We Study Billionaires - The Investor’s Podcast Network - TIP166: Mastermind Discussion 4Q 2017 - Stocks & Bitcoin (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, how's everyone doing out there? It's that time of the quarter where we get the mastermind group back together and talk about what's happening in the investing world. I'm always looking forward to the quarter of the mastermind meanings. And it's so much fun for us because they are the least scripted episodes. And the conversation just goes everywhere. And we talk about diverse industries like airlines, railroads, pharmaceutical companies.

Starting point is 00:00:26 And we even suddenly transition into a discussion about Bitcoin Katz. As you can like to tell, the group had a lot of fun recording this episode, and we hope you'll enjoy it too. 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, great to have everyone with us. These are the episodes that we really look forward to doing because we bring back our friends to sit around and chat, and we can beat each other up as to why something might be a good. good or bad investment. So we have Hari Ramachandra with us from Bits Business and executive out there

Starting point is 00:01:16 in Silicon Valley working with LinkedIn. We also have Toby Carlisle with us. He's the author of numerous books. Deep Value is one of me as a lot of others. We'll have all those in the show notes. We'll have the link to all of his websites in the show notes. He also has a website called The Acquires Multiple. Toby, fantastic to have you with us. And of course, we have Stig here and myself. So let's go head and get this thing started. All right. So the way that we go about this is the way we always do. So each of the members will give their pitch.

Starting point is 00:01:46 And then it's up to the group to come up with new questions, say what they like or why they don't like the pick. Who wants to go first or who dares to go first? I'll give it a bash. I don't mind. All right. So Toby? All right.

Starting point is 00:01:59 Hit this up there, Toby. Get the bats out, guys. My pick is Gilead. G-I-L-D is the ticker. It's one that I've picked before and it's one I get lots of questions about. So I thought I'd go back to it. I think when I first picked it, it was sort of in the high 60s, ran up as high as 85. It's run back now to around low 70s, $71, $72.

Starting point is 00:02:23 So people were asking me at 85. They're asking me again now. So I'll just talk about it. It's something that I still hold. I still think it's cheap. It hasn't really moved that much from where I bought it originally about six months ago. For those who don't know the stock, it's one of those stocks that, two years ago, it was a hugely popular stock.

Starting point is 00:02:40 If you go to any of the message boards at the time, it was one of the ones that everybody was kind of riding to victory. It was trading around 120 bucks, 120 bucks plus. Over the last two years, it's had this sort of terrible trajectory straight into the ground, and it's basically halved over two years. And now it's one of those stocks that everybody hates because it's one of those stocks that everybody held a couple of years ago, and they remember how badly they've all been burnt on it.

Starting point is 00:03:04 The reason for buying it two years ago was that it had this kind of stellar earnings growth that plateaued and the earnings have basically been falling since then. It looks like they're going to continue to fall for another 12 months to two years. So basically it's a biopharmaceutical company. Their specialty is antiviral drugs. So that means they treat particularly hepatitis B, hepatitis C, the flu, HIV. The problem for them has been that they've treated the hepatitis C, which was their big money maker so successfully that they've cured everybody who they've treated with it

Starting point is 00:03:40 rather than sort of drip feeding them this over a long period of time and building a really good business. So that's a great thing for the people who have received the treatment, not so great for the shareholders in the company right now. My sympathies are with the people who are receiving the treatment rather than the shareholders, but I'm a new shareholder, so they're looking for new revenues for growth. The things that I like about this stock, it's a $94 billion market capitalization as of today. enterprise value is about $95 billion. So net debt of about a billion dollars,

Starting point is 00:04:09 but it's got $40 billion in cash kind of balancing that off. So it's very, very liquid. It's hugely cash flow positive because they've got this drug that's basically in runoff. They're trying to find new sources of revenue, but they're generating cash flow in the meantime. So the chances of this going away as a business is very, very low. If I look at any of the statistical measures of distress or earnings,

Starting point is 00:04:34 manipulation or fraud or any of those things. There's nothing there. There's no indication. The return on invested capital, which is not a measure that I think is particularly useful most of the time, but in something like this where it's got patents, it's got various other protections, it is a kind of a useful metric. It's incredibly high. It sits around 73% return and invested capital, free cash flow yields around 15%. So when the return on invested capital is that much higher than the free cash flow yield, that's sort of an indication that the stock is, probably way too cheap. And so I think fair value for this stock probably around $100 to $105 sort of at the low end. And with the stock trading around $70, I think there's a fairly wide margin of safety there.

Starting point is 00:05:20 I think potentially it could be worth more over the next few years. But the issue is going to be declining revenues for the sort of immediate future. So anybody who buys this, you know, next quarter you're going to see revenues a little bit lower. The quarter after that revenue is going to be a little bit lower. The only thing that you have going for you in this is that it's incredibly cheap and it's generating huge amounts of cash flow and it's generating this incredibly high return on invested capital. So for me, this is exactly the kind of stock that I like. It might take a few years to work its way out. But by the time that the future is going to look a little bit brighter, it's going to be a

Starting point is 00:05:53 much more expensive stock. I'm so happy you brought up this stock pick, Toby. I've been asked about this pick for at least a year. And I want to say it's been on my radar for, yeah, two weeks. or something like what you're also saying, because it has been a very light stock and then it became a very cheap stock. And for me, I guess it always comes back to, I don't know how to value patents. For me, it's too complicated whenever I read through the financial statements and also look

Starting point is 00:06:21 into the business model in terms of figuring out how sustainable it is. So, Toby, could you talk to us about your process in terms of valuating patents? Sometimes I take a slightly different approach to these sort of stocks. The future is difficult for me to foresee. I think a lot of other people have much better for crystal balls than I do, but I have no idea what it looks like. For me, I sort of have to look at the immediate past. And for this stock, it doesn't look great.

Starting point is 00:06:46 The revenues have been falling with it. There are a few things that I should have mentioned. One of them is that they've used some of their enormous cash pile to buy another company for about $12 billion. That'll start generating earnings and income. and sometime next year, I think. And then it's not going to replace the HCV income, but it's going to come in at about a quarter of what the HCV income is,

Starting point is 00:07:08 which HCV is about $8 billion. This thing, I think, gets to one or two over the next few years. And then it continues to grow. I think that it's one of those things. The cash flow is very strong. The company's got lots of cash on its balance sheet. It has brought back some stock. All of those are things that indicate to me that it's got longevity

Starting point is 00:07:27 and the potential for something good to happen. And I'm just sort of at this price, I think it's so cheap that I'm prepared to sort of buy it and see if something good can happen. Following upon Stix's question about patents, what percentage of their revenue is from the HIV portfolio of their business? The reason I'm asking is their patents for HIV-related patents are supposed to start expiring, starting 2017 through 2021.

Starting point is 00:07:53 What are your concerns in that and how can they compensate for those expiry? The earnings are falling because they're negotiating the contracts for the sales of this into the future. For me, I don't know what's going to happen. I don't know how they replace it, but they are looking for ways to do it and they have the firepower there to do it. They're generating lots of free cash flow already from the existing portfolio. So I sort of think it's one of those things that revenues continue to fall. But as a deep value guy, I don't really mind that so much because the balance sheet is pretty strong. Free cash flows there.

Starting point is 00:08:26 still learning lots on its existing portfolio and very, very cheap. So Toby, I know nothing about technical analysis. So I'm just going to throw that out there. But whenever I'm looking at this and I'm looking at the top line that we're all talking about and how it's contracting and it's going down, and you kind of take a look at the chart and you're seeing the price chart, which I think this is the first time I've ever talked about a price chart on the show in 165 episodes. When you look at the price chart, I guess the pattern of the price is just keeps going down.

Starting point is 00:08:59 And you're not seeing much volume trying to stop that from happening. And so whenever I'm looking at a business like this, that's really big and has to do a lot of R&D, a billion dollars in R&D to create a new product. And then they have to go through all the marketing. And then they have to go through everything to try to make it a successful drug to potentially start growing that top line again. I think they've got a tough road ahead of themselves before you're going to see the price kind of normalized to start taking off again. There could be something. There could be a breakthrough in some type of R&D that they're doing right now that could make it pop on a whim.

Starting point is 00:09:36 But for me, I guess I love the price and I love the valuation on this. I'm not going to lie. Whenever I did the intrinsic value on this, I got a very high number, double digit number. But my concerns are more on the technical side of their performance on their income statement. expectation of what it's going to look like in a year from now. I think it's going to continue to contract. And I don't see anything in the volume of people buying that's going to maybe reverse that anytime soon. So I guess for me, I wouldn't buy this, even though it looks really juicy from a return standpoint, like from a value investing standpoint, it looks really juicy.

Starting point is 00:10:12 But I guess I'm going to continue to watch it. And if I feel like I see a large spike in the volume, I might miss out on a little bit, but I think it has more to go. I think it has more to fall before you're going to start to see the price return. That's my personal opinion. RIVs are definitely going to be lower this time next year, almost certainly. The thing is that by the time this sort of gets, when you can see the runway for this thing, the price is going to be a lot higher. It's lower than it was a few months ago, but it's higher than it was sort of six months ago. So I don't know if that means anything to the technical guys. They can shoot me a tweet and tell me.

Starting point is 00:10:46 I'm pretty sure no matter what comes out of the technical side, it probably won't be. Yeah, I just need to be quiet because I don't know. anything about technical. One of the reasons is you can have a look at the price chart from earlier this year. Johnny Hopkins, who writes the Acquirer's multiple blog posts, he wrote a post up about Gilead because he was excited about it and he said, I want to post this up. And I wanted to wait until the earnings data got populated into the spreadsheet from our data providers. And in that sort of period of time, it went, it kind of bounced really quickly from 64, where Johnny had found it kind of up to 67. And then it looked like it was going to get

Starting point is 00:11:22 away. And I felt really bad for Johnny because he'd picked it really well and it seemed looked like it had taken off. As it happens, as so often happens with these stocks, you do get another chance to buy them. But it's one of those things that I think I've just discovered over a long time trying to buy and sell stocks that if you like the price today, you got to do it today because you might not get it tomorrow. They can take off really, really quickly. So I agree with everything you just said. Let me ask you this then. Are you buying a small volume at this point and slowly working your way into it, or are you just taking a decent size position right now? I bought a chunk of it and I bought some leaps when I, six months ago or so, it was, it wasn't

Starting point is 00:12:02 the bottom, but it was, it was in the high 60s, I think, at the time that I did it. And it got a little bit cheaper after that and it's sort of taken off since. I have had a pretty full portfolio until today, so I'm going to revisit it. Again, it's probably something I'll buy some more of. I guess what I'm getting from Toby's point of view is that the price is so low. that there are a lot of upside, including acquisitions, which we didn't talk about, but they can be a potential target for acquisition and a quick payoff from that aspect as well. That's a good point. All right.

Starting point is 00:12:35 So I think that concludes Toby's stock pick and the stock ticker is G-I-L-D. And we're just going to go around the horn here. So, Hari, do you want to go next? Great. So, Hari, you're up. Always fun to sit around and chat with you guys and I'm ready to be beaten up. My pick today is Union Pacific, which is a railroad company. There is a lot of talk about tariff and restrictions on imports from Mexico and whatnot.

Starting point is 00:13:10 And Union Pacific does a lot of business with Mexico in the sense that a lot of companies, especially automobile manufacturers. They transport a lot of their parts through railroads. And Union Pacific and BNS are the two big railroads on the West. And for those of you who are not familiar with railroads in US, there are different classes of railroads. And back in the days, that is before 1980, there were many railroads because of a lot of regulations against consolidation.

Starting point is 00:13:42 However, things changed. And from then on, it's called as a state. Tigers Act. From then on, the consolidation started happening and a lot of synergies were realized and the number of railroads also started reducing. So today, there are only a handful of Class 1 railroads. On the west, we have Union Pacific and BNSF, which is now a wholly own subsidiary of Berkshire Hathaway. And on the east, it is CSX and Northfolk Southern. Of course, there is a Kansas City Railroad as well, which is a small player. And some of the interesting facts about railroads is that about 40% of all the intercity

Starting point is 00:14:26 freight volume are transported by rail today. And railroad today employs around 185,000 jobs. It used to be 1.5 million 100 years back. So they have definitely worked a lot on productivity and efficiency. and one train replaces around 250 trucks on the highway. And also some of the other interesting facts about railroads in terms of their efficiency is that a freight can be moved 479 miles on one gallon of fuel. So that's much more efficient and also safer way to transport freight than trucks. In terms of what they carry around 19% is coal.

Starting point is 00:15:16 So coal is a major contributor to their revenue, then chemicals, greens, and food, and then assembly parts, motor vehicles, and then finish goods and miscellaneous. So that's kind of the overall contributors to revenue. Union Pacific specifically operates mostly in the western region, as I said. most of their volume comes on the ports, ports of entry, which are on Los Angeles Long Beach on the West Coast. And they and BNSF pretty much are neck to neck. If you look at their revenue, number of miles of tracks, BNSF and UNP have a doopoly on the West Coast. One of the interesting facts about railroads is obviously their moat. It's really hard to create another railroad because of all the regulations.

Starting point is 00:16:07 in terms of land acquisitions and building out the infrastructure is concerned. UNP has been expanding quite a bit in the last couple of years and also it has increased its overall efficiency and productivity. The reason I picked it is there are some uncertainties going ahead in the next couple of months and based on how the policies on imports are shaped, it might impact railroads and specifically Union Pacific and BNSF. So this will be a stock to watch. It would be good for us to understand what are the different sources of revenue for this railroad. And if there is a panic about this particular stock and if people are ready to throw the baby with the bathtub, it might be

Starting point is 00:16:54 interesting pick for some of us. 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 got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Form is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year, bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building

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Starting point is 00:20:56 Go to Shopify.com slash WSB. That's Shopify. slash WSB. All right. Back to the show. So, Hari, for me, when I'm looking through this, I go straight to the numbers. And although I think that the competitive advantage piece of it, I completely agree with everything that you said.

Starting point is 00:21:17 I don't see the revenues really contracting at all. I think they're going to continue to be able to produce decent cash flow. But the premium that people were paying that own it today, for me, is not a buy. I'm kind of curious what you think the intrinsic value through like an IRR is, but for me, I'm coming up with, and I think I'm being very liberal in my assessment as to what I think they're able to do into the future, basically saying, I'm giving them much more a benefit of the doubt than being conservative with my numbers. And I'm still coming up with like about a three and a half percent return at the current price. So basically saying what they've got today, they can continue to sustain into the future. That's my worst case. my best case is saying that they're going to grow at 7%.

Starting point is 00:22:00 And those are the numbers that I'm using as my projections into the future. And I'm still coming up with 3.5%. And so I guess my question back to you is if that's a true statement, let's just assume that that's a true can get 3.5%. Why not just buy an S&P 500? Because I think you're going to get the same return and you're going to have less risk. That's a good point. I'm not recommending a buy at these levels.

Starting point is 00:22:21 My assumptions are also that this is not a stock that I would buy, hoping that they will grow their revenue at a faster pace from here. In fact, I'm not even assuming any growth in revenue. I am looking at them as a place to park my cash and earn some dividend. It's more like a income generating opportunity, but not at this price. I would be interested in this talk when it is in the lower 70s. That's when it becomes much more compelling and interesting. But however, it's good to study this now because I'm expecting that there will be a lot of rumors and news around banning Mexican imports or tariffs on Mexican imports. That can drastically impact the revenue of Union Pacific because they're already low on their revenues

Starting point is 00:23:14 from coal, which is slowly dwindling. And that is being compensated by the revenue from import from Mexico. So there is definitely some headwinds. So it's your number that you quoted there. You're looking for something in the $70 price range. And whenever I put that number into my intrinsic value assessment, I get around an 8% return if you can buy it for like 70 bucks. But the problem is, it's not $70. It's $15 right now. So I'm with you, Hari, as far as wait until around that price range. But by the time it gets to $70, there might be some other deals in the market that are way better than an 8 or 9% return. I also want the audience to know that right now,

Starting point is 00:23:55 the dividend on this is giving you a 2% yield at the current price. So that's not a bad dividend. And I think that all the money that you're going to make on this from now to moving forward at that price is really going to be the dividend. I was just going to throw some more thoughts at you on this one. If I look at it on a Petroski-Oltman, Benish, which are my statistical measures to determine if it's in any financial distress, if it's financially strong, if there's any sort of earnings manipulation.

Starting point is 00:24:21 So there's none of that, which is always a good sign. Market caps around 91 billion. Enterprise value is about 106 billion, which means that it's carrying sort of $15 billion in net debt, net obligations, which I don't typically love. If I look at on an acquirers multiple basis, it's trading a little bit over 13 times, which for a good business, for a really good business,

Starting point is 00:24:44 that could be about fair value. I think for this business, I think it's either just at fair value or it's just a little bit below fair value the way that I would calculate it. Returning on invested capital around 9%, and the return that's available is about 3%. So it's a little bit overvalued for me, but there are some things that are nice. One of them has got a very stable earnings trajectory. So it is one of those things that if you could get it at the right price, which $70 is probably the upper limit of the right price, but that's well within the possibility of something that you would do. It's probably something that you can buy there

Starting point is 00:25:19 and then let it sit for a long time in an account just to sort of accumulate and grow. So I think it's a really nice fundamental stock, a little bit worried about the level of debt that it's carrying, just not something that I love. I think, I'm sorry, I shouldn't say I'm worried about it. It's just not something that I like to see. But otherwise, I think it's a good fundamental business,

Starting point is 00:25:35 just a little bit expensive. Yeah, so for me, I don't have too many things to add. I also ran it through our intrinsic value calculator. And whenever I look at it, we're probably around called 3 or 4%. So I have very similar results as Preston. In terms of debt that Toby just mentioned, I don't think I'm as concerned. So you can have different types of obligations that might be more burdensome from the company than others. And if I look at at least the interest-bearing debt, it's not too bad.

Starting point is 00:26:03 You still have a coverage ratio above 10, which basically just means that you can pay the interest expenses with your operating income at least 10 times. And even though that the debt has slightly increased, I don't think it's a huge issue. So I think, Harry, that the feedback is really to sum it up is great business, not a lot to say about that. You bring up a lot of great points about local monopoly and perhaps pricing power to some extent, even though it's regulated. But really, the valuation is really the big red flag here. Yeah, I think I definitely agree with you. And one piece of information for the audience is that the previous month in October,

Starting point is 00:26:43 US Class 1 railroads together hauled more intramural containers in October than during any previous month in the history of railroads. So obviously the valuations are basically reflecting the recent trends and the recent numbers that are coming out of all the railroads. All the railroads are today valued either fair. as Toby was alluding to are a little bit higher than fair value. So it's definitely not something that I would buy right now, but I would definitely watch them. Whenever I look at the revenue, and I guess you can say that about a lot of coal utility companies, you'll see that it's more or less flat. And you also said before that you don't expect perhaps growth at all.

Starting point is 00:27:33 Is it even possible in this business to grow your top line, being as, a local monopoly as a UNAN Pacific corporation really is? If you look at their revenue growth, it pretty much tracks the GDP and also it tracks the import and export dynamics between US and Mexico. In fact, I have a chart in my analysis which essentially tracks the dollar amount of US and Mexico import export and the volumes, the freight volumes that UNP is hauling and they revenue from that particular part. And another interesting aspect of UNP is they own a significant percentage in Mexico's biggest

Starting point is 00:28:18 railroad. So they have some growth coming in from Mexico as well. But again, right now, I think everybody recognizes these facts, whatever I'm saying. So everything is baked into the stock price. Okay. So Stig and I, you know, Stig, go ahead and talk about your pick because I didn't know what your pick was until just a couple minutes before when I was doing a little bit of research on your pick. And I had the smile because we almost have identical picks with, this was not planned

Starting point is 00:28:48 in any way. But go ahead. Let's, let's hear yours first. So my pick is Southwest Airlines and the stock ticker is LUV. So what's not to like about that? It's a major airline. And together with Delta United and American, they control 70% of the U.S. US market. They're the biggest, at least measured and originated passengers bought it, and they provide scheduled air transportation throughout the US and also in near international markets. One thing to mention just before we talk about the industry is that they have 44 consecutive years of profitability. And that's almost unheard of, especially if you talk about an industry like the airline industry. Some of the key industry ratios to look.

Starting point is 00:29:37 And that's the, first of all, the load factor. So the load factor, that's basically the, how they fill their seats per mile. And if we look across the board, we're looking at something slightly above 80% in North America, 80.7 to be exact. LOV is one of the best airlines out there with 83.6. Unfortunately, the very best company is Delta. I don't know if I'm allowed to say that, Preston, because it's your pick. It's at 86, they're top of the class.

Starting point is 00:30:10 Where Southwest Airlines really makes its mark is on customer satisfaction. And if you look at the airlines, that's top ranked of all the major airlines, number two and three, JetBlue and Alaska. And then, if I might add, Delta as number four. But very interesting. And people are probably not surprised when I say that United Airlines, they're not doing that great in the customer satisfaction survey here. The oil price is very important and it's a high percentage of the operating expenses. It fluctuates a lot. If you look at the past 15 years for Southwest, it has been everything from 16.5 back in 2003

Starting point is 00:30:52 and up almost 38% of the operating expenses in 2011. Today, it's hovering around the low 20s because of the relatively low oil price that we see. that's another interesting factor to consider. So if you think the oil price was still down for a long time, it might be a more appealing pig, and if you have a different opinion, you might come up with a different expected yield. The rotation for the industry is really not good.

Starting point is 00:31:19 I don't know if people remember Warren Buffett buying into airlines a few decades ago, and he has continuously said almost ever since, I did say almost, because he actually just put into airlines, but he used to say that he has, has an 800 number that he used to call and say, hey, my name is Warren and I'm an airaholic, because he just loves buying his airlines, at least at that time. And it didn't pan out for him

Starting point is 00:31:47 as well in the 80s as he had hoped. Typically, it's also a hated industry because of the labor unionized. So it's a tricky business to be, and it definitely needs to put that out there. There have been quite a few changes in the airline industry over the few decades, though, which is probably also one of the reasons why you see investors like Warren Buffett and other investors too going into the industry. Why it's still a very competitive business, there are fewer airlines today than they used to be. It typically provides more monopoly and thereby also pricing power in different regions. Like if you are in the Dallas area, you might primarily be flying American or if you're in New Jersey, you might be flying United.

Starting point is 00:32:32 So you do have some pricing power. But even more importantly, the load factor all the past 15 years has gone from 70 above 80%. There's been very important that you've seen this consolidation in the industry. If I look specifically at LOV, I see almost no debt, almost no dividend either, but that's really not that important. I think that the way they allocate the capital is really good. you see a share buy back around 5%. But perhaps the thing I really like to highlight is the mode.

Starting point is 00:33:05 If you look at the competitive advantage of Lovie, I think it is the culture. And even though it's very hard to quantify the importance of a culture, I think that is one of the very reasons why you see this customer satisfaction being so high for this company. This is probably an anecdote more than anything, but the company, does not allow any type of art on the walls of the headquarters. Instead, they only allow pictures of employees, friends, and family. We spoke to Monis Paprai months ago about this and he talked about how the annual meeting people will give each other's hugs, which is typically something you don't see unless you team up with our crew in Omaha, I guess. It's a very appealing

Starting point is 00:33:51 company, both from a mental standpoint but also for the future prospects. But I'm curious to hear what the group has to say before we talk about the potential growth and the catalyst for the stock. I'm a big fan of the airlines. They've all come into the acquires, multiple screener, Delta, both and LUV. LUV is just sitting slightly outside of the screener at the moment. But I'll tell you a few things, the reasons that I like it, market caps 32 billion, enterprise value 32 billion, so almost no debt. On an acquirer's multiple of 9.6 times. So the most expensive stock in the screener at the moment is 9.2 times.

Starting point is 00:34:30 So that tells you how close it is to appearing in the screener. Of all the airlines, it's probably the best run airline. And that's reflected in a few things. It's got excellent return on an invested capital. It's among the best companies out there on that basis. I think the price is excellent to where it is. The only two concerns that I have, free cash flow yield is very low. So it's generating a little bit under $5.5.

Starting point is 00:34:56 percent on a free cash flow basis. And if I look at my statistical measures, if I look at my Petrosky Altman Benish, which are financial distress, financial strength, earnings manipulation, fraud, etc. It's fine. On financial distress, it's fine. It's not a manipulator. But Petroski F score is four out of a possible nine. So that's sort of towards the low end. I'd have to dig into that and find out exactly why that is, but it's just an observation. Otherwise, I think it's a good pick. So, Stig, this one also I agree. I think it's a decent pick.

Starting point is 00:35:27 But I'm curious what you got for the intrinsic value as far as what you think the yield is based off the current price. Yeah. So whenever I did that, and I think I was conservative. Now, we haven't talked too much about the growth opportunities I put 7% as my upper ban for with a 25% probability, 3% as my most likely growth. growth rate, 60%. The reason why I came up with 3% is that the expectations or until I think it's 2034, that's around 3.3, which is, it is hard to predict, and yet it's not. It has to do

Starting point is 00:36:06 with immigration, it has to do with GDP growth. And it would not be unreasonable to expect 3%. Whether or not Southwest could capture that, that's always up for discussion. And then I have a minus 2 in my lower band because I'm just very pessimistic, I guess. And I come up with an eternal rate of return or expected rate of return of 7.2%, which is not great. It's not something I'm super excited about. But I think a 7.2% in times like this, I think that might be, if you have some sort of certainty for that, might not be too bad. Luckily, I had a chance to speak with my good friend Chobie about this just last week. We talked about whether or not actually 7% was the upper limit, giving how the market is right now. I don't know. It is very modest, but it seems to me to be

Starting point is 00:36:59 good if you're paying the opportunity cost of the market. I'm curious to hear your thoughts about your intrinsic value calculation present. I had very similar numbers to you as far as the bans. An adjustment that I made, I think that their free cash flow that they had for this past year, coming in at $2 billion is what I had for this past year. It seemed like it was a little uncharacteristic of the previous period of time. And so I felt like that was a little high. So I adjusted that down. And whenever I did that, I ended up getting around a 5 to 6% return for the IRA on the company. So, I mean, if we split the difference, we just say it's somewhere in between, you know, five and your 7%, we're at 6%. So, you know, if the market's priced

Starting point is 00:37:44 at three, and we think we can get six with this, double the return of the S&P 500, that becomes a hard decision to go into an individual stock pick, especially something that's highly regulated, highly unionized, very susceptible to commodity prices as they fluctuate and chain. I don't know. I would probably buy a little bit of it, but it would not be a big position. You're the abominable no man. No, no, no, no, I'm not. I'm not.

Starting point is 00:38:11 I'm just a little hesitant because the return. aren't really, like, extremely fat. And it is a great business. I'm not going to lie. This is probably the best airline company out there. Yeah, it all comes down to the valuation. That's basically what you're saying, Preston. Just to provide a few comments to the discussion about free cash flow. I actually think I was conservative whenever I used the current number as the benchmark.

Starting point is 00:38:35 I don't think it's necessarily a low number when I see the possibilities moving ahead. And we can talk about more of that later. But the reason I also want to say that is if you look at the age of the fleets for Southwest, they've done massive capital investments. And the average age is 11.8 years west for, let's say, Delta, which is of the four major. They have the oldest fleet of 17.2. Now, it is actually part of Delta strategy, often to have an older fleet and then pay more maintenance costs, but then not as much in terms of the cost of some of the acquisitions.

Starting point is 00:39:09 but it's something that I guess it's my way of saying that if I look at numbers, I don't think that the current level we're seeing now is high. I just wanted to bring up the point that what's the downside from here? I was just looking at how they did during the 2007-2008 recession. I don't see any dip in their revenue during that time. It's very hard to believe that the airline is recession proof. So it's counterintuitive. The data at least is counterintuitive to me.

Starting point is 00:39:37 When you look at the numbers, I know. at least for the Delta numbers, when you go back and you look at 2008, 2009, the revenues were not impacted at all. In fact, the revenues went up from 2007 to 2008, and they went up again from 2008 to 2009, which I was blown away by that. But their bottom line suffered tremendously, and most of that was because of the oil prices went up to $150 a barrel during the 2008 period of time. So I'm with you. I thought the exact same thing, Harry, but the numbers were telling me a different story. So I guess the expectation moving forward is that if you have another credit contraction that the revenues probably wouldn't be impacted too much with the airlines,

Starting point is 00:40:12 which is surprising. But who knows? We'll see what happened. Yeah. And the thing is, I'm very excited to see what's going to happen the next few years. So Southwest only just started to grow outside of the U.S. a few years ago. And it still only accounts for 4% of the top line. And that's really the focus now. Typically, the margins are not as good, also because the low factor is not as high for international flights. But there's much more room to grow for Southwest than for the other airline. So even though I always like to be conservative in terms of my estimates, that's something I do put an emphasis on. Now, keep in mind that I did say that my upper band was just 7%, and I only give that 25% probability.

Starting point is 00:40:58 The analyst at Wall Street, they expect consensus around 10% growth for this company. The historical growth rate is pretty strong. Last 10 years, it's done, if I look at the data here, I think it was like, it's more than 20%, which is another thing that I found. It's, I found it difficult to believe, but on an annual basis, on an annual basis, it wasn't grown at 20% was it? I guess for me, when I'm just looking, because on our tool here, we plot the free cash flow, so we can like see graphically what they look like.

Starting point is 00:41:28 And then we kind of interpolate that line into the future with another line that we can graphically see. And I mean, if I put in 10%, if you put in 20%, it would be, it would not look right. I can tell you that much. No, well, so if you look at the like the 10 year average here with revenue, just last year, would be around 8.5% but then the operating income would be around like 15%. I mean, so it might not be 20%, but it's definitely, I guess, a lot more than most people would give you credit for. So, you know, again, yes, it does come down to the valuation. Is this a great airline company it is and we should probably have bought whenever Warren Buffett did and he acquired

Starting point is 00:42:08 his thing is 7 to 8% stake in both Delta and Southwest if I might add. But the price isn't too much different from whenever he got in. I mean it's a little bit, it's definitely higher than whenever he got in, but it's not a lot higher. You know, in the summer, both of these picks went way higher and they've come back quite a bit. I know for mine, for Delta, it was as high as $55 and now it's back down the 48. So, I mean, it's contracted. quite a bit. And I think the opportunity's there. I'm curious, let's transition over to my airline that I brought to the table. And I promise you, I had no idea Stig was coming to the table with an airline tonight. I was, I really laughed whenever I saw that and I was actually coming with an airline as well.

Starting point is 00:42:50 So Stig, I'm curious, what did you get for your intrinsic value for Delta before I even start my pitch? I want to hear what you got. Yeah. So I didn't know that you would pick Delta before I picked I actually came in a little higher for Delta than I did with the LOV. I think I came around eight, eight and a half, something like that. I don't think the airline is as good, but the valuation is definitely more interesting. Yeah. So I'm getting a higher evaluation than you, and I think I'm looking at it with the same conservative eye as, you know, whenever I was looking at the last one, and I'm getting 10%

Starting point is 00:43:26 on this. So when you go from 6 to 10%, you know, I mean, I think that's a significant. jump in the return. And, you know, when I'm thinking about a person that's booking their airline, I don't think that a person, if they can save $100 by going on Delta, opposed to going on Southwest, I think they're going to go on Delta every day of the week, for the most part, especially when you get into some of the more expensive tickets. I think people are looking to save money way over the brand of the airline. I might be wrong. So for me, when I'm thinking through that, the competitive advantage of the brand and all the quality that we talk about with Southwest, I don't know that I'm necessarily willing to take a cut in the yield that I expect to get for that to happen, simply because I don't think that it's a competitive advantage.

Starting point is 00:44:19 I mean, it's definitely a competitive advantage. Don't let me go to the extreme here, but I don't think it's as strong of a competitive advantage as what some people might give to some other type of industry. So that's why I think this is probably a better pick than yours, a lot better. I'm just joking. But I do think that the returns a little bit fatter. I could get into some of the numbers, something that I think has caused the airlines to maybe pull back a little bit from where they were at in the summer, because when you start looking at the revenue, when you look at the revenue for Delta from 2001 up until the year

Starting point is 00:44:55 2016, the revenues had increased every single year during that period of time, which I find just amazing. 2016 was the first year that you had the revenues actually contract just a touch. Looking at the trend for this year in 2017, it looks like the revenues are going to go higher than they were last year, which I think is good. But I think that maybe that's why you've been seeing the price, maybe not pop as much as what we probably expected a year ago. just to kind of put some context on this for people. So the price of Delta right now is $49 a share.

Starting point is 00:45:29 The earnings or the profit that you get for each one of those shares is $5.79. So good luck finding anything like that on the U.S. stock market. As far as I'm concerned, I think that you're going to have a very challenging time trying to find a company that's giving you that much profit for the price that you're paying, especially for something that's this large and this stable. The debt to equity on Delta is a 0.5 when the rest the industry is a 1.3. So their competitors are more than double the leverage than Delta. So in general, I think that those are all positives. This is something that I'm definitely taking a position in. That's not a very sizable position, but it's a position. And I think that the negatives here, the free cash flow seems to be holding pretty strong. It's growing, but it's not

Starting point is 00:46:16 growing at a rapid clip. And I think I already mentioned whenever Stig was talking there. I'm not a real big fan of how regulated this industry is, but I am a fan of how much it's been consolidating recently. And I think that that's one of the reasons why you're seeing it as a decent place to be based on the prices and the profits that you're seeing. So that's my pitch. I'm curious what everyone else thinks. I was just going to run through the numbers very quickly as I saw the market cap 35 billion enterprise value 41 and a half. So it's carrying a little bit of net debt. But as Preston points out, still very low debt to equity, I calculated it at 0.6. But acquire is multiple under seven times.

Starting point is 00:46:54 So it's slightly cheaper than Southwest, which was Stigs pick. So I think on a valuation basis might be a little bit weaker. I still think it's too cheap. So I pegged the DCF around $60, $65. The growth rates haven't been as strong as Southwest, but I think that the cheapness makes it a slightly more interesting pick. Trosky F score is around five out of nine, which is slightly better than average. So that's not too bad.

Starting point is 00:47:23 One thing that's worth raising the Altman Z score, which is the measure of financial distress, it has it in a distress zone that could be, sometimes it's just that the nature of the business model slightly confounds the statistical models. So it's not something that's necessarily a concern. It's just when I see something like that, it just tells me that I have to dig into it a little bit more. I haven't had the time to do that at the moment, but it's just something to bear in mind. and if it continues to deteriorate to understand why. But when I look at the other metrics, it doesn't bother me.

Starting point is 00:47:52 The pretty good return on invested capital doing much better than its free cash flow yield, so it's undervalued. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process

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Starting point is 00:51:31 Warren Buffett, greatest investor alive, probably greatest investor of the last four, five generations, I don't know, as far back as anybody can tell, he took a pass on that and he bought a basket of them. So there's no chance that I'm going to pick one over the other. That's true. How about you, Harry? Now you heard our pitches. What a squirmy way to get out of that question. Yeah. Hiding behind Buffett. But I had a question actually, like, we are talking about the consolidation, everything growing, why is the market not seeing it? Is it something that folks are seeing in the sense that it has been historically prone to competition and irrational participants? What are the arts that will not happen again? I think it's just been known

Starting point is 00:52:24 as such a hated sector. I think everyone latches onto the narratives that we're saying about the unions, about the government regulation and all that stuff that, even as the price becomes attractive, a lot of people are like, yeah, but no one ever makes money on airlines. And then they just stop their analysis there. So that's what I think it is, Harry, but who knows? I don't know. Part of the problem is that they have this massive operating leverage and they are levered to the oil price, which is currently low. And I'm surprised that they're not as levered to the economy as, I mean, maybe that's another bias of mine. But I do think that oil moves up, it might be a different complexion. But I think you can see when you, I fly a lot.

Starting point is 00:53:04 When I fly, the plane is full every single time I fly. So business is good. One thing about the culture that I do want to point out and also just to make sure that it's not, I guess, misinterpreted, is that I think that the culture is the most important thing to any organization. And I guess Preston had a good point whenever he was saying, you know, if I can save, call it 100 bucks or whatever on Delta, why wouldn't I fly with them? And obviously, you would. I don't see culture like that. I mean, it's kind of like the same reasons why Britswater is so successful. I don't think people are necessarily willing to pay higher fees to have Britswater handle the money because the culture is strong. I think it's the other way around.

Starting point is 00:53:48 I think you are building a stronger company, whether it's in how you train your company, whether it's how efficient you grow if you have the right culture in place. And it's more like it trickle down to the customer rather than the other way around. And I think that's something I want to pay a premium for. And I know this probably, I don't know if that makes sense whenever we talk about the calculator and we talk about whether or not we should adjust our growth rates. And if we have a higher growth, you have a stronger culture. I just think at the end of the day, giving that we know how important it is with taxes and moving around your portfolio, that if you want to hold something for the long run, it's very, very difficult not to hold

Starting point is 00:54:26 a company like LOV or Bridgewater, whatever you want to call it, because the culture is so strong. Hari, I see you have a point. Yeah, Stick, to follow on your point about culture and the service they provide, I think it can have a tangible benefit if it reduces the search cost for customers. Based on my experience and a lot of folks I interact with, here in the West Coast, especially in the Northern California, most of us don't even think about other airlines when we are buying tickets to L.A., for example, or any place that is nearby.

Starting point is 00:55:02 because we have got enough trust that the prices are usually fair or competitive. So that goes to the fact what Stig was mentioning, that culture in itself, the service in itself will not win customers. But the price point is also important. So the customers in the airline industry are very price sensitive. So whatever you do should be on top of the price. You cannot compromise the price. So the culture will not give you pricing power.

Starting point is 00:55:34 I don't think any of the airlines have pricing power. All right. So did you guys have anything else that you wanted to talk, Kern a van or anything like that that's just pressing? Are you have something? Go ahead, throw it out there. I wanted to throw at you a couple of points, so to just get your reaction.

Starting point is 00:55:50 Number one, Bitcoin Cash, is making a lot of news nowadays. I see a lot of folks in the Valley are very excited about Bitcoin Cash. The second thing I wanted to also throw at you is Ray Dalio, since we are talking about him, recently made a huge purchase in gold, which was what, 573% increase in his stake or something like that. What do you guys make of this? So, Hari, you just turned this into another hour episode here.

Starting point is 00:56:20 Well, I've got some hardcore opinions about the first one. So Bitcoin Cash versus Bitcoin. So let's just give a little context of people if they're not familiar. with this. So we're obviously talking about cryptocurrencies. Back in August, there was a hard fork that occurred between Bitcoin Cash and Bitcoin and a gentleman by the name of Roger Ver was behind the Bitcoin Cash fork. And the big debate goes down to why it ended up forking is because there's one camp of people that think that Bitcoin should be for everyday purchases so that you should be able to go out and buy a cup of coffee with Bitcoin with your smartphone.

Starting point is 00:57:00 There's another camp of people that say Bitcoin should replace gold and it should be what central banks ultimately store instead of gold itself. And it should be the new monetary baseline on a global level. I fall into the latter camp. I think that when you think about what Bitcoin's trying to do, it's trying to fix the monetary baseline so that these central banks cannot continue to print. So I guess this is the question I often ask people. What is Bitcoin? What's the purpose or what's the problem that it's trying to solve. I don't think that it's necessarily trying to solve everyday coffee purchases. I don't think that most people would say that there's an issue there as far as they're being taxed too much on the purchase through the currency itself.

Starting point is 00:57:46 So I don't see a fundamental issue there. Where I do see a fundamental issue is that right now, every developed country around the world has a fiat currency that's pegged to nothing. and these governments can continue to print at ridiculous levels. And since the currency is not pegged to anything, Bitcoin solves that fundamental problem. And so we could go into this a whole lot more, but we'd get into block sizes. And when you're talking Bitcoin cash and the way that they're scaling this within an 8 megabit block, that in the end creates a very big and chunky blockchain 10, 20, 30 years from now. if their solution to scaling is to just increase the size of the blocks that are produced every 10 minutes,

Starting point is 00:58:28 in the end, individual people can't mind that or can't keep the actual blockchain on their computer. And so then that becomes a security concern because now you're not having something that's going to be decentralized. In the end, you'll have something that's centralized, which actually doesn't solve the initial problem with the central banking part that I'm talking about. So I'm a Bitcoin fan, but I am not a Bitcoin cash fan at all. So I'm curious what you're hearing out in the valley. Are you on this one? One of the speculations in the valley is that folks in Asia are behind Bitcoin cash. And it's almost like a cryptocurrency for Asia.

Starting point is 00:59:05 And Bitcoin is the cryptocurrency for Europe or West. Well, what it's really coming down to is a miners versus the individual people and a money that will fix the monetary baseline. So think about it. All these mining pools that are over in China, what do they want? They want more power and control over the currency. So what they're trying to do, and you look at one of the guys who's behind us, he has one of the biggest mining operations there is in the world.

Starting point is 00:59:32 And so that's why he's trying to make it bigger blocks, because what does that do that centralizes the power into his hands and not into the greater good of the people? You know, something that Stig and I read about in the Dahlia book, and there's another book that I read called The Selfish Gene. And it talks about how when something is good for the masses for everybody, that's the direction that things will move naturally. But whenever things are only good for the individual,

Starting point is 00:59:59 the universe works in ways to always destroy that initiative. So whenever I'm looking at this debate through centralization, through greater power for the miners versus distributed power for everybody and for the greater good of the world, I think that they're swimming against the current with Bitcoin cash, and I think that the regular blockchain Bitcoin is actually swimming with the current. But that's my opinion. And just as a word of caution to anybody hearing this stuff,

Starting point is 01:00:26 I think cryptocurrencies are extremely dangerous, and we have no idea what this stuff is or what this is going to become. And if you're actually investing in this stuff, I hope you're not allocating a large portion of your cash flow to it because there's just ridiculous amounts of inherent risk associated with it. But I also believe that with that inherent risk, there is potential enormous upsides with the market caps so that a global currency could potentially arise to.

Starting point is 01:00:54 I've got a little bit of gold. I don't have any particular view on it other than I think it's a little bit of a hedge. I don't have any Bitcoin. I just don't have these cycles to kind of figure it out. I wish I'd bought some a few years ago. I had a client who put $10,000 into the ICO of, of Ethereum because he liked Bitcoin and he met the kid. He was in San Francisco. He met the kid who came up with Ethereum. I shouldn't call him a kid, but the young guy who came up with

Starting point is 01:01:17 Ethereum. He put $10,000 in the Kickstarter, which is what they described it as. This is before it was kind of called an initial coin offering. And that was worth like $10 million a few months ago. And he was at that stage where he was thinking about the influence of the moon on the tides in how he was going to trade it. So he figured he'd sort of lost his mind. So he sold out that $10,000 into $10 million that actually happened. Yeah. No, there's a lot of stories. I mean, there's a ton of stories out there like that.

Starting point is 01:01:44 In fact, Trace Mayer is a guy that I follow very closely in this space because I think that he has some of the best information out there on it. And Trace was an early adopter, you know, 2010 kind of guy. I think he was buying it at a quarter. And I saw some crazy stuff on Twitter where this guy, they were talking about this S2X fork that didn't happen, by the way. But Trace Mayer said something like, hey, you know, Roger, I'll bet you something like 30,000 Bitcoins, whatever it was. I can't remember what the number of Bitcoins were that he had, that he wanted to bet him. And this is just

Starting point is 01:02:23 what he was willing to bet. So I don't know what else he had on the side. But the amount came out to be $100 million. And so like these, some of these early adopters and these guys that have bought this back whenever it was a couple pennies, you know, and under a dollar, and now it's trading at $7,200. They are extraordinarily wealthy. And I can only imagine if, because we're talking about when you look at the market cap on this thing, and this is so crazy, when you're looking at the market cap on Bitcoin right now, it's around, I think, $120 billion or something like that, if this thing actually becomes a real currency, the global currency, we're talking trillions of dollars here for the market cap, because you look at what gold,

Starting point is 01:03:03 gold is as far as market cap. I want to say it's around $4 to $6 trillion in market cap for gold alone. You start talking about derivatives markets. There is $1,600 trillion in derivatives, just to kind of give you an idea of how big this is. And Bitcoin's just at $120 billion. So if this thing actually matures and goes to some of these levels, these guys that have those kind of positions today and they're already worth $100 million plus, there'll be some pretty wealthy people. in the world. They won't be excited about your Delta pick. At all. Preston. At all. You'll be like, it's not 6%, it's 10. And they'll be, yeah, you know, I just met 1000 X here over the past few years. So I'm looking at the price of Bitcoin. It did 10% today.

Starting point is 01:03:50 Like literally today. Now, it might do negative, it might do negative 30% tomorrow, but I did 10% today, which is what we were talking about the whole time about Delta potentially giving us on an annual basis. So a completely different, like I said, if you want to invest some money in this stuff, go ahead and do it. But I wouldn't use a large substantial portion of your free cash flow. But if this thing turns out to be something, you might be able to pay for your house with a very small sum of money invested.

Starting point is 01:04:16 Chulips.com bubble, South Sea bubble, housing bubble, Bitcoin bubble. And, you know, I might go down in the books as being criticized heavily for this comment, but I don't see Bitcoin as being anything remotely close to the tool of mania whatsoever. I think that there's actually something here. I think it's yet to be seen which blockchain might emerge as the currency. Right now, it sure looks like it's going to be Bitcoin. Yeah, my last comment is I believe blockchain technology and cryptocurrency are very interesting. However, it's very similar to the early 1900s when there were many automobile companies coming up.

Starting point is 01:04:56 At that point of time, if we had to bet, it would have been very hard. So that makes it very hard to bet on any cryptocurrency right now. And I've been trying to understand this technology and this market, but I'm still not at a place where I'm confident enough to invest in it. I love Buffett's line where he says, you didn't have to know which car company was going to win to know that you wanted to be short the horse. Yeah, but he doesn't sure it anything. That's a catchy quote, though.

Starting point is 01:05:31 I guess my point for you, Hari, first of all, would be I don't necessarily buy into that narrative comparing it to car companies because when you're dealing with this, I think there's really strong network effects that take hold when you're dealing with a cryptocurrency that don't exist when you're dealing with like an individual business with cars. Like there's no major, I don't want to say there's no. There's some network effects associated with cars. But as far as picking the right brand of car, I don't see there being network effects associated with that. When you're dealing with a currency on a global scale, I think you start getting into some of these network effects. I can name some of them off like speculation, merchant adoption, consumer adoption, security, developer mind share, where you're getting the smartest people involved in some of this stuff. And there's plenty more. So I think that that's a consideration to maybe move away from that narrative and think of it maybe a little bit different.

Starting point is 01:06:25 just because of the influence of those network effects that can take place. Anyway. All right. So, guys, I think that concludes our mastermind discussion about stockpicks slash Bitcoin cash. And if you want to go first, Harry, where can people learn more about what you're currently up to? Same blog, pitch business.com.

Starting point is 01:06:50 All right. We'll have a link for that in the show notes. How about you, Toby? Where can people find out more about you? acquire as multiple.com on Twitter at Greenbacked, which has a funny spelling. I know you'll put it in the show notes. And Ray Dalio's favorite book, I've just got it out now. It's called the Acquireas Multiple. It's available on Amazon. No, it's not his favorite book. It's his top five, Max. Hey, we got, just as a side note, we got a note from Ray this week. He listened to our episode that we did as a review of his book. He actually sent us a note on Twitter that he

Starting point is 01:07:24 listened to our show. So we were, yeah, we were super pumped. So, Ray, if you're listening to this, we're joking. We're just having a little bit of fun. All right, guys.

Starting point is 01:07:36 That was all that we 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 theinvestorspodcast.com. To get your questions played on the show,

Starting point is 01:07:51 go to AskTheInvesters.com and win a free subscription to any of our courses on TIP Academy. 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.

We Study Billionaires - The Investor’s Podcast Network - TIP166: Mastermind Discussion 4Q 2017 - Stocks & Bitcoin (Business Podcast)

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