The Dividend Cafe - A Fool's Game

Episode Date: July 15, 2022

I send this week’s Dividend Cafe at the end of a 24-hour trip to Las Vegas, where I spoke at a conference yesterday. 2,600 people have come to the 110-degree city of sin for the purpose of hearing various economic and political musings, and one such forum of musings was a panel with myself, Steve Forbes, George Gilder, and Mark Skousen discussing, of all things, my book! It was a surreal experience to be next to Gilder, whose Wealth and Poverty was a transformative book in my intellectual development as a pretty darn young guy (you would actually think less of me if you knew how young I was when I read it). Anyways, by the time you read this, I will be on a plane back to New York City Friday afternoon, where I will be working all of next week before returning to Newport Beach next weekend. We are living in a time where there have been more bad ideas than money to invest in (or at least bad prices at which to buy those ideas). Soon we will see more money than people acting on bad ideas. But right now, a little parsing out of what the laws of contrarian investing mean is in order, and I think you will find it fascinating. Jump on into the Dividend Cafe … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe. I am your host, David Bonson. I am recording from my hotel in Las Vegas where I've been here for just over 24 hours and now as soon as I'm done recording I'm going to head back to the airport to fly back to New York City. I actually put a picture at divinitycafe.com because it was kind of fun for me. Yesterday I gave a couple different speeches at this conference I'm at and one of them was a panel discussing my book There's No Free Lunch wherein I kind of lay out my basic case for restoration of the fundamental principles of economics. And joining me in that panel were

some of the people that actually quote in the book, Steve Forbes, George Gilder, Mark Skousen, some pretty well-known economists. And in the case of Gilder in particular, someone who was a profound influence on me intellectually. So it was an enjoyable experience. And getting back to New York City will be enjoyable. It's about 110 degrees here in Las Vegas. Not that I've got to spend much time outside. But I am looking forward to a very busy week in Manhattan next week before returning to California. I've been out on the East Coast for, I think, six weeks besides this little Vegas

jaunt. So all that to say that with the travel and all the time on the plane, reading, writing, thinking, reflecting, talking economics with a lot of people, and not to mention a reasonably volatile week in markets. I had plenty to choose from in my topic today, but it was actually a quote that I have heard, you know, countless times over the years, but rereading it in a research paper from my friend, Louis Gov of GovCal Research, that kind of inspired what I want to talk to you about today. And I want to give a little primer, a little refresher, if you will, on this idea of contrarian investing, of the wisdom of investing against the crowd, not with the crowd.

And the quote I'm referring to is essentially this notion that you really can do great investing when there is more money than fools, and it is very risky to invest when there are more fools than money. And I want to give you the caveat I gave those who are reading Dividend Cafe, because I am always a little uncomfortable at the idea of coming across more pejoratively than I mean it. When you're kind of calling the bulk of people who are investing at given times fools, I guess that does sound a bit pejorative, insulting, and condescending. And there's a sense in which that is exactly the intent, but that is not my intent in any kind of a personal or serious or directed way. It's an abstract, generic reference to the fact that there is often rampant foolishness.

often rampant foolishness. And that when there are more foolish things going on, then capital ideas to invest in, it is a very dangerous time for people to deploy capital. And when the inverse becomes true, there are better opportunities and less foolish people kind of polluting that trade-off, it can become very opportunistic. And so I think what that mantra misses, and this is where we get to kind of the heart of what I'm referring to about contrarian investing, is that saying you want to avoid being the foolish investor, the person who's chasing a bad idea, a person who's divorcing what they want to do with their capital from reality, from the laws of nature, from the basic principles of sound investing. When you want to do that, you force yourself into a period of sometimes sustained unpopularity. It could be short-lived,

but it could be longer. And that is the sacrifice that a contrarian investor, a successful contrarian investor has to make. And so let me kind of give a little context as to what I'm getting at here. I believe that investing is the deployment of debt or equity capital. You know, you taking your funds to deploy into some sort of project that is going to be cash flow generative. You're trying to capture a risk premium. You believe there will be future earnings generated or future ability to service debt and repay interest in principle in the future. A real estate investor that's going to generate a rent income, some sort of intellectual property, a trademark or a patent that is going to be paying a royalty. There is some form of future cash generation that you're trying to capture a return on.

And we can talk about how long that period will be, how quickly you think it may materialize, what will be the kind of eventual catalyst to this cash generation. There's all kinds of variables around it. But fundamentally, that's why people invest money to exit with cash now to get more cash later. And in equity, that generally has to do with profit generation. and in equity that generally has to do with profit generation. The cash generation comes from the materialization of earnings in debt. It has to do with the ability to pay a coupon and also repay the principal. And we know with real estate, it has to do with, again, creating a rental flow or creating a value that is going to drive higher cash generation at a sale, things like that. That's what investing is. You can come up with any other example criteria you

want. If it is divorced from some form of future cash generation, then it's not investing, it's speculating. And you can be wrong in what future cash generation will be an investment that is meant to target a future cash generation but then some new technology or new competition comes or there's mismanagement or or an unforeseen circumstance that's okay that's unfortunate but again it's within the kind of intent of sound investing when people get off of that and then callously and explicitly state oh come on all of that nonsense is out the window that now there is a new game in town and you can fill in the blank with whatever you want. We've lived through in just 25 years, we've lived through so many examples that it's becoming embarrassing to talk about. But

really, if you study history of this for centuries, and the only reason I don't say millennia is because I don't think there's much documented about investment manias and the foolishness of crowds prior to, you crazed investing predated the 17th century. But whether you're starting at Tulip Mania or just starting when I kind of became an adult investor in the 90s, and you're looking at dot com or, you know, the Japan bubble of the late 80s, The Japan bubble of the late 80s, the real estate insanity of the 2000s, and then more miniature versions, you know, post financial crisis, the Chinese kind of reverse merger IPO deal was a smaller scale version. But again, it was one just totally divorced from any real, actual investing thinking. And then now, it's gotten pretty serious. Now it's kind of at scale again. You know, there were a number of things that I lumped together as shiny objects for my nomenclature purposes the last two years. But if the vocabulary is being more precise, it would probably even separate out that, you know, the crypto and Bitcoin world was different from the kind of work from home stock or innovation tech stocks or the SPACs, the solar or EV, you know, there's been a number of different things.

And what I would say is, yes, you had a great growth in the people that wanted to go invest in these things. And there was a period of time where they were all going up. But see, I don't know of very many exceptions to that rule. It can, in hindsight, look foolish, but it basically only looks foolish in hindsight, other than for those elect few that maintain a true commitment and conviction about fundamentals, about investment principles throughout. But there's generally always a period where people first decide that there is this kind of new idea that's going to buck the trend that defies the laws of nature. And there's always some kind of prima facie reason why this time it's different. And then it lures people in. And then there's a period where it looks really smart. And then there's a period where it doesn't. And I believe that the conviction that goes with investing against those manias, it's not merely

as simple as saying, they're a fool and I'm not. It is because there will be a period where you're tested in conviction. The conviction to be able to ignore these things when they're continuing to go high is hard to come by. But I would argue that human nature, without personalizing to any particular person, a particular fad, a particular example of a craze, human nature will always be a failed investor. Um, it, human nature will always be a failed investor. Uh, human nature is itself prone to the delusion of crowds, to the, um, euphoria that comes with a mania and the panic that comes from hyper fear. And that there is some wisdom in both resisting what the crowds do and in fact investing against the crowds at those points of peak mania and and so forth that uh that really kind of uh delusion on steroids moments that we see um represent truly great contrarian opportunities. And this works both positively and negatively.

Sometimes things can be so incredibly unpopular, they're irresistible. And sometimes things can become so very popular that they really require our resistance. And yet I think this requires a discipline, an emotional fortitude, and a mindset about investing that is often hard to come by. History can be our guide, but the reality is human nature doesn't change from history. And as I've talked about quite a bit, oftentimes history just repeats itself right away.

Like we went straight from one mania and blow up to another. The only insulation I found, the only kind of immunity is, in my opinion, unrelenting commitment to sound investing, to a remembrance of what investing is, to the willingness to be insulted as old fashioned because you actually care about cash flows or profits or return of capital to shareholders. Now that might sound like it's all reference to dividend growth, which is, of course, what we do and believe in. And we do it and believe in it because it does replicate that. But there's other ways to do sound investing besides dividend growth. Don't get me wrong about that. I would make my argument for why I kind of believe dividend growth checks all the boxes in

better ways than others and so forth. But that's not really my agenda today. My agenda is just simply to say that there is sound investing that is going to have fallibility and there's unsound investing. And the pursuit of one unsound investment and then replacing it with another unsound investment, that's a pathology. It requires some form of reform and rehabilitation. Our reform and rehabilitation is that we, not only at our firm, but what I advocate on the Dividend Cafe and what I want you all to hear from me is the resistance to it is an understanding of human nature and a willingness to say that we would rather pursue good money opportunities than fools, than foolishness. And that makes you a

contrarian. It makes you countercultural these days. And it also makes you a better investor. You don't have to scream from the hills about good investments that have coherent conviction and a rational thesis behind them. It's one of the things I think is most evident about some of these kind of shiny object things that have blown up that throughout the last several years even in their periods of going in the right direction for them the people were quite angry in their defense of some of these things um i think a lot of us probably know full well what I'm referring to, the kind of personality of a lot of the various crypto Bitcoin investors that were not content to just hear that, oh, you know, blockchain has some real efficiency and utility into the future. But fundamentally, that had to mean, therefore, that this kind of, you know, permanently escalating price was what lied ahead.

You do not need to be angry to defend an investment you believe in. I use dividend growth as an example. I talk about it on television a lot. I write about it. I talk to you guys about it through video and podcast. I don't care to scream about it. I don't feel angry in my defense of this. I have a very high conviction and I'm really comfortable in my own skin about dividend growth investing.

There's been decades of research and analysis and testing and belief system reinforcement here. I think that when you see people that move to this hyper emotional place in defense of crowd category versus coherent, rational investing category. And those hints have to do with the anger component I just talked about. It has to do with those cultural indicators. We joke about magazine covers and Super Bowl commercials. I don't know if it's really a joke. I mean, how often does it have to be true to say this isn't funny? It's just the way it is. It's the way the world works.

It may not change anytime soon. Human nature is not going to change anytime soon. My encouragement to you in conclusion is to be content to have periods of time where you look foolish for the purpose of avoiding foolishness. That there are good, sound investments out there that flow from good, sound investing thinking. And to the extent that you do this, you will be rewarded. And you will stay off of the hamster wheel, a boom-bust cycle, a folly gambling speculation, and yes, foolishness that unfortunately is defined an entire personality and pathology of investor for so long.

We work for that to be different for you. I hope this is helpful. Reach out with any questions. I will let you go here. I will look forward to joining you next week from New York City. And in the meantime, have a wonderful weekend. Thanks for listening to and watching The Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower

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