running, which is even more subtle than hitting the ball. Like, going first to third on a single, tagging up on a fly ball, not grounding into double plays. None of these things show up in the highlight reels, but over 162 games they they really do matter. And and a good base runner might generate five to 10 extra runs a year just by making smarter decisions on the base paths. And and that's worth, you know, roughly one win. And defense is where WAR really starts to get kind of messy because, you know, hitting produces these clean events. You A pitch is thrown, contact is made or it isn't. You can count the result. Defense doesn't really quite work that way because, you know, did the did that shortstop make a great play because he was positioned brilliantly and he knew that a changeup was coming and that the batter was likely to be early, or was it because the ball was hit right at him and it was just luck? So, defensive metrics require quite a bit of estimates. They look at thousands of similar batted balls and ask how often does an average player convert that into an out? And so, players who consistently make like the low probability, the spectacular plays, they get credit for that. And and different systems make different assumptions. So, this is why there's a FanGraphs WAR versus a Baseball-Reference WAR. And sometimes they disagree by on a player based on their assumptions. And so, once we take everything here and denominate it in runs, WAR is this final calculation, which is converting the the runs into wins. And that's typically like 10 to 1. So, 10 extra runs that a a player produces translates into one extra WAR in in their season. So, let's get a little bit of the scale for some context. You know, zero WAR is a reprice a replacement level player. Two war is a solid everyday starter. Five war is an all-star. Eight war is like an MVP candidate. So, and Mike Trout has had seven seasons above an eight war, which is why he's going to go to Cooperstown someday. Babe Ruth had 10. And you can sort thousands and thousands of players over decades by this one number. And you know, [clears throat] it's important to note that war is has some context to it. Like there is Actually, it's it's it's actually context neutral. A home run in the third inning of a blowout game counts the same as a home run in the bottom of the ninth of, you know, game seven of the World Series. Like there's no real clutch factor to it. And that's kind of what makes fans often not like it. You know, because those big moments feel different. Like you want to You need that clutch player, right? So, but war strips that all out on purpose. It's trying to measure an underlying ability, not not the situation that the player happened to be walking into. Um and so, it obviously it has limits. And here's we'll try to stick the stick a little bit of an analogy. So, the reason [snorts] that maybe some of this matters outside of baseball is that that same kind of logic applies anywhere where capital and talent might be getting allocated. And maybe we'll talk about M&A as sort of the cleanest example. Research indicates that roughly 70% of acquisitions destroy value for the acquiring shareholders. And that the average premium paid is somewhere around 25 to 35% over the the market price that time. And that that premium has to be earned back through synergies, which are usually overestimated by at least half on the revenue side. And they almost always arrive years later than than the the slide deck promised. So, CEOs will justify a deal anyway by pointing at the accretion that happens. They're looking at the earnings per share number. Oh, it went up. So, the deal must be working. You know, and AOL bought Time Warner in 2000 in a deal that was accretive on day one and went on to then vaporize roughly $200 billion. And HP bought Autonomy for $11 billion and wrote it down $8 billion the next year. But both deals cleared this EPS accretion bar in the slide deck, and both were total disasters. And so accretion here in the EPS is a bit of a a financing trick. It's almost like RBI logic. The actual question is what that what could that cash have been used elsewhere? So, you know, typically the cleanest alternative might be buying the company's own stock because management should likely know that asset better than any other potential target, right? And a buyback at a fair price is sort of that replacement level capital allocation move. It's almost like a war. It's available. It's typically pretty cheap to administer. Doesn't require a 30% premium, you know, or 3 years of potential integration risk. And you usually get to size it kind of however you want. So, most acquisitions measured against that bar instead of this imaginary do-nothing bar are negative war deals. They look like eight war signings on the on the day, and they turn out to be like zero zero war contracts on like but paying all-star money for it. So, [clears throat] Babe Ruth Babe Ruth hit 714 home runs. War War doesn't take that back. Like that still counts. But what it does is kind of widen the field of what does count. You know, the walks count, the defense counts, the first to third on a single counts. And none of that really looked a much like anything in 1925, but it all adds up into wins, which is what you're really trying to get towards. So, and markets kind of work in that same way. The obvious things get priced. The subtle things often wait around to be measured. And war is just one example, you know, someone deciding to count subtlety. And so, of course, you know, markets eventually arb every every edge, everything that you would count, just like you know, walks in baseball have have been arbed away. But you have to kind kind keep looking for new approaches to arrive at value and but while still not sacrificing your principles. So, there's a little bit of baseball brought into to the investing world. For the lay fan of baseball or for the investors that don't follow the sport, I if I may Jake, I'll just summarize what you're saying. You've got >> Please. the entirety of MLB trying to figure out how to optimize their war to be able to beat the Dodgers, which they won't be able to do. That's the Yeah, I think salary cap or lack thereof might be one of the issues. Um Chris, for the last 15 minutes, can we talk about where you're finding opportunities sector wise, factor wise, size wise? I mean, country wise? What what what what's interesting? Oh, like I said, the starting to get some money invested into the home building type world. Um I guess you'll see tomorrow we just bought position in builder supply. Um Uh I still think Deckers is pretty cheap. Um >> [clears throat] >> working through whether that's a value trap. If you don't know the company, they own Hoka and Ugg. Uh they're two primary brands and Hoka's doing 3 billion in revenues on running. Their Their Swiss competitor's doing three as against Nike's 30 billion of shoe revenue out of their 50 billion. So, those two companies have taken meaningful market share. Ugg does 2 billion. It's been around a long time. Uh stock traded at above 200 like 250 uh couple of years ago and our basis in it is not much over 80. Uh it's trading a little over 100 today, maybe 108, 109, but with a billion and a half of net cash on the balance sheet, we bought it at 12 times earnings. So, it's pretty clear that the Hoka brand in North America going to slow. They've got a lot of room internationally. They do 40% of their business direct to consumer, which is much higher margin. I like the management team a lot, but I've got price as a margin of safety, so maybe it's trading at 14 times. Um margins will come down. They've got the highest margins in in the in the athletic shoe industry. Um Uh we've got some international investments that I won't name specifically because we don't have to disclose them, but trading at some Norwegian and Swiss companies trading at kind of five, six times earnings. Um We've been trimming gold only because we've made so much money. The position size has got very big and so when I buy something I tend to force myself to sell it. So >> that, you mean the miners, right? Not not the The miners. Yeah. But let's talk about builder for a little bit because I think that you know, it's not to talk about builder specifically, just the uh housing and construction is is interesting at the moment because the number of sales that are going through um are are lower now than they were in the 2008-2009 global financial crisis. And there are a lot of theories why. One is interest rates are too high even though I think interest rates are sub the long-run average. Um the other one is just there's a huge divide between buyers and sellers in the market. There was a chart doing the rounds yesterday that showed that we've never had so few buyers and I think there are twice the number of sell sell you know, it moves around a fair bit. But the idea is just that housing is as expensive as it's been. Median house price relative to the median income is as is as expensive as it's been in the data going back 50 years or something like that. So it seems like we need to have house prices come down pretty materially before buyers move back into that market and that that has knock-on effects for all of the housing industry and so on. So, there are a lot of housing and constructing construction businesses that are not doing as well as they might be. Look better when the cycle ticks up a little bit. What what's your thesis there? I think there's a there's a nuance to how the median housing price is calculated that that distorts that perspective a bit. Uh you've got this apparent huge rise in median household prices. Um but if you go back a handful of years when the mortgage rates were sub-three two and five eights, two and three quarters, everybody refinanced their mortgage. And when mortgage rates crashed through six and spiked up to seven and eight if you were in a two and three quarter percent mortgage and your household income and assets were not at the upper 1% or top 5% of the population, you were not selling your house. You were not trading homes unless you moved and your house is not going to sell unless you died because you're not leaving that two and five eights mortgage. And so tran- the transactions that have taken place nationally tend to be at higher home prices. So, that makes the median household price appear as though it's moved up. And it did move up for inflation and and lumber costs and construction costs and labor costs. So, it is higher. But it's not so much higher. So, you're starting to see in the last three four years you're starting to see the proportion of 30-year mortgages that are at 6% or higher start to move up because you do have activity. You relocate your job. There is transactions there are transactions taking place in multi-family and in smaller homes, but it's the preponderance of activity is in larger homes. To me, it's interest rates. At at a at a level of rates somewhere south of six, which is about where you are now at five or four there's a I I think there's an enormous amount of pent-up demand for homes. Uh you don't have much construction act- activity, so I think you're probably going to have somewhat of a shortage against all of the young generation that are living in their parents' basement, so they're living below their lifestyle expectation of where they want to live and where they want to move, but but they're not going until the mortgage rate makes housing prices more accessible. And so, I don't know what it's going to take to get there. It'll certainly get there in the next recession. If you have a bad crisis or if you have another panic, uh the Fed, because they've shrunk the balance sheet from 9 trillion to 6 and 1/2 trillion, they they have room to do at least another or multiple rounds of QE. And so, I I almost think the housing market and the construction market as a surrogate of that are pretty good recession hedges in that if things get really bad, my guess is you're going to see more real estate activity uh from the pent-up demand and the prices of some of the very well-run home builders like an NVR or a Lennar uh have come in. We We bought builder supply, think lumberyards, but with higher margin product that home builders like. So, instead of stick build, they've got full truss systems and full siding systems and wall systems. It's a very well-run company. Um So, I don't know. I I I But, I can't give you a timeline. I just know that the prices as the stocks have come down and down and down and down are starting to be pretty attractive. And um you know, time will be the enemy of making a bunch of money, but if if the economy gets worse sooner than later, I think they become a similar hedge to bad times like a Dollar General has historically been where you get trade downs from uh the middle class, uh but you also get uh an accelerated use of snap, which are food stamps. And so, there's I I think I think in housing and construction >> [snorts] >> there's a bit of a I think there's a bit of a contra-cyclicality to them because of what's happened in the last five or six years with interest rates that make these things pretty attractive. Do you have a view on oil other than when when it spikes like this you try and bring back a little bit? Do you think that it's a risk to the rest of the economy if it stays elevated? Or do you think these levels are are fine given the changes in just inflation over the last five or 10 years? And we've heard that argument that the the price of oil might be its own kind of like Fed funds rate in a lot of ways. Um, I don't know. We have clients that trade oil and energy um, that until Iran, um, couldn't make much of a long-term bull case for oil. We do have steadily growing 1% a year increase in demand for oil. I mean, the world thought a few years ago you wouldn't have the global uh, consumption of north of 100 million barrels and you're 7 or 8 million barrels north of that. Um, my working assumption is we get through this Iran thing, um, sooner rather than later. Uh, you've got an awful lot of disruption in the meantime, but here's another place where where I think we're taking great advantage of this short the short-term pain. Airlines are going to just lose money because they hadn't hedged out this immediate spike in fuel costs. So, you'll see in our 13F that gets filed tomorrow, we've made Alaska Air despite airlines being terrible industries. Alaska's really well run. They're working off a merger. They historically have run kind of net cash on the balance sheet, which is very aberrant. But, you know, they're they're more exposed to the surge in jet fuel prices than some of their competitors. They've added international routes and now they're flying to Asia. They've got some longer haul. They fly to Mexico. They fly to Hawaii. But the stock traded into the low 30s and it's worth a heck of a lot more. And so, with oil having come back down the last few days on the apparent uh peace negotiations underway, oil's decline, the energy stocks that we've been selling have declined, and Alaska, it's up like it's up 7% um this morning before we jumped on the call. So, we're delicately long some places that I think will benefit from oil reverting kind of mean reverting back to where you were. But if you get a protracted war and uh if you don't run if you don't run refining and energy assets, yeah, you start to have problems. But I think we're a long way from that. What about the destruction that seems to have gone on through the Middle East? Yeah, I don't know. Qatar had some of their LNG uh terminal assets uh harmed, something like 20% of their assets. I don't know how durable that'll be. Um uh I think you've got enough ability to turn the crank even from the US perspective. I mean, you know, we we we can send more LNG. We're putting a rope around the Chinese at the moment. We've gone after their proxies, been going after Venezuela, going after Iran, most likely Cuba next um rightly or wrongly. Um >> [clears throat] >> Uh I I I I've done a lot of reading. I don't think we've durably harmed energy assets. But if we if we take out a million or million and a half barrels of Iranian capacity to refine and export. I mean, they import things like jet fuel. Their their their refining capacity is is not the complex variety that Valero and Holly have here in the US. I don't think we've done much damage, but if we or the Israelis bomb Kharg Island and some of these more durable um energy assets, yeah yeah yeah you could definitely have a problem. You could see oil price a heck of a lot higher and if that's the case, uh we're not going to make money at least in the short or intermediate term on something like an Alaska Air. But I I don't know. I think I think we're I think we're close enough to the end uh that if we get through it, you'll have oil back at 60 in pretty short order, I think. But who knows? I mean, It's always the challenge of value, right? You got to buy it in the middle of the crisis not knowing when the crisis passes. But knowing that eventually it does. Yeah, you didn't know you we had no idea how quickly we would clear COVID and the lockdowns. Um but at one and a half to cash flow, yeah, we were buying Valero and Holly and right after we bought Holly, they bought a refinery in Washington state for 350 million, 250 million net of inventory, finished product and and raw crude. Um and then the hands of the management team it's a better asset than it was when Royal Dutch Shell ran it. And so they basically paid one times cash flow and stole the asset. Um California, uh I mean, you know, Valero's closing one of the refineries. Phillips is closing a refinery. I mean, there are places in the world that have very irrational energy policy. Um and you we can take advantage of that. Holly can take advantage of that by distributing uh via rail um to California. Um I don't know. I I'd I'm not sophisticated enough on geopolitics or on pandemics to know the outcome, but I mean generally these things in my 35 years investing, whatever the imminent crisis is front and center tends to resolve itself. And when it resolves itself oil will be lower and airlines will be higher. Um, we've got about through the any of the SAS apocalypse names? I mean things are up quite a bit and I don't it's kind of not traditionally been where you where you look, but you know, at some point there's a price for every asset, right? No, I mean doing a bunch of work on service now at the moment. Um Okay. Adobe, I mean there it There there are there some clear businesses that are harmed and a service now might be one. They enjoy very very high margins, so I don't think they're going to lose in in the IT world that they cater to and their big S&P 500 Fortune 500 clientele. They're not going to get displaced from the processes that are in place, but incrementally they may not drive 20 plus percent revenue growth. And if you do get a disruptive competitor via AI that uses much cheaper tool at the margin you'll see margin compression pretty severely. Um In the ratings world and some of the businesses like an S&P Global's very interesting. Moody's if it gets cheaper very interesting. Um But the SAS things are so funny because you look at them and forever they traded at crazy multiples to revenues and crazy multiples to earnings if they had them and there's just been an awful lot of evisceration and anytime you get this sometimes it goes too far and sometimes it doesn't, so we're spending a lot of time on it. Uh, Chris just we've got about a minute left, but I just thought you might want to say some words about Buffett stepping down. It's one of the sections in your letter. Just recover what you discussed in that. In 1 minute um >> [laughter] >> Yeah, some of the Buffett It wasn't It was 2 minutes before we started talking S & P 500. It was my 180-page letter. Of 90 or 100 was um Berkshire and I I do have a tribute. So, I won't get into the math, but I'll I'll leave it at I mean he was the best investor of all time, but he was also the best operator in terms of running a business with morality and ethics and executive compensation. And he was just such a great mentor to all of us in terms of how to behave with honor. It's something you don't see in a lot of places, but the performance track record, which is just a a component of it. I've got a section starting on I don't know page 95 of the letter. And I had that I had the the I I told Warren in in a note a few years ago that I did the math It's just a quick simple algebra that Berkshire could lose 99%. 99.3% of its market cap and share price and still outperform the S & P 500 since he got control of Berkshire in 1965. And he said wow, that's Ben Graham would be proud. That's a testament to compound interest. And so I mentioned that to Charlie a couple months later at the Westco meeting and he said Chris, this is it's just compound interest. That's nothing special. And so I just >> [laughter] >> This is basic math. >> I've got a I've got a So, I in in doing my long-term compounding against the Ibbotson, it dawned on me. Well, I'll just tell you I'll take 30 seconds. So, what one day in the history of the US stock market one what what single moment would be would be the best time to buy the stock market via the S & P 500? I guess like the '29 low? The '32 low. '32 low. June 1 of '32. The S & P had fallen 86%. The the Dow had fallen by a little bit later in in July, 89%. So, if you bought the S&P 500 on an 86% decline, and owned it through today, you've compounded at 12.2%, which is way better than the Ibbotson 10 and 1/2. And had you bought the peak in 1929, you compounded at something like nine. Well, over a century, that's huge. Instead, had you bought the S&P 500 at the low, the absolute day of the low, and held it until September 30, 1964, which was the end of Berkshire Hathaway's 1964 fiscal year, and been willing to lose 99% of your money, and put all your remaining money. So, so $100 from the low in 1932 to 1964 compounded at 15 and 1/2%. From $100 invested to $10,000, you go back from $10,000 to a hundred, buy Berkshire, and still have outperformed with Berkshire. So, essentially, sit on cash for 33 years, 32 and 1/2 years, earning absolutely nothing, and then buy Berkshire, and in a third of a century shorter, compound $100 in Berkshire's case to 6.1 million, where the S&P 500 from 1932 grew to 4 and 1/2 million dollars. So, it it only grew to $45,000, the S&P being it from 1965. So, essentially, you can lose 99% twice in Berkshire's case and still would beat the market. And I think Charlie would have been impressed with that. With that figure, even though it's simple mathematics, compound interest. Uh amazing. Uh on that note, Chris, if folks want to get in contact with you or follow along with what you're doing, what's the best way of doing that? Well, I used to say check me on Twitter. I'm not on very much. I did post something on Cathie Wood on the weekend, but Shots fired. I caught that one. That was For for sure our website. So, we've got the archive of a bunch of our annual letters on the website. And then any interviews or podcasts we tend to post. So, whenever you guys post this thing um you know, we'll put the YouTube link and the podcast link on. So, we've got I don't know, 20 or 30 or something interviews and podcasts in addition to all the letters on the website, semperaugustus.com. JT, any final words? Just always good catching up with Chris. Thanks for coming on. >> Yeah. Christopher Bloomstran, Semper Augustus. Thank you very much. Thanks, gents. Uh folks, we'll see you next week. Um
Christopher Bloomstran on Warren Buffett, Berkshire Hathaway $BRK.B, $BLDR, $DECK, $ALK, | S08 E14
Summary
Value: After Hours is a podcast about value investing, Fintwit, and all things finance and investment by investors Tobias Carlisle, …Transcript
Well, I've this is Value After Hours. I'm Tobias Carlisle joined as always by my co-host Jake Taylor. Our special guest today uh he's a regular. He's back again. We love to have him. Christopher Bloomstrand. Simple Augustus. How are [snorts] you Chris? Good good good to see you. I'm doing great. How are you guys? It's good to always good to be on with you. The two of you. You've uh you've completed your annual opus. Um it was uh as good as you've as good as you've done. We I enjoyed it. New record on length. It was thanks thanks for that. >> [laughter] >> It was indeed. I I I thoroughly intended to not do that lengthwise. Um What happened? Uh well, I added a section on AI that I thought uh I I would try to tackle not being an expert on it. Um and then I was going to cut uh some of it is you know, I up I update the portfolio each year and that's a little bit repetitive and then some of my Berkshire um subsidiary work and and various of the valuation tools that I use are are updating. And I you know, with new text and kind of an update on with the subsidiaries you're doing. And I was going to cut about 30 pages from that and you know, Lincoln edits and ran it by a couple friends and they said, "Man, if anybody thinks it's too long at 150 pages, who cares if it's 180? It's your letter." >> [laughter] >> That's right. I carry it around in my briefcase and I'll pull it out in meetings and just >> circle back. Just just to remind me of what's happening with some of the numbers and what I thought at year end. So one of these days I'll shrink it. Um hopefully next year. But I thought it was a good one. I've I've had some great feedback and there were some fun things in it that were pretty interesting. In fact, some of the things on uh little tribute to Warren Buffett on his retirement and his performance record that were astonishing. Um Yeah, give it a Let me take you through it, Chris, cuz I got I got a few questions. So, uh let's talk about let's just talk about Let's start with the overall valuation of the market and the play of Magnificent Seven, margins. Let's talk about that. What What's your What's your view? Where are we? Well, you know, I wrote I modified my note my notion that we were at a secular peak to a secular plateau. Yeah, I like that. I saw that. Going back to Irving Fisher because I thought we were at a peak in 2021, which on the whatever the S&P declined for the year 18 or 19% and the Nasdaq down 35 looked fairly prescient, but then you snap back with back-to-back 25% years. And so, valuations essentially at the end of 25 were either back to '21 levels and in some cases slightly beyond. So, uh I think for the cap-weighted large-cap US investor, uh prospects are pretty grim for a long-term horizon, 10 or 15 years. And I go through my five factors, and we can get into that. Yeah, let's do that. Uh well, huh Okay, so [clears throat] just just get right into it. Yeah. >> Um So, in '21, No foreplay. in 2021, you had a 10-year period where the S&P earned 16.6%. And you had just an explosion in profit margins and in multiples. Not much top-line growth, but you had the market trading at 22.something, 22.8 times a record profit margin of 13.3% and you know, we've talked about Warren Buffett having been wrong in his '99 Fortune article. You had a various various combination confluence of factors that that drove margins higher over time um a lower corporate tax rate certainly lower interest rates mean allowed very high amount of leverage on the corporate balance sheet to not be financed at much of an interest burden and that added about three full percentage points to the margin. Then you had the cap light businesses uh the big tech companies that sit atop the market now that they have been properly rewarded for a lot of revenue growth very high margins much more growth than you can get anywhere else and so I don't think the market got those wrong but they're very fully valued so um at at 22.8 on a 13.3 margin you didn't leave a lot for future return and so in the interim you had a big decline in margins in 21 and then a recovery so you're back up to 12.8% at year end so you're not back to the 13.3 but you're close but the the multiple is even higher. You're 26 times. um and you you can go through any combination of of the factors revenue growth what might happen with the share count which is actually rising in the last few years and stunningly for 25 years the share count's higher than it was despite an enormous amount of cash from operations going to share repurchases and so you know I've got a uh I've got scenarios by which you'll have margin compression and multiple compression and you get to a best case 10-year return of 5% and if it gets a little more grim you can make a case that you'd have negative returns much like you had after the stock market peaked in 1999 which >> You mean 5% compound or 5% over the entire Oh annual annual returns. Okay. annual returns and so you can play around with all those numbers but I ran scenarios to to get to the Ibbotson long-term stock market return of 10 and 1/2% so you know you're starting at a record profit or near record profit margin and a 26 multiple which is really at levels never before seen on high margins. I mean you can have a really high multiple under depressed earnings. If you're in a recession and earnings drop to nothing like they did in '08-'09, the market can trade at 40 or 50 or 60 times or can trade at an infinite multiple if you have losses which you had for a couple quarters. Mhm. But [clears throat] if you run a 10-year let me find this cuz I it'd be fun to get the numbers right. Um So if you take an expectation of earning 10 and 1/2 you're going to get there through some combination of margin expansion or multiple expansion. So if you hold the margin over the next 10 years constant at 12.8% it's going to require a 43 PE on a 12.8 margin and then you basically get your sales growth and what what what starts as a 1.2% dividend yield. So the prices are so high the dividend yield's low. If you do it at the other extreme um uh getting it all through multiple expansion uh or margin expansion you've got to take the margin from 12.8 to 20.7% holding the multiple at 26. And if you just simply do a 50/50 uh and combine your multiple and margin expansion you take the you take the margin up to 16.4 and the multiple to 33.3. So all you get is your sales growth and your dividends and then just an enormous amount of margin and multiple expansion which isn't going to happen. So there's there's just to me there's no way to make 10 and 1/2% unless you're in a hyperinflation and you just own tangible assets because you've got incredibly high inflation. but otherwise, if you have a rational economy, there's no way to make 10 and 1/2 in the cap-weighted S&P 500. Just to play devil's advocate because we're all in the choir here, but isn't isn't the thesis would be something like AI spurs top-line growth the likes of which we've never seen before. Or takes cost out in a way we've never seen before. That's true. How do you feel about that? >> Yeah. Um plausibly Um but I would take the counterargument and I in my AI section simply take the amount of CapEx that's now being spent by these formerly capital-light businesses and the dollars are so great that you're you've introduced trailing growing depreciation expense which begins as a fraction of your CapEx depending on your depreciation schedule. And who would have thought that Microsoft would no longer have net cash on the balance sheet? I mean Right. These guys have gone from CapEx being 12% of cash from operations to what's going to be darn near 100% this year from '23 to '26. For four years, you're going to spend all of your cash from operations on CapEx. That crowds out share repurchases. You It's It's requiring leverage and so you're already starting to see declining margins and because you're introducing capital intensity to these capital-light balance sheets, you're already starting to see declining returns on equity and returns on capital. So this may be the classic capital cycle where the dollars wind up being spent redundant redundantly by I mean, everybody doesn't need to be building their own LLMs. I mean, we didn't need we didn't need as many fiber optic networks as we're being built in 1999. You didn't need the number of track miles that we built in railroads 100 plus years ago, 150 years ago. Um So you'll have beneficiaries of of the tool we're a beneficiary of the tool. You guys are beneficiaries of the tool, but I don't know that the revenues and the profits uh will can can even plausibly catch up with what was $400 in CapEx last year by the hyperscalers, which is going to be north of $700 this year. And three trillion, let's say, cumulatively or higher by 2030. I mean, just last year's CapEx. For $400 Depending on who you listen to, the revenues that are being produced on AI are somewhere around 30 or 40 billion. So less or equal to the CapEx. Well if you're spending the CapEx, you want to make a return on the CapEx. And so if you're going to make a 15% return on capital you need 60 billion in profit and your revenues are half that. You extrapolate that out to three trillion dollars in CapEx, which is being depreciated and depreciated over somewhere between six, seven, eight years. And there's an argument as to whether the the scaler should have whether it was reasonable or conservative to extend the depreciable lives of chips from three or four years to five or six years. Well, that to me that's not the argument. It's the argument is the depreciation expense is coming, the CapEx is there. So on three trillion dollars to make a 15% return you have $450 billion. I mean, of of profit. I mean, Microsoft's revenues are $300. Each of the hyperscalers, you know, you take Microsoft, you take Amazon, you take Google, you take Meta, they've all just got somewhat north of $100 in cash from operations, which roughly equates to net income. So, the numbers in a four-year period of time, at least for those that are spending the money, don't make sense. So, I have a hard time thinking that you're going to get margin expansion from here. I think rather to the contrary, you're already seeing front and center margin contraction. And I think if if they really do spend the amounts that are suggested over the next three or four years, I don't think there's any way in aggregate society or the aggregate of the S&P 500 benefits enough to offset what's going to happen to these handful of tech companies that are spending enormous sums of capital. I guess the bulls would say that the uptake is still fairly low for ChatGPT subscriptions and so on, and probably there, you know, there are super users who are paying hundreds of dollars a month, so you transition the $20 plan to a $50 plan, and $100 to or hundreds of dollars to $1,000, and you get some more growth, and that's how they And then you look at Anthropic's been growing very quickly, too. They've like doubled their went from four to eight billion dollars over 12 months or something like that, which is I think they're like 30 billion, right? >> 30 billion. Yeah, it's been >> Yeah, it's it's in the enterprise world, it's in the business world where where you really generate revenues. And then on the offset of your Google or your meta, and you've already got an enormous advertising platform, the retail side of your business, the individual subscriber will will pay subscriptions. I mean, it's coming. They're giving it away at first. It's the it's the crack cocaine dealer. Uh but they're they're eventually going to charge you for it. Um but it'll be augmented with advertising revenues. I mean, Sam A Sam Altman said, "We're never going to advertise." And guess what? They're advertising. Um you you you just can't recover the capital without without trying to push the top line. But the numbers are stunning. I mean the the the numbers are already 1 and 1/2% of GDP on CapEx, and they're going to be close to 3% this year. They're enormous amounts of money. So, you think this looks something more like a a railway build-out or a um fiber optic cable build-out, both of which had very long lives, and chips have a much shorter life. So, I guess that's a that's a problem. I think that there are a lot of parallels. Um all of those prior capital booms from canals to railroads um to the auto and infrastructure and electricity. Um a lot of that was debt-financed or it was financed by the government {slash} the taxpayer. Uh the fiber boom was financed with leverage. I mean, it was the pipeline companies. It was anybody that had rights-of-way. But, the leverage that was introduced was enormous. So far, the leverage isn't that big. But, unlike a railroad that was building 100-year assets, these these things depreciate. Uh I was having a conversation the other day. I think what I what I haven't got my mind around, and maybe some that are a lot smarter in this space have, but will be the transition from from training to inference. And so, once you've built the models, and once you've essentially uh appropriated all of the all of the the the the knowledge in the world, um does does the does the chip in the data center cost of simply using the LLMs is is it materially lower? In other words, is maintenance CapEx a thing on the CapEx being spent now, or having built the railroad, does it become somewhat less expensive to maintain it? I mean, Warren Buffett talk talks about the trillions of dollars that would be that would be required today if you were to build the railroads from scratch in today's dollars and many of the assets are very, very old and fully depreciated. You you wouldn't do that, of course. And so, I what I don't what I have no idea what the capital intensity winds up being 5 years from now or 10 years from now. If it winds up being cap light and you just have a short period of time where you spend a whole bunch of capital, then I think you can you can lean more into and the scenario you just talked about, but the dollars are so large, I'm still I'm very skeptical. Yeah, I think I mean, one way [snorts] to maybe think about it is the the sources of data that are being used for the training. And so, right now, you know, it's been this the corpus of all of written history, basically, and you know, IP rights be damned, sounds like in a lot of cases, but you know, at some point we kind of run out of raw materials of original words that were put in orders for it to train on. And then, we need to have something else for it to look at. And that's where I think it's a little bit interesting when you think about other forms of intelligence, like language is one form, but there's also you know, a squirrel has a certain type of intelligence from just being out in the real world and experiencing data as it comes in of I put this I plant this nut here and then I can find it later. Well, it the modern equivalent of that might be robots who have all these sensors that can then learn in the real world like how things work, like a a real-world model of things, not just not just language-based. In which case, the training may be for as long as you I can see to incorporate these new data sets over time as they get built out. Um So, who knows? I mean, it's obviously starting to get into sci-fi stuff, but but it is interesting. Yeah, and I'm as an investor, I'm going to go back to the capital and the dollars being spent. And so you had the enormous sums that were spent on fiber. And massively redundant, massively overbuilt. You'd lit something like 4% of the fiber that was that was laid was actually lit by 2001, and then everybody went bankrupt. But had you not laid the fiber, you wouldn't have had YouTube, you wouldn't have had Netflix, you wouldn't have had all the streaming. And so there was an end user that benefited from it, but it was not the ones that spent the money. Mhm. Um Microsoft can spend I mean Google's going to outspend everybody on this. And they can do it. I mean I don't think there's unless Sam is continues to be um uh as apparently impressive as he is when he's raising money. Uh and he actually can spend 1.4 trillion dollars. Google's going to spend to make sure they're the ones that win this thing. But all the CEOs have said, "Look, we don't we probably don't all need to be doing this. We don't need five of these things. We don't need seven or whatever it is." Um so clearly portions of society are going to win. And because they're they're they generate so much money and they're already so big, they will grow and they'll have revenues that grow out of this thing. But I think it comes in the case of the tech companies at at a decline at at at at at at at a harming their profitability, harming the returns on capital. And Wall Street does not generally like paying 35 times for declining returns on capital. Um >> [snorts] >> so we'll see. I mean it's it's a hard thing and we don't have direct investments trying to benefit from it. We don't have direct investments other than a really tiny short on Nvidia, which is really just valuation um and the notion that I don't think they can maintain a 58% net margin, especially as this thing evolves, but um you know, as a user >> Also, probably a little under appreciated that, you know, when these guys were cap light and making all that money, they kind of ceded territory of different things to each other and didn't compete all that hard where they were inter- overlapping. But, it seems like this, you know, the LLM world is lots of overlapping use cases, lots of competition potentially, and and it's like you know what competition does to profit margins, right? Well, and and capital spending uh forces competition. Um especially when the sums are so enormous that you get redundancy. So, they will compete on price. Right. The enterprise user is going to negotiate and and play one against the other for capacity. And again, much like the fiber, you just don't you you didn't need it all immediately. So, we'll see. There's There's >> free there's free models around, and it seems like the the new model sort of makes the the old model obsolete in that the old model's probably pretty useful. So, I think there's going to be plenty of people using older models for specific tasks that won't need to update all the time. Plus, the Chinese free models that seem to be popping up. Right. Yeah, they're going to have to charge, but um you know, OpenAI, and I've got a I I went through and looked up all of their funding rounds and and where the source of their capital came from. Well, I mean, they by year end, before this last funding round, they'd they'd raised something like 73 billion, had already burned through 50 billion of it. And you listen to Sam A on an interview last year, and they were trying to tease out what his revenues were, and he said, "Well, they're they're 20 billion." And somebody said, "I I what Sam, it can't be that high." And uh essentially, what he's done in his mind is taking the current minute or the current quarter's run rate, multiplying it by four. Well, that's that's Kenny that's the stuff out of Kenny Lay when Enron was telling you that their revenues were the largest in the world and he wouldn't commit to the dollar revenue amount. Um Well, if your revenues were 12.7 and they've increased their funding rounds. I mean, they just raised over 100 billion at an 800 something funding round. Microsoft is only in on the first couple three funding rounds. It's something like 13 billion. Um Revenues [clears throat] need to come from somewhere. Uh If I had to bet at this stage who wins and who loses, Open AI probably loses this thing and in that case Microsoft wins because if Open AI doesn't make it, they own the IP. But Microsoft does. What do you think about the this potentially big IPOs that that might be coming down the pike? Is this good or bad for the average person? SpaceX Oh, I just can't wait. I I cannot wait to read the S-1s. Uh This is going to be the the entertainment value of the year. Uh particularly SpaceX's. To see what has happened with the shareholders the Twitter buyout with the leverage, Morgan Stanley being able to get out of their debt. I mean, I think you're going to wind up reading and and maybe they'll maybe they'll figure out a way to to not detail it in the footnotes. But you know, let's go let's just go Twitter. Um It pays whatever 44 billion for it. Put all the leverage in it. Um Elon's got equity. Uh Larry Ellison's got some equity. Well, the revenues immediately got cut in half from whatever it was, 4 billion to 2 billion and with the debt in the business, I think they had 1.2 billion dollars of interest expense. And so, they were burning through a whole bunch of cash. So, my understanding is and I couldn't get verification of this because I couldn't get the summary. Presumably, there were some summary financials, maybe not fully audited, but summary financials. But when Morgan Stanley and the others sold their debt, Elon said, "Well, we're making money." Thinking, "Well, how are you making money?" Well, my understanding is XAI paid a billion or a billion two as a royalty payment to Twitter, which get gets booked above the line, so it gets booked as revenue, not as a capital infusion. And so, you can say, "Well, we're generating a billion two of EBITDA because there's no cost associated with a with a royalty payment." Well, shortly after that, the the the the the guys with the debt got out of all of it. And immediately, the equity owners of of Twitter {slash} X lined up merging and owning XAI, and then they're going to roll XI into SpaceX. It's going to be really interesting. I've got a friend who's one of the largest investors in SpaceX. It's his largest holding. It's a big investor in terms of dollars under management, and he was in at one of the early funding rounds. Um Starlink is flex. I mean, it's Starlink is now started to generate an enormous amount of cash flow. Um but, if we're going to do this valuation at two trillion, I mean, this is going to just get into the the the the Elon stuff of pixie dust where there's to me, there's just no way to support it and data centers in space, and I guess we've backed off from data centers and populating Mars, having just sent astronauts around the moon. Uh the time it took, you do the miles to the moon and the miles to Mars. And I I think I think between uh these big techs, the the the the the offering documents are going to be interesting at a minimum. One of the things that Jake and I have talked about a little bit has been the strength of the S&P 500 last year because of the uh Magnificent Seven. And then Magnificent Seven seems to have fallen off, but not the S&P 500. It's managed to be The other 493 companies are now pulling their weight in the S&P 500, but um how do you think about the uh How do you think about that interplay between the concentration, dispersion? What's keeping the S&P 500 up? If if you If you continue with the cap-weighted and you and you pull out the Mag Seven from the S&P 493, the 493 were still trading at 22 plus to earnings. I mean, they're on a cap-weighted basis, they're still expensive. There's There's a There are a bunch of companies from Costco to Walmart to some of the drug companies that are still very very expensive, 40 plus times earnings that don't have the revenue growth or the potential the potential to expand margins to support it. Um under the hood though, when you drill down into uh and I hate doing um sectors, and I don't like doing market caps, and I don't like doing uh international jurisdictions, but there are a whole bunch of companies that are I mean, very very reasonably priced if not give away cheap. Um International markets had a big year last year for the first time in a long time. The The MSCI XUS was way ahead of the S&P. Uh and you've still got an enormous small cap versus large cap valuation disparity. The reality is, there aren't that many companies left. I mean, the Wilshire 5000 has something like 3600 components in it. Um and over all these years, a lot of the great businesses either grew to be mid-cap or large-cap companies uh or they were acquired. And so you've you've got an awful lot of mediocre companies, both smaller cap in the US and abroad, that just aren't great businesses. So again, I don't think the market's got it wrong, but the multiples being paid today uh for where the the money in the US stock market is concentrated, things are still pretty expensive, but from an active investor's perspective where you can buy differing sizes and not constrained by the the Berkshire Hathaway type enormous amount of capital where the pond you can swim in is pretty limited. There's an awful lot to do with money. Uh I think Semper's historical portfolio right now is probably as maybe attractive even on an absolute basis as it's been even not even relative basis. Do you do you agree with that? Well, we I mean we we made a a bunch of money last year. We were up 40 whatever percent, 42%. Um February of this year uh we were up something like 12 for the year, and then we were down every day for 3 weeks. So the minute my letter was out, I mean That's what cured the Every single day lost money, but then So I I think we wind up the quarter up about three for the year. But we've been very active. Um and by very active, this is not 100 150% turnover, but taking advantage of the tariffs last year, uh having invested a a big chunk of money in various um corners of the energy patch. In 2020, we bought a couple of refiners in the fall of 2020 for 1 and 1/2 times cash flow, Valero and what's now HF Sinclair, the old Holly Frontier. Numerous international energy assets, some of the integrateds. Um Well, we've taken advantage of A early um especially in the case of Valero, we trimmed it way back on the Maduro extraction, but then um Here with I would have predicted a run, uh but we've shaved big big chunks of our energy holdings. And And to me, they're cyclical assets that you can't own for 30 years. You buy them when nobody wants them. And when you get oil tight like it is and uh it it's pretty good time to trim those. But we've peeled back big chunk of the gains we had in Dollar General. We've been using gold as a source of capital. And so we're finding places at the moment that are really really attractive and really cheap. And so Yeah, I think we we probably ended the year at about 12 to earnings on the portfolio versus 26 for the S&P. And that's about where we've been historically. At the end of the prior year, we were 10x. And so you wouldn't have predicted a 42% return. But we also didn't grow the multiple from 10 to 14 because of portfolio activity plus ongoing earnings progression of the things that we own have things pretty reasonably valued. And uh we've really concentrated capital with the proceeds from the the not uh not small sales into six or seven companies that are very very very cheap. Um And so I I I like how we're positioned. We're we're generally pretty tax efficient with our taxable clients. But we are distributing capital gains this year. And And you know, like I I I don't hope that we have uh before year-end some unrealized losses. But we just don't have unrealized losses in the portfolio to offset gains where, you know, typically you do. Um But at the mo at the at the prices that that we're getting uh harvesting some of the profits that we've made on assets that you don't want to own for 30 years. Yeah. Uh it has to your point and to your question, um yeah, I portfolio is still pretty darn cheap. Do you feel like you've been able to move up in quality a little bit out of some of the more cyclical things that have started to work the last couple years? Yeah, if you would Yeah, I think if you'd say, "Well, energy is cyclical and it's not high quality just because it's cyclical." then yes, uh but we still have some cyclical things. And, you know, at some point the construction world is going to turn and even the housing market's going to turn. So, we're doing some things there that that would still be cyclical assets, but you're on the front end of the cycle instead of the back end of the cycle. Right. Um There was this There was this notion that we talked about in the fall, Jake, and it was just the whole concept of value investing. And there's a a bunch of our world that defines value investing as uh Warren Buffett's notion that you buy something and the the ideal holding period is forever. Well, that's Yeah, that's been the case at Berkshire with the wholly owned businesses, but his portfolio over the years has been very actively turned. You know, if you go through the list of holdings, uh which used to appear in the chairman's letter for years and years and years, you'd see wholesale changes and he tended to own various cyclical things. And then I think the other thing is the concept of 100 baggers and buying a business and owning it forever. Those are hard. There there aren't that many you can get. Uh and even where Warren screwed up with Coca-Cola uh having made a mountain of money buying it in '98 and '99 or or '88 and '89, got $1.3 billion invested by June of '98, he had the high-class problem where that was 30% of assets. 60% of equity was just Coca-Cola. And it went from trading from 15 times earnings to 58 times earnings. They had grown sales at 9% a year for that first decade that he owned it. And the margin went from 12% to something like 19%. But then the stock traded at 58X. So, he he later acknowledged he should have sold it, but he did essentially double Berkshire's assets nearly by buying Gen Re, which cut the Coke position in half. And got a I've got one of my five factors in the letter that showed Berkshire's Coke position compounding at something like 36% a year for the first decade. Well, what do you think the compound return has been for the last since '98? 27 years. per year annual Uh not much, low. four and a half >> four and a half, yeah. And the S&P was expensive. The S&P has only done eight or eight and a half, but Coke did four and a half. Like 60, 65% of the returns come from the dividends. Mhm. And so, you didn't have ongoing 8, 9% sales growth. Sales growth slowed. Margins no longer expanded, but the multiples come back down to the mid-20s from 58. And so, That That's what generally happens with the Everybody's got a list of the great compounders that have been phenomenal businesses in the last whatever period. Some of the the beverage companies, Pernod Ricard, Brown-Forman Yeah, Monster. And for years they would trade at 40, 50 times earnings. And once the growth is obviously and apparently slowed or you get some disruption in your industry or you overbuild, they just shoot these things and the valuations just get crushed. And so, in the ashes of some of that you'll find some great assets, but to me you've got to be willing to sell things when they're either on the back end of a cycle or if you've got a a business that's still going to grow, but the price is just wrong, you have to be willing to sell. I I you cannot have an infinite permanent holding period, I think. It's been really interesting to see a lot of the CPG companies, which were almost bond proxies five years ago. If you remember when everyone was like, "There is no alternative. Why would I want 1% T-bills? I'm going to own Campbell Soup instead." Like you heard that all the time. And now that whole CPG complex has really been taken to the woodshed. It's I find it very interesting how the narratives change on these things. You weren't going to get much more than nominal GDP growth and in some cases you don't even have that because taste change and Yeah, direct to consumers hurt a lot of that. Dollar brands. But a nominal GDP growing business that's already max profitable that's introduced leverage upon leverage upon leverage onto the balance sheet to finance share repurchases uh to finance incremental bolt-on deals they're not worth nominal GDP growing business that's got a lot of leverage is not worth 40 times. Yeah, you shouldn't do a 2% earnings yield on that. No, Costco's one of the best business in the world and it traded at almost 60 times earnings a year ago. It's still trading at 50. I mean, and I love the company. It's it's the probably the best run business I've ever encountered. We've owned it. I still own little stubs in taxable accounts where my basis is $19 a share. But you are not going to make money owning Costco. You're not going to make much money owning Costco at prices above or at where they are today. I mean, there's and there's just a number of those companies that have been the best businesses in the world. But price matters. I guess Let me let me do a quick shout-out around the horn. And then J say you get some veggies for today. We I do. Okay. Pit a tick for Israel. What's up? Pittsburgh, Tampa, Florida, Philly, Valparaiso, Boise. Wasan, Switzerland, Breckenridge, Bethesda Fredericton, Canada Toronto, Wagga Wagga, Australia. What's up? Tallahassee Zagreb, Madeira, Ireland That's in Portugal. You've already won. Skip ahead. Uh Moss Feldspar, Iceland. How did I go with that pronunciation? Let me know. Vancouver, Bologna, Italy. What's up? Jamaica. Nice. What's up, Monique? Uh JT Veggies, let's go market folks, 6 minutes past the hour. Cincinnati, Ohio, last one. Okay. So, uh you know, Iran war happening. We're going to be talking about war. Uh but actually there's a little twist to this cuz I know Chris is also a sports fan. So, we're going to be talking about war and baseball. Uh so, Babe Ruth hit 714 home runs. And by this modern measure of war, you know, he wasn't maybe even the most valuable position player of his era. It might have been Rogers Hornsby. Uh that probably sounds wrong, right? Cuz Ruth is sort of the patron saint of home runs. You're the Babe Ruth of XYZ, uh you know, it's the best of all time kind of thing. But but war says otherwise. And war stands in baseball for wins above replacement. Uh and it's it's asking a different question. How many wins did this player produce that the next guy in line wouldn't have done? And what does this like next guy in line really mean? Uh this is actually more like a bench player, AAA call-up, a minor league veteran on a one-year deal. Every team in baseball has access to this uh replacement player at a minimum cost. Uh he's not average. Average is actually pretty good in the league. Replacement is the floor. Uh you know, what can you get if your starter goes down and you have to grab someone off the waiver wire on a random Tuesday afternoon? This is the baseline that war is built on. And and it changes really kind of how you think about the value of things. So, this uh >> [clears throat] >> war puts a number to all of this. And once you have this baseline, you you need a unit of measurement. And and for baseball, this is it's runs. And every action on the field either creates a runs or prevents the other team from scoring runs. So, a single, a walk, a stolen base, a diving catch in the gap, like all of it gets translated into runs. So, a home run is worth more than a double. A double's worth more than a single. A walk has value because it doesn't make an out. That And this last point sounds kind of boring, but it sits at the center of the modern game right now. You know, Bill James spent decades arguing that avoiding outs was undervalued. And Billy Beane read about this, and he built a playoff team in the Oakland A's in 2002 that was, you know, now Moneyball. And And every front office now in baseball understands this. So, but then let's let's add in base running, which is even more subtle than hitting the ball. Like, going first to third on a single, tagging up on a fly ball, not grounding into double plays. None of these things show up in the highlight reels, but over 162 games they they really do matter. And and a good base runner might generate five to 10 extra runs a year just by making smarter decisions on the base paths. And and that's worth, you know, roughly one win. And defense is where WAR really starts to get kind of messy because, you know, hitting produces these clean events. You A pitch is thrown, contact is made or it isn't. You can count the result. Defense doesn't really quite work that way because, you know, did the did that shortstop make a great play because he was positioned brilliantly and he knew that a changeup was coming and that the batter was likely to be early, or was it because the ball was hit right at him and it was just luck? So, defensive metrics require quite a bit of estimates. They look at thousands of similar batted balls and ask how often does an average player convert that into an out? And so, players who consistently make like the low probability, the spectacular plays, they get credit for that. And and different systems make different assumptions. So, this is why there's a FanGraphs WAR versus a Baseball-Reference WAR. And sometimes they disagree by on a player based on their assumptions. And so, once we take everything here and denominate it in runs, WAR is this final calculation, which is converting the the runs into wins. And that's typically like 10 to 1. So, 10 extra runs that a a player produces translates into one extra WAR in in their season. So, let's get a little bit of the scale for some context. You know, zero WAR is a reprice a replacement level player. Two war is a solid everyday starter. Five war is an all-star. Eight war is like an MVP candidate. So, and Mike Trout has had seven seasons above an eight war, which is why he's going to go to Cooperstown someday. Babe Ruth had 10. And you can sort thousands and thousands of players over decades by this one number. And you know, [clears throat] it's important to note that war is has some context to it. Like there is Actually, it's it's it's actually context neutral. A home run in the third inning of a blowout game counts the same as a home run in the bottom of the ninth of, you know, game seven of the World Series. Like there's no real clutch factor to it. And that's kind of what makes fans often not like it. You know, because those big moments feel different. Like you want to You need that clutch player, right? So, but war strips that all out on purpose. It's trying to measure an underlying ability, not not the situation that the player happened to be walking into. Um and so, it obviously it has limits. And here's we'll try to stick the stick a little bit of an analogy. So, the reason [snorts] that maybe some of this matters outside of baseball is that that same kind of logic applies anywhere where capital and talent might be getting allocated. And maybe we'll talk about M&A as sort of the cleanest example. Research indicates that roughly 70% of acquisitions destroy value for the acquiring shareholders. And that the average premium paid is somewhere around 25 to 35% over the the market price that time. And that that premium has to be earned back through synergies, which are usually overestimated by at least half on the revenue side. And they almost always arrive years later than than the the slide deck promised. So, CEOs will justify a deal anyway by pointing at the accretion that happens. They're looking at the earnings per share number. Oh, it went up. So, the deal must be working. You know, and AOL bought Time Warner in 2000 in a deal that was accretive on day one and went on to then vaporize roughly $200 billion. And HP bought Autonomy for $11 billion and wrote it down $8 billion the next year. But both deals cleared this EPS accretion bar in the slide deck, and both were total disasters. And so accretion here in the EPS is a bit of a a financing trick. It's almost like RBI logic. The actual question is what that what could that cash have been used elsewhere? So, you know, typically the cleanest alternative might be buying the company's own stock because management should likely know that asset better than any other potential target, right? And a buyback at a fair price is sort of that replacement level capital allocation move. It's almost like a war. It's available. It's typically pretty cheap to administer. Doesn't require a 30% premium, you know, or 3 years of potential integration risk. And you usually get to size it kind of however you want. So, most acquisitions measured against that bar instead of this imaginary do-nothing bar are negative war deals. They look like eight war signings on the on the day, and they turn out to be like zero zero war contracts on like but paying all-star money for it. So, [clears throat] Babe Ruth Babe Ruth hit 714 home runs. War War doesn't take that back. Like that still counts. But what it does is kind of widen the field of what does count. You know, the walks count, the defense counts, the first to third on a single counts. And none of that really looked a much like anything in 1925, but it all adds up into wins, which is what you're really trying to get towards. So, and markets kind of work in that same way. The obvious things get priced. The subtle things often wait around to be measured. And war is just one example, you know, someone deciding to count subtlety. And so, of course, you know, markets eventually arb every every edge, everything that you would count, just like you know, walks in baseball have have been arbed away. But you have to kind kind keep looking for new approaches to arrive at value and but while still not sacrificing your principles. So, there's a little bit of baseball brought into to the investing world. For the lay fan of baseball or for the investors that don't follow the sport, I if I may Jake, I'll just summarize what you're saying. You've got >> Please. the entirety of MLB trying to figure out how to optimize their war to be able to beat the Dodgers, which they won't be able to do. That's the Yeah, I think salary cap or lack thereof might be one of the issues. Um Chris, for the last 15 minutes, can we talk about where you're finding opportunities sector wise, factor wise, size wise? I mean, country wise? What what what what's interesting? Oh, like I said, the starting to get some money invested into the home building type world. Um I guess you'll see tomorrow we just bought position in builder supply. Um Uh I still think Deckers is pretty cheap. Um >> [clears throat] >> working through whether that's a value trap. If you don't know the company, they own Hoka and Ugg. Uh they're two primary brands and Hoka's doing 3 billion in revenues on running. Their Their Swiss competitor's doing three as against Nike's 30 billion of shoe revenue out of their 50 billion. So, those two companies have taken meaningful market share. Ugg does 2 billion. It's been around a long time. Uh stock traded at above 200 like 250 uh couple of years ago and our basis in it is not much over 80. Uh it's trading a little over 100 today, maybe 108, 109, but with a billion and a half of net cash on the balance sheet, we bought it at 12 times earnings. So, it's pretty clear that the Hoka brand in North America going to slow. They've got a lot of room internationally. They do 40% of their business direct to consumer, which is much higher margin. I like the management team a lot, but I've got price as a margin of safety, so maybe it's trading at 14 times. Um margins will come down. They've got the highest margins in in the in the athletic shoe industry. Um Uh we've got some international investments that I won't name specifically because we don't have to disclose them, but trading at some Norwegian and Swiss companies trading at kind of five, six times earnings. Um We've been trimming gold only because we've made so much money. The position size has got very big and so when I buy something I tend to force myself to sell it. So >> that, you mean the miners, right? Not not the The miners. Yeah. But let's talk about builder for a little bit because I think that you know, it's not to talk about builder specifically, just the uh housing and construction is is interesting at the moment because the number of sales that are going through um are are lower now than they were in the 2008-2009 global financial crisis. And there are a lot of theories why. One is interest rates are too high even though I think interest rates are sub the long-run average. Um the other one is just there's a huge divide between buyers and sellers in the market. There was a chart doing the rounds yesterday that showed that we've never had so few buyers and I think there are twice the number of sell sell you know, it moves around a fair bit. But the idea is just that housing is as expensive as it's been. Median house price relative to the median income is as is as expensive as it's been in the data going back 50 years or something like that. So it seems like we need to have house prices come down pretty materially before buyers move back into that market and that that has knock-on effects for all of the housing industry and so on. So, there are a lot of housing and constructing construction businesses that are not doing as well as they might be. Look better when the cycle ticks up a little bit. What what's your thesis there? I think there's a there's a nuance to how the median housing price is calculated that that distorts that perspective a bit. Uh you've got this apparent huge rise in median household prices. Um but if you go back a handful of years when the mortgage rates were sub-three two and five eights, two and three quarters, everybody refinanced their mortgage. And when mortgage rates crashed through six and spiked up to seven and eight if you were in a two and three quarter percent mortgage and your household income and assets were not at the upper 1% or top 5% of the population, you were not selling your house. You were not trading homes unless you moved and your house is not going to sell unless you died because you're not leaving that two and five eights mortgage. And so tran- the transactions that have taken place nationally tend to be at higher home prices. So, that makes the median household price appear as though it's moved up. And it did move up for inflation and and lumber costs and construction costs and labor costs. So, it is higher. But it's not so much higher. So, you're starting to see in the last three four years you're starting to see the proportion of 30-year mortgages that are at 6% or higher start to move up because you do have activity. You relocate your job. There is transactions there are transactions taking place in multi-family and in smaller homes, but it's the preponderance of activity is in larger homes. To me, it's interest rates. At at a at a level of rates somewhere south of six, which is about where you are now at five or four there's a I I think there's an enormous amount of pent-up demand for homes. Uh you don't have much construction act- activity, so I think you're probably going to have somewhat of a shortage against all of the young generation that are living in their parents' basement, so they're living below their lifestyle expectation of where they want to live and where they want to move, but but they're not going until the mortgage rate makes housing prices more accessible. And so, I don't know what it's going to take to get there. It'll certainly get there in the next recession. If you have a bad crisis or if you have another panic, uh the Fed, because they've shrunk the balance sheet from 9 trillion to 6 and 1/2 trillion, they they have room to do at least another or multiple rounds of QE. And so, I I almost think the housing market and the construction market as a surrogate of that are pretty good recession hedges in that if things get really bad, my guess is you're going to see more real estate activity uh from the pent-up demand and the prices of some of the very well-run home builders like an NVR or a Lennar uh have come in. We We bought builder supply, think lumberyards, but with higher margin product that home builders like. So, instead of stick build, they've got full truss systems and full siding systems and wall systems. It's a very well-run company. Um So, I don't know. I I I But, I can't give you a timeline. I just know that the prices as the stocks have come down and down and down and down are starting to be pretty attractive. And um you know, time will be the enemy of making a bunch of money, but if if the economy gets worse sooner than later, I think they become a similar hedge to bad times like a Dollar General has historically been where you get trade downs from uh the middle class, uh but you also get uh an accelerated use of snap, which are food stamps. And so, there's I I think I think in housing and construction >> [snorts] >> there's a bit of a I think there's a bit of a contra-cyclicality to them because of what's happened in the last five or six years with interest rates that make these things pretty attractive. Do you have a view on oil other than when when it spikes like this you try and bring back a little bit? Do you think that it's a risk to the rest of the economy if it stays elevated? Or do you think these levels are are fine given the changes in just inflation over the last five or 10 years? And we've heard that argument that the the price of oil might be its own kind of like Fed funds rate in a lot of ways. Um, I don't know. We have clients that trade oil and energy um, that until Iran, um, couldn't make much of a long-term bull case for oil. We do have steadily growing 1% a year increase in demand for oil. I mean, the world thought a few years ago you wouldn't have the global uh, consumption of north of 100 million barrels and you're 7 or 8 million barrels north of that. Um, my working assumption is we get through this Iran thing, um, sooner rather than later. Uh, you've got an awful lot of disruption in the meantime, but here's another place where where I think we're taking great advantage of this short the short-term pain. Airlines are going to just lose money because they hadn't hedged out this immediate spike in fuel costs. So, you'll see in our 13F that gets filed tomorrow, we've made Alaska Air despite airlines being terrible industries. Alaska's really well run. They're working off a merger. They historically have run kind of net cash on the balance sheet, which is very aberrant. But, you know, they're they're more exposed to the surge in jet fuel prices than some of their competitors. They've added international routes and now they're flying to Asia. They've got some longer haul. They fly to Mexico. They fly to Hawaii. But the stock traded into the low 30s and it's worth a heck of a lot more. And so, with oil having come back down the last few days on the apparent uh peace negotiations underway, oil's decline, the energy stocks that we've been selling have declined, and Alaska, it's up like it's up 7% um this morning before we jumped on the call. So, we're delicately long some places that I think will benefit from oil reverting kind of mean reverting back to where you were. But if you get a protracted war and uh if you don't run if you don't run refining and energy assets, yeah, you start to have problems. But I think we're a long way from that. What about the destruction that seems to have gone on through the Middle East? Yeah, I don't know. Qatar had some of their LNG uh terminal assets uh harmed, something like 20% of their assets. I don't know how durable that'll be. Um uh I think you've got enough ability to turn the crank even from the US perspective. I mean, you know, we we we can send more LNG. We're putting a rope around the Chinese at the moment. We've gone after their proxies, been going after Venezuela, going after Iran, most likely Cuba next um rightly or wrongly. Um >> [clears throat] >> Uh I I I I've done a lot of reading. I don't think we've durably harmed energy assets. But if we if we take out a million or million and a half barrels of Iranian capacity to refine and export. I mean, they import things like jet fuel. Their their their refining capacity is is not the complex variety that Valero and Holly have here in the US. I don't think we've done much damage, but if we or the Israelis bomb Kharg Island and some of these more durable um energy assets, yeah yeah yeah you could definitely have a problem. You could see oil price a heck of a lot higher and if that's the case, uh we're not going to make money at least in the short or intermediate term on something like an Alaska Air. But I I don't know. I think I think we're I think we're close enough to the end uh that if we get through it, you'll have oil back at 60 in pretty short order, I think. But who knows? I mean, It's always the challenge of value, right? You got to buy it in the middle of the crisis not knowing when the crisis passes. But knowing that eventually it does. Yeah, you didn't know you we had no idea how quickly we would clear COVID and the lockdowns. Um but at one and a half to cash flow, yeah, we were buying Valero and Holly and right after we bought Holly, they bought a refinery in Washington state for 350 million, 250 million net of inventory, finished product and and raw crude. Um and then the hands of the management team it's a better asset than it was when Royal Dutch Shell ran it. And so they basically paid one times cash flow and stole the asset. Um California, uh I mean, you know, Valero's closing one of the refineries. Phillips is closing a refinery. I mean, there are places in the world that have very irrational energy policy. Um and you we can take advantage of that. Holly can take advantage of that by distributing uh via rail um to California. Um I don't know. I I'd I'm not sophisticated enough on geopolitics or on pandemics to know the outcome, but I mean generally these things in my 35 years investing, whatever the imminent crisis is front and center tends to resolve itself. And when it resolves itself oil will be lower and airlines will be higher. Um, we've got about through the any of the SAS apocalypse names? I mean things are up quite a bit and I don't it's kind of not traditionally been where you where you look, but you know, at some point there's a price for every asset, right? No, I mean doing a bunch of work on service now at the moment. Um Okay. Adobe, I mean there it There there are there some clear businesses that are harmed and a service now might be one. They enjoy very very high margins, so I don't think they're going to lose in in the IT world that they cater to and their big S&P 500 Fortune 500 clientele. They're not going to get displaced from the processes that are in place, but incrementally they may not drive 20 plus percent revenue growth. And if you do get a disruptive competitor via AI that uses much cheaper tool at the margin you'll see margin compression pretty severely. Um In the ratings world and some of the businesses like an S&P Global's very interesting. Moody's if it gets cheaper very interesting. Um But the SAS things are so funny because you look at them and forever they traded at crazy multiples to revenues and crazy multiples to earnings if they had them and there's just been an awful lot of evisceration and anytime you get this sometimes it goes too far and sometimes it doesn't, so we're spending a lot of time on it. Uh, Chris just we've got about a minute left, but I just thought you might want to say some words about Buffett stepping down. It's one of the sections in your letter. Just recover what you discussed in that. In 1 minute um >> [laughter] >> Yeah, some of the Buffett It wasn't It was 2 minutes before we started talking S & P 500. It was my 180-page letter. Of 90 or 100 was um Berkshire and I I do have a tribute. So, I won't get into the math, but I'll I'll leave it at I mean he was the best investor of all time, but he was also the best operator in terms of running a business with morality and ethics and executive compensation. And he was just such a great mentor to all of us in terms of how to behave with honor. It's something you don't see in a lot of places, but the performance track record, which is just a a component of it. I've got a section starting on I don't know page 95 of the letter. And I had that I had the the I I told Warren in in a note a few years ago that I did the math It's just a quick simple algebra that Berkshire could lose 99%. 99.3% of its market cap and share price and still outperform the S & P 500 since he got control of Berkshire in 1965. And he said wow, that's Ben Graham would be proud. That's a testament to compound interest. And so I mentioned that to Charlie a couple months later at the Westco meeting and he said Chris, this is it's just compound interest. That's nothing special. And so I just >> [laughter] >> This is basic math. >> I've got a I've got a So, I in in doing my long-term compounding against the Ibbotson, it dawned on me. Well, I'll just tell you I'll take 30 seconds. So, what one day in the history of the US stock market one what what single moment would be would be the best time to buy the stock market via the S & P 500? I guess like the '29 low? The '32 low. '32 low. June 1 of '32. The S & P had fallen 86%. The the Dow had fallen by a little bit later in in July, 89%. So, if you bought the S&P 500 on an 86% decline, and owned it through today, you've compounded at 12.2%, which is way better than the Ibbotson 10 and 1/2. And had you bought the peak in 1929, you compounded at something like nine. Well, over a century, that's huge. Instead, had you bought the S&P 500 at the low, the absolute day of the low, and held it until September 30, 1964, which was the end of Berkshire Hathaway's 1964 fiscal year, and been willing to lose 99% of your money, and put all your remaining money. So, so $100 from the low in 1932 to 1964 compounded at 15 and 1/2%. From $100 invested to $10,000, you go back from $10,000 to a hundred, buy Berkshire, and still have outperformed with Berkshire. So, essentially, sit on cash for 33 years, 32 and 1/2 years, earning absolutely nothing, and then buy Berkshire, and in a third of a century shorter, compound $100 in Berkshire's case to 6.1 million, where the S&P 500 from 1932 grew to 4 and 1/2 million dollars. So, it it only grew to $45,000, the S&P being it from 1965. So, essentially, you can lose 99% twice in Berkshire's case and still would beat the market. And I think Charlie would have been impressed with that. With that figure, even though it's simple mathematics, compound interest. Uh amazing. Uh on that note, Chris, if folks want to get in contact with you or follow along with what you're doing, what's the best way of doing that? Well, I used to say check me on Twitter. I'm not on very much. I did post something on Cathie Wood on the weekend, but Shots fired. I caught that one. That was For for sure our website. So, we've got the archive of a bunch of our annual letters on the website. And then any interviews or podcasts we tend to post. So, whenever you guys post this thing um you know, we'll put the YouTube link and the podcast link on. So, we've got I don't know, 20 or 30 or something interviews and podcasts in addition to all the letters on the website, semperaugustus.com. JT, any final words? Just always good catching up with Chris. Thanks for coming on. >> Yeah. Christopher Bloomstran, Semper Augustus. Thank you very much. Thanks, gents. Uh folks, we'll see you next week. Um