We Study Billionaires - The Investor’s Podcast Network - TIP 117 : Value Investing Legend, Bill Miller (Business Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 117 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is the Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish, and Stig Broderson. Hey, hey, hey, how's everybody doing out there?

Starting point is 00:00:31 My name is Preston Pish, and I'm your host for The Investors Podcast, and as usual, I'm accompanied by my co-host, Stig Broderson out in Seoul, South Korea. And hold on to your hats, folks, because today we have one of the biggest names in finance with us, and his name is Mr. Bill Miller. Bill has been named Fund Manager of the Decade by Morningstar, and he's been ranked as the top 30 most influential people in investing by smart money. He's the former chairman and chief investment officer of Leg Mason Capital Management, and he has a very long list of similar titles and accomplishments. So let me give you some numbers here. In 1990, Bill was managing $750 million. And within 15 years, that was up to $75 billion. He beat the S&P 500 for 15 straight years.

Starting point is 00:01:21 And just if you're wondering what the odds of doing something like that is, it's $1.2.3 million. That's how hard that is to do. So I think I speak for everyone, Bill, by saying, thank you so much for taking time, your valuable time out of your day to talk to us. I know our audience are huge value investors. We're big Warren Buffett followers. So having a person like you on our show is just so exciting. And I know our audience is going to learn so much. Great question.

Starting point is 00:01:49 Thanks for having me. So let's dive right into this. So I think for me, when I was thinking through these questions, the thing that I really want to know when I'm talking about, to a person that's at your level is where do you see yourself as far as having differences from a Buffett or a Joel Greenblatt or any other famous value investor that I could name, what makes you kind of stand out or what do you think is one of your things that you do a little bit differently than a lot of those guys? You know, I answered that a little bit obliquely and say that every investor, every value investor that I know and know well, I know most of them

Starting point is 00:02:22 pretty well, all of them have a unique style, something that they do that's a little bit different. And I've made the comment that if you showed me a portfolio of 20 value investors and then the names on the other side, I could probably match the portfolio up with the names knowing the style and how they operate. I'd say with respect to the way that I do things somewhat differently, I'd say that I'm more eclectic. You know, Warren's talked about having migrated from the old Ben Graham style of deep values, a deep discount to tangible book value, low p, low price to cash flow, to a style that favors really good businesses that he can buy at fair prices, let those. compound for you. And so he refers to the old Ben Graham style as a cigar butt investing. And I would say that I'm comfortable with that whole range. So I'm comfortable doing the cigar butt style. I'm also comfortable doing what Warren's doing today. I think Joel has had a and Joel's kind of switched. He used to do a very concentrated style with high returns on capital.

Starting point is 00:03:15 And now he's got an approach where at least the last time I checked, you know, in hundreds of companies, all of which had good financial characteristics. But he did that because he thought that trying to select out from that group became much more difficult than had too much volatility. So it's a way from to lower the volatility while still retaining the characteristics. I, on the other hand, am volatility agnostic. I mean, my colleague, Samantha McLemore says, I think correctly that since the financial crisis, volatility is the price you pay for performance, which people have been so risk-averse. So I'd say that I think I'm willing to tolerate a lot more perceived risk in the portfolio,

Starting point is 00:03:47 companies with high debt leverage, for example, or companies that have a lot of headline risk, than most value investors that I know, not all but most. And, you know, in preparation for this interview, I was listening to some of the other interviews that you've done in the past. And one of the things that kind of struck me was you were really comfortable diving into companies that I think a lot of value, hardcore value investors might not ever look at a business that has these large top line revenues growth, but maybe not necessarily showing up on the net income side.

Starting point is 00:04:16 It sounded to me like you're happy to start diving into some of those companies. and considering that growth aspect of it. Could you elaborate on maybe Amazon specifically or just kind of that thought? Sure. One of the things that Warren has said when we talks about growth and value is that those things are not opposed to each other, that the growth is an input to the calculation of value. And I think what's happened with a lot of value investors is when they see companies that trade at what looked to be high multiples, they immediately rule them out as not having

Starting point is 00:04:45 any value or being too expensive without actually looking at the underlying business and looking at really what it's worth and trying to figure out what it's worth. So with Amazon as a good example, one of the questions I ask you, you may ask it is your biggest mistake in investing. And certainly one of my best investments, I'd say the best decision I made in investing

Starting point is 00:05:04 is probably to buy Amazon and the IPO and the worst decision was ever to sell any Amazon. You know, it came at a 400 million market cap and it's pushing a 400 billion market cap right now. So I think that with respect to something like Amazon, what we got right, and I still think most people get, wrong about Amazon is that they confuse GAAP accounting profits with the creation of value.

Starting point is 00:05:25 And so values created whenever you earn above your cost of capital and you can reinvest it above the cost of capital. That's been something Amazon has been brilliant at. And the way that GAAP accounting carves those investments, some are expense, some are capitalized. And one of the things that Jeff has tried to do is to take in essence all of the excess cash that they have and invest it at what he still believes are close to triple digit returns on capital, even though that may not show up for several years or even decades. I mean, the thing that's interesting about Amazon right now to compare it to Facebook and Google, I think we're the second largest buyer of Google on the IPO, for example, is that Facebook

Starting point is 00:05:58 and Google's got about a $500 billion market cap on Facebook call out $350 billion or thereabouts. Both of those companies at their core are addressing or attacking the global ad market. That's where they get most of their revenues. Now, they'll get it from different places, they'll diversify, but that's the core of what they're doing. That's a $500 billion market about $250 billion in the U.S., $250 billion outside the U.S. growing maybe a little bit faster than global GDP. So you have $800 billion of market cap just with those two companies,

Starting point is 00:06:26 attacking a $500 billion pool of money. Amazon, on the other hand, is roughly the same market cap as Facebook, we'll call it rounding $350 billion, and they're attacking retail at their core. U.S. retail alone is $5 trillion. So that market is 10 times the same. size of the global market that Facebook and Google are attacking. And that's part of the reason that I think people continue to underestimate Amazon's long-term growth and their ability to reach

Starting point is 00:06:53 an enormous size. I want to highlight something to our listeners that you just really couldn't have illustrated more clearly, to me at least, is how big picture you are, how you're starting with this really large idea, how big is the market size, how many major players are in it, and how much of that can they still capture? And I think that so many investors out there are down in the weeds looking at things that they don't understand that growth potential and what it could actually size to. That is such an amazing learning lesson that you just pointed out. I wanted to just highlight that. The next question, Bill, is a question that is really, really hot at the moment, because it's about cash. When we look at the actions of many value investors, some are describing

Starting point is 00:07:38 in cash as a great way to have optionality in the U.S. market. And perhaps the prime example of that is Berksa Hellerwe's balance sheet with over $70 billion in cash. So I'm curious, do you agree with this allocation decision or do you think that some investors are proceeding with too much caution right now? I think that all depends on, A, the type of investor we're talking about. So with respect to Warren and Charlie, they have this monstrous cap cash generative machine that if they just sit there, it's going to build up vast amounts of cash just by itself,

Starting point is 00:08:11 naturally. Whereas if you're a mutual fund manager like I am, you're looking at a cash depletion machine because we're getting, at least up until the Trump election, steady redemptions all across the U.S. equity space. So I think, first of all, it's going to depend slightly on are you getting cash inflows or are you getting cash outflows or are you neutral on cash, how you begin to think about cash? In terms of optionality of cash, yeah, I think that's an important the thing. So what cash gives you the ability to do is to take advantage of opportunities that the market might throw up for you. And again, if you think about in this recent environment when cash is earning zero, so it's effectively earning zero your opportunity cost and a low nominal rate of return is not

Starting point is 00:08:47 very high, you know, for holding cash. And we're in a world where the, I mean, bonds, you know, put it in 10 year treasuries at up until a few weeks ago, you know, one, seven with a lot of risk in that if things go the wrong way as we've seen how they've done. On the other hand, I'd say I differ from people like Seth Claremont, where people who tend to hold lots of cash almost all the time because they don't find the market cheaper enough, but they think the market might go down. My thought on that is I think there's a little bit of, again, I understand it, but I find it somewhat puzzling in the sense of if you're holding 40% cash, the other 60% that you're going to have invested, you obviously believe we'll beat cash, so that would be cash too.

Starting point is 00:09:25 But if that's going to beat cash, why don't you have it all in those 60% names and hold zero cash. Then if things get worse, I mean, sell off some of the names to pick up to better bargains. But again, I think it all has to do with people's temperament. I mean, my temperament typically has been to hold almost no cash. And that comes out of what I try and be is, you know, what Warren and Charlie say they are is rational. If you look over long periods of time, cash underperform stocks. So the longer I'm holding cash as a percent of the assets I'm holding, the greater probability that's going to be doing poorly for me. And I'm going to need periods where I can put that cash to work to make up for, in essence, the lower rate of return for the

Starting point is 00:09:59 losses I've had relative to the market by holding cash. So, and I want to touch on this bond discussion because you hint at it a little bit there. And I know you've been thinking that this bull market on bonds, it's started back in 81 and it's been running for 35 years, was going to die for the last couple years. And this summer, we started sending out emails to some of our followers saying, hey, this is getting so asymmetrical at this point when bond yields were hitting 1.7 percent. And Trump gets elected. And now everyone's seeing that there's a potential for inflation.

Starting point is 00:10:35 And that's the new narrative at this point is that inflation is going to be higher in the U.S. They're going to change these trade agreements, which is going to create this influx of capital, creating the bond prices to start going up. So do you really think that because we had billionaire Ray Dalio come out and say he feels that maybe we hit the top of the prices, but the bottom of the yields in the bond market. Would you agree with that thesis? Do you see these bond yields just going up from this point in a huge sell-off? I mean, we had $1.7 trillion this month.

Starting point is 00:11:03 Yeah, I mean, I think the bond of bull market has been on life support since 2012, and it finally expired this summer at $1.35 in July. And even with the economy being okay and the market being okay since then, the yields began to move up. You mentioned there were 175 or so that around, what, 240 or so, I think. today. We had a huge outflow in bonds. I think that, you know, in this very short run, maybe it's overdone, but in the longer run, I think that I think you're looking at a long bond to bear market. I mean, I think who was it? I might have been Ray who came out of

Starting point is 00:11:33 the day or talked about 6% yields. I think Gunlock has talked about that as well over the next few years. I think that's not out of the question. That to me is a more extreme view, but I do think four to five percent is in the cards in the next three years. And I also think that that's it's both good and bad for equities because the only time, except for since the Trump win, the only time since the financial crisis there have been net inflows into the U.S. Equity Funds was in 2013 during the taper tantrum. And all the other time, money's been flowed out of that and into bonds. And there's several trillion dollars, according to Michael Goldstein at empirical, of excess allocation to bonds at an average interest rate is 2.75%.

Starting point is 00:12:12 So if we go above 2.75%, that money is all I'm going to think reversed. and you can see very significant inflows into equities, pushing equity prices up more than people think, which is good and bad, right? So it would be good while it's occurring, but if market's too expensive, that's not good for long-term investors. Yeah, I think short-term, you know, you talk maybe a quarter or two, if you see that same rate of sell-off in the fixed income into equities, it's going to be great for these equity investors. But as that parity and yield between equities and fixed income get closer to parity, I think that's where it really starts getting scary for a lot. of people and how far do you want to take it to that parody point before it really starts to unravel itself because I mean, whenever I hear Jeff Gunlock, like you said, say 6%, Ray Dalio say 6%, Stanley Drunken Miller, say 6%. And these guys are some of the brightest macro thinkers in the world. And they're saying

Starting point is 00:13:07 that it could reach that within a year or a year and a half. I would disagree fairly strongly with the idea that that could be reached in a year or even two years. Okay. I think we're still in a low nominal rate of return world. And even the, I mean, the markets beginning to discount positive growth aspects to the Trump stated policies. Those policies have to actually get passed. They have to get to work. And I think you're talking so, you know, infrastructure, tax reform, you're talking a year or two years before that stuff actually begins to get passed and affects things. So I would say six percent maybe in five years, maybe. I don't think it's going to get that high. Six percent was what we averaged in the 1990s. And I think we're in a

Starting point is 00:13:46 different world since the financial crisis. But again, I think I think four to five is reasonable. And I think around something in the, you know, on the 10 years, something in the 4% range would probably be break even against, you know, a market that might be trading moderately higher than this one. So you'd have kind of an equilibrium at that level. So I was reading something that was published by Goldman Sachs yesterday where they were saying that they felt that if you had sell off some bonds, it took it about another percent, you'd be looking at a point where that's whenever the equity prices would start getting a little scary. Would you agree with that as far as you feel like it has about another percent of sell off in the fixed-income market before it starts going in that direction?

Starting point is 00:14:26 It depends on the speed. I mean, if it were another hundred basis points in the next two weeks, it'd probably be pretty bad for equities. If it takes a year to get there, probably not. I mean, we were over three, three percent, you know, several years ago in the equity market. So the market wasn't scared about that at the time. I think it all relates to the growth rate and the inflation rate. So if we do get pro-growth policies and we get moderately higher inflation, something called it two, two and a half, that actually you can justify a multiple in the low 20s on that, even against the three plus percent tenure. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:19:03 Back to the show. So let's see if gears here a bit. So this is a question I'm really excited about and I just know that our audience out there, like me, they've been sitting with a stock screener from time to time and thinking, hmm, how can I find the best metrics to filter the best stocks? So Preston and I, we've been discussing this a lot and we feel that one of the best ways to discover value in the market is filtering results based on the ratio of EBIT versus enterprise value.

Starting point is 00:19:31 I'm curious to hear your thoughts on this. and if you perhaps know of a better way to be looking across a broad range of securities and success to find value investing gems? Oh, I think that's very sensible. I think it has every screening technique has pluses and minuses. You know, what that one does, what enterprise ID EBITDA does, for example, is it gets things in the right kind of order from cheapest to most expensive. And then you can begin making adjustments, you know, based on the balance sheet, for example,

Starting point is 00:20:00 or the leverage or, you know, after tax adjustment. adjusting the EBIT, for example. I think that's a good solid, a very good solid way to approach things. Now, if you were filtering off of that, where would you be looking for risk mitigation? Because now you know you got a great price, but then what would be the next couple of things that you'd be looking at in order to pin down that you're not in some type of value trap at that point? Well, first of all, we don't use that as a screening technique for a variety of different reasons. The one that we found most useful to ourselves is free cash flow yield.

Starting point is 00:20:34 And so once we find things that have very high free cash flow yields relative to the market, market right now is about six, close to six, five and a half to six. And so we typically don't even get interested until they're around 10, you know, nine to 10. And what that does for us is then we have to ask ourselves on free cash flow yield is normalization. So what's going on? Why is the free cash flow yield so high here?

Starting point is 00:20:55 And is it because they're underspending and they're going to, to ramping capital spending program up or, you know, is it because they've got return capital is dropping and the business is getting worse, but there are all kinds of different reasons, but it gives us a filter to compare things to. And again, we're looking at sustainability of that because our view is everything's priced off the risk-free rate. So you've got a risk-free rate, you have an equity risk premium, and then you've got the way in which the, we've got sort of the median free cash flow yield of the overall market. You've got a whole lot of data on what the history of that has been relative to rates. And then you get to the outliers

Starting point is 00:21:25 of much higher free cash flow yields, meaning much higher equity risk premium for what you're trying to do. And then the question is, is that justified or not? Is it likely to revert to the mean over time or even go below that? So I think for people that are listening to that, you're making that assessment of what you think that the future free cash flows might look like from a conservative standpoint. You're looking at the current price that you're being offered. And then you're figuring out what the discount rate would be based off of those two variables being

Starting point is 00:21:53 fixed, correct? Yeah, partly. And also, again, that's just one. So we also use free cash flow total return. So in essence, if you take a company like Amazon, which historically would tend to trade at around a 2 to 3% free cash flow yield, but it's growing its free cash flow at 30% a year, that's a 33% free cash flow total return, which slows the market. And then the question is, can they sustain that and can they do that? But again, that forces you to think out a little bit longer term than just today. Now, I know for myself, when I'm trying to understand the valuation on call it an Amazon, one of the things that I pay really close attention to is the top line revenue, opposed to a lot of the other pieces as you get further and further down the income statement. Would you agree that that would be something that you would focus more on for a growth company is that top line revenue when you're looking at trying to make those estimates? Yeah, absolutely.

Starting point is 00:22:43 If you actually take the old DuPont formula in terms of how to disaggregate the sources of return, and what it basically comes down to, I'm over simply a little bit, but if you earn above your cost of capital, then other things equal in that formula, the revenue growth rate represents the growth of value in the underlying business. And so the faster the revenue growth, the greater the value accretion. So if you look at Amazon, it's a really good example where in the late 1990s, they had a very fast growth rate, and then we had the dot com bust, and they had to focus a lot more in the balance sheet at the time because they weren't profitable. And they had to slow down the growth rate significantly, which meant the stock collapsed. Then as the growth rate came back up, the stock

Starting point is 00:23:22 followed that back up. But, you know, every company is somewhat different. So with Amazon, for example, we actually went through and did a regression. We actually regressed, I think, over 200 variables against each other to see what really was correlated with Amazon stock price. And as you might expect, it isn't gap earnings. It isn't free cash flow even, what it is, at least as of two years ago, it was growth of gross profit dollars. And that was a really really. interesting thing. That's what we actually thought it was likely to be. And Jeff Bezos had made a comment easily 15 years ago that that was what he was focused on. He wasn't focused on margin. He was focused on gross profit dollars. And lo and behold, that had a 95% correlation with

Starting point is 00:24:02 Amazon's stock price. And if you began to think about it, that actually made perfect sense because the gross profits, so in essence, that's the cash they had to work with after cost of goods sold. Yeah. And everything that they did with that cash was, quote, an investment. It could be a capitalized investment, it could be an advertising expense. It was an investment of one sort or another. And if the aggregate of those things was earning above the cost of capital, then that was a perfect correlation with the growth of stock price. And I think for a lot of people, that's an amazing point because a lot of people don't understand necessarily the gap accounting on some of those investments not getting, because they're R&D, they're not getting listed onto the balance sheet. And so you're not necessarily

Starting point is 00:24:41 seeing that the way that you would maybe look at the equity growth might not be showing up. It's just getting costed out on the income statement. So that's a really interesting point. I love that. That's fascinating to hear you say that. One of the most interesting things to me about that is when everybody talked about Amazon never making any money. I mean, now they quote, make money, but now it trades in a stupid multiple, as they say, is that we, you know, in essence, we've seen this movie before with John Malone and the cable business. I mean, John Malone, if you invested with John Malone when he first took over TCI, and then you sold your stock when he sold the company to AT&T, you made 900 times your money with him, and he never reported a profit, ever.

Starting point is 00:25:22 How'd that happen? Well, because he's taking a lot of value. It just wasn't shown up in normal gap accounting profits. Amazing. Yeah, really interesting discussion about Amazon than I think most people, including Preston and me, haven't really thought about. Bill, I'm really curious about your response to the next question, because the guests that we have had on the show, the audience, like, it seems like everyone's looking for

Starting point is 00:25:46 opportunities in an overvalued market, not only for equities, but basically more or less all asset classes that there is. So I'm curious to know, what do you think is the one thing everyone is missing in the markets here at the end of 2016? I think they're missing the opportunities in the equity market relative to other places to put their money. I think for the last 35 years up until the summer of this year, the bond market, you know, certainly on a risk-adjusted basis, Even on absolute basis has beaten the equity market. And so that was a very rational place to put your money. Right now, I think you have almost no choice.

Starting point is 00:26:24 And by that I don't mean you're going to have really terrible returns in equities. I think equities will give you the best rates of return. And people still haven't figured that out. They're focused on the fact that, oh, we're six years or seven years into a bull market. It's gone up so much. I think they're missing the opportunities in the equity market that still exist. Now I'm curious. And I don't think that this question really applies to the typical one.

Starting point is 00:26:44 investor because I don't really recommend shorting for a lot of people. But I'm curious, would you be interested in shorting the long-term 30-year bond at this point? Do you have that much confidence that the bond rates are going up at this point? We actually have a partnership that we began incubating in the summer and we'll be kind of ready for prime time live and month. And in the incubation phase, we've been short the 20-year treasury. So it's worked out nicely so far. I think probably right now, we've had such a big move. It's not the most opportune time. time, but I certainly wouldn't, if I was coming into it today, and would you rather be short or long, I'd say, I'll have a starter short position there. And if it goes against me and

Starting point is 00:27:23 rates go back to two, then I'll just keep increasing that. Buy some more. Yeah. Very interesting. So, Bill, when we look across the landscape of great value investors, people like Howard Marks comes to mind, but what people do you admire? This is kind of the Buffett question of, like, who is some of your competitors out there in the value investing space that you really look up to and that you admire that are worth studying. I give you a group of names, but when I get asked that question on who I admire, my initial answer is always the same, which is anybody who can survive in the business for longer than 25 years. Because there's actually a guy over the Times of London who claimed to have

Starting point is 00:27:59 studied every investor who was hot for a while. And he said that if you made it beyond 25 years, then you actually had some level of skill. And he said, even 20 years doesn't do it. people get washed out at a certain point in time. I don't know if that's right or not, but I do think that just surviving in the equity markets as a professional investor who has to satisfy clients and consultants and people like that, it's a tough thing to do because everybody's going to run through difficult periods and bad periods of performance and people do not have a lot of patience for that. So with that as a preface, in terms of value investors, many of them come to mind.

Starting point is 00:28:35 My friend Chris Davis, I think, is a very solid value investor whose family's been doing it for three generations. Bruce Berkowitz, who's having a great year this year after a terrible couple of years, but again, a great long-term record and concentrated value investing. And a company, you know, a name or two that might be less familiar to people, Tom Gaynor at Markell, the insurance company, he's been the chief investment officer there. One obvious Seth Klarman at Belfost does stuff very differently from the way I do it, but it does it brilliantly and, of course, a great value investor.

Starting point is 00:29:04 So while I was preparing for this interview, Bill, I have the chance to see you in some other interview And one of the things you said there was that you're really looking at Apple from two different angles. So on one hand, you're really impressed by their technology, the really top of the class in terms of innovation. But on the other hand, especially in terms of capital allocation, that was something where you really deemed that they didn't do a good job. So some time has passed now.

Starting point is 00:29:31 And I was wondering, do you still hold the same opinion about Apple and their capital education decisions? Well, when I made those statements about Apple, I thought that they were terrible at capital allocation. And I think they've improved very, very dramatically. And one of the things that, you know, made me sit up and take notice about how bad that they were was when Tim Cook on a call, on an earnings call three or four years ago was asked about their share buyback program. And that analyst said to him, the stock's down 30 percent since you announced the share buyback. Do you buy more shares when the stock is lower? And he said, oh, we live.

Starting point is 00:30:07 like our stock at whatever price it is. So we like to buy it no matter what the price, which of course is just a bizarre statement. Now, what subsequently happened, since I think Carl I kind of had a big influence there, is that they've actually gotten much, much better at capital allocation. And their problem in capital allocation was a narrow one. It wasn't the case that if you looked at when they spent money operationally or on new product, but what they did was it generated such high returns that they built up massive amounts of cash in the balance sheet. And when you have at one point in $1.5.00. time close to half their market cap in cash on the balance sheet, basically you're destroying a large

Starting point is 00:30:41 amount of value with that. So what they have done, not as aggressive as they should have. What they have done, though, is use a fair amount of that overseas cash issued bonds against it. And so defees that with the debt and bought in stock. I think they could have been more aggressive on the dividend side, but their capital allocation now is much, much better than it used to be. And we saw Berkshire do that. I think about, what was it, a year ago when they were issuing European debt. Okay, so Bill, the thing that we learn the most from are big mistakes. And I know for me there's no greater way to learn than making big mistakes, usually public mistakes.

Starting point is 00:31:16 And so for you, I'm curious, what is one of the biggest mistakes that you've made in your entire career? And what do you do differently now that you learn from that mistake? So I'm going to give you two mistakes because they operate at two different levels. So one of them is I'll call it a micro mistake, meaning a mistake at the kind of company analytical level. So we, our biggest mistake there was Kodak, which we owned for close to 10 years and lost almost all, probably lost 95% of our money on. The issue with Kodak, I'd say was twofold from my standpoint. One of them was, I'll call it the curse of mark to market. I think that

Starting point is 00:31:52 when you have to mark your portfolio market, there's a certain blessing there, which is, okay, if it's marked to market, the current news is in the price. So that's already in there. But the curse of that is if you keep believing that the current news is in the price, it tends to keep you in things, even when the news gets worse and worse and worse, it's always in the price if you're still optimistic about the business. So I think the mistake we made with Kodak was just staying with a serial disappointer because their strategy was right, but we found out that their culture couldn't adapt for the change in digital technology, even though the management tried to get it to do so.

Starting point is 00:32:25 So the solution there, I'm sort of embarrassed to admit this, the old Ben Graham solution that he recommended probably 70 years ago, which is in these kinds of deep value situations, really low price to book, low price to cash flow, maybe secular decliners, maybe not, just put a time limit on it. If it hasn't worked in three years, you sell it automatically done. That would have saved us seven years of pain, I think, in Kodak. And I think that's a good rule. And so we've adopted that rule. If we have a serial disappointer, it's not that it's got a last three years, if we just decide that they are not make the business is not making the progress that we think it should, then we'll sell.

Starting point is 00:32:59 Then at the macro level, and much more devastating than any individual stock was we get the financial crisis from. And I thought we'd had fairly robust, this is the macro problem. So I thought we had fairly robust strategies to deal with almost anything that happened really since the in the post-war period. So, you know, wars, political crises like Watergate, inverted yield curves, inflation going to double digits, all that kind of stuff. And what we didn't understand was the difference between a liquidity-driven crisis and an asset-based crisis, almost all the crises, except that since the Great Depression have been liquidity crises. In a liquidity crisis, when the Fed turn liquidity spickets on, you jump in.

Starting point is 00:33:38 And in an asset-based crisis, as we learned later, once the academic research has figured this out, in an asset-based crisis, what happens is the Fed turns liquidity spickets on. You get a bounce in the market. That's what we saw in the fall of 2007, actually, to all-new-time highs. Then it rolls over again because you haven't solved the problem, which is, the problem of asset values that are too high and they're over levered. And so in an asset-based crisis, and they only come about because you miss specified the safety of the asset, in that case, housing.

Starting point is 00:34:03 In an asset-based crisis, the proper strategy is to do absolutely nothing except for get liquid until the authorities get together to prop up asset prices or else to say, stabilize asset prices. That's what happened with TARP in the fall of 08. So until TARP, every time the government got involved, they wiped out equity. Even though they told the banks to raise equity, and they'd wipe it out. out again. So TARP actually came in and preserved the equity, the bond value, and the equity, and there were no failures after that, and we began to come out of that. So the lesson there is

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Starting point is 00:38:29 Mainly the differences are political. So I think that's why the recovery there has been much, much, much slower than it was over here, because the austerity programs were much more severe. We do own, and the partnership that I mentioned, Credit Suisse, which we believe is turned profitable and has that adequate capital. We don't own the other dilution coming, especially in the Italian banks. But even in something like Deutsche Bank, and Santerre looks okay right now,

Starting point is 00:38:52 but the UK banks look fine except for RBS, but we don't see them as cheap enough. I guess my concern, and we saw this play out in 2008, let's just say that in reality, that's the direction that this goes over in Europe. In the U.S., when one bank went down,

Starting point is 00:39:08 the next one went down, I mean, it turned into a domino scenario with these banks like overnight. And so I guess my concern over in Europe and for anybody else, it might be listening to this, they might be concerned with, you know, you mentioned Credit Swiss, where they're so dependent on their counterparts that they're surrounded with over there,

Starting point is 00:39:27 that let's say that Deutsche Bank does have a major event or some of these Italian banks have major event. Couldn't that quickly turn and really become a nightmare scenario for, call it Credit Suisse or some of these ones that look like they're really good deep value picks right now? It could be. It could be. It all depends on when it happened and how it spread and what the authority's response, you know, was to it. So if you go back to the 2008 crisis and had the government done nothing, then, I mean, Warren made a comment that even Berkshire might have gone down in that case, that commercial paper markets, the credit markets were so disrupted. So I think the question is, if you have a systemic problem, you know, it's incumbent on the authorities

Starting point is 00:40:05 stem that systemic problem. We're already getting better growth at the margin out of Europe. I think from our standpoint, we think that systemic risk is much lower than it has been, but it's not vanishingly small, and it's pretty significant in the Italian banks. But we think even with the Italian banks like Montepestri, I think that's not going to affect Credit Suisse except in the short run. I mean, Deutsche Bank had a scare over the summer, and the stock has recovered pretty nicely from that. Yeah, that was a little scary.

Starting point is 00:40:32 It was amazing how they were out making announcements. They were doing everything they could to try to stabilize the price on that. But yeah, it has had a drastic turnaround since that point in time. You had mentioned inverted yield curves. And, you know, some of the research that I've done, anytime you see a yield curve that's really starting to go inverted. And for anyone who doesn't understand what that is, whenever you have the front end, the short duration portion of bonds have a really high interest rate relative to the long end, to call it the 30 year end, where it's actually higher. That's an inverted yield curve. Whenever I've seen inverted yield curve studying the historicals on it, usually you are in for some very rough times in equity markets moving ahead.

Starting point is 00:41:12 Would you agree with that? Does that make the hair on your back kind of stand up when you start seeing inverted yield curves? Or is that not necessarily something that you consider when you're looking at value investing? Oh, yeah. Inverted yield curves have a high degree of correlation with various forms of economic stress. And so it's not a one-to-one correspondence every time they invert that there's some catastrophe. But the correlation is high enough that, and especially combined with other things, that you'd have to get worried about it. So I think, you know, we're a long, long way from that.

Starting point is 00:41:42 I think it's going to be a long way from that for a long time. So if the bull market and bonds is over, what would that mean for the U.S. real estate prices in the long run? And the reason why I'm asking this is that for our audience, a lot of the net worth are tied up into their home? Are you a bear? Because if we see this interest goes up, it will be all asset classes and clearly also homes that will be affected by this. So I'm curious to know how you see the U.S. real estate market. I think it's all systems go and all lights are green on U.S. residential real estate. The only problem with U.S. residential real estate is the price has been rising too fast.

Starting point is 00:42:19 There rose five over five percent over the last 12 months. They should be rising. If they're going to rise sustainably, call it 2 percent, 3 percent a year. If it rises, you know, over 5 percent, you've got a lot of problems that come out. First of all, it reduces affordability. Second, and maybe more problematically or paradoxically is that right now you can get 30-year mortgages still, you know, I'd call it 4% out there. Well, your house prices rise in 5 and you're borrowing a 4, there's a big incentive there to load up on houses, right? And I think that's

Starting point is 00:42:50 the problem that we had back in 2000, you know, 2 to 2006 rates were too low relative to the both the absolute level of houses and the way house price were rising. So I would expect, I think the current rise in house prices, residential real estate prices is due to the fact that it's not enough supply relative to demand. We're a 30-year low at new homes, you know, new home inventory for example. And I think that, and you also have a tougher, more just tougher to get. So I do think that's going to ease over the next 12 months. So we're actually real bullish both on U.S. housing overall and then on individual housing stops. So first real estate's different because the cap rates of adjusted mail.

Starting point is 00:43:26 Yeah. And the cap rates are so different depending on where you go in the region around the U.S. I've got a question for you that I know a lot of people love talking about this one in our audience. And that's Tesla, Elon Musk, the merger that just recently has. happen. What are your thoughts when you look at a Tesla? Can you take us from like big picture down into a little bit into the weeds on the income statement and how you might look at it from a value standpoint? Yeah, one of those missed, you know, opportunities of omission is that we looked at Tesla fairly carefully when it was trading in the $20 range. And then it went to, what, 300 or so after that. Once it got to like 40, we said, well, we missed it. Well, we didn't miss it. It went up

Starting point is 00:44:06 I actually think that Tesla has the current price. A, I don't think it's attractive and not because Elon Musk isn't a business genius, maybe an overall genius, but he's certainly a, you know, a business genius. But I think the issue with that is that the merger with Solar City complicates the analysis of the business pretty significantly. And second, and maybe more importantly, I think you're likely to have under a Trump administration probably a rethink of all these subsidies for alternative fuels and electric vehicles and stuff like that. That's one problem, because that's been an important part of the overall analysis that people can go through if they're buying a Tesla is, what kind of credits can they get? But maybe more important than that is that the auto companies themselves, you know, as slow as they are to adjust, have now sort of woken up.

Starting point is 00:44:50 And Chevy's coming out with, you know, with a competitor to, I think the new Model 3, the Tesla has that looks to be at least as good, if not better in terms of, you know, range. And BMW has gone very deeply into electric cars. and so now you have companies with massive resources that are going to be rolling out a whole variety of different competitive models and I think that's the greater problem for, I think for somebody like a Tesla. We thought that it would have been an interesting thing

Starting point is 00:45:16 if Apple bought Tesla and it still might be an interesting thing there because Apple has so much cash that that would not, it wouldn't strain them at all. And again, they're very creative. It's such a gigantic market that it provides a lot of opportunity for the people that are in it. So if Apple had bought Tesla, for example, Apple needs to operate in gigantic markets because they've already gotten over 90% of the profits in the smartphone market.

Starting point is 00:45:38 So that would be an opportunity for Apple. And it would be an interesting thing to watch. I also think that I'm not sure how we went far on this, but the other auto companies have awakened now. And they represent a pretty significant challenge to Tesla. And I think Tesla's market cap probably still exceeds all of the yacht Chrysler, for example, which doesn't make a whole lot of... Yeah. And the number of cars that just the number of jeeps that they're cranking out at very profitably at the yacht. Yeah, it's priced in. And I want to say the market caps 30 billion or somewhere around there and you look at like a Ford.

Starting point is 00:46:07 I want to say it's like 50. So it's amazing where the market's pricing it considering the number of vehicles that are out there. I think the thing that's really amazing when you look into the car industry is how much software and this Uber combination, autonomous driving, where you could basically program your car to go out and make money for you as a taxi service when you're not using all that stuff. is just so fascinating and really exciting in that space. And I agree with you, combining with an Apple or some type of tech company would really just kind of produce some quite amazing results. But, yes, Tesla's 30 billion market cap and Biot Chrysler is 10. So.

Starting point is 00:46:48 Amazing. And very profitable. Yeah, and very has a much better bottom line. All right. So, Bill, this is the question we really like to ask people. And I know that you're a person who reads books that are well outside of the, standard business reading list. And that goes to your background and what you've studied in your undergrad and graduate

Starting point is 00:47:07 and doctorate level studies. But what book would you recommend to our audience that has had the biggest impact on you as a person and it doesn't necessarily have to relate to investing? But what book have you read that's really influenced your life the most? Well, it's impossible to me to give just one. So I'm going to give you a thumbnail on a few. So, you know, the reminiscence to the stock operator and the money game, you know, 1968, I guess it was. Both of those books, I think, are as good as it gets in understanding the behavioral aspects of markets.

Starting point is 00:47:37 You know, Ben Graham and all the stuff that you learn in business school or all the stuff that you do in the CFA stuff tends to be. And again, it's incorporated, especially in the CFA stuff, some behavioral aspects. But the market at the end of the day is all about human behavior and how that works its way through people's belief structures. And so I'd say reminisces to the stock operator and the money game are both. really can't be beef or giving you a feel for how that works. So, Bill, what I want to do right now is give you a chance to brag because I know you'd never bring this kind of stuff up, but since I'm asking, I want you to tell our audience the performance of your fun, because I know you guys have been knocking it out of the ballpark

Starting point is 00:48:12 in the last couple years. Give us a little sample of what you guys have been able to do here in the last couple years as far as performance to the market. So I do two products. The team here does two products, now called the Lake Mason Opportunity Trust and the Miller. Income Opportunity Trust, those are both going to be rebranded probably by the second quarter of this year because I and the family are buying those products from Blake Mason. So they'll both be named under a Miller name. But in terms of results in both those products, so if you take the Opportunity Trust, it's actually in a very unusual position between the third quarter of this year and the end of this year. And the reason I say it's so, it'll be something will never be repeated again as long as I live, I would guess.

Starting point is 00:48:52 but the Opportunity Fund was the single best reforming fund of all U.S. mutual funds in the third quarter of 2016. And then for the five-year period, ended the third quarter of 2016, it was a single best performing fund of all funds in America for the past five years. And that includes the poor year that we're having this year. We're probably in the bottom 5% for the year to date this year. But as I said, that five-year performance even includes that. So that's that product. And that product's beaten the market. It's got a 16-year record.

Starting point is 00:49:20 It's beaten the market on average by about 200. basis points a year over that 16 year period. Not every year, of course, but on average over time. And then the other product that we have, a newer product is called the Miller Income Opportunity Trust. It's just, it'll be finishing its third year this year, but to give you a sense of the current stuff, for the past month, it's the top 1% for the year to date. It's in the top 3%. And for the one year, it's in the top 1%. So it's having a very good year, unlike the Opportunity trust and I do the opportunity trust with my colleague Samantha McLemore co-managed with me and then the income fund is done with my son Bill the fourth. And I think the difference in the performance

Starting point is 00:49:57 is really striking in that the opportunity trust is close to the bottom of the page this year and the income fund is at the top of the page. And those are being run with the exact same investment philosophy, the exact same analytical approach. It's just the case that in the types of names that we own in the income fund, the market is looking very favorably on those so far this year. And in many of the names that we have in the Opportunity Fund that we've owned for a number of years, the market doesn't like them this year for a wide variety of reasons. So you get that diversions and opinion, even from the market standpoint, even when you have the same managers and the same investment philosophy. And in some cases, even some of the same names. Absolutely,

Starting point is 00:50:35 phenomenal. I can't say that I'm surprised, but that is just amazing, the performance that you've had across your career. And I know I speak for everyone. Your responses to these questions, it's just amazing to gain this insight. And we can't thank you enough for coming on the show. So thank you so much, Bill, for taking this time to talk with us. Thanks, Preston. I really appreciate the invitation. Okay, guys, that was all at Preston and I had for this week's episode of the investors podcast. We'll see each other again next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www. or request a guest appearance to the investors podcast by going to www.w.com.

Starting point is 00:51:24 If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before a commercial application.

We Study Billionaires - The Investor’s Podcast Network - TIP 117 : Value Investing Legend, Bill Miller (Business Podcast)

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