Bill Nygren (03:40):
That’s about 15% of the market cap today. And then additionally, the spending that they’re doing on Oculus Augmented Reality Metaverse accounts for something on the order of four or $5 a share. If those were done as venture capital investments instead of done within Facebook, it would be less efficient for us as shareholders. They’d be paying somebody two plus 20 to do that. But since it’s done inside of Facebook, it goes through the income statement. If it was done with a venture capital firm, it wouldn’t touch the income statement and you’d end up with this big asset of venture capital investments. So we look it piece by piece. How much have they spent on venture cap? What do we think WhatsApp is worth? How much cash is there? And deduct that from the stock price, as you mentioned, is down to just over $200 a share now. $210 a share, we think the consensus numbers for this year are about $19 of earnings from the apps businesses, mostly Facebook and Instagram, and then losses coming through the other side.

Bill Nygren (04:50):
So one way of looking at this is if you pay 210, you’re getting $20 a share of cash and you’re paying 10 times earnings for what they’re earning on the apps businesses. You’re getting WhatsApp for free. You’re getting all the augmented reality for free. You can argue about how fast Facebook’s going to grow. I think their number that they were suggesting for the first half of the year would be a high single digit number. But at 10 times earnings, high single digit growth rate is more than adequate to justify that price. And further, Facebook generates so much cash. If they put as much into repurchase this coming year as they did in the past year, they’d be shrinking the share base by seven or 8%. So that top line growth of call it seven or 8% along with the shrinkage and the denominator, you’d be getting revenues per share growing 15% at this company and available in the market at 10 times earnings. We think that is much too cheap.

Trey Lockerbie (05:52):
I love the way you break that down and kind of take apart the bolt-on companies or aspects of the company and get down to the brass tacks of what the company’s actually doing, what the earnings are. And I love the upside potential you’re painting there. Is now a time when others are fearful and we should be greedy?

Bill Nygren (06:09):
Well, I wouldn’t say that about the whole market, for sure. And certainly not about most of the hyper growth names that still sell at very high multiples. But I think there are sectors of the market and I would include Facebook in that where the price just doesn’t make a lot of sense to us. You have to envision a very draconian future for Facebook to make it worth less than 10 times earnings today. So yeah, I think there is definitely a bunch of fear. And Facebook’s also kind of in this weird position where for a long time it was owned by growth investors, value investors didn’t like the headline multiple and a lot of them weren’t doing the work that we’re doing piece by piece to show how inexpensively you’re getting Instagram and Facebook.

Bill Nygren (06:58):
You’ve got kind of a gap today where that top line growth is no longer enough to attract the very high growth investors, but value investors still have what we think is kind of an outdated view of Facebook being one of the FANG Stocks being too expensive. It wouldn’t surprise me if it takes a little while for it to find its natural investor audience, but that’s what creates the opportunity. And nobody knows precisely when that’s going to go away. So it pays to be early.

Trey Lockerbie (07:29):
What’s your take on the ethical dilemma that always seems to be surrounding Facebook? There was a recent whistleblower again talking about some illegal activity in the company. They seem to just be constantly in this fight against bad PR. Is that a management issue in your mind? Is there anything that you question there?

Bill Nygren (07:46):
I think it’s a media issue more than it is a management issue. And I joke that Facebook is one of the only companies that can unite the political spectrum from the left to the right. The left blames Facebook for the 2016 elections. The right blames Facebook for the 2020 elections. And I think there is a large segment of the population that they’ve kind of lost the art of doing their own due diligence and thinking about what they’re hearing in media and discerning what they want to believe or not believe. There’s this hope that everything you could hear in any form of media would be true. And I think media hasn’t been that way for a long time. But on Facebook where you can give a loud microphone to people at the extremes, it really seems to be a lightning rod for controversy. But I do think there is a tremendous benefit, just like there is to advertisers of being able to access a market that is not easily accessible, there’s a tremendous benefit to giving people who think they’ve got something to say a platform to be able to speak.

Trey Lockerbie (08:55):
What is your take on the name change itself? We keep referring to it as Facebook, but really it’s Meta now. And they’re taking really interesting steps. They’re calling all their employees Metamates nowadays. And they’re obviously trying to create a huge shift, not only in the perception of the company, but maybe even the mission itself of the company entering the Metaverse, et cetera. What’s your take on the change of direction here?

Bill Nygren (09:18):
Well, I think I’m about 30 years too old to understand the Metaverse. I’ve got to admit it, doesn’t make a lot of sense to me. But the concept of changing their name, I think it’s the same thing that Alphabet went through a few years ago, where they wanted to reflect the breadth of assets the company owned beyond just the Google search engine. And they came up with a name that was completely unrelated to search or to Google. And Alphabet doesn’t really convey a lot of information to you about what the company does, but it does reflect that if you’re going to invest in the company, you need to think about more than just the search engine asset that they own.

Bill Nygren (10:01):
And I think Facebook was in the same position where if you look at the rapid growth that Instagram has had, you could argue that Facebook might not be the majority of earnings this coming year, or if not this year, the year after. And you want to convey to investors that there’s more to owning Facebook than just the blue app that we’re all used to using. There has been some criticism that people think they’re too early in the Metaverse and that a lot of the spending there will not have economic return. I’d have to say that the history of this management team where they’ve invested in what was at the time unprofitable investments has actually been quite good. And I think they deserve the benefit of the doubt.

Trey Lockerbie (10:47):
That’s true. They do have a really good track record there, but I think they’ve spent something like 10 billion to date on the Metaverse idea and probably more. So it’s definitely a big bet. Oculus, I just have one last question around, because I noticed around December the Google trend spiked significantly around Oculus. It went about 300% spike, meaning probably a lot of people got Oculus gifts for Christmas, it would seem. What’s your take on the future of VR? Is that something that you guys do a lot of research around as part of at least the thesis around this company itself?

Bill Nygren (11:20):
Well, I think it’s natural that gaming would trend toward VR. The more business use for VR, we have not spent a lot of time trying to develop the case for that. I mean, if you haven’t tried the Oculus product, it’s really cool. And I’m definitely not a gamer, but we had one in the office to just fool around with. Since we’re invested in it, we thought we should know what the product is. And it is a lot of fun and the price point is not that high compared to other gaming consoles. So it completely makes sense to me that interest in it would’ve spiked around the holidays.

Trey Lockerbie (11:53):
All right. Well, let’s move on a little bit from here. I’d love to dig into OakMark’s philosophy and strategy a little bit more. Walk us through the way you think about price growth and management because these appear to be the three pillars of your strategy.

Bill Nygren (12:09):
At OakMark, we are very long term investors. So when we acquire shares in a company, we’re thinking about how much do we believe this business could be worth five to seven years down the road. So we are using a much longer time horizon than most investors are. And there are three things that we think can help turn the risk-reward ratio to our benefit. And academics will tell you the only way to get a higher reward or return on your investment is to take more risk. And while we think that’s generally true, we do think there are some ways to tweak that in your favor. The first of those is if you have an opinion of what the business is actually worth, buying at a large discount to that increases the return and at the same time decreases the risk. So we try to make an estimate of what any business would be worth if you owned the entire business and you had to pay cash for it.

Bill Nygren (13:09):
And our estimate of business value is the highest price an all cash buyer could pay and still earn an adequate rate of return on their investment. Now, some companies that are well run, that’s pretty straightforward. It’s not that different than looking at a DCF, discounted cash flow of the existing business, the way it’s being run today. But then there are other companies where you think there’d be a lot of synergy if a larger company purchased them. You might think there’s some mismanagement and there are either growth opportunities that aren’t being pursued or cost cutting opportunities the company’s not done yet. And you might be capitalizing a much higher stream of income than the business is currently reporting. So we look at acquisitions of similar companies. We do look at discounted cash flow multiples.

Bill Nygren (13:59):
We look at trading multiples in the stock market of similar companies and try and find some metric where those numbers all kind of converge. It might be in a media name. It might be a price per subscriber. In a bank, it might be as simple as a price to book or P/E ratio. In a drug company, it might be enterprise value divided by EBITDA before R&D spending. So we make those adjustments and come up with the metrics that we think best define value in each industry. And then we see what those metrics would suggest that a public company in that industry is worth. If we think it’s worth a hundred, we want to pay less than 70. So very traditional value based approach there with the exception that we’re forecasting out a few years. So it may leave us paying a little bit more for near term growth than some of our value peers do.

Bill Nygren (14:57):
The second thing we look for is growth in value. One of the downsides of a deep value or statistically based value approach is if you’re looking at the lowest P/E, lowest price to book value stocks, you’re usually ending up with structurally disadvantaged businesses. They are maybe at a cost disadvantage, maybe they aren’t industry leading technology and they’re losing market share. And you’re kind of fighting this battle where the business is worth less as each year goes by and you hope something happens quickly. So you become catalyst focused. So if you think it’s worth a hundred and you’re buying 70, that’s great if something happens next year, but because the business is declining in value a year from now, maybe it’s worth 92 and then 85, and you don’t have the luxury of a long term time horizon if you’re buying into a declining business. So what we look for is we look at our expected sum of dividend yield and per share value growth for the S&P 500.

Bill Nygren (16:01):
So today you might say dividend yield’s about 2%, maybe you’d be looking for 6% earnings growth, which would mimic per share value growth in the S&P. So you’d say a total return earn of 8%. So we want our stocks to have at least 8% total return. We’re agnostic as to whether that comes from an 8% dividend and no growth or no dividend and 8% or higher growth. But that’s part of what gives us the luxury of a very long term time horizon is the longer it takes for the gap between value and price and value to close, the higher that ultimate value is. And then the third thing we look for is a management that’s aligned with its outside shareholders. Now everybody says they want a well-managed company, but we all mean something a little bit different when we say that. To us, a well-managed company is a comp by management team that’s looking to maximize long term per share business value.

Bill Nygren (17:05):
And all of those words are important. Maximizing is important because there isn’t a growth rate that’s high enough. You want them to do the best they can. Long term, we don’t want somebody trying to maximize next year or the year after. We want them thinking five to 10 years in the future and making the investments that maximize that value. And then probably most importantly, per share. Companies can all get bigger. All you have to do is make big acquisitions and you get bigger. But if you pay too much, you’re actually destroying per share value. So we want managements that think per share because as an owner of a public company, we’re certainly thinking per share because we’re owning shares. So we look for things like what are management’s incentives? Is there a denominator in all of them?

Bill Nygren (17:54):
We don’t want just sales growth or earnings growth, earnings per share, sales per share, return on invested capital. So if their bonus compensation is based on improving those metrics, we’re pretty confident that the public shareholders will also fare very well. We like to see them own stock. We like to see them have option plans that are long termed in nature and reward them if the shareholder does very well over a long term time period. So when we get all three of these things to combine, the discount to value, the annual growth in value, and the owner oriented management team, that’s what really lets us think about what does five to seven years in the future look like. And I think for OakMark, that’s probably our biggest competitive difference and biggest competitive advantage is we see most of the competition trying to look at what business value is today, maybe what it’ll be next year, a lot of focus on next quarter or next year’s earnings.

Bill Nygren (18:59):
And I think it’s almost impossible to out predict the street on those kinds of metrics. When you start thinking about how might this business look different five years down the road, are there divisions that maybe there’s another buyer that’s a more logical owner because they have synergies? Maybe the whole company should be owned by somebody else. You think about business metrics like, is this company competitively advantaged? What will its market share look like? Will the addressable market be growing or losing share, or growing or losing in scale? All those things are what matter in five to seven years. And I think ironically, it’s actually easier to have a meaningfully different view of the five to seven year future than other investors have. You think, Well, you’re thinking out farther. It must be really tough to get a good forecast out that far. But we think the reality is its much easier to come up with a meaningfully non-consensus view of the long term future than it is next quarter’s earnings.

Trey Lockerbie (20:00):
Well, I love that you broke out the opportunity cost it sounds like that you’re focused in on what the S&P essentially being the benchmark. The dividend yield of 2% are matching that to the S&P in the earnings yield at six. So coming up with that 8%, almost like a discount rate it sounds like that you’re using. With inflation now creeping up and over seven and half percent, does that affect that number at all or does it kind of make you even more grounded in that approach?

Bill Nygren (20:28):
If you think about the approach, again trying to think five to seven years in the future, I don’t think anybody is forecasting the inflation rate over the next seven years is going to average the 7% that we’ve seen in the past six months. There may be a difference of opinion as to will that start falling in the first half of this year or the second half. Maybe it takes till 2023. But almost everyone who’s trying to project long term is having the current inflation rate kind of regress down toward that two to 3% level that the federal reserve has been targeting. And I think our long term forecasts are consistent with a two to 3% inflation rate. I think it’s reasonable to think that the S&P can grow earnings five or 6% in a two to 3% inflation world. It’s reasonable to think that the free cash flow yield will allow them to continue to pay a 2% dividend.

Bill Nygren (21:26):
I would say that current inflation is having a relatively trivial effect on our business valuations. It’s definitely for some of our companies increasing the cash flow we expect them to generate in the next couple of years. Thinking like oil companies where most forecasts have long term prices of oil going back down to the 60 to 70 range that it’s kind of averaged over the past decade. Current prices are at 90. So those companies are going to be a lot more profitable in the next couple years than we had expected. And we give them credit for that cash flow, but we don’t want to put a terminal multiple on a number that we don’t believe is sustainable.

Trey Lockerbie (22:06):
As I was reading about your process, something jumped out at me. And basically you have a bottoms up approach, and you have a team of analysts that are sourcing ideas out of a fairly small universe of options. And then it’s kicked around by an investment committee. Who makes up the committee? And how often are you meeting? And what is often discussed? I’d just love to be a fly on the wall in that room.

Bill Nygren (22:27):
Each week we have what we call it our stock selection group meeting. And all of the domestic investment professionals sit around a very large table. It’s probably 25 of us in the room. That meeting for us is Tuesday morning. And Monday at lunchtime, we’ll get a packet of everything the analysts want to present at that meeting. And that meeting includes our new ideas. We probably average a little more than one new idea a week over the course of the year. And in a new idea report an analyst is saying, this is a stock we don’t own. It’s not on our approved list. I think it meets our criteria for these reasons. And this is what I think it’s worth. This is why I think it’s being well managed. This is why we think it’ll be a winner in the competitive marketplace. It deserves to be in our portfolios. We’ll spend Monday afternoon reading it, reading sell-side reports on the same company and coming up with questions for why we think the analyst’s viewpoint might be wrong.

Bill Nygren (23:31):
Somebody else will have been assigned the job of being the devil’s advocate. So the analyst will come into the meeting and in front of 25 people summarize why they think this stock should be bought. The devil’s advocate will summarize why they think the analyst is wrong. Three of us that are most senior investment professionals, myself; Clyde McGregor, who runs our equity and income fund; Tony Coniaris, who runs a lot of our institutional products. He’s also a co-manager with me on OakMark Select and Global Select. The three of us lead the questioning. We’ll basically have a heated argument for half an hour with the goal of identifying our mistakes in that meeting before we’ve lost a single dollar of client money on those mistakes. At the end of the meeting, the three of us will vote on whether or not we think the case has been made to see this stock added to our portfolios. And if two of the three of us believe that it should be added, then the stock goes on the approved list.

Bill Nygren (24:31):
And I would say at that point, 80% or so of those names end up in our portfolios. Now, in addition at those meetings, we’ll also have devil’s advocate reviews on our large holdings. We target once a year. Our 25 largest positions will assign an analyst or an analyst who feels passionate about it will volunteer to say: I don’t think we should own X, Y, Z anymore and here are the reasons. And again, just like when it’s presented for a new idea, we’ll sit there and argue for half an hour about whether or not it belongs in our portfolios. The result of that process is very rarely that we immediately sell the stock. But quite often, that discussion helps us better set our signed posts for what it would take to see a new information over the upcoming year to concede that our thesis might be wrong, or conversely, what are the things we’d see over the next year that give us a higher conviction level and maybe would be deserving of increasing our position sizes?

Bill Nygren (25:36):
And then finally at these meetings, once a year every name on our approved list is represented by the analyst to update us on all the new information since last time it was presented, updating our targets. Importantly, we never change our buy and sell targets because of the stock price movement. We change them because of the fundamentals in the company are unfolding slightly differently than what we’d originally anticipated. So stock on our buy lists that maybe earnings are coming in better than we had expected that would lead to us increasing our target price a little bit, or conversely decreasing it. The meetings are fun. We’re a very intense group for this meeting, but we can have knock-down-drag-out arguments and walk out of the room and say: Hey, you want to grab lunch? It’s never about the individual. It’s always about the idea.

Trey Lockerbie (26:30):
I love that. And it’s written on your website that the team is basically comprised of generalists. And I found that interesting as well, obviously the committee is in place to try to root out human bias, but we all seem to have that. Do you have analysts that, not that it’s a meritocracy, but if they’re presenting ideas in a certain sector that you just know that they’re savvier on or have more intelligence on, do you have anything in place to kind of protect against a bias from whoever the idea is coming from?

Bill Nygren (26:57):
I would say we intensely try to make sure that there isn’t a presenter who is generally favored. But if you’ve got someone who’s looked at one cable TV company, I wouldn’t even call it a bias to say you expect that person to be the best equipped in our firm to look at a second cable TV company. There are industries where the companies are quite similar to each other. And just from an economy as a scale of our time efficiency, it makes more sense to have that same individual look at a second idea. We clearly have no biases based on seniority. The most senior analysts are questioned every bit as intensely as the most junior analysts. And the most junior analysts are strongly encouraged to speak up and challenge the most senior analysts. In that meeting, it is extremely horizontal and titles mean nothing, ideas mean everything.

Trey Lockerbie (27:58):
How much does industry diversification play into the strategy? For example, you’ve held quite a few financial stocks for a few years now in some of the funds. Do you ever seem to reach a threshold where your analyst might present an idea and says: Hey, we really should go in on this. And you’re like: Sorry, we’re already tapped out in banking or financials at 20 plus percent.

Bill Nygren (28:18):
I think there’s probably a point a year and a half ago where if you just rank ordered our stocks most attractive down to least attractive on our approved list, most of our portfolio would’ve been finance and energy. What we try to do is create a progressively higher hurdle as we’re doubling up or tripling up on exposure to the same macro risks. So clearly a company like Ally Financial, leading car loan lender, and Capital One, leading credit card company, lot of similarities. They’re lending to in some cases less than prime customers. In one case against cars and another case against income. The liability side of their balance sheet is very similar, it’s deposits. Most days, those stocks are either both up or both down. The risk profile is very similar to the two companies. So to us, that would be an exposure we say: Okay, we’ve got a lot of exposure to consumer banking and the third consumer bank. We’re not saying no, but it’s going to have a substantially higher risk-reward ratio than a food stock that we don’t own any of, or a technology name that we’re under-weighted in.

Bill Nygren (29:35):
And we just try to use that type of common sense approach to increase the hurdles to make it worth increasing the risk in the portfolio. Now, it’s interesting you mentioned financials because I think that points out a weakness in the way that a lot of the industry looks at risk exposure when they do it just by S&P industry categorization. We’ve got 30 some percent of our portfolio in financials. But inside of that, we have small positions in Standard and Poor’s and Moody’s, basically the rating agencies. Those stocks behave nothing like Capital One and Ally Financial or our other banks. Companies like Visa and Mastercard are considered financials.

Bill Nygren (30:21):
Now, we look at them as more overrides or royalties with a tailwind on consumer spending as it moves more from cash to plastic. Again, nothing like a bank at all. So I think it would be easy to make a mistake and say, look at our financial exposure and how large that is relative to the portfolio when really inside of financials are a lot of very different exposures, very different risk profiles. So our approach may not be quite as satisfying to people that are super quantitative, but I think there’s a common sense element to it has really worked well for us.

Trey Lockerbie (31:02):
I like to shift a little bit into some positions you’re actually holding in some of the funds. One number that really jumped out at me was from your Global Select Fund where you allocate to 20 companies or so from around the world. In most of these funds, the allocation is somewhere around three to 5% on average. However, in this fund, the allocation to Alphabet was over 13% and it’s even over 10% in the Select Fund. Is this due to appreciation without much rebalancing? Or is this just a conviction level that’s three X the size of the others?

Bill Nygren (31:34):
Kind of yes and yes. Neither of those positions that you referred to the 10 or 13% in our concentrated funds started out at that level. We’ve owned the Alphabet for seven years. Maybe it’s longer than that. It has appreciated substantially. In fact, we’ve trimmed the position somewhat so that it didn’t become an even larger percentage of the portfolio. One thing that’s importantly different about OakMark funds relative to our competitives, we’re very focused on minimizing the amount of our return that’s lost to taxes. And I say that as opposed to minimizing taxes, we want to maximize after tax return. And I think some of the tax oriented funds get it a little wrong. We’re trying to minimize the hole in the donut that is lost to taxes so that we maximize the volume of the after tax return.

Bill Nygren (32:29):
There are a lot of funds that focus more on taxes that really hurt their pre-tax return by their actions. And by allowing the position in Alphabet to get larger as the stock price has done well and trimming it only somewhat has limited the amount of our return that would be lost to taxes. Now, the Alphabet position in those funds did start a little bit larger than the other names, because when we think about position sizing, and I think this is a really important point, we think about our exposure to the enterprise value of the company as opposed to just the equity value. So if a company is highly levered, our position size is going to be much smaller than average.

Bill Nygren (33:13):
And if a company has excess cash like in Alphabet does, today you’re paying 2,500 a share or something for Alphabet and you’re getting several hundred dollars of cash, we think of it as we’re buying a couple hundred dollars of cash and we’re paying less than the market price for the business. So we offset that by weighting the position somewhat higher. Something like an Apache petroleum that has a fair amount of debt, but we also think is very attractive, is a much lesser weighting in our portfolio because when you buy a share of it, you’re getting a lot of enterprise value because you’re also getting debt tied to it. It’s a little bit of both. We think Alphabet is more attractive than the average stock in our portfolio. It’s less levered and it’s performed very well.

Trey Lockerbie (34:02):
Now I was just having this discussion around stock splits. Tesla recently did a stock split five to one in their stock, then two to three X from there. Alphabet has recently announced a 20 for one stock split. I’m just eager to hear your overview of general thoughts on if that’s a good thing, a bad thing. What are your thoughts?

Bill Nygren (34:23):
Certainly the quantitative side of it, I would say we’re agnostic. You divide the value of Alphabet across 20 times as many shares, you’re going to get a number 1/20th as large and it’s completely meaningless. I think stock splits at one point in time did actually broaden the investor universe. Back in the day when it was typical to buy round locks and you were buying hundred shares of something at a time, and you’re somewhat of a pariah if you went into a brokerage firm and said you want to buy three shares of something. And today you can buy fractional shares, it’s relatively meaningless. The way that I think stock split still matter a little bit is I think it’s an indication of the confidence management has as to how deserving they are of the business is selling at.

Bill Nygren (35:13):
I think if the management of Alphabet thought that their business was worth substantially less than it’s selling for today, it’s very unlikely they’d be suggesting splitting the shares 20 fold. There is still somewhat a desire, I guess, on the part of management to have a stocks price that fits in somewhat normally with the average stock out there. I think most companies that are announcing stock splits, it’s an indication that the management team is pretty comfortable with how their business is being valued.

Trey Lockerbie (35:44):
I didn’t see names like Visa or Mastercard at least in the top holdings of the funds. And knowing that these are kind of a duopoly of sorts in the financial space especially. I was kind of surprised by that. Do you have any general thoughts on those two companies or why you shied away?

Bill Nygren (36:00):
They’re great businesses, no question about it. And we do still have a very small position in both names inside of OakMark. If we were having this conversation five years ago, those would’ve been much more meaningful positions for us, but the stocks have performed exceptionally well. We have bought into Mastercard 12 years ago, maybe even a little longer than that, back when something called the Durbin Amendment was going to limit the profitability they could have from debit card transactions. And you only had to project out a couple years of the growth Mastercard was achieving to get the multiple to fall beneath the normal S&P 500 multiple. I think one of the ways value investors differ from growth investors is value investors acknowledge their crystal balls become cloudy faster.

Bill Nygren (36:51):
It’s not that we don’t like growth, but we don’t like to pay for growth beyond the level that would get the multiple of a company down to an S&P multiple within about a seven year time period. And during a lot of the past several years, Mastercard and Visa did not meet that criteria that even anticipating growth continuing, anticipating continued share repurchases, that multiple didn’t collapse beneath an S&P 500 multiple in a seven year time horizon. And to us, that’s kind of a bright line that we don’t want to continue holding the stock. So we were trimming and trimming and trimming, hadn’t quite gotten rid of the position. Now the names have come back down to a level, the stocks have underperformed significantly.

Bill Nygren (37:36):
You could at least enter into a reasoned argument that maybe they’ve fallen enough that you could again call them value stocks. I think some people get so hung up on this definition of value versus growth and they try to define value as below average businesses that are selling for below average prices. And you kind of tag value on all these businesses, bad businesses, and then you tag the name growth on above average businesses. We don’t think about it that way at all. We think growth is a great attribute. We’ll project growth out for seven years. And if the stock looks cheap based on that, I would say happy to buy it despite the growth. Actually, there are a lot of times that we think the value and growth universe is overlap, and those tend to be some of the best ideas in our portfolio.

Trey Lockerbie (38:26):
I love that distinction. And a lot of people say Buffett is the greatest value investor of all time. And he’d be the first to tell you that he’s just an investor, right? That’s how he puts it. And I think you guys described to the same philosophy there. Speaking of Buffett, he did recently trim his positions in Visa and Mastercard and seems to be in favor of building a new position over $1 billion now in Nubank, which is a neobank out of Brazil. I think his first FinTech play and I should also mention it’s “crypto friendly,” which I think is a little bit adjacent to some other interesting topics, but OakMark has chosen different positions in that space. Fiserv have come to mind, Ally. I’m curious what your take is on Nubank, if it was ever a consideration for you guys and maybe compares to the positions you’re holding.

Bill Nygren (39:13):
First off, on the domestic side of our company, we would never look at a leading South American business. That would be something for David Herro and the international team. And I think I know very little about Nubank, so I’m going to say two sentences about it and then we will have exhausted my knowledge. I think that it’s a very early stage company. Even the way we look at time horizons of looking out five to seven years, I think it would be very difficult to argue that Nubank is inexpensive, direct contrast to something like Ally, which has become the leading internet bank. So the liability side of their balance sheet is deposits that are raised largely consumer deposits and largely from their internet banking system. It gives them a great cost advantage, which can be passed through to the depositors. So Ally has a very low cost access to funds that then goes into used car lending, new car lending.

Bill Nygren (40:18):
And they’re generally staying right beneath that subprime level that the banks like Bank of America and Wells Fargo, JP Morgan want to cross sell to their high net worth clients. So I think Ally is kind of in a best of both worlds where there’s not a lot of competition on the asset side for the customer they’re going after and they have cheap access to funds. It’s given them a very large net interest margin spread. And with what’s been going on today in inflating used car prices and shortages of new cars, Ally is going to be earning something like seven to $8 a share for the next couple years. Stock sells at 50, it’s at seven times earnings. It doesn’t take much imagination to think of that being squarely in the value category. Ally is generating so much excess cash right now that if the stock stays at about 50 for the entire year, they’ll be able to reduce their share base by 13%, pay about a 3% dividend yield, and end the year in just as strong financial position as they started it.

Bill Nygren (41:24):
So even if they only grow a couple percent on the top line, EPS could grow 15% a year because the denominator is shrinking so rapidly. That’s why Ally appeals to us. And then Fiserv, we got involved after the large merger with First Data. We were a believer in the management team achieving lots of cost synergies from putting those two businesses together. They’re still in process of doing that, but all indications are they will be successful. That was all you had to believe, to believe you were buying Fiserv at a pretty significant discount to the S&P 500. And then importantly, within Fiserv is a FinTech company Clover, which is very similar to Stripe or Toast, where it’s got the little thing you can stick on an iPad and turn it into a terminal to process. Checking, it’s got the software that becomes important to the small and midsize retailer.

Bill Nygren (42:24):
And the business is migrating from the traditional model to a Clover or Stripe model. And Clover actually does more volume than Stripe does. It’s growing just as rapidly. And the entire market cap of Fiserv is barely higher than where Stripe’s market cap was recently. So there’s kind of an argument that you’re getting this exciting FinTech company inside of it almost for free. We think in general, a mistake a lot of the investors are making, who are targeting disruptors is ignoring the advantages that the incumbents have and how much R&D capital inside of a company like Fiserv or like GM or like Allison Transmission, how much R&D capital is going into them trying to maintain a leadership position as the industry shifts in any of these companies. You can make an argument that what GM is doing in electric vehicles, if that were valued at some fraction of what Tesla is being valued at, you’d get more than the market cap of GM.

Bill Nygren (43:33):
In the case of Allison, if you valued their investment in e-axle businesses and the R&D that they’ve put into that, if you valued that similar to some of the companies that have come public that are pure plays, you get more than the value of the company today. And yet Allison bought back more than 10% of their stock on average each of the past five years, sells at about eight times expected earnings. It’s kind of being left for dead, even though we think they’ve positioned themselves to be a leader in this new emerging industry. We love hidden assets. We adjust numbers for income statements spending. And it makes these stocks look even cheaper when you think about them that way.

Trey Lockerbie (44:17):
Going back to Ally for a second, I agree with you. I mean, the numbers are incredibly compelling, at least the way we value stocks and definitely stood out to me. I’m kind of curious to get your take if you have one on why you think the price action has been sideways since June of last year.

Bill Nygren (44:34):
We are the world’s worst at trying to explain why a stock has behaved like it has over a short time period. Now this was a stock that traded in the thirties before the pandemic. I think it trough at about 11 in early 2020 when we were all locked up in our houses. From that point up to 50 today, it’s been a very good performer. Past six months, it hasn’t been such a good performer. One of the nice things about owning businesses that are generating a tremendous amount of capital and redeploying it in their own equity is they’re able to take advantage of a market that isn’t immediately reacting to better fundamentals. So, like I said, Ally is buying back about 13% of their stock this year. You keep that up for about three, four years and earnings will double just based on the lower denominator. We like the companies that are in a position to help themselves and take advantage of a market that isn’t reflecting value.

Bill Nygren (45:34):
And I think that’s a position, not just Ally, but most of our banks are in. And we spend a lot of time trying to identify those management teams that are excited about the opportunity to reduce the denominator when the price is right rather than I think the banking industry and the energy industry a couple decades ago were both guilty of using almost all their free cash to try and maximize their top line growth rate. And world couldn’t be more different today. These companies are all in on the idea that they’re mature businesses. There’s no way they can grow the top line in a healthy fashion, putting all their capital to work. So that capital is going back to shareholders. I don’t understand why repurchasing stock has gotten such a bad name and it’s become politically charged. We think it’s the best thing for the economy.

Bill Nygren (46:24):
Last thing in the world you wanted was IBM reinvesting all of their excess capital over the past 30 years into mature business. Much better to give it back to investors and let them fund all these startups that are becoming incredibly great businesses. We always want our management teams to reinvest only where they believe they’re competitively advantaged, and then return the rest of the capital to us. And we’ve got a much larger opportunity set than they do. And we want to be able to redeploy that in the hands of other managers that we think do have competitively advantaged ways to redeploy that capital.

Trey Lockerbie (47:01):
And jumping back to Meta really quick. Netflix is another name that similarly had a huge dive, dropping nearly 50% from its all time high. And I’ve heard you say, “When expectations are high, it’s easy to disappoint.” And I love that quote. Is that the case here with Netflix or is there something else going on?

Bill Nygren (47:21):
Well, I think, yes, that’s partly the case. A lot more has to go, right? When the stock is selling at almost $700 a share to justify that price than today when that’s down at 400. We were trimming our stock position pretty significantly when it was up at that level, unfortunately did not get out of it completely. And we own more shares of it today than we did when it was at the peak at around 700. And I think the Netflix story was complicated further by the pandemic in 2020 and how rapidly their subscribers grew. And it became difficult to be able to figure out what their normal growth rate was and how much of their growth was coming from pandemic pull forward. When we’re all stuck at home, it became a favorite inexpensive form of entertainment to pay $13 a month and have unlimited access to their streaming library.

Bill Nygren (48:18):
They were coming out with a lot of new content that other media was not. We didn’t have sports to watch, live sports to watch at the time. So the demand soared and they brought in two years worth of normal growth in a relatively short time period. And investors have struggled as we’ve seen those numbers fall now to how much of that is a competitive response. Disney Plus is now a big competitor. Apple, Amazon, all of those streaming services. When we step back and look to say the current market price of Netflix is only about a thousand dollars a subscriber. That’s about the same price that we think was implied when AT&T purchased Time Warner for their ownership of HBO. We think Netflix is in a far superior competitive position to HBO, especially given the scale it has by having more subscribers than any other global platform.

Bill Nygren (49:18):
Whenever they spend money on programming, they get to divide it across a bigger denominator. So on a per subscriber basis, programming is cheaper at Netflix than at any of the competition. And you get this virtuous circle where they spend more on programming. It gives them more subscribers. It gives them a bigger cost advantage, which gives the customer a better deal, gives them more customers. And the whole thing just keeps feeding into itself. Netflix is growing. Netflix is still capable of raising prices. Even after some price rises, you still ask people if you had to give up one of your monthly subscriptions, SiriusXM, Spotify, HBO, Netflix, which one are you going to give up? Nobody says Netflix. And yet it’s still priced at somewhat of a discount to most of those other monthly services. We think they are still using price as a competitive advantage to grow scale to put them in a far superior position several years from now than they’re in today. And we think at current prices, we’re paying virtually nothing for the growth that we think is very likely ahead of them.

Trey Lockerbie (50:29):
All right. I have one more question around your positions. Oil had a recent huge run up lately and your position EOG has followed. What’s your forecast for oil and your energy positions going from here?

Bill Nygren (50:43):
So for a few years, we were very wrong on oil. We’ve been saying for some time that in a strong global economy, demand for oil, demand growth was going to outstrip supply growth. And we would be in a position where the only way to resolve that gap between demand growth and supply growth would be through higher prices. And that prices would have to go up enough to incentify more drilling and to reduce demand somewhat. And it seemed like each year we’d start the year with the World Bank saying global growth should be 5% real this year. And we’d run that through our models. And we’d say, this is going to be the year we’re finally going to get a supply greater than demand. And then by July, they would’ve reduced their estimate of global growth to 2%. It’s one more year out in the future. And we underestimated how much the historical CapEx of the E&P companies was going to continue growing supply even after they had brought down their expenditures.

Bill Nygren (51:44):
This year, we finally hit that point where the supply and demand curves crossed. And we’re looking at shortages. $60 a barrel is not enough in today’s economy to incentify oil and gas companies to shift their cash flow allocation away from shareholders toward growth. They need something more like $70 a barrel. And the switch doesn’t flip instantly. So once they decide they need to increase spending, we’ve probably got three years until we do see that growth in supply. In the meantime, prices have drifted up to over $90 a barrel. All of our E&P investments sell at single digit P/E multiple, some of them mid single digit P/E multiples if oil stays at $90 a barrel. We give them credit for that cash flow, but we think it’s wrong to assume that price stays this high five to seven years in the future. We aren’t giving them credit for that in a terminal multiple, but these companies are going to have a tremendous ability to return very significant cash to shareholders, at the same time, they grow their underlying business.

Bill Nygren (52:57):
Conoco, one of the names that we owned in the OakMark fund, I think did a great thing last summer when at their analyst day, they put out a 10 year forecast. And not many companies are willing to potentially look silly. You can be wrong if you guess out 10 years. But they said, if oil prices average 50 a barrel for the next decade, we think at the end of 10 years, our production will be a third higher than it is today and we will have returned 90% of our market cap to shareholders in the form of dividends and share repurchase. To us, the comparison of that to a 10 year bond was striking. You buy a 10 year bond and you’re getting 2% a year. So over a decade, you get 20% of your capital back. And then you get your investment back.

Bill Nygren (53:47):
You buy Conoco, you get 90% back over the decade. And at the end of the decade, it’s worth one and a third times what it was. And that was with oil at 50. And as oil crosses 60, the return to the shareholder is higher and more of their growth spending makes sense. So not only do you get more capital back, but the end business is worth more than it is. And then the same thing at 70 and at 80, and it just keeps scaling up. We think the energy sector continues to be meaningfully undervalued. We think the ESG investors have kind of shied away from anything fossil fuel related, leaving somewhat of a vacuum of those of us that are willing to purchase it. And it’s not that we’re willing to purchase because we’re environmentally irresponsible, but the US E&P industry is 20% more carbon efficient than non-US.

Bill Nygren (54:40):
So if the ESG crowd wants to stop the US E&P industry and you don’t stop demand, all that it’s achieving is you shift that demand from US companies to global companies. And the carbon production goes up 25%. And maybe we can pat ourselves on the back that US carbon production goes down, but it hurts the world. I don’t think there’s a disconnect between saying, we think Conoco and EOG and Apache are really attractive investments and we don’t believe we’re being irresponsible to the environment by holding those investments. These companies are doing the right thing. They’re sending most of the capital back to shareholders. They’re investing in ways to be more carbon efficient. And they’re growing their business so we can decrease the amount of demand for the rest of the world. And global carbon production will go down if these companies prosper.

Trey Lockerbie (55:37):
All amazing points. Well, Bill, this is so amazing. Thank you so much for being just incredibly generous with your time and with your knowledge. And it’s always a treasure to have you on this show because we get so much out of it. And there’s so many great takeaways. I would really love to continue to do this again, but until then, we’ll be following closely. Before I let you go, I want to make sure I give you a handoff to give folks what they need, the resources to find more about you, OakMark, et cetera.

Bill Nygren (56:05):
Yeah. I think the easiest way to learn more about us is our website, which is oakmark.com. And I would say for anyone who is really curious about any mutual fund, go to the website and read quarterly reports. I know it’s become kind of old fashioned to read the reports that the money managers actually write about how they’re invested. And I think we’ve kind of done that to ourselves in the industry because a lot of my competitors view the communication to shareholders as almost an obligation. Twice a year, you have to tell them what made the stocks in their portfolio go up or down. And they kind of limit their communication to that. The commentary pieces that I write once a quarter aim to be educational. And I would tell people, if you go back and read five years worth of those, you’re going to have a really good understanding of how we think about investing at OakMark.

Bill Nygren (56:59):
And the reason that’s important is the market has a way of making you doubt your convictions at the moment it’s most expensive for you to doubt and act on that doubt. And the best way to counteract that is to understand how the people managing your money think, how they approach investing, how they’re likely to react to price changes. And if you can get comfortable with that, then you as the investor are much more capable of riding out the difficult periods and then you won’t suffer from that negative gap between returns investors tend to get out of mutual funds and the returns the funds themselves achieve. And our goal is that any investor in OakMark who reads our quarterly commentaries, they’ll understand how we think and they’ll be much better equipped to take the same long term approach to investing that we do. And those are the investors that’ll have the most success with us.

Trey Lockerbie (57:57):
Very timely advice, especially with all the chop we’re seeing in the market today. Bill, I can’t thank you enough. Really enjoyed it. Let’s do it again. Appreciate it. Thanks again.

Bill Nygren (58:07):
Thanks again for having me.

Trey Lockerbie (58:09):
All right, everybody. That’s all we have for you this week. If you’re loving the show, please don’t forget to follow us on your favorite podcast app. Definitely reach out to us. You can find me on Twitter @TreyLockerbie. And if you haven’t already done so, be sure to check out all the resources we have for you at theinvestorspodcast.com. And with that, we’ll see you again next time.

Outro (58:26):
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