We Study Billionaires - The Investor’s Podcast Network - TIP155: Mastermind Discussion (Part 2) - Intrinsic Value of 2 Stock Picks (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, how's everyone doing out there? In this week's episode, we are really excited to bring you the second half of our mastermind discussion. If you miss part one of our discussion, you might want to go back and start there first. But during this week's show, Hari Ramachandra and myself provide our two stock recommendations. And as always, it was really a lot of fun to hear comments from the group about why they liked or disliked the way we were looking at the potential value of our picks. In this episode, we'll be talking about retail. stock and retail, as you might know, is one of the most hated industries right now.

Starting point is 00:00:35 So we're really excited to have John Hoover from Saber Capital Management on to join the group. He has some very interesting insights about the retail industry that you probably haven't thought about. We'll also be talking about reeds and discuss whether or not reeds are the best placeholder for cash if you're looking for a limited downside but are not satisfied with the fixed returns you can get elsewhere. All right, let's hop to it. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, guys, how is everybody doing today?

Starting point is 00:01:25 This is the second part of a mastermind discussion, as we said there in the intro, and why don't we just jump right into it? And Preston, you have the first stock pitch. So mine is a company that anyone in the United States knows about. It's Target. and this is a retailer. You know, big competitor for them is obviously Amazon and Walmart. When you look at the space, I would segment it more that Walmart is much more of a competitor to Amazon just because they are in the same brick and mortar space moving forward. And I think that whenever you look at this company, the prospect for their growth is abysmal.

Starting point is 00:02:02 I think it's actually quite terrible. I don't expect the top line to actually grow. I expect it to be flat if not go down. Whenever I look at their free cash flow, I expect that also to be flat if not to go down. But with that expectation moving into the next 10 years, I think that it's going to eventually kind of reach kind of a plateau and it's going to continue to do fine.

Starting point is 00:02:26 But valuing that expectation moving forward, assuming the worst case scenario, if the free cash flows were declining at 10% per year for the next 10 years, you would still get a 4% return on target. I think that that's very aggressive. I think that that would absolutely be my worst case scenario. If I was going to say what my best case scenario would be, I would say that maybe a 0% free cash flow growth would be what I would expect in the next 10 years. It'd just be completely flat. That would be my best case scenario. And if that's true, then I'm getting about a 12% annual return by owning target. So I,

Starting point is 00:03:03 I think that this is something that would be something that'd be entertaining for a person to maybe take a position in Target. I think that recently Amazon came out. They bought Whole Foods. Everyone's expecting that to really play into disrupting a little bit of the market share for Target and for Walmart because now they're competing in that space. But whenever I look at Target, I think that they have decent brand loyalty. I think most people actually like going to Target. I don't think that I could say the same about people. people that go to Walmart. I think most people that shop at Walmart really don't like to shop there. I think that you have a different mindset with people that go to Target. Another thing that I think is a huge asset for Target is this relationship with Starbucks. And I know a lot of people might laugh at this, but think about it. A lot of people driving past the Target know that there's a Starbucks in there. I don't know if you guys have ever looked at how many people when they walk into a target make the immediate left or right hand turn and go to Starbucks before they go and actually stop in the store. But I'd be willing to bet it's a very high

Starting point is 00:04:05 percentage, much higher than people might think. And I think that that's a unique piece that Target has going for it that drives a lot of customers into the store. And I think it will continue to drive them into the store as long as that relationship continues to exist moving forward. So although I'm not expecting a lot of growth like none, I do like the brand. I do like the brand loyalty that they have, I think that they're pretty efficient in their management. And I think that the numbers make a lot of sense when you're looking at the potential return compared to the other options that are out there like investing in an S&P 500 index. I think that the returns are at least double, if not maybe even triple, the returns that you'd see out of the S&P 500. I just wanted to revisit

Starting point is 00:04:49 what John discussed during we were talking about 10 cents, is that with companies that have a tailwind or a wave that is going in their favor, they really benefit and it becomes easier for us as investors to forecast, at least to some extent, what's going to happen. However, in case of target, they're actually facing headwind. They're against the tide and the trend is towards online and e-commerce. At the same time, you have a competitor like Amazon who is also trying to get into groceries and brick and mortar through the acquisition of whole, foods and the groceries at Target is not as good as Whole Foods. For example, the brand loyalty that Whole Foods commands is much better than Target. Of course, I agree that the target audience or target market is totally different folks

Starting point is 00:05:39 who shop at Whole Foods might not necessarily shop at Target, but there might be some overlap as well. So considering this and your worst case scenario is a 4% return and the best is 12, why take the risk of picking a single stock when the upside? is not that high was my opinion. I'll let John comment. Yeah, I think that, I mean, obviously Amazon is the obvious threat to this one, Preston, as you mentioned. I think, you know, one of the things that I have thought about with the brick and mortar retailers, and this is something, on the contrary, I've thought about this with some of the stock markets, all-time

Starting point is 00:06:15 great winners, is that the market, in some cases, in very rare cases, has actually undervalued some of these great all-time companies like Walmart in the 80s or Starbucks in the 90s. and, you know, these were stocks that traded at 50 times earnings in some cases and were still undervalued because the market was directionally right. They knew these companies were great, but they actually discounted how good they actually were. And I think in some regards, the same thing is happening in reverse when it comes to brick and mortar. I think the market in some cases, not necessarily with target, but in brick and mortar in general, I think is actually discounting how bad things could be. If you think,

Starting point is 00:06:55 about Amazon, let's say they're doing around $100 billion in revenue right now in their retail business. And if you think about that, it took them maybe 20 years to get to that level, but their growth rate is maybe 20 to 25 percent right now. So sometime in the next four years, they're going to essentially extract the same amount of pain, meaning they're going to add another $100 billion of revenue, which is the same amount of revenue that it took them the first 20 years to get. So in other words, they could potentially do as much damage to brick and mortar in the next five years as they did in the last 20. And to Hari's point, I think when you think about the earning power of the company, it is facing this headwind. They're still doing a lot of business.

Starting point is 00:07:40 They're still, I think they're going to do close to $70 billion in revenue or so, or $65 or $70 billion somewhere in that neck of the woods. And so that, there's still a lot of business. The problem is Amazon causes, I think, for a lot of these brick and mortar retailers that I think doesn't doesn't get as much press as it should is they really attack these companies at the margin. So companies like Target or Bedbeth and Meon or companies that have like big brick and mortar footprints, if you reduce the traffic, even if you have a retailer that's doing 50 billion or $75 billion in revenue, if you reduce enough, even a small amount of foot traffic, you take away these incremental impulse purchases that you will make when you're in the store.

Starting point is 00:08:20 You know, that person that walks into the Starbucks, they get their coffee and then walk through Target, probably is going to walk out with five or $10 or $15 worth of merchandise that they didn't plan on buying when they were there. And so when you take that away, you take away some of the highest margin items that these retailers have. And I think that's the biggest risk that some of these retailers face is that they have to cut prices to maintain market share. When the $30 box of diapers goes to 29 and you have 8% margins, and you lose, you know, 3% off your top line, you just lost a third of your operating profit. So they're getting squeezed. And even though they're still going to do a lot of business, I think that's a headwind that they'll face.

Starting point is 00:09:03 Yeah, I definitely agree with you guys on the headwind piece of this. Whenever I'm looking at the top line of the revenue, which I think is a great indicator of showing what this trend in this headwind really looks like, targets revenue peaked in 2013 at $73 billion. The next year, it was $71 billion. The year after that, it was 72. So they had a little bit of jump at a billion dollar jump back up. The year after that, they hit 73 again.

Starting point is 00:09:29 So they were able to sustain this through all this Amazon growth. They've been close to 70 billion for five years. Now, 2017, it dropped down to 69 billion. So, you know, when you look at this, I guess this is the question that I'd ask you guys. Do you feel like if you shop and Stig obviously can't be included? Because he's over in South Korea, so he can't answer this. Plus, I was way too hard on him, so he's going to be hard on me no matter what. So you're not allowed to answer, Stig.

Starting point is 00:09:56 Hari and John, if you go to Target, do you feel like you're paying a higher premium than what you'd pay for things than you would on Amazon? No. I mean, in fact, I've done some price comparisons, and I think Target has gotten competitive with a lot of the stuff there. I think for me, you know, if I look at like my shopping habits or my household shopping habits, you know, the way my wife shops, we are starting. more and more of our purchases on Amazon's app. I open up my app and I order whatever I need. And it's getting so easy and so convenient that Target is losing, you just make fewer trips to the store.

Starting point is 00:10:36 So even if you shop on Target.com, like we were buying, you know, Target.com, I think their prices are pretty competitive, at least for some of the household goods that we were purchasing, and we still do some of our buying on Target.com. But again, I think as more money shifts toward Target.com, even if it stays in Target, you lose those incremental high margin impulse purchases. And that's a problem. And you look at the target's gross margin.

Starting point is 00:11:02 It's gone from 32% to 29%. And again, that doesn't sound like much, but any retail business has enormous operating leverage. And, you know, if you have a 32% gross margin and an 8% operating margin, you lose three points, you're going to lose, you know, a third of your profit. So it's a difficult balance that they're facing. I completely agree with what you just said. And I see it the same way, John. For me, the question then becomes, because I agree with all of that, I see it happening

Starting point is 00:11:30 the same way that you do. And just so you know, when I go into a target, I see the price as being the same as Amazon. In fact, I stopped looking at what the price is on Amazon because I'm just assuming I'm getting a pretty similar price. And I think most people probably would feel the same way. But the question then becomes, how much is Amazon able to attract? trit away from the typical target customer through these purchases that you're describing because I'm going through the exact same thing. I mean, Amazon's so intelligent with their platform that

Starting point is 00:11:59 it's like, hey, it's time to buy more coconut water. You know, it's like, okay, yeah, you knew exactly when I needed to purchase that. And so then I have it delivered two days and right on time. How many of those types of purchases are going to continue to suck away from the top line and the margin specifically that you're talking about. And when does it come to an equilibrium point? Is it another five years? Is it another 10 years? Because at the end of the day, people still have a demand to go to a brick and mortar store

Starting point is 00:12:29 and buy something today. I know I still have that demand in my life. And I'm pretty sure everybody else that's listening to this still has that demand in their life. The question is, is when will that become an equilibrium where the revenue kind of flattens out and it's not being attritted anymore by this Amazon factor. I think that that's in the cards. Within five to ten years, I think that the top line's going to stop degrading like that. And I think you're going to hit a steady point. And based on how much it's eaten away over the

Starting point is 00:12:58 last five years, it's about three to four percent off the top line every year is how much it's eating away right now. So whenever I'm looking at the numbers, if that's true and it lasts for just another five years and then it hits a balance and they only eat away at about three or four or five percent each year. The numbers on this are huge compared to everything else that's being traded on the market with so much stability in the numbers at least. I think you're literally seeing two to three times the return that you'd get by buying the S&P 500 index today at the current price. But that's in a really important consideration when you're developing the model is what John's talking about, because if I'm wrong and it's much deeper than what I'm expecting, well, then the numbers start

Starting point is 00:13:39 you know, getting closer to what you're going to get out of the S&P 500, which is, you know, 3% or 4% or whatever. I completely agree. And to answer your question about my shopping habits, I see Target as my savior when I have forgotten to buy a gift for a birthday party on my way, I just go to Target and buy it. And I think also clothing, for example, many of us are still not comfortable ordering online. So, clothing might be another area where people might still want to go to a store nearby. So there are certain aspects where brick and mortar still is relevant.

Starting point is 00:14:13 And that's one of the things I think even Amazon has realized that an only channel approach in retailing might not work in the long run. They need to have multiple channels like both e-commerce as well as a storefront. And probably Whole Foods is a good example where they're realizing it and getting into the grocery business through Whole Foods. So my question is, I agree with all your saying, but I'm not sure whether to bet on target that they will be able to capture all this physical foot traffic. What if Amazon also competes with them in that area? And so is Walmart and so is other retailers. 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. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every

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Starting point is 00:19:16 When you look at the top line on Walmart, the top line is still growing. It's still getting bigger and bigger each year, which I find fascinating. Now, with that said, I'm going to kind of counter myself just so everyone has, you know, full knowledge of the different things that are popping around in my head as I'm thinking through this. Why did Warren Buffett and Charlie Munger sell their position in Walmart? Because that happened just recent, you know, within the year. They got out of this space and they got out of this space. and they got out of this space, I would argue, because of Jeff Bezos, and they kind of see it as being very disruptive in, you know, having a headwind. So just some thoughts.

Starting point is 00:19:54 I'm throwing it out because from a financial standpoint, it makes a lot of sense by the numbers. Maybe I'm not being hard enough on some of the numbers. Maybe it should be like negative 15 percent annual growth rate for the free cash. So I don't know. But the numbers that I'm saying that I'm using, those are the returns that I'm kind of expecting based on the current price. So this is the second time we're doing this format of the show. And the last time I was pitching Beth Bath Beyond and I thought that was the ugliest pick. And then Preston trumped me.

Starting point is 00:20:23 And he came up with the GameStop. Whenever I saw this pick, I was like, Preston did it again. I thought I found the ugliest stock on the market and still Preston trumped me. Because whenever I'm looking at Target, I actually mean this in the best possible way, it's definitely not a sexy company. It's probably the least sexy company or close to that you can find out there. I mean, it's just this old giant. You see that even though that the top line is somewhat stable, you see that the gross margin is slightly slipping and you see the same thing with the operating margin.

Starting point is 00:20:56 And there's a lot of good stories to tell about why targets shouldn't be performing well in the future. But I think if you go through the earning statements, you'll hear the management talk about digital has been going up by 32%. and is that on top on 16% growth, it's still almost nothing. And they're really not making any money. It's around 4% of total revenue anyway. And that's not where the future is for them. And they're talking about this transformation, about the new small format stores, which will really take a toll on the CAPEX in the next year.

Starting point is 00:21:28 That's not a catalyst either. I don't think that's what people need to look for. I think that it really boils down to value. Can people see the value in this? Can people see the value from the future cash flows? And really to give you like an argument to, for instance, what you said, John before about using the Amazon app or whatever app you're using because it's simply more convenient, I think, yes, there will be some kind of created destruction. I mean, we can look at something like, it's more efficient with driverless cars than driving your own car. Yes, that's more efficient. And we can say the same thing about online shopping. But that doesn't mean that the old thing will go away. That just means that will coexist. And for at least a few decades, if we can even predict that long, I see a lot of value in retail, especially right now when it's so beaten up. So, yes, I don't expect any growth at all from target.

Starting point is 00:22:17 But if you look at the valuation, that's also what Preston looked at before. If you look at the valuation, you don't need that to justify purchase. You just need to make sure that the target is not performing horribly. And I don't really see that coming. It's probably slightly worse, but that's still okay if you look at the mind conditions right now. So I was just going to chime in with one other thought on this is a lot of people look at the Amazon versus all of brick and mortar retail as if it's like a winner take all type of a contest. And that's not necessarily the case. So I completely agree that brick and mortar is not going away. I do think that the U.S. in particular has probably far too much per capita retail square footage than it needs. And I think that's a headwind for any company that owns or leases real estate to do business.

Starting point is 00:23:10 So I think there's headwinds, but there's going to be brick and mortar. It's a retail is a $5 trillion industry in the U.S. And Amazon has two or three percent of that maybe. But it's not going to all go to Amazon. The problem that I see is, again, back to my original point on this, was Amazon is attacking the margins. And, you know, the Whole Foods is another example. and people say, well, Whole Foods is brick and mortar, and so see, you need brick and mortar, but what they're going to do is they're going to, you know, the lowered avocado prices by 43% today, I saw,

Starting point is 00:23:43 and they're going to begin to attack the margins at the grocery store, you know, the Kroger's of the world and the Costco's of the world, and certainly Target and Walmart do an enormous amount of grocery business as well. So I think my concern with brick and mortar retailers, and especially companies like Target, that a lot of people, I think, can replace some of that purchasing on Amazon, is that those margins are going to be hurt. I think it was Kroger's CEO said just this weekend that, you know, if we have to sell a can of corn for 40 cents, we're going to sell a can of corn for 40 cents.

Starting point is 00:24:15 And so these guys are cutting prices, defending market share, and all of that is at the expense of profits. Target's doing it, Walmart's doing it. And so you kind of have to look at it and say, where is the puck going over the next five years? and try to visualize what you think it's going to look like. And I think Target will still be here. And I think they'll probably still be doing a lot of business.

Starting point is 00:24:38 But I think it's going to be a very difficult business for them. And I think it's just going to be a very, you know, it's going to be a tough slog, I think, to compete as Amazon continues to grow. That's kind of my thought. It's not an all or nothing. There's going to be brick and mortar and Target will still be probably doing an enormous amount of business. But what is that cash flow going to look like? That's my question. All right, guys. Let's go ahead and hear Hari's pick.

Starting point is 00:25:03 Thank you, guys. My pick today is store capital. It is a real estate investment trust. And I'm really happy that John is with us today because in his previous life, many of you might not know. John was a very successful real estate investor before he started managing his own fund. So I'll be eager to know his thoughts on this particular investment. To give you all a background on this company, store capital is relatively young company. It went public three, four years back. It came into the news because Warren Buffett or not really Warren Buffett, but Berkshire Hathaway took a meaningful stake, 9.8% of the entire market cap in tour capital. In reeds, there are different type of reads based on the properties they invest in.

Starting point is 00:25:50 This is an equity reet and they focus on single tenant or freestanding properties. What it means is you might have seen these properties where you have an Applebee restaurant or a health or a movie theater. They're not attached to a mall or they're not part of a strip mall. They're just single properties. And store capital specializes in it. They have published numbers since 2013. They have been growing steadily at a good rate. They started with the total net assets of 1.7 billion. Now they're around 4.9 billion, a 30% growth. They have been growing their revenue as well at the same rate and net income as well. Of course, like any other, Reit store capital also relies on two main sources of funding. One is external by one type of capital

Starting point is 00:26:43 they raise is through issuing equities, which is always diluting for the existing shareholders, as well as they take on mortgage or issue bonds. And of course, they have their own organic funds that they generate over a period of time. They have a very healthy dividend. payout ratio of 67%. And their management, especially the CEO, has more than 30 years of experience, is well known in the industry.

Starting point is 00:27:09 And one of the interesting thing about store capital is the kind of lease they employ and that basically a triple net lease, what it means is that in this kind of lease, the tenant is responsible for paying operational expenses,

Starting point is 00:27:26 property taxes, etc. So all the landlord would do in this case is just collect their rent. So that relieves them of a lot of variable costs. So their revenues are more predictable. The other thing that store capital has in its favor is that they explicitly mention that they focus on businesses that are profitable and are Amazon proof in a way or not prone to disruption from e-commerce. And in fact, what they do is require their tenants to disclose unit level financial statements. And in fact, 97% of their properties, they actually have access to unit level financial statement as well as the credit quality of the customer. In terms of diversification or their tenant pays, one of their main industry, they serve is the restaurants industry where almost 20% of their tenants are in the restaurant industry.

Starting point is 00:28:23 So they are exposed to that industry very much. Apart from that, they have education institutions. Recently, they signed up with TATPOR, which is a very popular education institution in the California, as well as health clubs, movie theater, colleges, furniture, stores, and stuff like that. The other thing is none of their customer constitute more than 10%, in fact, much less. The highest percentage of rent coming from a single tenant is less than 4%. And geographically, they're spread across the United States. Their highest presence is in Texas at 12.9% but they're in other states as well.

Starting point is 00:29:03 And finally, one other thing that works to their advantage is their lease duration or lease terms. Most of their tenants, their lease don't expire or they probably expire after 2026. So the leases are usually 10 years or more, which protects them from business cycles. However, the downside is, especially when the lease terms are long, the stock tends to behave like a bond because their revenue, unlike a reed that focuses on cell storage or hotels, cannot adjust to interest rates. If the interest rate starts going up, the leases cannot be changed to reflect the interest rate environment. However, their leases do have built in escalation, rent escalation. So that will protect them to some extent, but at the same time, it might not be enough. So in terms of their growth potential, according to their annual report, the overall market

Starting point is 00:30:02 size for single tenant operations is $2 trillion in the United States. Well, I haven't verified from an independent source, so I cannot really vouch for it. But I did look at other publicly traded reeds in this area. And if I look at the net total assets from all those rates, it comes to around. 36 billion. So there is a huge gap between the two trillion number they are projecting and the current assets that are held by various reads in this domain. So that's store capital. I would like to know your feedback and your thoughts on it. And just so everyone knows the ticker, it's S-T-O-R. Yeah, so I'll chime in. Thanks for sharing those thoughts, Harry. And just to clarify the record,

Starting point is 00:30:47 I appreciate the nice words. I was a real estate investor. in a previous career before I started Saber. I've always loved investing in general and always loved the stock market, but I did do some real estate investing. One of the headwinds, I guess, or just not headwind necessarily, but nature of the business is that real estate's an inherently low return on capital business.

Starting point is 00:31:09 And the way you get attractive or adequate returns on equity is through leverage. So obviously any read out there has to take on a lot of debt to get a decent return on equity for shareholders. And the $2 trillion comment is interesting because I was reading through, I think, their investor presentation, and I saw that. And what's funny about that is that, obviously, the single tenant market is a massive market. I don't know if it's $2 trillion or what it is, but it's huge.

Starting point is 00:31:38 But to think of a real estate investment trust as a growth company is probably not the best way to think about it because the returns on incremental capital that a company like store is going to produce going forward is probably going to be rather low. So growth is not always a good thing when it comes to real estate companies. And, you know, one thing to note about real estate companies is if you pull up their cash flow statements, you're going to see, you know, the three different sections of a cash flow statement. You're going to see positive cash flow in the operating section. And then you're going to see huge negative cash flow in the investment section. And that's just simply because they're growing. And, you know, most READ CEOs are not content just

Starting point is 00:32:19 to own the properties that they have in their current portfolio and spin off cash flow, they want to grow because more often than not, they're incentivized to grow. And so basically all REITs are attempting to grow, and you grow through other people's capital. And then if you look at the third part of that cash flow statement, you're going to see a huge positive cash flow from new equity and new debt. So you have companies that can't finance their growth with internally generated cash flow, and therefore you have the need to take on more and more capital.

Starting point is 00:32:49 And so the question you have to ask as an owner or as an investor in these companies is what is the return on that capital? It's okay if you raise a lot of debt or raise a lot of equity. The problem I see with single tenant is these guys are taking their newly injected equity capital or debt capital and investing it in new single tenant properties with cap rates at, you know, near all time lows, which cap rates just the cash flow yield essentially on a property. So, you know, like a bond as interest rates rise, bond prices fall as cap rates rise. which they tend to do with interest rates, you know, property values tend to fall. So my fear, long story short, is that they're getting this new capital. They're growing, but they're reinvesting the capital at mediocre rates of return. And I think Buffett or Berkshire, whoever made the decision, Westler or Combs,

Starting point is 00:33:34 is probably looking at this $400 million investment almost like a bond. And you mentioned that, Hary is, you know, single tenant real estate is essentially like a bond. And it's very high quality. I think you're right that these assets are very high quality, very safe. They're structured in a way that mitigates a lot of risks at stores level. But I would view it more like a bond. I think they're going to pay their 5% dividend. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:37:02 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. I'm actually curious, Hardy, why did you decide to take this pick? I mean, it looks like a really good income stock. If that is the intention, we're all in different life situations. So what might sound like interesting stock run person say that you are about to retire, you might be looking for more steady income more than necessarily capital gains. So obviously it would be nice to have capital gains, but also with a downside

Starting point is 00:37:42 risk that might follow. So, Hari, is this a part of your strategy to have this stable, collect that dividend payment? Or are you seeing something that we're not seeing in terms of the growth prospects? I think I agree with John. My assessment of Berkshire's stake in store capital is that this is a bond equivalent, or as Munger would say, a placeholder for cash. And my motivation for looking into it is the recent memo by Harvard Marks where he cautions against the prevailing risks where a lot of stocks which are considered safe or of the growth stocks like the fangs. He doesn't think that we are in a bubble, but he says proceed with caution. And one of the reasons why I was looking into store capital was to understand, first of all,

Starting point is 00:38:34 to reverse engineer what was the thinking of Berkshire, whether it's Ted and Todd or Buffett. what were the thinking here. And the second thing was to see if this is one of those investment where the downside is relatively very limited, even the upside I know. It's not very high. But is it a safe place compared to my bank account to park where I don't get anything if I park my cash? But is this a safe place to park my cash?

Starting point is 00:39:05 So whenever I hear that Buffett took a position in this and he took a position back whenever they first went public. Is that right, Hari? No, I think he took the position recently. They went public in 2013 or 12. Yeah, it was a private placement. I think it was earlier this year. It was a Berkshire bought roughly 10%, maybe 9.8% of the company for I think 377 million. Berkshire's like price was $20.25. In fact, this was an unusual transaction because store capital issued new equities. So they diluted actually. So it was not that Berkshire bought it on the market. This was a specific deal where store capital's board decided to issue new shares to Berkshire,

Starting point is 00:39:54 which basically took a hit for around four cents per share in terms of their earnings for the current shareholders. So with our expectation of where interest rates might go, as John pointed out, If interest rates do go up, that means the value of real estate and everything else goes down. So whenever you see Buffett and Munger take a position in a company like this with interest rates already like ridiculously low, that tells me, and we kind of got a hint at this at the meeting when we were out there in May, that their expectation is interest rates are just going to keep on going lower moving into the next 10 years. Or else they wouldn't buy something like this. If they thought interest rates were going to go up, they would never buy something like this, right?

Starting point is 00:40:36 John? I mean, I would agree with that general assessment, and I did scratch my head when they made this investment. I do think that the assets are safe. And, you know, single tenant, this is a diversified group of tenants that they have. And so I don't think any tenant makes up more than a couple percent of their overall rent. But I think it's a safe collection of assets. But the prices of these assets do in many ways trade-like bonds and with interest rates. And so, yeah, I would think that if you had a view that interest rates are going to rise, which I don't really have that view necessarily, although I'd certainly say they're probably likely to go up rather than down.

Starting point is 00:41:16 I do get the sense that Buffett has talked about, you know, like for instance, S&P 500 multiples being reasonable, simply because interest rates are so low. And the implication there, I don't necessarily know if I agree with that or not, but the implication there is that you wouldn't call the S&P 500 reasonable at, you know, 22 times earnings or whatever it is if you thought interest rates were going to rise. So that does seem to be the case that he would expect rates to stay low enough for an investment like this to work out. You know, Hari, I was looking at the cash flow statement, right as John said, you know, you got to look at the cash flow statement and it really tells you a lot. And I would completely agree with that. Whenever I'm looking at the cash from the operations of the business, And then you compare that number to the dividends that are being paid. A huge chunk of what's being paid out as a dividend is coming straight from the operation.

Starting point is 00:42:12 So that tells you if they're expanding their business, they're getting bigger. It's almost all from diluting shareholder of the value per share or they're raising money through debt markets in order to do it. And so, you know, when I'm looking at this, I'm trying to place a value or expected return on it. I would expect the return to pretty much be the dividend, and that's about it at this point, based on how I'm looking at the cash flow statement. Yeah, just a quick comment to that. So the management has said that after the capital injection from Berkshire, they're not really looking to raise more capital, at least not in the near future.

Starting point is 00:42:46 They are very conservatively funded for the type of company they are. Right now, the borrower at 4.5%. It's going to be really interesting to see what will happen to the credit rating. And just as an example, so you need also to compare the 4.5%. with how much the average leads us. And if you just look at a second quarter, you're looking at a lease of 7.8% on amortage. So the adjusted funds from operations was around, I think it was 68, which is kind of like the key metric you look at real estate, which is not that high, especially because it's a read, and you are trading around a multiple 15. It looks like a stable

Starting point is 00:43:20 bond to me. I don't necessarily think that the valuation is as attractive. But again, there might be, you might be in a different situation where you need that cash flow and need to collect that dividend. So one of the things I was thinking about is like, I guess Preston mentioned earlier, when you're talking about Pabri or Buffett or Berkshire, the reasons they invest are different than what an individual investor like us would be considering. But I was also thinking that not only it can be a cash parking space for Berkshire, but it can also be a potential place where Berkshire can deploy its excesses.

Starting point is 00:43:55 capital in terms of credit, loan, or some other ways in which they can provide capital to store capital, where store gets capital from Berkshire. So it stays within the family, if you will. And at the same time, store has less pressure in terms of raising capital in the future. There are such examples already. For example, there are private equity firms who also have fun of REITs. and they fund those reeds by taking stake in the reed as well as by providing capital in terms of loan or whatnot. So I'm not saying this is necessarily the case, but I just wanted to know your thoughts about it.

Starting point is 00:44:40 Yeah, I mean, I think it's tough to know exactly what the rationale was behind the scenes, obviously. And so it's always fun to speculate on what Warren thinks or what, you know, Ted and Todd are thinking. But yeah, I look at it and as I analyze it, as I say, I look at it like a pretty safe collection of real estate assets that will provide a nice, steady dividend. And it appears to me that the dividend is probably safe and well covered by the current cash flow. But I don't know what the long-term game plan would be for Berkshire. I will say it's interesting. If you look back at some of Buffett's personal investments, and you can kind of piece this together through research,

Starting point is 00:45:18 and there have been references to this in some of the books out there on Buffett, but he has a history of investing in Reeds. And he said a few things publicly, which would contradict that. He said it's always better to own real estate directly because you have slippage costs when you buy a reed. You have management fees. And in his view, it's better to own real estate directly. But he has invested in REITs in his personal account, which is kind of interesting. 15 or 20 years ago, REITs went through a period where they were, the tax laws changed to

Starting point is 00:45:46 where you could convert from a C-Corp to a REIT structure and pass your cash flow on tax-free to the owners as long as I think 90 or 95% of the cash flow came from passive real estate investments. And so there were a lot of real estate companies that made this transition. And Buffett made a lot of investments in Reeds back then. And they were relatively short-term investments. He would buy them. The stock would rise 30, 40, 50%. He would sell them.

Starting point is 00:46:14 And so I think with this investment, it's a very small investment, number one. $400 million is, you know, he's got $100 billion in the bank that probably will earn somewhere around a billion dollars just on interest this year alone. So the investment is very, very small when you put it in the context of that balance sheet, obviously, it's less than one percent, less than half of one percent of the cash. So I wouldn't read a whole lot into it, but I think it's probably one of those investments that he'll clip the coupon for a little while. And my guess is he would sell it at a certain point, you know, if it does appreciate, but he may hold on to for a long time and just continued to collect the dividend on that. The nice thing about the private

Starting point is 00:46:54 placement is he does inject the capital. He did this with Home Capital Group, the Canadian subprime lender too, that, and that was a different situation, obviously. But by virtue of his reputation, he basically saved that company. This is much different. This is a stable company. But he provides them with capital. He gets stock by virtue of his reputation. You know, the stock is already risen. So he's already in the money by 20% or something. So it's tough to lose on a situation like this if you're Buffet, and that could be what they're thinking there. I don't think it's a, because of the size of the investment, I wouldn't read too much into it. Just so everyone knows, we planned on making this about a one-hour episode where we'd go through four picks, but, you know, we were having

Starting point is 00:47:34 so much fun talking that this actually turned into two episodes. We really want to thank Hari Ramachandra coming from Bits Business. He's an executive over at LinkedIn. He's been with us since day one. I also want to thank John Huber for coming out. John, the website, Base Hit Investing. Fantastic blog. I highly recommend you guys go there. He has a subscription where you guys can sign up and get all of his tips that he's putting out about the investing world. Fantastic articles there as well.

Starting point is 00:48:02 So, John, thank you so much for joining us. All right, guys. That was all. And Preston and I had for this week's episode of The Investors Podcast. We see each other again next week. Thanks for listening to TIP. To access the show notes, courses, or forums, go to the investorspodcast.com. To get your questions played on the show, go to AskTheInvesters.com and win a free subscription to any of our courses on TIP Academy.

Starting point is 00:48:27 This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP Network. Written permission must be granted before syndication or rebroadcasting.

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