Bill Nygren: "Value Investing Principles and Approach" | Talks at Google
Hello. And welcome everyone today. We have a very special guest with us here today building, a green quick. Round of introductions for. Bill bill. Has been a manager of the oak mark select fund since 96, oak. Mark fern since 2000. And oak mark global, select fund since, 2006. He, is also the chief investment, officer, for US, equities, at had, his associates, which, he joined in, 1983. He, served as a firm's director, of research from 1990. To 98. Bill. Has received many accolades during, his investment, career including. Being named morning stars domestic. Stock manager, of the year for, 2001. I. Would. Just add a footnote to that a lot. Of people who earn that distinction, she, talked. To them 10 or 15 years down the line there very few who are still performing as strongly as bill has been. He. Holds an MS, in finance, from the University, of Wisconsin's. Applied security, analysis, program, and a. Bachelor's, in accounting from, the University, of Minnesota. Just. Personally speaking I've read a lot about investing, over the past few years but I think Bill, is unique, in his ability. To talk. About the story of value, investing, in technology. So. We are very very honored to have you here with us today well thank you so much for being here thank you great to be here. Excellent. So, I thought we. Might begin, by, just asking, you, to talk, to us about what. Got you started in, value, investing, and maybe we can pick up the story from there, sure. I. Was. As a as a kid was always a more interested, in numbers than words and that. Quantitative. Bias led, me to. Baseball. As an interesting, hobby because, baseball. So. Many the. Same. Situation, recurs so many times you get good. Quality statistical. Samples, and. Statistics. Mean something. Uhit's 300 s better a better player more valuable than somebody who hits 250, and. So. I was always interested, in in baseball. Statistics. And growing. Up in st. Paul Minnesota, in. Our newspaper, the, stock quotes were always right next to the baseball box, scores and, I. Was. Very interesting, because there. Were all these numbers, and they moved around every day and when I asked my dad what they were and he said they represented, money it got really interesting. So. I started getting interested in, all, kinds, of different ways that you could put capital at risk and. Whether, that was in. Things. We'd call gambling, like slot machines, there. Was a family trip to Las Vegas where we were visiting, one, of my cousins who was in the Air Force and. My. Dad took us across the street to I think it was a Kroger, grocery store, and. My. Older, brother and I and he's like kids, I'm going to show you why you don't want well, don't want to gamble and he put like five nickels in his hand and. Starts putting them into the slot machine, the. First one that he puts in seven. Come back out the, next one it goes in more, comes out and this object lesson. Gone awry was, it was. Turning me into a slot machine, fanatic. Because, it took him half an hour to get rid of all the nickels that came out and it was like he was getting madder and madder yeah, you should stop we're way ahead and, he's like no I'm gonna show you this is stupid and keeps putting the money in. So. That. Fascination. Then, was you know why. Was gambling, stupid, I knew my dad was smart and, you. Start, investigating, you see that the casino keeps 15%. Of. Of. The take on blackjack and, one. One and a half percent on craps about the same on blackjack, horse-racing. Is something, in the upper teens percentage. And. There are these things called stocks, that, if you did average in stocks, your. Money was worth maybe eight or ten percent more a year later rather, less and. Kind of that distinction, between gambling. And investing. Putting. Capital at risk either way but in. Investing. Expected. Returns were positive, and. From. The time I was in high school started. Reading everything I could about investing. Go. To the local library take, a couple books home and, back then the investing, section was probably just. This wide so it, wasn't heroic to think you could read everything about investing, that was, available and. As. I read about investing. And, of, course all kinds of different approaches. The. Ones that made sense to me were the value, ones because. I grew up in a middle-class family going, shopping with my mom and. If. Grapes were on sale this week we'd buy more than we usually would and if cherries.
Weren't On sale we'd wait until they went on sale so this idea that is a consumer. You, could get more for your money if you paid cents if you paid attention to price, was. Something that was very appealing to me and that of course that's what value investing, is is being. Patient and wanting, to make sure that, you're actually getting more value than you're expending, to to make a purchase. I. Thought. That, if, I wanted investing, to be a career. That. It only made sense that, I would learn the language of business which to me was accounting, so. I got an accounting, degree as, an undergraduate, it still surprises me today, how many people go into finance, and don't. Have a good solid understanding of. Accounting, I think. It's been very helpful through, the course of my career. Then. Got a master's, degree at, the University of Wisconsin, was part of their applied securities, program. Worked. A couple years at Northwestern Mutual. Life and. During. That experience, really, learned how important, it was, that. If you're going to be a valuable. Research. Analyst, to portfolio, managers, you have to have the same investment, philosophy, they do and. What. They did at Northwestern, Mutual, was quite, a ways away from value. Invest, so when. I'd look at a company and say hey nobody on Wall Street's recommending. This the assets, the. Real estate they own looks like it's worth more than the stock price. They. Would say well let's wait a while let's, see. If. We can get a couple of Wall Street recommendations. On this first and then. You, know a year or two would go by and the stock would have gone up somewhat, it, was becoming a little more popular and, they'd ask me about it again and be like well at, this price it's not very interesting to me because it's, it's, no longer a value, story I can't tell you the real estate is worth more than we're, paying for it and. Just. Pause there for a second, because this. Reminds me of something that I had to ask you and maybe, you know this will be entertaining, for the group as we move forward through the conversation, so. I'm gonna phrase, my question, trying. To be in a more. Entertaining, way rather. Than necessarily, factual. So, I'll let you sort the facts out later so. One of your analysts, wrote to us they. Said that bill. Really likes and remembers, the facts when you present something, true bill so. They presented, a stock to you at ten dollars and. About six years later when the stock had you. Know grown 20 times you. Still remember the presentation. And. You liked it even more so you purchased. The stock at, $200. I did. Say thanks Rory is that correct what, is the message you're trying to send here. Well. Things change over time. The. The stock that. We're talking about is Netflix, and. One. Of our analysts, presented, it, about. Seven years ago and his. Story was basically. Everybody's. Focused on the wrong numbers, here what you should look at is the. Market thinks HBO subscribers. Are worth whatever. The number was I don't remember eight hundred dollars a sub and Netflix. Subs are worth a small, fraction, of that in the market and it. Seems like that's. Wrong NetFlow, is growing so rapidly HBO. Isn't, so. At the time we knew. A lot of people in the media industry because. Of investments, that we had we talked to them and. They said Netflix, is hugely risky. HBO. Spends about three times as much on programming. As Netflix, does they could basically squash, it any time they want to and. By. The way look at look at their turn statistics. Especially in the month of February when they release house of cards this. Is a one show company. The. Most, of the media companies, that have sold programming.
To Them regret, the decision, they had no idea it would be sold to so many people. So. They're gonna see enormous, increases in programming, costs when, house of cards goes up for rebid they'll easily be outbid by one of the bigger studios. And. We looked at it and said the stocks cheap but it's really at a very risky stage, of. Its lifetime, and. One. Of the things we, do at Oak mark is if. We think the risk, the. Risk and reward have, to have to be in balance to make something interesting you, can't go into a high risk situation, for a small reward, you'd. Only want to be in a high risk situation if the reward is, very very large and as we looked at it the risks were just too high, so. I was saying earlier I, don't even think of this as a mistake I think. You learn a lot about investors. By what they look back on and say were big mistakes, a lot of people would say this, stock went up 10 full 20. Fold maybe not. Buying it was a big mistake, well. It didn't meet our criteria when. We researched, it thoroughly it didn't, have the risk return profile, that we were looking for and. Fast. Forward, to just a few months ago one of our young analysts. Comes. Into a large room they're about 20 of us the investment, team that sit around the table, he'd. Written. A report on why we should buy Netflix, and I'd. Gone through it and of course it's hard to get out of your mind that you missed buying it at 5 or 10 percent of the current price and. The. Report didn't really jump out at me we go into the room and he starts by saying. People. Subscribe, to HBO, now and they pay $15. A month they. Subscribe to Spotify, they pay $15. A month Sirius. XM, more like $20. A month. Those. Same people when they rate the services, they subscribe, to say Netflix, is more valuable, to them he. Said if Netflix instead. Of charging $10. A month charged, 15, it. Would be selling at 13 times earnings, and. It. Was like the bell went off it's like that's. That's. A way of thinking about the business value there that I had never thought of that. The. The. Willingness, of Netflix, to, sacrifice, current, income, by not charging as much as they could for their product, to, instead grow their subscriber, base, 25%. A year get. To the point today where the moat has become almost so large that it's impossible to think of somebody displacing. Them eight. Billion dollars a year on programming, that's almost now two to, three times what HBO, spends, on programming, and, because. The sub-base is growing so rapidly the. Cost per subscriber is, going to be substantially. Less for any programming, that Netflix considers, buying compared. To HBO now. Clearly that's a stock most value managers, won't touch it sells it almost, 200, times earnings, and markets at 18 times earnings. It's. Just a name they don't even think about, but. I think as, as. Value, investing, has evolved. More, of the interesting, opportunities. Today are. Coming. From, these businesses, that the p/e ratio. Does a really, poor job of assigning, value. We've. Talked, about companies, that have non earning assets and I was asked not to talk about, this. Company so I won't but. There are companies that have a lot of cash on their balance sheet, that earns. Almost nothing today so the p/e investor, really is getting cash for free, there. Are companies that are investing in unrelated businesses. It's costing, them current income, and the. The accounting, does set up an asset. To. Represent, the venture captain. Tatar, making, there. Are companies that are investing in largely. Unrelated, businesses. Like, a Netflix, sacrificing. Current, income to grow scale and. When you can find companies, with those characteristics, that, happen, to have large p/e ratios. You're. Getting kind of this weird area where most value investors, won't buy it because the p/e ratio, is too high sometimes. Growth, investors, aren't excited, about them anymore because, they are in that, upper Des aisle of growth rates, so.
I Think of it as kind of an overlapping, area, between growth, and value where. The growth rates are higher than value investors, are used to the prices are cheaper than growth, investors, are used to and. It kind of the names kind of fall through the cracks there and. You. Find a lot of our portfolio. To oak mark has. Large, pieces, of hidden, value in, assets, that are currently, earning anything. So. Just to take that talk, one. Step further a lot. Of companies and I'm thinking, Amazon, for example you, know which have large. A, large, user Network are also in, a position. Where they can invest, in content. And. I'm. Not necessarily posing, this as a question of Amazon, versus, Netflix, but I am just wondering, about Netflix's. Mode in general, independent. Of their valuation. Could. There be danger, to Netflix, from, other people who could come in and compete with them on as, a bigger scale as Netflix, has right. I think I think that is a risk, but when you look at the scale that would have to be today it's a pretty small number, of companies and. You. Know Amazon. Is probably, large enough to do that maybe Facebook. Maybe alphabet, maybe Apple but. To, go in and say we're going to commit ten billion dollars to programming, without an obvious revenue. Source to offset, that, there, are many companies that can take that kind of risk and then, I would also add yeah. People, people are paying today a hundred one hundred and fifty dollars a month for their cable TV subscriptions. This. Doesn't, have to be a winner take all market you. Can have a fifteen dollar Netflix, subscription, and, maybe a hulu, subscription. And an Amazon, Prime and there's, no reason to think that it has to be one versus, the other, I think, there are a small handful, of companies that. Will. Be disruptors. Relative. To the current cable, TV model that we have and. There'll, be more than one winner, all. Right and then and. I know I paused you there while you were continuing, your story so I just want to throw the gauntlet back, at you oh. It. So, you know we had kind of this different style of investing and, when I got an opportunity to interview at Harris associates. And all. Of the companies, that they were talking about were, the same companies, that I'd been doing research work on you. Could see kind of the meeting of the minds and I. Knew. That was a way that I would be able to maximize my value as an analyst is working, in a shop where other people, were like-minded hmm. And, I, think that's. Been one of the biggest reasons, that Harris, and Oak mark have been as successful as, we've been is. Our. Brand means something, oak. Mark anybody. Who hears that knows it's long-term value investing. It doesn't matter if it's our international, fund if it's a domestic fund. Our. Funds that combine stocks and bonds to have more of an income element, it's all long-term, value investing. And that. That. Helps, it's, sort of multiple. Ways a network, effect where, smart. Analysts, know that. Other value, analysts, are at Harris associates, so, they, want to come there to be in like company. Investors. Know that the oak mark fund is a Value Fund so maybe they should look at oak market or national if that type of investing works for them and. One. Of the big, advantages we've, had is. Because. Of that environment. Where, everything. We do is value, investing. We. Don't lose a lot of people so, our top investment, decision-makers, from. The time I've been there have always worked with each other for more than a decade and when. You work with somebody that long you, get to know their strengths, and weaknesses you know their biases, you. Know what. You can learn from them bouncing, ideas off, of them, it. Makes our, effective. Li gives us a moat because, you, couldn't just take a, similar. Group of talented, people throw, them in a room and have. Something as successful, as harrison oak mark is, because. The. Group has worked together and, that's a big asset you, think of most mutual, fund companies, and. It's almost like they're trying to fill the morning star style boxes, though they'll. Have a high, turnover. Growth. Fund they'll, have a long term growth fund they'll have a Value, Fund they have all the different the. Different boxes filled, but, when you do it that way your, brand loses, value both. In terms of attracting customers and, attracting. Employee. Talent, and I. Think, it's something that's really helped us, and. Do you see that this philosophical. Evolution. In. Value, investing, is going. To a different, level. Now, people. Were talking about this in 2000.
So So. I think I asked, this question with a lot of humility in fact and, skepticism. Because in 2000. When people were investing, in technology, companies there. Was a case to be made that value, investors, were not they, were saying they were not getting. In on the Internet. What. You're saying is that there. Is a similar, case today but the situation, has changed where, these companies are big enough they're producing, cash and real earnings. Little. Later out for us help us understand, what. The reality, is now sure, to that specific, question and, I want to go broader with that. But. When I started in the business in the early 80s, most, of the companies we think of as tech leaders, today. Were. Of a size that. The, ability, that they could be displaced, by someone else was, was a very real risk and. They used to joke about you know two high school kids in a garage coming, up with an invention that would. Eliminate. One of the one of the industry, leaders you. Think today, of the. Market, position. That companies like Intel have. Or, Texas, Instruments. Microsoft. Two, kids in a garage aren't going to displace these companies, and one of the things as a value investor you're always thinking, out like five to seven years into the future, how's. The company likely, to change, how, will it mark its market chair change how will cash flows change. How. Does the addressable, market, change, the. Tech companies back in the 80s, your. Vision got really, cloudy fast, because. The industries were changing, so much and. I think now the companies, are of a scale that that can't happen, but. The. The, evolution, of value investing I'd like to take back to more just the evolution of, investing. If you think you. Know this. Asset. Category, called stocks that got me interested in investing, because it had such a high expected. Value. 50. Years ago maybe the. Only way you could access, that was, your local stock broker and that, was a pretty high-cost way to access. And, then. Came, along mutual, funds which was a much lower cost way to access, this wonderful, asset, category, and. Just. By being a mutual, fund and. Passing. Along the cost savings you got by aggregating, all the customers, was. A tremendous, advantage, for the customers and gave mutual, funds a big leg up on the local stock broker, then. You take that to a farther extreme, and. Indexing. Came along said, you just, aggregating, isn't enough to add value anymore, that's not enough to charge your active manager, Phee because, we can aggregate do. It in a no cost way pass the savings on to you and. We. Will be better than the average mutual fund. So. Then value investing, says well we can we can one-up that we'll we'll just buy the lowest quartile of Pease and, you. Know this is that probably still worked in the 80s domestically. Maybe in the 90s internationally. You. Just put a portfolio together of, all the low p/e stocks, you'd be patient, you hold them until they're not low p/e anymore, and that was enough to work, well. Then the ETFs, came along said we. Don't we don't need to pay stock pickers, to get low p/e stocks, we can we, can get a computer program, to pick low p/e stocks we'll give that to you for almost free, so. To. Earn an active, management fee you've always had to stay like one step ahead of the computers, hmm, and, I, think. One of the frustrations, you hear with a lot of value managers, today is what. I did 20 years ago isn't working, anymore right, I think, that's always been the case what what worked 20 years ago very rarely still, works today, 20. Years ago you could just buy low p/e low, price to book value stocks. And that was enough to be attractive. Now. You can do that for almost no fee hmm. And. The. Computers, have gotten smarter. About, combining. Low, p/e low, priced a book with some positive characteristics. Book, value growth earnings, growth and. So. The simple, obvious. Stocks. That look cheap, generally. Deserve. To be cheap and when. I started at Harris thirty years ago we. Were we were one of the earliest firms, to. Do. Computer. Screening, to find, ideas and, once. A month we would pay to have the, universe of fifteen hundred stocks ranked. Ordered by p/e ratio, and as. Analyst the day that, output. Came in we would all be crawling, all over it to look at what the new low p/e stocks, were well. Today today, any, of our administrative, assistants, could put that screen together in a couple of minutes, and. Because. It's become so easy to get it's. Not valuable anymore and.
I Think that's. That's. It's, probably not just investing, that's through a lot of industries, as information. Becomes, more. Easily accessible, it loses its value, so. Today. The. More interesting. Ideas to. Me at least are these ideas where a p/e. Ratio, misses, it where, there is a non earning, asset, we. Talked about cash we talked about. Unrelated. Investments. We talked about income, statement, investing, where you're. Offering the customer an unusual, bargain, to grow scale and grow the size of your moat and that's. Kind. Of evolved. Into the technology area, today, because. These companies have become big enough to think about what. They might look like five, to seven years down the road and, think. It's really not, much riskier, to try and guess what, Intel. Will look like five years from now than. It is to try and guess what Procter & Gamble will look like five years from now all, industries, are undergoing rapid, change and. The. The. Idea that, technology. Is outside, of my sphere of competence. Because. It changes, so fast I think has become an outdated idea, so, we. Own a lot of technology, names at Oak mark and most. Of them follow the the idea that there is a way to look at the assets kind of piece by piece, that. Gets you to a core that you're not paying nearly as high a multiple, on as, it. Appears, on the surface. And. I see that in your portfolio you, not only have technology, companies, but you also have the, traditional, value investing, names and. Thinking for example Citigroup. And AIG could. You maybe you know for the purposes of our audience. In. Maybe, we're your professors, hat or. A teacher's, hat and walk. Us through one, of these theses as to how do you analyze it in, a way that you know maybe we can all learn from. So. We. Felt that the financial, sector, became very. Attractively. Valued after. The financial crisis. Obviously. The stocks had been horrible, performers. And. There's. Always a tendency of investors, to, look too much out the rearview mirror and truck instead of trying to guess, what, lies. Ahead through the windshield. And. Financial. Stocks had been a disaster, so a lot of people didn't want to own them even value, investors. You'd. Often hear something, like yeah. I really made a mistake owning, the financials, in 2007. And eight I had no idea what they were doing there too opaque we're just never going to buy them again and. That. Never really resonated. With us to us, you. Know we didn't see the housing crisis, coming I wish we'd been smarter, on that we weren't but. If you think about what, banks do I mean they take in deposits, they generally, lend mostly, against real estate if, you knew real estate prices we're going to fall by 20%, or so you, know you don't want to own banks and it didn't matter what, kind of securitization happened. The. Main asset, category. That they, owned on a levered. Basis, suffered. Unprecedented. Decline, so. So. We said, you. Don't have to be afraid of banks. If, you don't think the same circumstances. Are going to recur, and, on, a price to book value basis. Banks. Used to sell it two, times tangible, equity pretty consistently. You know they vary around that they'd be cheap at one and a half they'd be expensive, if they were much more than two and. Most. Of them were selling in the marketplace, at a large discount. To. Tangible, books so our. Interest was piqued because it was contrarian, and. The. Pricing, was out of line with historical. Guidelines. And very, much out of line on the cheap side and. We. Started talking to. Executives. Of those banks, and you. Could see a dramatic change in behavior, that they. Realized, they've made mistakes. Into. Going, into the housing crisis. They they were lending without. Taking, into, account the, probability, that the person they were lending to would pay them back it. Was more just saying this house is worth a million dollars will lend 800,000, and if they don't pay us back somebody else will we don't have to worry about it but, they're getting back to good old-fashioned, lending standards. One. Of the other other reasons banks had gotten riskier. Was. The, dollars, of assets. That. They had relevant, relative, to the dollars of equities, that ratio, just kept growing and growing and, very. Quickly the banks. Partly. Of their own accord partly, because of regulation. Dramatically. Increased, the amount of capital they had relative, to the amount of loans outstanding, so. Instead of 5 percent equity against, the loans they were at 10 percent so, you have twice as much capital there's. Half as much risk. We. People. Were afraid that with. The regulation.
That, The companies weren't ever going to be able to get capital out to shareholders. One. Of the things we heard a lot as. We were trying to explore bear cases, for this industry, was they're, gonna get over regulated, to the point that they basically trade like electric, utilities, Wow. And. We looked at it and said the. Average banks, at about half a Book value the average electric, utility, is at about one and a half or two times book this, wouldn't be so awful if they started trading like electric, utilities, so. We started to not be too concerned about regulation. And thought. We're, buying it less than book value absolute, worst case if. Over-regulation. Makes these companies not want to be in these businesses. They. Can stop making new loans their, loan book can run off and in. Company after company as, we started, penciling, out what that would mean for cash flows, we. Said in this downside, scenario we, still come out ok given, that we're buying at such a discount, and on the upside, if. Earnings, get back to, where, the companies can earn 15%, on, equity, and sell it book and a half or two times book there's, very significant. Side so. One of the things that was important, to us as we started interviewing management. Teams and listening, to presentations. That they'd made was. That we were invested, with management, teams that were okay with growing, through. Shrinking, so, taking. Capital, and reducing, the equity, base because. It's dangerous if you're a financial to go out and just try and grow your assets, when you really try and push the accelerator down. On growth you. Often make mistakes. With. Who you lend to but. Growth, through repurchasing, your shares at half a book value that. That. Increases. The book value of the remaining shares it, decreases. The risk profile, of the company, so. We're. Always focused, on trying to invest with management's. That want to maximize, long term per share value and. In this case we thought that meant having, a willingness to, repurchase. Shares, so. We. Started investing, in the companies that were repurchasing. Shares that. Became a more popular, way for the, the banks, to reinvest, their capital, so. What. Started out as an investment, in, JPMorgan. Quickly. Became JP Morgan bank America, Citigroup, Wells, Fargo. And. We. Didn't own all of them but we owned most of the major banks, with. An entry price significantly under. Book value and. As. As. This. Story progresses, last, year, after. The elections, when. Regardless. Of what you think of the politics, there there, was more confidence. In. A growth outlook. That. Is, good for banks now it means higher interest, rates it, means. Higher asset, values, which helps the loans that are on their books already probably. Means less, regulation. In terms of being able to get capital, back to shareholders, and, we've, seen a tremendous run, in these names but. Still most, of them are selling at less than a hundred and fifty percent a tangible book most. Of them will still see earnings, growth if interest. Rates normalized. To a two or three percent inflation level. And, most of them still have significant. Excess capital on the balance sheet that either, ought to be valued. By investors, through. Requiring, a lower discount rate, because these are less risky businesses. Or, could, potentially be returned to investors. Which. Then it's, dollar-for-dollar that. That. You realize, value, for, for. Excess capital so. Them house would have deferred tax assets right right, the deferred tax assets another. Non, earning asset. Along. Along that theme they'll both deferred, tax assets and, excess, capital really aren't generating much. Much. Today in the way of income, so you missed that if you're just looking at the, banks selling at a 12 or 13 times p/e multiple. Now, there's some risk with, the, tax bill that the. House passed yesterday, that, would take corporate. Rates down to 20% you. Might see right offs on some of these. Deferred. Tax assets the. Flip side of that is. The. Financial, industry, in the u.s. is one of the highest tax paying industries, playing quite close to the statutory rate, and. Normally. It takes a number of years before a competitive, industry returns. A change in tax policy, to the, customers, so. Even. Though a large holding for us like City would, see several dollars, a share of Book value go, away if the, tax laws end up getting, passed like. The one did yesterday, we, think that would be more than made up by, the increase. In their after-tax earnings. That. They would benefit from, until, the banks start competing that away from each other so along, those lines. We. Talked about tech companies we, talked about financial services companies. But. You, also have you know high-quality, compounders, in your portfolio, and I'm thinking companies like MasterCard, and Visa for example.
Talk. To us a little bit bill about, a company, like Visa and MasterCard we. Know that most of the transactions. In the world are still based on cash I think about 80 85 percent. In. That ballpark, so the market understands, the value and, the growth that is possible, but. These. Are not selling. At low multiples, right, now so, why do you continue to hold, these and and will. There come a multiple, in terms of valuation, where you will say that yes this is overvalued, sure. I mean going back to our previous, discussion, about Netflix and can't there be competitors. Even. Though, process. Card processing, payment processing, is, just. As much a network, business as, companies. Like Visa MasterCard. It's a great example that they're, not fighting each other they're both fighting cash yeah and there are two big winners. The. Way we look at trying, to assign values, here, is. In any company, we make a projection out two years all, of the financial, statements. And. Then. For the five years following, that we, assign, an. Estimated, growth rate in operating, earnings for, the company, make. An estimate of what the. Cash. Needs or cash production, of the company will be if they meet our targets, and and. Then get to a growth rate in business, value per share and. We. Say our crystal ball gets too cloudy after, about seven years for any company, to make much of a forecast, beyond, that time period so. The assumption, is that at, the end of that seven, year period, companies. Sell at pretty. Similar, multiples, to each other okay, we've. Made estimates. Starting. With, how. Much of world, commerce, is being, done by, cards, today and what. An extrapolation. Of those trends would, likely produce for, revenue. Growth for MasterCard. And Visa what. Kind of incremental margins, these companies, are. Capable, of having again, if they aren't investing, in adjacent technologies. And. Based. On that and just, a mathematical, model that we use produce. What kind of premium to the normal PE. This. Company would, be deserving of selling at, and despite. MasterCard. And Visa selling, it pretty strong premiums, to the market, they still haven't gotten to that level that that. We would call fully valued now. I would say we got a little bit lucky here, where. The. Market, gave us a great opportunity to. Buy these companies. Back. When. Regulation. Called the Durbin bill credit, card Act yeah was going was going to dramatically. Reduce what, they could get on debit, cards, and, both. MasterCard. And Visa fell, to prices that they weren't much of a premium to the market at the time we bought them so. We've benefited. From business. Value, growth and stock prices both growing it, pretty. Similar, slopes, with. The stocks never getting to a level that we would be, wanting to sell them. Most. Of this time they haven't been cheap enough that we'd say if, new money came to us today and we had to start a portfolio from, scratch would we buy this company mm-hmm, but they've. Kind of stayed between buy, and sell targets for, an extended, period of time and as. Each year rolls by and, our analysts then starts to look at a new year you, know the new year that's seven years out, the. Confidence hasn't, wavered at all that these two companies are going to continue to dominate payment. Processing, as much as they do today so. Let's. Put some some. Some numbers so that we get some ballpark, to what you just said you. Know if I'd. Say there's, their. Revenues. Keep growing at double digits for five years and they keep getting some. Operating leverage in the business so, earnings. Grow at around, fifteen percent let's say for five years so that would mean two, earnings. Have doubled roughly in five years. If. The multiple, goes let's say from, thirty. To twenty because.
You Say after seven years you're approaching, roughly market multiples, so, you get 100%. Upside and then fifty percent contraction due to the multiple does, that that's. Net, fifty percent in five years, does. That cross, the hurdle like how does one think about it like, where would you say. You. Know and I'm just putting some numbers, to ask the question that you know where would one make the call say I'm gonna sit in cash and not stay, invested so. That, the answer gets pretty pretty, complex, and quantitative. But if there's ever a group that that wants to walk through it that way it's probably this group, we. Start with the idea that if, you want to invest capital at, no risk for seven years the. US, government, bond for, US investors is, the way to do that if. You do that today you're earning something around two percent maybe, a little bit less than that to. Take the risk of a normal, equity, you need during a premium to that so, we start we say the two percent level we, actually make an adjustment and say a two. Percent seven year doesn't really make sense in a two percent inflation environment. So. We're we're, gonna pretend, that, three, those bonds are at three percent that we. Don't want to be investing, based on an interest, rate for that bond that we don't think is long-term rational. So. If we say the bond would be at three percent and we want about a four percent premium which is in line with history, for. Stocks we'd say we wanted to stock during seven percent, a year to, call it fairly valued. And. We. Want to sell a stock at about ninety percent of, what we think is fair and buy, it at about two-thirds of what we think is fair so. When we go through that math of saying based, on our seven-year forecast, for MasterCard. That. You. Know we we, think it makes sense that it would sell at, 20, times pre-tax. Earnings two, years from now. And. The. Math behind that would say then. You would still earn your, appropriate. Risk premium, to the seven-year bond if it sold mmm. If it, today. Sold at that price so on. Our, math. Something. With the growth characteristics. Of a MasterCard, or Visa is, worth, something on the order of 20 times pre-tax. Even. Though the rest of the market sells it somewhere around 12, or 13 times, pre-tax. Even. Five years from now you think.
We. Are, five year from now guests for the market, would be based on a seven-year that's at three percent sure, and would still be at about that level I see because, these are high quality compounders. No. I'm saying market, would still be at about a twelve times level so if, five years from now we, still thought we had seven years of, runway. Ahead of us or supernormal growth at MasterCard, and Visa then. We'd still have a very high relative multiple. On it now but the, way our math works today we're assuming that as, each year that goes by that they're growing fifteen or twenty percent. The. The, years eight years out nine years out those are normal growth years, mm-hmm and one. Of the reasons it's been such a good holding for us and we've held it like five years or so is, as every year goes by and, we, start, that you're worried, about. Disruption. Risk from alternative. Payment processing, systems, at the end of the year we end up saying the. Moat that MasterCard, and Visa have is just as strong as the year as it started at the year so, we don't have to lower our multiple, and, if. The company is growing 15%. A year and you aren't growing and you aren't lowering your multiple, your business value is growing 15%. A year you. You're, putting yourself in a position to, get lucky if. You, buy these companies, that have disruption, risk and, then that disruption, doesn't, have doesn't happen yeah yeah I see what you're saying great. And thank, you I mean this was a great example just to sort of walk, through as to where you about what, was the motivation how. Do you think about long term short term valuation. And what happens in, the course of holding. An investment, how you make a decision. So. Moving. On from there a couple, of related questions, and then we'll open up to the audience I wanted, to ask you, who, are some investors. That, you personally, admire, or look up to or that, have been influential for, you, I. Would. Start with what. What I jokingly referred, to as the usual suspects. You. Talk to any value manager. And they're. Going to tell you they were strongly. By Warren, Buffett. Benjamin. Graham John Templeton. The. Those, are my heroes I've read, almost anything, that they've written and. They. Have had a very dramatic, impact. On my way of thinking. Harris. Associates, and oak mark, I. Think. Value. Managers, especially, tend. Not to go a lot broader than that and. To. Me that's a mistake. Yeah. After you've read a few books about Warren Buffett, and. You, read the next book and maybe, you learn what his breakfast, habits are what he shows, he likes but, you. Really had the foundation for. What's made him a successful investor. Already, and. It's like comfort food you know it's not really good for you but there's something about reading, another Warren Buffett book that makes you feel good as a value investor and. The. Investors who are very different than, us. Tend. Not to want to emulate their style of investing, but. I find, I learn more when I read books about some. Of the great hedge fund managers. Appall. Tudor Jones a Michael Steinhardt, George. Soros, and it's. Not that. There's. Not nearly the overlap, of the circles, what from like Berkshire, Hathaway, and the way we differ, from them I mean their differences, at the edges, but, it's a very similar thought, process, mm-hmm. The. Circle, with Michael, Steinhardt still overlaps, but it's not nearly as much and. I've. Never, read, a book about one of those great investors, who work value, investors, that, hasn't made me think about some, detail. Of our investing, process, for. Example Mike Steinhardt I was. Famous for never wanting to make an investment, until. He'd sat down with the person he thought was the smartest bear on the stock and understood.
Their Case. We. Try to do that in our process, at Oak mark by, whatever somebody's presenting. A new idea to us we assign the task to someone who's saying your, job is to now come into the room and explain why this person, is wrong and. We want you to argue, to the best of your ability, to prevent us from making this investment and hearing. The two argue, the two sides argue, with each other is, a much, more productive atmosphere. For learning about, an investment, than, just hearing the bullish case Paul. Tudor Jones there's, a famous picture of him sitting in his desk and. And. Pinned. Onto the bulletin board behind him as a sign that says, losers, average, losers. How. Many times have you heard a value investor say. The. Stocks down 20% today, but my estimate of business value is only down 10% so it's really cheaper, today than it than it was yesterday I mean. One of the great things about. Data. Analysis, having, become so cheap and us. Having the history that we have it's really easy to analyze our own history, now and be more data-driven in our own decision-making. Mmm-hmm. And we can look at and say okay, we've got 20 years of history here of about a hundred and thirty stocks, on our approved list what. Happened when the fundamentals, started to deviate, from what the analysts, suggested, were those good opportunities. To add and. We looked into you know what that. Was really more of an indication that, we, were off base in our analysis and, it was going to get worse after, that before, it got better and. Adding. Some guardrails. To our process, of saying when. Things start to go negative on, the fundamental. Story and we don't ever want to be the investor, that says if the stock falls 20%. It's an automatic sale hmm, but, if the fundamentals, start to deviate and, the, story isn't playing out the way we thought it would the fundamental, story, we. Want to increase the pressure. The. Analysis, to make sure more people in the firm are thinking about it, forcing. More meetings with the management team forcing. More of a devil's advocate thought, process. With. The idea that one. Of the most productive ways, we can add to our performance, is to get rid of our losers earlier, and. I get. Teased there and we're not momentum. Investors by, any way, shape or form but, I do believe there is such a thing as fundamental. Momentum. That companies, that are performing, well are more, likely to continue performing, well and companies that are performing, poorly are. More likely to continue poorly. It's Newton's first law of motion, yes yeah so it's not a new concept but at Oak mark it's applying something, that's thousands, of years old. So. Me. You can take these nuggins, you, know George Soros, with his theory of reflexivity, which, was. Written up in a book, hundreds, of pages long that I find, very difficult to follow but way way oversimplified. Says. That. What's. Going on, emotionally. And investors, can actually, influence, the real economy, and that. Psychology. Has, a real, effect on the economy and when. When. Direction, changes, a simple. Psychological, change, can be enough to to, bring about a real change in the economy. When. You go through tough cycles, like Oh 8 no 9 and. People. Are always saying you know sure. If things get back to normal then everything, out there is really cheap and the names you own or would be the right, basket, and names to own but.
What Can what can ever change to, make things get better just. Thinking that things can change to get to. Get back to normal can, be an impetus, to start that process happening. In the same way that if, you've gone through an extended, recovery, that's, created, tremendous excess. In the economy. Just. People starting to worry that things go back to normal could be enough - mm-hmm. It's slow, the speculation, slow, price increases. And bring things back to normal those, are things you don't usually read, in books, about great value, investors, that. I I think can really help. Refine. A value, approach and. Like. I say I think I think I learned more reading, about how, great, investors. Who work value, investors. Invested. That, I do by reading. The 200. About, about, value investing, that. That's a very good suggestion so. Final question is, what. Does your day. What do your routines, look like what are some of your eating habits and any advice you have for those, of us here and people, who are going to be watching you on YouTube how, they can be. Better investors, so. The alarm, goes off at 5:52, in the morning mm-hmm. That's so that I can watch the, top 10 plays of the day on SportsCenter, before I get started on on. The business part of the day good, I, read. The Wall Street Journal, New York Times business section Chicago. Tribune. CNBC's. Top, stories, of the day real. Clear markets, top stories, of the day. Do. Most of that, before. Before I go into the office some. Do some of it while I'm writing an exercise, bicycle in the morning always. Trying to multitask. Try, to get into the market, a good hour before the market opens which is 8:30 Central Time we're in Chicago. So. That I can see if, investors, have given us new money to invest have taken money away we have to figure out, how. To manage cash flow changes, want. To make sure I've had a chance to read the important, first call notes on the companies were invested. In or considering, investing in mm-hmm, and, then most of the day at the office I, mean, you you. See, movies and they show pictures, of what, asset, management firms, look like and you see this trading room and people are on two phones and they're getting angry and throwing, things, our. Office is more laying a lighted Ariens yeah, yeah all the screens all around them everything electronic. Flashing, you. Walk into our offices, and it's mostly people sitting at a desk reading with a pile of papers stacked on their on their desk and. Most of the day is reading, and it's. Reading about companies, were invested, in it's reading about companies. That are trying to, challenge. Those companies, were, disruptors. It's. Reading, stuff. Written by other investors, that we admire. Companies, that they own that we don't trying, to see if we missed anything if we can learn something from what they wrote. Its, sitting. Around in a room with other analysts, bouncing ideas off each other. Which. Again is one of the great advantages that. We have at Oak mark is either, direction outside, of my door I think can walk all the way around the office and, find another value, investor, who's got a slightly different perspective on, things who. Knows me, well enough who, knows Oak Marx way of investing, well enough that. We can really learn from each other bouncing, ideas off, each other, mm-hmm and you. Know you hear about like the investment banking firms where people are still at their desks at midnight. One. Of the nice things about reading, being a big part of what, our job is is. You. Can do that anywhere hmm. So, I've. Had the good fortune of being able to have a lifestyle. That, I'm. Home at dinnertime almost, every night but. Might. Might, be reading. An annual report before, I'm falling asleep so. The. There's. A tremendous. Blurring, it's. Probably true in any industry where people are really passionate about what they do tremendous. Blurring, between, business, time and private, time. It. Might, be at the office and, having, a personal conversation, with. My dad or somebody else in the family and. You can say is that really fair to your employer to be taking that that time but. You, know at, home I'm watching a baseball game and reading. Annual reports, or you, know other reports. By other investors, that whole time. Go. Shopping, and I can't help but see you, know what what new products, are out and how they're priced compared, to old products, or if you're in an off price store that. There's suddenly a tremendous, amount of inventory from, Nike and there wasn't before and is that does that mean something it's just I think. To, be a successful. Investor it has to be something you love so much that you can't you can't ever really turn it off and you don't want to turn it off they, you, you get enough enjoyment, from. And, it. Doesn't create stress, in a way that you feel you need to get away from it to relax, so.
Those. Are my days and, then every once in a while it's traveling it's going out to meet management's, we like to sit across the table from the. CEOs, and CFOs of, the companies that were invested, in and here in their own words what's important, to them what their goals are, I, was, out in New York the past couple days, meeting. With the management's, with a lot of the cable TV investments. That we have. We we owned QVC, the TV. And Internet, Shopping Network. Charter. Communications. Recently. Meeting with the management and GE which, has been a. A. Breath of fresh air in terms of the change at the company but not entirely pleasant, for us because it's been a position, we've owned for a while. But. To us there's, there's. No substitute, for the. Sitting across the table and getting a feel of what's him really important, to these people and. Again along the lines of to. Earn an active management fee you've got to be able to do something that a computer can't do mm-hmm. After. You've interviewed a hundred, investment. Not, investment yeah a hundred corporate, management teams, you. Really start to have an ability to say these. Guys are really above average these. Not so much and, you. Don't have to be perfect, with it but if you can be. Be better than 5050, and how you bucket, them as above average and below average it. Can be a tremendous addition to. What's. Largely a quantitative. Approach to investing, okay. I think your love and passion and, enthusiasm for. Investing, is it's, very obvious. And is very contagious. Thank. You so much for sharing your thoughts with us if, you have any last-minute questions and, the audience we're open yeah I'll, just repeat the question there, was this talk about like is, there a bubble in the market everything seems overvalued. Other, people are making a lot of money out of Bitcoin, and what. Do we do right now, so. We're. Generally, in the camp that if you if you can't understand, how something is, it's better not to talk about it but.
Intellectually. I'm more in the camp with Jamie Dimon that I have a very hard time understanding why. Bitcoin is valued at. Whatever. Price it ends up being valued, at and. It. You're not going to find it in the oak mark portfolios. I don't, think markets. Today are in. Bubble, territory. Relative. Pease, are only slightly higher than they've, averaged, in the past 30 or 40 years and I think with interest rates as low as they are inflation. As low as it is it. Makes sense that peas, would be somewhat, elevated. Not. To mention the things like. All. The, technology. Companies, that are making so, many investments, in, areas, tangential. To their basic business that. Are depressing current, earnings and, one of the statistics. I put in the last commentary, we wrote. Was. That if the, for, Fang stocks weren't, in the S&P 500 the SMP multiple, would be about a point and a half lower. Which. When, you're talking about a multiple, that's maybe two or three points elevated. Relative to history a point and a half's a big deal and. I don't say take the Fang stocks out just because they look expensive on a p/e basis, but p/e is such a bad metric, for measuring the. Value of those four companies. So. We we don't think the markets really elevated, you know the recoveries, 9 years old. But. The magnitude, of the recovery, has been, relatively. Trivial. Compared. To historic, growth of the economy, recessions. Come about to correct excesses, in the economy, it's hard to see those excesses, being created. To. Me the more fascinating. Part of your question is how do you deal with a bubble, like mm. Where. You, know a strict discipline, valuation. Approach to investing, just. Says none of these names make sense to us we can't figure out the values, and how. Do you keep people invested. With you when. When you're holding the line that says, these. Names just don't make sense. The, oak mark fund assets. Peaked at about 10 billion dollars, in. 1997-98. And. Even though our asset, our net asset value had been about flat for the following two years, our. Assets were down to two billion dollars, because. We refused, to buy anything in the technology. Space people took 80 percent of the investments, away from us and. That's. A tremendously. Difficult time, when you're running a business and you've got people to employ that. You want to have continued, with you and you're seeing your revenues fall by 80 percent. But. I remember. A conference. Call I was on one. Of the advisors. Who. Was in the process of selling out of the fund was. Pleading with me saying won't you please just own one technology, stock, if you buy one of them then I can go back to my investment, committee and tell them that's okay, and I. Remember saying to her I said, if we could find one that fit our value, criteria, we'd happily, own it but, we can't and because. Of that we won't I said no bet you something else there's gonna be a time in the future, that. You're going to say it's, not that oak Marc's incapable, of, buying technology. But. When, technology, is out of favor we're going to own more than a market waiting in it and I, said you're. Probably gonna be just as upset with us then as you are now because. We're investing, in something then that would be unpopular, and. It's. Tough but if you don't stick to your discipline, you, know there's there's a Chicago, firm that was known more for growth investing. That. Was, still a pretty strong fundamental. Value, firm but they applied it to growth stocks, and. About. February. Of 2000. They. Threw in the towel and said we've lost too many of our investors, we're gonna start buying these very, high-priced, internet, names even though they don't work under the way we used to invest so. They didn't tried the market up they wrote it all the way down and it put their firm out of business, you.
Mentioned Earlier as. Named Morningstar, manager, of the year in 2001. It. Wasn't that we did anything different, in 2001. The, we did in 2000. Or 99, or 98, it. Was the market, suddenly, corrected, valuation. Excesses, and the traditional, companies, we'd, owned through this whole period went, up in price significantly. While all the tech names came crashing, down, but. It was the discipline, to say, we're. Gonna keep doing the same thing, and. We know if we're fundamentally, right on the analysis, the stock prices, will eventually follow and. We're not going to try and placate. Investors. Who, want to see us. Invest. In the current bubble I remember, being on CNBC. Back. Then talking. About how high-priced, we thought technology. Names were and. I. Hopped. Into a cab on my way home from work and, I can see the cab driver looking in his rearview mirror, and, he's like I think I know you and. I might kind, of got my head down and like no I don't think so like yeah yeah I do I've, seen you on TV, and, I'm, maybe. He's. Like you're that guy on CNBC. Like, in my portfolio is kicking your butt. And. I'm like you know what it's not that far to my house once you just drop me off here I'll walk the rest of the way but. You. Know when when things get that popular. It's. Very, rare that that, they end up being good investments. And as, long-term value, investors. We, get a lot of comfort from the history, of. Seeing bubbles grow and bubbles pop and, the. People who who. Whether those bubbles, well. Are the, ones who had a philosophy. That grounded, them and they, didn't change it to refet to reflect bubble, level pricing. Okay. Well, thank you so much really appreciate all the time that you took being here great thank you thank, you all. You. You.