We Study Billionaires - The Investor’s Podcast Network - TIP651: Value Investing in a Growth-Obsessed Market w/ Scott Barbee

Starting point is 00:00:00 You're listening to TIP. Does traditional value investing still work today? You know, the low price to book and low price to earning strategies that Graham and Buffett made so popular many decades ago? I think most investors have moved away from that style as more and more money goes into high-flying tech stocks that have rapidly improved evaluations over the last decade. But Scott Barbie has defied the odds, sticking to the principles of value investing. And while you can find many institutions that hold Alphabet, Amazon and Microsoft, not many of these closet index funds have actually beaten the market. But Scott Barbies' Agis Value Fund has beaten the market, compounding at 11% since inception in 1998 versus the S&P 500 indexes results of only 7.8%. In today's chat, we'll cover some of the

Starting point is 00:00:42 primary reasons why Scott has outperformed the market, why he prefers to be in stocks that very few other investors will touch, how he dealt with drawdowns during the great financial crisis, how he tries to avoid unconventional errors, how he's managed to create alignment with his investing team and the funds investors and a whole lot more. Whether you're a value investor looking for your next beaten down industry or idea to research, or just want to improve your ability to deal with volatile markets, you'll take something valuable away from today's episode. Now, let's get right into this week's episode with Scott Barbie. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets

Starting point is 00:01:26 and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Kyle Greve. Welcome to the Investors Podcast. I'm your host, Kyle Greve, and today we bring Scott Barbie onto the show. Scott, welcome to the podcast. Hey, thank you so much for having me. It's a delight to be here.

Starting point is 00:01:56 So when I think of a lot of the original value investors who search for similar stocks to you that are low price-to-book businesses, Not many names come to me outside of, you know, Benjamin Graham or early Warren Buffett. But Scott, you definitely fit this mold. So in your latest manager's letter, you noted that stocks in the Ages Fund at the end of 2023 were trading at a quarter of the valuation on a price to book basis compared to the S&P 500. So I'm always thrilled to learn more about how investors arrive at their investing strategy.

Starting point is 00:02:28 So can you please maybe expand on some of the events, maybe influential people and just the background in your education that has helped? shaped your investing philosophy that you've now been implementing for well over two decades. Gosh, that's a pretty big question. I got into investing, I think a little bit later than a lot of folks. I've been interested in kind of, you know, I was a mechanical engineer in college. I'd worked at Chevron and did a couple of summer jobs at Chevron and was very interested in being an entrepreneur and interested a little bit in investing.

Starting point is 00:02:59 It followed some of my family investments and bought and sold a few. stocks, but really didn't kind of catch the bug until I'd gotten out of college. I took a job at Simmons Company, which was an oil service investment bank doing their analyst rotational program. There, I started to listen to the conference calls with the various oil service companies and really got interested in what made the market tick. I was a very junior guy, but also did the monthly oil service fact sheet. So I was coming up with what was going on with the various valuations or oil service companies on a month-by-month basis. So it became a very junior guy. I'm interested in why different ones were going up or down as I would track those sheets and

Starting point is 00:03:38 just got very interested in value investing. There was an individual who came in a young guy who came in from the business schools for their summer and he'd heard of Warren Buffett. So I'd gotten interested in Buffett and what he was doing and just started reading everything under the sun about Buffett, Munger, and all these various value investors. So when I got into business school, I came to the conclusion I really wanted to make a switch. I bought a screen tool, right one of these market screening tools were just coming out and started looking at, if you tighten up the screens really hard, you could see what came out, and then went and hunted through the e-filinges to try to really understand what these companies were about and came across. My first company was Advanced

Starting point is 00:04:16 Marketing Services, which was a bookseller that distributed books through Costco, Walmart's, and so forth. And it was a classic Ben Graham NetNet and bought it and made some money on it. And that really caught my attention then. In business school, I saw that Barron's came out. And I think They've highlighted the Con brothers, which was Irving Khan was Ben Graham's teaching assistant at Columbia and worked at Graham Newman and one of the kind of the value all-star original gangsters, I guess. So I'd noticed that brothers had owned advanced marketing services too. And so I started to reverse engineer kind of what were the other stocks that they'd looked at and ended up calling up Alan, who was gracious enough to start a dialogue with me.

Starting point is 00:04:58 And at that time in my early career in investing was really helpful. helpful. And then my real break was in some ways a summer job that I picked up, though. You know, I had a guy named Ken Corn Gable, who I passed at Wharton, who was walking across the campus. And he told me about a guy who he knew called Donald Smith, who was a deep value institutional investor. And that kind of chance and counter, you know, really changed my life because I got to know Don and called him up and ended up working with him and Rich Greenberg over the summer and really starting to learn the business. So then for me, after that, I had to be a lot of, I had to know, ended up getting to know a number of folks, a couple of people that left Con Brothers.

Starting point is 00:05:38 Alan had referred me to Bill Burno and Paul Gamble, who were down here in D.C. They were the Washington D.C. office of Conn Brothers, but had left two or three years earlier and set up on their own a duly registered investment advisor broker-dealer. And after my summer, I hung my brokerage license that I'd earned while I was at Simmons with Burnow and Gamble. and I started marketing discounted securities to the street while I was in my second year of business school. And Don was gracious enough to help bring me along and show me the ropes of how to do real good research on these companies. And so got started to do that and ended up meeting a whole slew of others in the industry.

Starting point is 00:06:19 I remember going to Wall Street and wrote to Bill Ackman back when he was running Pershing Square. and told him he was maybe three, four years older than I was and had started a hedge fund. So I'd say, hey, I'd love to meet you. And I set up a time and took the train up to New York. One of the first times I'd been up to New York, I hadn't been to New York much. But Bill was kind enough to make a whole bunch of calls and introduced me to a number of other people. And so very, very kind to a really new person in the industry, which I'm really grateful for. I met Bob Rabati that day, which was one of the other folks you'd covered.

Starting point is 00:06:54 year recently and got to know a little bit to some of the other guys. But then when I graduated, I ended up figuring out I could sort of, I felt like I had enough interaction with some of these folks who was making enough money on my trading and might be worthwhile to try to do this on my own. And so I came down and bought into the small broker dealer investment advisor here in town. And interestingly, on the brokerage side, they were covering at the time, Peter Kundle and Walter and Edwin Schloss. So I got a chance to kind of watch the way they were trading. and how they scaled into positions and the kind of things that they were looking at. That was a real eye-opener for me around how the business kind of worked

Starting point is 00:07:32 and the kind of things that the value set were working on and looking at and thinking about. But Donald Smith was really one of my key mentors in the business over the years. We've been very close until he passed in 2019. It's kind of the genesis of how I got my start over the subsequent years. I started the Aege's Value Fund in 1998. one of the guys at Simmons, Denny Kinsomo, had an older brother who had started a mutual fund on a shoestring budget, copying other people's legal work and all the big no-nows. I figured out how to do that and the mutual fund started and 98. I'm sort of 27 years into the management of that now.

Starting point is 00:08:13 I bought out my partners in 2006 and 2008. I've been kind of doing sort of similar deep value investing every. So one of the most admirable traits that I find in many, many great investors is this unwillingness to sacrifice core principles and philosophies to fit in with their peers. And I think a lot of the people who have influenced you probably have that exact same character trait. So you've been running ages like you just pointed out since 1998 now. And obviously there's been tons of ups and downs, tons of volatility. But you've essentially maintained your strategy here of, you know, buying low price of book companies all throughout the years.

Starting point is 00:08:52 So, you know, with all these bubbles that you've gone through and obviously you are observing, you know, a lot of these, say like in 1999, high price tech stocks that we're doing really, really well. But you, you know, through all that, you just stuck to your strategy. So I'm just interested in learning a little bit more about, you know, what is it about your underlying investing principles that maybe you've learned from some of these influences that have kind of helped you maintain your path and not get sidetracked by shiny objects? Well, you know, I read somewhere that when you buy things that are under intrinsic value when you're waiting for the prices to get up to intrinsic value, it's more of an investing

Starting point is 00:09:26 kind of orientation. And when you buy things that are above intrinsic value or own things above intrinsic value, hoping for a higher price, that's sort of a wish upon a greater fool kind of idea. That is more of a speculation-oriented philosophy. I've always had the value philosophy. My history has been sort of an engineer, I'm a mechanical engineer and economics major. I like the grounding or the idea of really determining the fundamental value and owning it at a margin of safety. So whenever things were higher than that, I didn't have a lot of guidelines to really determine how to act and how to position myself. And so I was always much more comfortable, you know, understanding that here's my assessment of intrinsic value. And if the stock is at a

Starting point is 00:10:10 discount and it goes lower, well, then it's an even better deal. Of course, you'd check your numbers, but if it's still penciled out, I was not a person to be easily swayed. And when the markets got above intrinsic value or above what I kind of estimate, which I think certainly happened during the TMT bubble in 99, you know, it becomes a very difficult time. You know, we were almost so small that we didn't really have many clients to lose, but we had a lot of pressure and weren't getting a lot of growth. And we were just sort of sitting there.

Starting point is 00:10:39 And but I empathized with guys like Jean-Marie out of yard who would say, I'd rather lose half my clients than half my clients' assets. And so I think there's an element of cyclicality where a properly positioned investment-oriented firm needs to allow some of their clients to move off. It's always a struggle over those periods of time when you're really underperforming a kind of a high-flying adrenaline-oriented market. To me, and we just, right at the beginning in 99, we'd started out with one of those load up those markets just after we started the fund.

Starting point is 00:11:11 And the thing that was so intriguing to me, though, is that a lot of these deep value names dropped to even lower valuations as the capital flows from investors shifted to chase the shiny objects, as you say, right? And so, you know, it's almost like the real returns that were being offered by the old economy stocks had to adjust to match the, you know, kind of the Ponzi returns that were available in these other high flyers. So I kind of thought it made a lot more sense to own the old economy stuff that was the jewels that were being sold off that really had the baseline cash flows, underline cash flows that the companies were generating were supportive evaluations. And that approach seemed to fit with our whole strategy and positioned us really

Starting point is 00:11:56 nicely for when things imploded in kind of a 102 or three. So yeah, that was the start of our kind of the way we dealt with it. But 08 was a real mess. It was just the opposite of the situation. and everybody's losing assets and so forth. So I wanted to go over a presentation that you gave this year for the Ivy Business School that I really, really enjoyed. So you listed some really fascinating reasons that are responsible for your outperformance. And the one that really stuck out to me was some of the aspects that belonged to the subject of being unconventional.

Starting point is 00:12:31 So you listed three primary ones here. So one was, do not rely on historical price volatility as an effective measurement tool of investment risk. consider permanent capital loss the true measure of risk. Number two, we will concentrate capital in a particular sector and on a small number of holdings. And number three, do not manage invested capital to avoid short run index tracking errors. So I'm just interested in learning a little bit more about what helped you arrive at these three tenets of unconventionality. And why do you think very few other investors follow these principles? Yeah, I think there's a lot of confusion

Starting point is 00:13:03 and folks think that the stock price is equivalent to the value of the company. But stock prices move around in a variety of manners and the value of companies will move around as well, but they don't always correlate. And in the long run, it's the value of the company that really is what matters. When you have a stock price, some volatility or a huge downward shift in the stock price of some kind, if the underlying company hasn't suffered, the evaluation of the underlying company hasn't suffered or hasn't dropped nearly as much, you can get the investor base very negative on a particular company and thinking that there's more risk involved in the company.

Starting point is 00:13:43 When in reality, once the stock price has dropped, margin of safety is much bigger. It's a lot of the air is out of the blown or whatever metaphor you want to use. And it's a much safer kind of time. So for us, kind of, you know, we're much more thinking of, you know, the true risks that occur in a situation or risks that really impair, you know, long-term value. And I think I kind of put those in the three primary buckets in terms of the way I view risk. One is multiple. You know, when multiples are very, very high, even if it's a good company, those multiples can come down just a little bit and you can lose an immense amount of money. So the higher the multiple,

Starting point is 00:14:22 the more really the risky there is because, you know, clearly growth hurdles that the management teams have to hop over to meet that really high multiple. These hurdles are much. much bigger. The second one is leverage. So, you know, when companies have high degrees of leverage, you know, clearly the, you know, the company can get into cash flow problems much, much more quickly when they hit a problematic market or a cyclical downturn. And so, you know, companies that employ leverage are clearly ones that have a higher degree of risk to long-term capital. And the third is sort of the fundamental business risk or, you know, your assessment of those business fundamentals could be off. And so you think that you got a good company, but you've missed two or

Starting point is 00:15:05 three really key fundamental issues that are going on. And those are really three sources of kind of long-term risk that we spend an awful lot of time focused on. And I think the other, you know, when you focus on stock price volatility as a measure of risk, and a lot of quants do this, it can be sort of helpful. But I think in some ways you can be off quite a bit. I think folks have gotten very focused on this volatility measure because we've had 10 years of, of very low interest rates. And there's a lot of leverage in the system. So investors, they're in pod shops, they're employing leverage. And so they need to very closely watch volatility metrics because they are levered and they can't, yeah, they've got to be much more mindful of drawdown.

Starting point is 00:15:49 And so I think that gives us a differential view on stocks that might have some near-term problems. and we're much more willing to focus in the longer run, even if a quarter or two directly ahead of us might be somewhat messy. So that's kind of our thinking on that. We, you know, with respect to the number of concentration on a number of holdings in the, in the sector, or, you know, our focus on industry concentration or index tracking error, you know, we're guys that focus a lot more on taking really strong positions in companies where we've done the fundamental due diligence. You can't really beat an index if you're trying

Starting point is 00:16:28 to replicate it. And so we are really active in the way we pursue our approach. So there was a quote that you said that I found very, very thought provoking, which was, I'm often a contrarian, but not always, understanding that sometimes the crowd can be correct. So, you know, seeing as your investments definitely tend to diverge from the herd, I'm interested in just understanding a little bit more about how you have been able to best assess whether, you know, the crowd is right or wrong about a business that maybe you already own in the fund or maybe something that you're heavily researching. Yeah, you know, I think when I wrote that, I think I was kind of reminding myself.

Starting point is 00:17:08 I'm kind of a genetic contrarian, you know, as a little kid, one of my favorite books was survive the coming thermonuclear war, how to do it, which I remember carrying it around on a vacation one year, and I must have depressed everybody. I think it's really important, though, for genetic contrarians to realize that sometimes, you know, you don't want to just be opposed for the sake of being opposed to people, that the markets can sometimes be correct in their assessment of things. And often, I think I saw a saying somewhere that crowd is wrong at the extremes and right in between. As I've gotten older, I've spent a lot more time trying to puzzle through where we are, trying to fight my inherent dislike of crowd

Starting point is 00:17:51 to think a little more about where we might be in that cycle and whether we're at the extreme, either on the positive valuation or low valuation side. 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 conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum 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.

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Starting point is 00:22:16 which seems like a kind of a classic contrarian play. So let me just discuss that in a little bit of brevity here. So business that owns a mine in Burkina Faso, the country's had multiple coup d'etaz. they've expelled Western military forces from the country and they have armed conflicts against ideological extremists. So definitely, you know, speaking about what you just said to in relation to sentiment, it's the pretty sour sentiment regarding this exact investment. So I'm just interested if you could speak to the thought process on some of these contrarian plays like this one. You know, how are you generating enough conviction in an investment like this when it is

Starting point is 00:22:53 clearly surrounded by so much uncertainty. Orzone is one of many. We have a basket of these things that make up about a quarter of the fund. And Orzone's one of a dozen or so names. And interestingly, you know, within the resource space, these precious metals mining kind of companies, they can have a whole slew of risks. There can be geologic risk, metallurgical risk, management agency risk, you know, construction, regulatory permitting, country risk. There's a, there's a whole slew of them. And Warzone, interestingly, the geology is excellent. The metallurgy works great. Management is phenomenal. Patrick Downey, he's got a great reputation having turned around Claude Resources in Canada and Delradian. It was sold off under his directorship. He was on the board at

Starting point is 00:23:42 Delradian as well. So just a phenomenal individual. Construction risk, you know, in West Africa, The construction generally has been on budget and on time, which is big rarity in the resource space, interestingly enough. The regulatory mine is permitted and there's minimal permitting problems in Burkina. So what we're left with is country risk. And clearly, you know, on the one hand, you know, like Rothschild said, you want to buy it the sound of the cannons and sell it the sound of the trumpets. You know, and that's the way to really make it in the world. And going back to the contrarian mindset, we've got to make sure we're not, maybe the crowd is right here or not, but this is something we're all obviously thinking about as well. There has been a number of coups in the area. A lot of times with the various coups, the minds keep working.

Starting point is 00:24:31 There's been a lot of unrest in the country with Islamic fundamentalists coming into the north, in the north side of the country and a lot of trouble. But this is a very, very big country. and the middle of the middle of the country is the capital city and this mine is very close to the capital city so it's not really in the

Starting point is 00:24:50 right next to an army base so it's really the idea of this being subject to some of the risks of some of the other mines in the country I think are a little bit I think the risk are a little lower interestingly the new military guy

Starting point is 00:25:02 Traore who took over was a former mining geologist so you know has some understanding of the industry through his own history And I think they, at the core, while they, you know, I think they're probably frustrated with the French who'd kind of run it as part of Francophile Africa, I think they are understanding of the fact that, you know, Western know how and operations are really needed to kind of keep those minds running to keep the government nicely funded. There is clearly risk in that situation. But I think, you know, the returns, you need to judge risk, of course, in the context of return. And I think that in the case of war zone, they're funded to do an expansion of their processing that should increase

Starting point is 00:25:46 production by 70, 80 percent in the next couple of years, after which if the current gold price holds on and stays just static, doesn't even go up, it just stays static, I think we're at free cash flow multiples that are almost 30, 40 percent. So once you get the benefit of this mine expansion coming on, to me, it's one of those where it looks like the, the, the reward is pretty darn strong too and probably offset some of the risk factors, particularly given that so many of these other risks that plague mining projects seem to be non-existent with ozone or minimized, I'd say, with ozone. So in an investor business daily interview, you said something that really got my attention.

Starting point is 00:26:31 When we're surrounded by many investors and lots of company, we get uncomfortable. So for you, I'm just trying to kind of wrap my head around this situation. Is it simple for you when you're trying to find you ideas, you know, are you just screening for low price to earnings or low price to book stocks that you, you know, think that the investing industry is going to dislike as a whole? Or, you know, is there some sort of other heuristics that you're using in order to help you find businesses that are just unloved and not appreciated on Wall Street? Yeah, you know, we spend a lot of time looking at the watch list, but looking at the screens that are coming off of the markets. And the discounted

Starting point is 00:27:09 book screen is one of the key ones that we've used to help us sort of orient and focus our kind of limited analytical resources on a subset that we think might provide some of the best returns. And historically, the discount to book stocks have done very well against the broader markets. The last 10 years has been a little more of a hard slog, but clearly I think some of that has to do with the interest rates having been sub-market levels. And I think some of that is likely to change. And back in the 70s, when you last had interest rates spiking and concerns over inflation, the value premium of owning really heavily discounted price to book securities was really strong.

Starting point is 00:27:51 So we're pretty optimistic that this initial heuristic of evaluating on book is likely to come a little bit more into phase and deliver probably pretty solid returns. Yeah, when we look at the top of the funnel, of course, doing the quantitative. analysis of the markets and focusing ourselves at that level. As the start, we also look at cash flow, EV to EBITDA, and then we're looking a lot at other indicators of value, share repurchases or buybacks, whether there's a restructuring, whether there's been management change recently or activism, and how much leverage is in the system. If the stock is highly levered, clearly that's a big risk factor for us. Bear Stearns at 40 to one leverage, even if it's at 50% of book value, the asset value drops a little bit and the company gets into a lot of trouble.

Starting point is 00:28:40 So highly levered entities don't provide that margin of safety from an asset perspective that very low or unlevered companies typically can. So we watch a lot of those things. We don't exclusively do price to book stocks. Price to book is excellent at picking up companies that are trading that have a suppressed return on equity because they're at a cyclical low. And so to catch some of these companies at cyclical turning points, price to book is a very nice initial indicator.

Starting point is 00:29:09 But we also do EV to EBDA kind of analyses to more cash flow type metrics in order to pick up some of these companies that might be producing a little higher return on equities, but the market might be missing something and yet they're trading at low valuations on cash flow. So one energy holding that stood out to me when I was researching your commentary was natural gas services. So this one has performed incredibly well for you. And I know you noted that during the first time you started buying it, it was trading at a discount about 45% to tangible book value after a large shareholder had

Starting point is 00:29:44 exited their position. So how are you thinking just about the energy industry today? And are you still finding compelling investments in that sector, even though the S&P 500 is gone stratospheric? Yeah, natural gas services was a nice pick for us last year. We've probably made 70, 80% of our money presuming on exit today, which like, not have occurred. But a year ago, this was an interesting classic case of a company trading at a big discount to book. There was some perceived CEO turnover. As an old CEO tried to retire

Starting point is 00:30:15 and the new CEO could come in and then had left the business after a short period. There was a lot of big CAPEX that had been getting spent without seeing a lot of results in terms of additional margin dollars coming in. And so there was a worry that maybe there was a problem there, I would suspect. And on top of it, there was some significant selling by some other institutions. And that combined to just make an unloved kind of entity at the time. But, you know, we understood the compressor rental space. I had followed and owned in the past CSI Compress Go. So we kind of understood what was happening. A lot of these companies in the compressor business, when you spend the CAPEX, interestingly, you don't get the benefit of the compressor being in the fleet

Starting point is 00:30:59 earning for about 15 to 18 months. So there's this long lag from CAPEX to interest earning asset. So when you have a big expenditure and all the debt associated with that, starting to come into the book, and you're not seeing the benefit of having that additional enterprise value growth offset with additional cash flow immediately. There was some concern. But when you study it, you realize that these are long, it's just this long cycle, capEx. And these guys were seeing excellent opportunities for strong ROE compressor rental additions, and they put those on, you know, they were really ramping their CAPEX very, very hard to grow their fleet. Interestingly, it was at a time when CSI Compresco and a lot of the other competitors had levered up historically. And, you know,

Starting point is 00:31:46 because there was a big MLP craze from years back where they put a bunch of leverage on these things, and you offer a big dividend and put it in an MLP structure. So a lot of compressor rental guys were in these kind of structures. And when interest rates wet up really, really strongly, they were in a debt reduction mode and weren't available to grow their own CAPEX. So it left the supply response that you would normally see in the compressor space wasn't occurring because of the leverage of the competitors. And so we kind of saw that dynamic and saw that was a very productive one and bought in. Now, with respect to energy, it's been our favorite sectors over the last couple of years, you know, the supply and demand dynamics from an aggregate level appear to me

Starting point is 00:32:30 to be really unusually strong. Over the last probably 10 or 10 or 12 years, the U.S. shale has been responsible for adding something like 8 million barrels a day of additional supply into the global oil supply. And today, those levels of shale expansion just do not appear to be sustainable in any situation. It looks to me like it is likely to be extraordinarily flat. going forward on an aggregate basis. So this immense pulsing out of additional supply that had come out of the shale plays is likely to end. And on the demand side, there's a little bit of a view that in the market that I think it's driven more by politics than by evaluation of facts. And as a result, there's a view that fossil fuels are going to go away soon that have been very,

Starting point is 00:33:20 very prevalent in the market and still remains somewhat prevalent. I'm a believer in some of the some of the work that's been done by guys like Arjun Merti at Veritan, who explains that the S-curve of development of countries like China and India, even Africa, where the per capita consumption of energy is a small fraction of what it is in the United States. If you take China and if you take India and Africa and non-China Asia and you bring the consumption levels just up to China, you've got almost a 60, 70% increase in the overall demand for oil. So in some ways, if you're going to try to mandate the end of fossil fuel use, you're really mandating that these countries remain mired in sort of energy poverty in our view. Nevertheless, you've got

Starting point is 00:34:11 this huge long-term demand trend at your back. And you've got this supply that's kind of falling off the supply growth from the United States that is just slowing immensely. And I think that's going to create a real inflection in the market over the next couple of years. So I like the underlying demand dynamics. And then on top of it, within the energy space, there was an awful lot of companies that were being disposed of from pools of money that had chosen to manage the money based on metrics other than maximizing risk-adjusted return. for ESG purposes or anything else, but in some ways, very happy to come in and take advantage of these kind of pricing dislocations that have been occurring within these companies.

Starting point is 00:34:59 So obviously during this chat, we've talked a lot about book value, obviously, like cheap book value, and we talked a little bit about cash flow generation. So I'm just trying to get to wrap my head a little bit more around your strategy here. So are you looking at more the low price of book values being your margin of safety and then, you know, any type of future cash flow generation, as the growth driver for your businesses or just give me a little bit more information on how you use that as a framework for your investing? When we buy these companies, a lot of times if you can assure yourselves that you're buying at a pretty nice discount to book, and book is real.

Starting point is 00:35:33 So we look a lot at book to market adjustments to try to evaluate how good is book value. Sometimes you'll have markets, you know, book value adjustments that are positive. Like you have a land position where the land is on the books at some value from 50, 100 years, ago and then you've got kind of a hidden asset there. Or you can have book values that's overvalued. Maybe you have a malinvestment that's occurred that you placed your capital in the wrong business, the wrong industry in a sunset, and there's a lot of additional reorienting your business structure would require a lot of charges and one-time charges associated with rationalizing the personnel or whatnot. When you look at both the assets and liabilities to come up with your book,

Starting point is 00:36:15 there's a lot of work that's done there. If you can buy it, at a discount, particularly an unlevered discount to those names. Clearly, that provides us a lot more downside protection, because those assets will be there for quite some time when you can ride through a cyclical downturn in the economy or something. On the flip side, though, sometimes when you're buying it at these levels, we're catching a bottom of a cycle, the return on equity, the return on that book value is very, very low,

Starting point is 00:36:40 and sometimes negative. And so some of the analysis that we really do is to say, look, We're trying to get through a lot of the, how do we get the car through the tunnel without us having to hand the keys of the car over to the banks? And that's really the, you know, there's a lot of analysis that we do, it's like we'll bottoms around that kind of analysis when we do buy companies that have leverage. We want to make sure the shareholders, the equity guys are going to be able to avail themselves to the recovery before a failure. And so presuming that that can be done, we're looking several years out,

Starting point is 00:37:14 and we're looking for tangible issues that can create an improvement in the return on equity of the business. And we do this in an engineering type way. There's two ways you can get better EBITDA, right? And what I really want to focus on when we're looking at this, I like the cost side in some ways better because you can determine how many heads you've cut and what that cost structure that you take out could be and how that could drive the cost down. I think those are more measurable with a higher degree of confidence than sometimes revered a growth that sometimes looks like a hockey stick and sometimes that can get fairly esoteric.

Starting point is 00:37:47 And I prefer to try to tie that back to tangible situations. Like we're talking about CSI Compresco where there's been $60 million that have been spent on on compressors and they're going to come on in the next 15 months and here's what they could earn potentially at 20% if they were put on at 15 to 18% ROEs. And it's that kind of analysis that we like to see. So newly contracted situations or areas where we've already seen

Starting point is 00:38:10 the price movement because two competitors have merged and the pricing in a business has gotten better. And so you can you can then say, well, as our supply boats all come off of contract and they get renewed, here's the bump up in revenues that we're going to see. But we have as a tether, we could tether that all to today's day rate, you know, and say, hey, the day rates have already moved. And I find that to be so much more tangible thing to bet on, kind of the cell phone penetration is going to be, you know, X plus 10% for the next 10 years or something like that where these to me are harder to determine. 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

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Starting point is 00:41:55 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. So one of the more prominent trends today in investing is investing in high quality businesses that can be held for, you know, decades. Warren Buffett has obviously had a big effect on investors looking for these. Now, your strategy isn't really interested in looking for, you know, the highest quality businesses because oftentimes, you know, those businesses aren't trading for low priced book. So I'm just interested in learning a little bit more about how you

Starting point is 00:42:32 view quality, you know, how are you looking at quality in terms of your own investing philosophy based around that low price to book? Yeah, that's a good question because I think there's a lot misunderstanding around what value investing is all about. We all love quality businesses. I guess the real question is, what is the price of quality? At the moment, my perception is that, you know, So it's really important that quality is trading at a really very big premium now to cyclical stocks that have more volatility of their earnings. My guess is that a lot of that has been driven by the ability for quality companies in a time when debt is available and very inexpensive to lever up a more stable earnings stream.

Starting point is 00:43:16 And so if the problem of the economy has been too much debt, I think maybe quality companies getting a premium might be somewhat related to that. So I prefer to stick with some of these other companies that might be perceived as lower quality with more volatile earnings streams because I think in many cases, these companies have reduced financial leverage pretty significantly over the last several years because they've been, in some cases, because of ESG and the fossil fuel business, they've been kind of starved of their bank lines. And as a result, they've really pulled down on their leverage. Quality businesses, the ones with stable earnings and stable, slightly growing earnings are kind of

Starting point is 00:43:52 the darlings of the private equity buyout craze. And I find it interesting that Dan Rasmussen and Verdad, you know, he's done a lot of work on the valuation that a lot of these businesses have been bought out at. These quality businesses have been bought out, continues to climb higher and higher and higher. And so there's an awful lot of kind of high multiple companies inside the private equity space. And I think there's high multiple quality companies inside of private equity that, you know, if there is a downturn and an increase in interest rates, which has already occurred, if a lot of these guys, as they start to roll their corporate debt up to today's market rates, there's likely to be a lot of damage in that. We're going to see

Starting point is 00:44:31 perhaps a decline in the valuation of quality companies. And at that point, I think we may make a shift and get back involved in a more stable earnings type companies. But for the time being, I think there's a lot of systemic financial risk that's kind of associated with low wall and quality type companies. So continuing on with the topic of quality here, so I'm going to loop it in, but I love asking really good value investors just about how they monitor their investments and also how they approach the selling process. So obviously with your style investing, you're most likely you're buying these businesses

Starting point is 00:45:05 lower than intrinsic value than selling when they get close to intrinsic value. But I'm also interested in learning a little bit more about, you know, what about businesses maybe that have, you know, maybe they increase in quality while you own them, maybe it's a hidden increase or maybe it's something that you did account for. Are you willing to hold these types of businesses past intrinsic value if they're increasing their intrinsic value at a high enough rate? Just give me some more information on that. Yeah, you know, there's clearly a lot of tax advantage to writing a business that continues to grow. And it allows you to take advantage of growth in your own capital and compounding without having to pay taxes on that capital,

Starting point is 00:45:43 as opposed to the sort of cigar butt approach where you're buying things, then you shift out into something new. That's a very high tax arena. I think sometimes the valuations of the companies have adjusted to account for that. So you get perhaps better valuations within our space because of that tax issue that occurs. In terms of discipline or sell selling decision, I think one of the biggest issues of discipline, one of the biggest reasons why investors, professional investors anyway, might have problems with discipline, I think, is that they have a fully invested mandate. And so they are then forced to hold things longer than they would otherwise. We don't hold ourselves to a fully invested mandate.

Starting point is 00:46:22 We'll have higher cash levels from time to time with cash being a derivative of the investment process. There are a couple of reasons why we might sell something. First is the positive stock goes up to the point where the multiple becomes more of a market-based multiple or above-market-based multiple, where it's above our assessment of intrinsic value, where the margin of safety drops off because of share price appreciation. We'll sell under those scenarios. If we don't have something new to buy, we'll just hold cash. In another case, something will be still at a discount,

Starting point is 00:46:51 but all of a sudden we'll find something new in the portfolio will be 100% invested. And we'll find something new outside the portfolio that is a really good investment and it'll be worthwhile to swap despite the fact that we're selling an investment that we still believe is somewhat undervalued. So it will sometimes pull off the swap when we can get a bigger margin of safety elsewhere, risk return profile elsewhere. And then I guess the third, which is the problem case is, you know, some new piece of information comes to light that makes you question your original analysis that you thought you were buying a dollar for 50 cents and you turned out you were

Starting point is 00:47:23 buying a quarter for 50 cents or a dime for 50 cents. And then under those sort of scenarios, those are really the most emotionally frustrating. But I think it's important to really be willing to assess that accurately and not be stuck in your behavioral biases and exit. I keep trying to remind myself, you don't have to make your money back where you lost it. So as of June 2023, Aegis's employees and their families invested a combined 48 million in the fund out of total assets of 342 million. So I'm just interested if you could comment a little bit on how you've created alignment between investors and employees in the fund to maximize value for both investors and your colleagues and yourself. Yeah, you know, I personally have an immense amount

Starting point is 00:48:06 my own personal wealth, the vast majority of my personal wealth, liquid anyway, in the fund. It's the way I personally would choose to place my investments. So I think I'm fairly strongly aligned. I think with the other employees here, we don't have a real requirement. I'm kind of a freedom guy, that liberty guy. So I let people decide how they want to do it. That said, what's been interesting is that over time, a lot of the people who work here end up owning a pretty nice piece of the fund as well. So during my research process for this call, I found another quote that you had that was really good regarding reputation. So you said, as a deep value investor, if you get it wrong, you can get hit. It's one thing to forecast Cisco earnings wrong in 1999 and lose money conventionally.

Starting point is 00:48:50 But if a deep value manager loses money failing to spot an accounting scam on, say, a small mining stock, that can really damage the reputation. Now, this makes me think of one of my favorite John Maynard Keynes quotes, which is worldly wisdom teaches us, that it's better for reputation to fail conventionally than to succeed unconventionally. So, you know, you've managed to avoid probably a lot, hopefully, of unconventional errors over the years. Now, I've just interested in learning a little bit more about how you've managed to do that. I wrote that quote kind of trying to explain why precious metals mining is such an interesting area, because I think there's probably a few businesses in the market where being wrong would very quickly determine that you're kind of inept. And so, you know, these shares carry a high degree

Starting point is 00:49:37 of reputational risk associated with them from an investment manager perspective. And as a result, I think they trade more cheaply than the broader markets. And so it's been an area that, where there's been a lot of misperception with respect to precious metals, where the average, kind of the average guy thinks what a mine is, it was, mine as a whole with a liar on top or so. And when you really dig in, you begin to realize that it, you know, particularly after the, it was 2013 to 2015, when the mining index dropped something like 85% in the context of a rising market, it just blew up all the mining investors out there. They just lost just about all their capital. What was left in the business was, you know, the folks that were the liars on top of the

Starting point is 00:50:22 hole in the ground, they'd moved on to greener pastures. They usually don't take it down 85% a market to work in. They wound up Bitcoin or whatever else, greener pastures for the speculators. But what they left in the mining space was a bunch of really interesting engineers and technical people that I thought were really, as an engineer, I appreciated and enjoyed, I felt like they were very focused on a, albeit a volatile business where the commodity

Starting point is 00:50:49 changes, and that can create a lot of differences. But I thought it was an interesting area to dive in. Precious metals is so interesting, too. that a lot of these guys have party reports on the reserves and on the mining plan. These engineering reports are available for everybody to read. And so the level of publicly available granularity is significantly higher in the mining space, which is something that is totally off from what my original perception of mining might be. So being able to get in and do significant due diligence on these things

Starting point is 00:51:22 and be able to tether your due diligence to third-party mining reports and whatnot. It can be a very helpful way of avoiding kind of getting in a situation. It's kind of interesting. There haven't been that many times where I can say somebody really lied to me. But what I find kind of intriguing is that there are generally two kinds of ways that people will obfuscate. The first one, I find I can identify very, very easily. And that's the guy who just doesn't want to get into the detail. Because normally if you really love what you do and you find the right guy, they just really want to talk to you about their business and are excited about it and are willing to give you.

Starting point is 00:52:02 It's like sometimes they're like drinking from a fire hydrant. But there's a second level of person that I have a much harder time with. And it's the person that will give you a great, it's like the realtor or something that will give you the great detail on the granite in the kitchen. And it makes you think, well, they're an honest broker because of the level of grant. granularity that they're giving you and detail they're giving you. And meanwhile, they're totally ignoring that the bathroom is smoking or something. There's a fire in the other part of the house or something. And that's a tougher one because you end up getting somewhat, you know, you feel a little more affinity for a person who gives you that level of detail and you can give them the benefit of the doubt that

Starting point is 00:52:41 they're really giving you everything they think. So that's something I'm still working on. So I love to learn more about the drawdown that Ages Fund went through in 2007, 2009. And so this was probably a pretty painful time for you as the fund went down about 72% during that period. So I just love to know more. You know, how did you navigate this investing experience? And, you know, did you ever feel at that point your strategy was no longer viable? Well, yeah, that was a tough time. I just had my first child in 2007.

Starting point is 00:53:11 And so my wife and I were watching Friday night lights, you know, and I've been born in Texas and got to school there. And so I really liked the Friday night football series. But they had the slow guitar music. could be on the front of the show. And I'd felt like gotten up and crashed my car every day coming home for weeks and then watching one or two episodes a night and going to bed. And for years after that experience, when I heard that kind of show and the guitar music, that kind of gets chills.

Starting point is 00:53:38 It's a very, very tough time, probably the toughest thing I'd ever gone through. Interestingly, the kids wanted to watch it in 2020 during COVID. So that was a recast there. But, you know, in terms of the drop-off, you know, these companies were trading at valuation levels. When you sat down and you looked at the valuations, they were absurdly cheap. You know, it was not a problem. On the whole, in our stocks, it was much, much more of a problem of the other shareholders of the companies and not the companies themselves. Coming into 2007, a lot of the quantitative guys had really ramped up leverage on and playing of the value factor.

Starting point is 00:54:17 So they were buying a lot of discount to book securities, and they were shorting out high price to book and playing convergence. And those guys gotten blown up in the latter part of 07, even. And then it just, it's all sort of cascaded to the point where, you know, the proprietary trading desks of a lot of the brokerage firms

Starting point is 00:54:35 that held a lot of the deep value special situation stuff we were dealing in, we're really getting, you know, repo funding pulled. And we're being forced to liquidate these companies. And in the fog of war, you kind of knew part of the story, but you didn't know the whole situation until months and years later, really. But you're trying to assess everything that is going on.

Starting point is 00:54:58 In the case of a fund, a lot of companies were trading down to very, very cheap multiples, even discounting a recession or a deep recession. Some of the leveraged companies had more significant declines, but some of them had no debt. Sometimes companies were trading down to levels below the cash per share. I didn't feel like, oh, gosh, unless the government bails out everything, these companies are going to go to zero. It seemed pretty obvious that there was going to be a purge of whatever these margin calls were all going to cause. And then there was going to be a reset. And interestingly, in 2009, we went down, it was another 25, 30 percent to the bottom in 2009, just didn't year-to-date 09 alone.

Starting point is 00:55:37 And then we ended up for the year at 91%. And then, of course, 91% got us on the cover of the Wall Street Journal and whatnot and saying, how did you do this? How did you navigate through it? Well, I felt very sheepish about that because I didn't do anything. I just held the same thing. And the stock price went down because they were purging out shares. And then the stock price came back because they finished.

Starting point is 00:56:02 And I think our holdings would have lasted a lot better, even if the government hadn't done the big bailout. So we weren't like a lot of the investment banks that were really going to be zeros. if the government had just let the free market take its toll, these companies that we had would have struggled, but they would have, you know, maybe at a poorer market, but I think they would have come through with significant value on the backside of some of this. Now, it certainly may have taken longer if the Fed hadn't, you know, kind of went and juiced the monetary system a bunch.

Starting point is 00:56:28 But yeah, so I guess here, the point I was thinking, the other thing was that source of stress, for me during that time was one of, I built up a lot of clients, and it's not so much a worry. that the stocks are not going to recover. I had pretty high confidence that they would be able to recover. And it just a matter of waiting for the time for them to do it. The real stress was the clients and the fact that as they panic and pull assets,

Starting point is 00:56:55 there's no opportunity to recover out of those assets and come back. And so your permanent business value begins to suffer. And then you worry about everything, all the other employees and the company here and how are you going to pull through. So that was a source of stress. But the underlying companies, you know, not so much. Now, that wasn't the key source. So in your manager's letter from 2023, you mentioned how scary that the S&P 500 currently looks due to the multiple expansion of the Magnificent Seven, and it's, you know, gotten worse now.

Starting point is 00:57:25 So it appeared at that time that a lot of the future growth was already priced into these stocks and, you know, any potential earnings misses could clearly have a significant impact on their high price earnings ratios. So, you know, I don't need any predictions from you for going from here. But, you know, what are your thoughts on the S&P 500 today, especially? especially, you know, in regard to the valuations of the Magnificent Seven. Yeah, I was pretty shocked, to be honest, around the significant recovery of the tech stocks that occurred in three.

Starting point is 00:57:54 I thought that, you know, that this kind of, I thought there was sort of a bubble earlier. And then in 2022, when the valuations came down significantly on these, I thought this was the start of a longer term, a longer term trend and was a little bit surprised that we had the AI-driven sort of reversal, once again reignited so much of the animal spirits here, particularly in the context of interest rate that had already, you know, had been hiked up real high. You know, historically, when the S&P was very high, people would say, well, that's because the interest rates are very low, so interest rate adjusted basis, it's not really all that, you know, the multiple is not a less stretched. But now you have interest rates at a period of high level,

Starting point is 00:58:40 yield, and yet you have these stocks having ripped higher, a very focused subset of these stocks really driving, you know, a very narrow market driving everything. One of the highest percentages of stocks, S&P 500 are now underperforming, have been underperforming the SP because they're not the seven. I think a lot about the work of Michael Green and Einhorn talked about the market sort of being broken. Horizon Kinetics has done some great work on the impact. of this immense fund flow that's been going into passive, I think there's this belief that, oh, we can just set it and forget it, put this money in this fund, and there's no need to do anything else for the rest of your life, and you're going to be fine, you're going to outperform

Starting point is 00:59:24 most money managers. It strikes me, you know, what other investment product, and I think Horizon Kinetics had mentioned this, so I want to give it credit to them, because it was something that resonated with me. What other investment product do you know of where you can set it and forget it and that works in the long run. I think Michael Green has done some work on this that shows that maybe there's some market cornering aspects that are going on within the S&P and maybe the top stocks of the SP where they're becoming higher and higher, valued. I find clearly within NVIDIA, which sits at the top, there's been strong earnings growth. But the sustainability of that, I would put in some question.

Starting point is 01:00:07 I look at just the energy consumption of the Nvidia chips that are supposed to be put out just this year. Each chip requires as much energy as one household. And when you look at the two and a half million that they're contemplating putting out, that's like a city almost the size of Houston that you're going to put into a 70-year-old electricity grid and doesn't want to use coal plants, hasn't built a gnat gas plant in years, and doesn't like nuclear either and just wants to run on solar and wind, there's going to be the emergence of bottlenecks to the ability of these companies to continue to grow for sure, but also even to continue to produce at today's levels with the margins.

Starting point is 01:00:56 And as such, I think we may be at a time that could be close to 1999 again, where you had the NASDAQ 100 that lost something like 75% of its value after we got through March of 2000. So I think there's some real risk in that sector of the market. I think for those who have been fortunate enough to have played in that, you know, I think it would pay to remember what Sir John Templeton said, that it always pays to change a winning game. And I think there's, I can say it, but the chance of, number of people doing it are very low, but for a guy to have done this and to have the mental

Starting point is 01:01:37 acuity and agility to get off of these and to get into some of these others that haven't performed as well, because the market is hugely binary. And just like in 1999, when the tech stocks had sucked money out of everything else, clearly when you look at fund flows, information technology fund flows are way high and a lot of energy and so forth that continue to lose some assets. And so there's a real opportunity here for somebody that has that mental agility to switch into things that are much, much cheaper and perhaps get a double run. We had clearly missed the backside of this. They could be pretty nasty, I would think.

Starting point is 01:02:12 So yeah, that's kind of what I'm thinking about the market. There's a real big opportunity for somebody who's made money in it to kind of pull back and reassess and that I think I would suspect that the future returns of these kinds of companies are going to be significantly more muted. Scott, I just want to say thank you so much for coming onto the show today and sharing your excellent insights. I was going to hand it off to you. Where can the audience learn more about you and the Aegis Fund? Well, thank you. I really enjoyed doing it. I've loved this podcast for so long, and it's been a real delight to be on. And you can find me at Aegis Funds, A-E-G-I-S-U-N-D-S-P-U-N-D-S-P-Rol.com.

Starting point is 01:02:50 Thank you for listening to T-I-P. Make sure to follow We Study Billionaires on your favorite podcast. app and never miss out on episodes. To access our show notes, transcripts or courses, go to Theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP651: Value Investing in a Growth-Obsessed Market w/ Scott Barbee

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