In this episode, Preston and Stig conduct an analysis of three publicly traded stocks.  Since the stock market is currently at one of the highest market premiums ever recorded (the only time it was higher was in 2000), the search for yield produced some interesting results.  The companies discussed are McKesson Corp (MCK), Gazprom (OGZPY), and McDonald’s (MCD).

In this episode, you’ll learn:

  • Why McDonald’s is a great company but a horrible stock pick in 2017
  • Should you invest in Russia given the high US stock market?
  • Why dividend payments might be more important for certain stocks
  • How to think about the risk of an individual company compared to the market
  • Ask The Investors: What will happen to ETFs if the market crashes?

Tweet your comments about this episode directly to Preston, Stig, and the rest of The Investor’s Podcast Community using #TIPMoney.

Get The Investor’s Podcast blog posts and podcast episode updates on your Facebook feed by liking We Study Billionaires.

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Podcast Transcript and Summary

Preston Pysh: [00:00:00] We have a fun episode for you because we’re going to talk about the current market conditions and then when we do as we go through three individual stock picks that we talk about two of the stock picks are companies that we personally like and that we think have a lot of promise and that are priced appropriately that give a person a decent return even though the stock market is extremely high right now. And then the last stock pick that we talk about is a company that we think has a lot of cash flow and has a very good business that would give you a really bad return. And we talk about this to illustrate a couple important points about value investing and just really investing in general that we think is really important for the audience to understand.

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Stig: [00:00:47] We’ll also discuss whether or not you should invest in Russia given that the American stock market is so expensive and we are also going to have a discussion about dividend payments and how that is different. If you invest in the U.S. or international. All right so this should be a really fun one. And let’s hop to it. You’re listening to the investor’s podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected.

Preston: [00:03:51] Yeah absolutely. I mean I think you’re at 3 percent at best is what I would. What I would say and I can see you nodding your head you kind of see it the same way we’ve been seeing that figure for ever. You know when our I was up at the mountain there with Jesse and some of the people that listen to the show we were sitting around chatting and you know a couple of the guys said you know we’ve heard you talk about this narrative that you’re investing operationally that you’re investing more on the private side than in the public markets. And for us that makes total sense and we totally get it because you’re getting higher yields and you know I hate to continue to talk that narrative but you know not too much has changed. And when the public markets they even go higher that only makes you dig in even further into that position because they expect that Yoda’s is even that much lower as the prices go up. So what we really want to talk about today are some of the stock picks that we’re seeing even though the market is really really expensive.

Preston: [00:04:49] You’re not getting big returns. We want to talk about a couple of different companies one in particular we think is a very good pick that has a lot to return to it based on the price that it’s trading at today. We’re also going to talk about a really bad stock pick. Now this is not a bad company is actually a very good company. It’s just the price that it creates at right now. You really can’t justify to expect a return. And I think that the learning objective is something like that is perhaps even more valuable than for the first stock pick. I think that’s going to be an interesting discussion as we’re here at such a high market price. P Thirty-One Stig higher than the Shiller P during the 1929 crash. Not as high as it was in 2000 but still the second highest market price based on earnings that we’ve ever seen in the history of the stock market so a very high price premiums right now.

Stig: [00:05:43] We often talk about the Schiller PE here on the show because the PE is basically adjusting for the different cycles and then is comparing to how much money are you paying for want of earnings. Now obviously there are a lot of different ways that you can value the margin and we like the Shiller but you can also find other valuation metrics. So I’m just going to give the handoff to one of the resources that the short is creating. And this is also something that was syndicated on our side. And what they do really need is that once a month they pop this all the different valuation metrics and how they rank and how much they think they can explain what’s happening in the market and what’s really interesting because I’ve been falling short for a long time and know it’s ranging. Mean eight percent all value the low side. Two hundred and eighteen percent on the high side but it’s really need to go dig into the different valuation to see if it’s valued and not giving like more conventional and metrics.

Preston: [00:06:41] So one of the things that I think is a really important discussion is the idea of investing in ETF versus investing in individual companies. So if you’re buying an ETF you’re buying this 3 percent that we keep throwing around. That’s what you should expect to get with your allocated cash flow into an ETF today by talking about individual stock picks which is what we’re about to do. We’re thinking that you could potentially bump that return. Our first pick here I think that you might be able to get three times that return in this individual pick. But the risk that you have is now you’re dealing with an individual company you’re not distributing. Ross 500 companies. So that’s where we can’t tell you to do one thing or the other that’s where you have to make that decision for yourself. Do I go for three times the yield with the risk that it’s only in an individual company or do I take a much lower yield call at 3 percent and buy an ETF and if the market crashes in a year or two years and you lose a lot of that in the short term. But then it eventually comes back within another five or six years or whatever. That’s just part of the process. That’s just something that you have to be willing to accept that volatility by buying into an ETF at such a high market price. So all these considerations are things that you have to be thinking about. So with all that said let’s go ahead and dive into some of these individual stock picks that we think are quite interesting.

Preston: [00:08:02] So the very first one that I want to talk about is called McKesson Corp. And this is a health care company whose operations are divided into two major segments. They’ve got McKesson distribution solutions and they got McKesson technology solutions and it’s a business that sells pharmaceuticals at the retail level and it also provides medical supplies and health information technology. This company is big. It is really big. And when you look at their top line revenue it is one hundred ninety eight point five billion dollars and their free cash flow for the previous year was $4.2 billion. So this company is massive. It’s very very big. It’s in the S&P 500 and the stock ticker. If you guys are curious about the ticker it’s m c a so when I’m looking at this company the first thing that I’m doing when I’m looking at this company that I really like is I’m looking at the top line I’m looking at the wrong number of like the sales that the company is doing because there’s nothing that’s being deducted out of that there’s no expenses being subtracted out. This is the fundamental number of the money flowing into the company. And when I look at that or this company over the last 10 years it has done extremely well every single year. The revenues are going up and it’s going up and a nice trend it’s going up in a very predictable manner.

Preston: [00:09:32] Whenever I look at the net income after you back out all of the costs associated with achieving that revenue the net income is growing the net income is doing fabulous. When you look at the free cash flow of the business after they’re making capital investments their capital expenditures being taking out the free cash flow is doing fabulous it’s trending up every single year. And so for me that’s really exciting. When you look at the balance sheet the balance sheet is very healthy. And so you know when I’m looking at the competitive advantages and you know what we’re going to e-mail this out on our e-mail is if you sign up on our e-mail list will send out a write up of our assessment of this where we go through the competitive advantages the enduring competitive advantages for the company. You know it’s an oligopoly as far as we’re concerned. There’s other efficiencies of scale that we see with the company. There’s intangible assets that look great and there’s economies of scale that we’ve identified. In general this looks like a fabulous pick when we go and we look at the future free cash flow as we come up with an intrinsic value of this business. I’m getting a very very good number and we’re counting for the potential for the free cash flow to even go down in our model. And with that said we’re looking at about an 8 percent to 9 percent return on this company. So if that’s true if we can get a 9 percent return based on the projection of the future free cash flows and everything that we’re talking about here looks good that’s three times higher than what you could get by investing in the S&P 500.

Preston: [00:11:09] And so then it it goes back again to my original comment of. Are you willing to take a three times higher return than the S&P 500 but have a little bit more risk because you’re only in one company that’s specifically in health care for me I’m willing to take that risk. I think that this is a good pick and this is something that I am buying right now. I’m not buying a large quantity of it because I’ve got concerns from a macro perspective but I’m definitely buying this company and I think that it’s going to do quite well moving forward into the future. Now I want to highlight that this pick him to us from one of the members of our community and that’s David flood and David. Huge shout out to you because looking through the numbers on this I’m kind of like this looks really good. It’s rare that I’ve been able to find a company with such incredible financials. That’s a large cap company that’s in a space that I think is going to continue to do quite well moving forward. So huge kudos to you for identifying this pick. And we’re just really happy that you were able to help us go through it and look at this a little bit closer.

Stig: [00:12:16] One thing that I really like to look for whenever I check out the stock that is how the dividend is growing and how these shares are shrinking it’s very interesting to look back at the past 10 years because what you would like to see from those companies that it would just slowly increase the dividend especially if you don’t know the company too well and just starting to do your analysis because of course we had this discussion before and like how much do the company pay our dividend. How much should be stock buyback and how much should be retained and then reinvest. And of course if you want Buffett you don’t want to see a lot of dividend payments. But whenever you see that almost all the companies and you see that gradual increase usually means that the free cash flows the money that’s flowing out or the cash flowing back to the owners is just growing and it’s just growing at a steady pace and that’s what you see for this company and what you also see is that the company is gradually buying back Yes and it’s not to a large extent. It doesn’t seem like they’re really timing it. Yes they actually did buy these in the back whenever it was cheap. After the financial crisis. But it’s more the how do we think about reallocating our capital. You see this trend with a company like Disney. You see the same thing slowly increasing the dividend.

Stig: [00:13:42] Never have any problems. And then they slowly buy back. Yes. And as you as a shareholder I just rewarded now I do want to say that one of the main concerns I have for a company like this that might be the red tape. I think this is a really interesting company. I don’t know if I’m necessarily an expert in this. I see a lot of regulations that might change and I’m not too much into that. But the thing that really concerns me is that how excited I was I guess like preste of when they saw it was called the 8 percent and it just shows you something about what you used to see. Like what ever I’m doing this calculation I come up with you know minus 3 percent for this company or plus one point five percent. The other company. And then I finally look at something and it’s call the 8 percent and it just gets so excited and it’s just important for me to remember that this is probably not the thoughts I would have called that five seven years ago. So I want to be cautious. I want to say given the opportunity cost. Yes this might be interesting. That kind of return but also knowing that if the markets should crash you might be facing a very different result. As an investor and I mean then that’s an opportunity to buy more equity of this.

Preston: [00:14:53] So this is a pick for me that I don’t really mind buying at such a high market you know price for the market in general the market’s very highly priced right now. I don’t mind buying this right. The reason why is because if the market does crash I am holding something that I have no problems buying more equity of if the price would even go lower which you know when I’m looking through this thing I’m having a hard time identifying the risks. And usually that’s a red flag for me like hey there’s you need to do more research you’re messing up somewhere because typically at this point in the credit cycle you’re not able to find companies that are so quality that have such strong financials that such a return and so you know I charge the audience if you’re seeing something that we’re missing. Hit us up on Twitter because we’d really like to know and we’d like to be able to identify that to the rest of the community. But honestly when I’m going through this and I’m looking at the potential risks I’m not really seeing too many relative to other things that are out there. This is one of the best picks I’ve seen in a long time.

Stig: [00:15:52] Really like this. And it really makes me think of target that discuss not too long ago it’s probably also because I’m not too bear on retail even though I guess you can make that argument. But you also these very very stable numbers there were not even as good as they were here for me. But it basically boils down to valuation because we’re looking at two different numbers here looking at what’s intrinsic value here. And for a company like Miki’s if you look into their financial statements it really looks like they’re compounding that intrinsic value with and call it six or eight or nine whatever that is. And then you just have the market price just all over the place. So what person is basically saying here is that he is very confident that the intrinsic value will just keep company for this company and then if you see the market price Krass Well that’s probably a good time to buy a little more. Yeah it’s an exciting time.

Preston: [00:16:43] I mean I’d be looking forward to that as long as I don’t see risks that mature out of a crash you know. But I don’t see that I mean they’re not really that leveraged. Whenever I’m looking at the company the industry average for this sector is point for the debt to equity and the company is 0.7. You know you look at the cash flow statement. I mean they’re very healthy on the operational side that’s where they’re generating the money to pay the bills. I mean it’s just in general I really like it if you guys go into the show notes we’re going to have a link into our forum for this specific company and we’d love to have people come in there and contribute some comments and some analysis and help us identify some of the risks that we’re obviously not seeing right now as we’re talking about this. But help us identify that as a community. And I think that this is something that we can get some serious value out of. All right. So let’s go ahead and talk about the next pick that we’ve got here and this one is a Russian company and I’m sure most people probably know where I’m going with this so it’s Gazprom and this is a huge business in Russia. It’s one of the top four oil producers in Russia and it’s the country’s only producer exporter of liquefied natural gas. The company’s ticker if you guys are wanting to look this one up is oh geez Z P Y O G Z p y.

Preston: [00:18:08] And when we look at Gazprom you know I remember talking about Gazprom on our forum what five years ago Stig I mean we’ve been talking about this one for quite a while. The reason we’ve been talking about it is because it always seems to be trading at a low malt. I’ve never seen this thing traded at a high multiple. So I think that that’s a consideration just right out of the gate like historically. From what I’ve seen this this company just does not trade at a very high end and so maybe that’s a good thing if you’re trying to accumulate more and more equity of it and getting decent earnings for the price that you’re paying when you look at the free cash flow of this business. It’s very cyclical. It’s all over the place. You know and recently you’ve seen the free cash flow kind of in a decline in 2015 2016 and it seems to be coming back down. So when we’re looking at normalizing those free cash flows we’ve tried to do a very conservative estimate moving forward. We have like a little graph that will send this out on our email list and we’ll have some links to the articles that we’ve written on this stuff in our show notes if you want to see the charts that we’re coming up with. But in general when you’re looking at this thing and you’re looking at the multiples you’re willing to pay compared to other companies in this sector. Gazprom has such a low multiple which means that your yield is way higher than the other businesses that are trading at a higher premium.

Preston: [00:19:33] And we have a couple of different methods we have a PE multiple price the book multiple price the sales multiple and we go through these and we look at what the emerging market is. In general we look at the global market for this sector and then we look specifically at Gazprom and we compare it to all these other sectors. When we look at like the P E ratio gas problems at a 3.7 P when the rest of the sector is at about a 10 to 12. So you’re looking at something that’s like three times less in price for the same amount of profits. Something else that I really like about Russia right now. Is the fact that the inflation rate is lower than it’s ever been. I mean the inflation rate in Russia right now is well like 3 percent stake. It’s not a lot. And so when you’re in the past when you know when you’re making discounts to this company specifically and you’re justifying why the multiple was lower when they have an inflation rate of 7 percent or whatever it was you know you go back maybe five years ago. That was a very strong consideration that’s going to erode the profits that you’re making on the business. And today I think that that is much lower and I think that maybe people were still thinking that that inflation rate is a lot higher than what it is.

Preston: [00:20:50] And when you look at the trend of that inflation rate it’s been going down. So in general I think that there’s a decent return here. I think that the return is you know maybe around nine to 10 percent up in that range pretty much the same return that we are looking at with the last pic. I think that there is definitely risks here. I think there’s a lot more risks here than the first pick that we are talking about and I think the risk. I think everyone knows what the risks are and the governmental risks associated with dealing with the Russian government that could nationalize things they could do all sorts of interesting things over there that I think for the typical Western investor like myself I don’t understand that culture like people that live over there. And that’s a risk in itself that you know I just have to acknowledge exists whenever I make an investment like this one here. And so this is something that I have purchased recently. Again not a very large position but it’s a position that I’m comfortable taking and I think that the multiple I mean I think it was Peter Lynch wrote in his book it’s really hard to go wrong when you’re buying a large company that has a P E multiple of four. And that’s kind of where we’re at right now with Gazprom and you know I like it. I think that it has some really good attributes. I’m curious what you think Stig.

Stig: [00:22:08] I never bought Gazprom before but I bought like oil a few years ago and it was not the best experience I have to say that part of it was because the oil price was cut in half even though I felt that the oil price was not too high back when they bought that thing was like late 2014 or 13 perhaps even bought. One thing I realized that was super important investing in emerging markets is what kind of dividend yield can you expect because dividends are really hard to manipulate because after all this is cash that’s going out of the company’s bank account to your bank account. And right now for Gazprom that would be six point six percent. And if you look at the payout ratio it’s still very low. I think it’s in the tweezed something like that. I mean there’s still a lot more room to free cash flow is still very appealing for this company. Margins are really good. And then when you look at the risks definitely there’s a lot of risk in terms of the government. But I also think that you need to look at deaths and that’s definitely a criteria that it’s not too burdensome for Gazprom because their debt to equity right now just so people know based on this comment there that the equity on the company is a point to the industry average is a point for.

Preston: [00:23:30] So it’s very healthy on the balance sheet when you look at something like the price to book and this is sort of cuts eristic for all companies especially in Russia you just see this ridiculous low numbers so right now it’s playing to I would definitely be very concerned about putting too much emphasis on this number. I would expect goodwill impairment and goodwill impairments. That’s basically just a fancy word for writing down the value of the assets in years to come because of the low oil price. I’m not an expert in gas from an oil but I would assume that there is something there and sometimes specially in the Russian oil and gas prices you sometimes see like really high good real impediments. But that’s really just a testament to how much you should look into the free cash flows and of how much you should look into the dividend payments. So one of the things that’s really interesting about Russia right now is the pressure that they have from the government in terms of paying out more and more in dividend because they realized years ago that one way to attract foreign capital is to ensure stability in your investments.

Stig: [00:24:36] And Preston already talked about inflation and how that’s a big concern. I can say that for myself whenever I bought Lukoil I was not happy about the development of the ruble. To put it mildly despite the company’s still making a lot of money. But unfortunately that was in rubles and this kind of like a risk you just have to come for one of the things that they’re doing to mitigate that is that they are putting more and more systems in place in terms of always ensuring that U.S. investors will collect a really good dividend because as we talked about before it’s really hard. You mean you play that gives investors some type of certainty and it also Lorsch downside. And this we all talked about before the dividend yield right now was six point 6.6 percent. I don’t see that go down at all and it’s time to come with this. Obviously a lot more appealing than say 2 percent on your 10 year treasury or you expected 3 percent in the market. So yes I think this is a very interesting pick. Even though people might be shaking their heads and saying oppressiveness Stig buying into Russian oil companies right now what’s happening there must be really really frustrated Despite looking at that because of the conditions.

Preston: [00:25:48] I mean I just look at it from just even a basic level. So this company is trading for $4 and 30 cents a share in one year later. The earnings the profit that this one share of stock is making is $1 and 13 cents. So when you take all the confusing terms and everything else off of this thing and you just look at it from a really simple vantage point and you’re making a buck 13 for a $4 and 30 cent stock this is a large cap company I mean you’re not talking about some like 10 million dollar company here. You’re talking about a $47 billion company. I have a lot of expectation that that profit is going to be able to be sustained moved or at least some of it if you even took a 50 percent cut on that profit you’re still making a lot of money on this company so it’s price to perform and that’s what I really like about it and it’s priced to perform in a currency that has really kind of done quite well lately and has started to stabilize and it looks very promising moving forward. So whenever I compare a buck 13 in earnings to a company there’s a lot of companies in the U.S. trading for $100 to get a dollar and 13 cents of profit paying for bucks and 30 cents for something. Now that’s for me that’s a steal and that’s something that I have no problem putting my money in.

Preston: [00:27:09] Even if you’re at the top of a credit cycle because how much more can this go down. I mean how much more can this thing go down when you’re making a buck 13 in profit something real quick that I want to talk about Stig is that oil prices and the gas prices and really commodity prices in general. I think that you’re really kind of seen them at a somewhat steady position. You know if we would go into a market crash in a year or whenever I think that yeah you’ll see the price of oil you’ll see the price of some of this stuff come down because the demand is going to contract significantly. But I don’t think that you’re going to see things pull back anything like we saw two years ago when oil went from over $100 a barrel clear down into the 30s like that was dramatic. That was yeah that was total destruction. Now oil’s price at fifty fifty two dollars a barrel you’re seeing other commodities really kind of hitting a steady state when you go and you look at the derivatives market where these things are being traded into the future a year from now or three years from now the prices are really flat like you’re looking at the spot price and the price that it’s trading for three years from now is being the same number.

Preston: [00:28:20] And for me when I see that and I see that line I think you’re at a kind of a steady state in that market. So you know I like this. I think that this is another good pick but I’m very curious to hear what the audience thinks. I would love for people to shoot some holes through this and tell us why we’re wrong and help us identify more risks. So I’m curious so you’re talking about this stock just being priced above $4 and then the listeners are hearing that you’re talking about a buck in 13 cents. Year after so why would you call with respect to a return of call the 8 to 10 percent. Could you talk about the process and how you think about that. Well so that’s more just me being ultra conservative with what I expect to get out of it. I think on the high end I think you could I mean you might be able to get 20 percent out of this thing without any problem at all but conservatively speaking I think that you got a discount for some of those risks. I think you’ve got to also account for the fact that this thing usually doesn’t trade at a high premium to its earnings. And I think that that’s probably one of the biggest factors of why I think you might not get 20 percent out of it is because in the long run I think that it’s always going to be kind of discounted because of the fact that it’s a Russian company that a lot of people have concern with the government there.

Stig: [00:29:35] If people are thinking how can we get that kind of return. And why is it trading so low. Well let me ask this question of you instead. How do you feel about investing in a Russian oil company right now. And you know everybody else has the same feelings so that’s really the reason why there’s so much psychology in this. This is also relates back to what we talked about before the oil price. Like how can it be stabilizing in the 50s and not too long ago in the high 20s. Well sure. If you look at this fundamentally didn’t any kind of sense because you can’t extract all that kind of price and the utility is so much higher there was just all psychology. What does the consensus say right now. And same thing you can say about the Maiga price of gas from Stig something that I look at. Like for me this is really important for this company. The market cap what I’m looking at a company that’s a 47 billion dollar company. There is a lot of people there’s a lot of hardware there’s a lot of things that are happening by the sheer size of this business and that doesn’t mean that it can’t go into oblivion and disappear.

Preston: [00:30:45] But when I look at how leveraged they are and they’re not leveraged hardly at all and they have that kind of market cap and they have the revenue that they have that’s coming in. I mean man this thing’s not going anywhere anytime soon. Going down I mean you know it’s not going to be destroyed any time soon. There’s a lot of momentum behind a company of this size. And when you see a race like it is for the profits that it’s producing I mean this is I don’t know I have I feel very comfortable buying something like this right now. All right so enough about Gazprom we’ll let the listener decide whether they they want to buy a Russian energy company or not. But I think it’s an interesting discussion. So the next one here is a fun one. And the reason that we’re highlighting this one is because it’s we think it’s a horrible pick right now but we think it’s a great business. Well I don’t I don’t know if I’ll say it’s a great business but it’s a good business that’s making a lot of money and we want to highlight why we think it’s such a bad pick for somebody to own right now. And we’re talking about McDonald’s. So McDonald’s makes a lot of money and whenever I say they make a lot of money let me just tell you some of the figures here.

Preston: [00:31:55] So the top line for McDonald’s is their revenue in 2016 was twenty four billion dollars. Twenty four point six billion dollars. Their net income was 4.6 billion dollars profit. Literally the money that is leftover has retained earnings for this business was 4.6 $87 billion. That’s before the dividend was paid. So they’re making a lot of money. That is a very high margin especially for the food industry which everyone knows the saying that it’s a real estate company. But when you look at this and you look at the margin this margin is really fat. But let’s talk through why we think this is something that you would not want to own today in 2017 and it really comes down to the intrinsic value calculation even though they have so much momentum this company. You know when you look at their top line it’s been suffering a little bit lately. It’s been going down a little bit. Not a lot but a little bit. Their highest revenue their top line was 28 billion and now they’re $24 and that was four years previous that they were at 28 billion and they’ve contracted a little bit. So that’s a reason that it should be trading at a discount as just because the revenues are contracting and it’s not. It’s trading at a very high price. I wanted to talk about McDonald’s because it does has really been on my radar for quite some time because going yes back.

Stig: [00:33:15] I just like numbers and I like companies I know how to value a company like McDonald’s. It’s just really easy to value because it’s so stable. And whenever Preston is talking about well you know revenue has contracted and it has you know it’s back in 2013 it was $20 billion and now it’s getting 12 months is around 24 billion but that’s a high fluctuation for a company like McDonald’s which really tells you something about this is not like a high growing whatever. I mean this is very stable. If you look at the gross margins we had the 40s the operating margin. You know we are around 30. And if something is very stable you ceased to value my dollars is definitely a good business. It is a good business in the sense that it really has no death for the conservative investor. It also has a high pay rate you if you look at the numbers I’m just laughing here and it’s hard for Stig to retain its luster because we just keep saying it’s a good company but in my mind I’m thinking yeah but I won’t eat there. So I’m sorry. Go ahead Stig. I’ll try to not smile so much. Straight ahead sorry. I’m all about the numbers. I don’t know if I’m about the food but I’m definitely about the numbers and the numbers are good.

Preston: [00:34:29] And but when you say the numbers are good the numbers are good from like the revenue they’re stable but from an intrinsic value I don’t want people to get confused but from an intrinsic value the numbers are not good. Right. Yes it’s a really good point. If you look at numbers in terms of the stability and billions of dollars that it’s making every year into a good company. If you look at how it’s priced it’s not a good company. If you look at our model and I put in my assumptions and we’ll have a link in the show knows where people can go in and read more about their assumptions. But we’re probably looking at 1 percent return something like that. I mean it’s not a lot that you can expect and that would be even worse than buying into the market. But as also very interesting if you compare it to a company like Gazprom as you can tell we’re excited about Gazprom. But yes it’s a lot more risky despite its size. Way more risky than a company like McDonald’s. But it all boils down to the price. If you’re paying $4 and then some for a dollar and 13 cents that’s attractive and then you look at a company like McDonald’s and McDonald’s is currently trading at one hundred sixty six dollars and that’s for an earning per share around six dollars.

Preston: [00:35:39] So it’s just not as interesting. Just. I want to I want to clarify because you were saying that Gazprom is a lot more riskier than McDonald’s. But you know Buffett in some of these guys will say that the risk is actually in the price not in some of these other things that people identify. And so this for me is a perfect example of that because whenever I look at McDonald’s all the risk here is in the price. The fact that the market has valued it so highly and that you’re going to get a 1 percent return if you buy it today in the long term we’re not saying in the next year or two years. But if you own this in the perpetuity you plan on owning it for 30 years. I would expect to get a 1 percent return on my money annually for the next 30 years on this company based on how it’s priced today. And so for me that’s a ton of risk. That’s a ton of risk because I can take that same amount of principal when invested in the S&P 500 and get 3 percent based on how it’s priced. Or I can go to Gazprom and get what I think is 10 percent or even higher. So for me the risk when you talk about the most risky thing here it’s a business that’s extremely stable that’s making a ton of money.

Preston: [00:36:47] But it is priced just completely to the moon. So that’s why I think it’s really great that we’re talking this company and other people may completely disagree with this they might think that there’s a lot of growth opportunity that McDonald’s is somehow going to grow their top line which I don’t see that happening. And so for me I see this as a huge risk and it’s really good that you clarified that because whenever I said risk here was probably shouldn’t have used. It’s the thought of my dollars going from earnings per share of $6 to minus two or three dollars for that matter. I don’t see that happening at all. And I think that the likelihood of something like Gazprom that could happen also because they’re in commodities business is a lot more cyclical. A lot of other reasons why they would suddenly like for legal reasons why they would see a drop. I don’t see that at all for McDonald’s and McDonald’s is very Stigy business even though it’s not it doesn’t have the same kind of sickness as a company like Starbucks or a company like COLA where people always get the daily coke or daily cup of coffee. I mean people do change what they eat. But still it has so much more Stiginess that other fast food change. It’s also because of the locations. I mean it’s not always a question about taste and decor.

Stig: [00:38:04] And I might get a lot of mad tweets because I say that a lot of the fast food tastes similar and there were a lot of hot coffee that would say it doesn’t at all. But I think it’s also a question of if you are hungry and you want to go for a burger. Sometimes you will just take what’s more lenient. And it’s really hard to find a company whether it’s in Europe or the U.S. They have better locations than McDonald’s to just all the right places even though people sometimes might want to go to Burger King or Wendy’s or whatever. You know what you’re going to get. And it’s everywhere. Everywhere you look it’s there. All right. So instead of kind of harping on this one any more. The reason we want to talk is because we wanted to talk about a great company the company that’s making a ton of profits but is probably something you don’t want to own at this point in time in 2017. Now as the market conditions change let’s say we have a big pullback a big contraction and this thing gets priced in it’s at a you know a completely different multiple than it is today. This thing might be priced at a 15 percent return and then it might be a great time to come in and buy this equity of this business.

Speaker2: [00:39:12] But today we don’t see that at all and we think it’s important to highlight that so you can see a great business at a poor price is a lot of risk. So that was our main point. All right so at this point of time the show would like to play a question from the audience and this question comes from. And your show guys and I really appreciate the Epstein ask you a question. So with this massive push into passage now you have a lot of big names on both sides of the index argument. You have guys like Buffett saying that you know the average retail investor should just go into indexing and forget about it for the next 20 30 years. So that being said the way I see it is we recreate a kind of a. Positive feedback loop on the way up. And I just I’m afraid that on the way back down it’s going to be the same thing is going to be a positive feedback loop where recession causes people to pull out of index funds and that further pushes down market. You think that guys like Buffett are doing a disservice to retail investors because chances are most retail guys don’t have the temperament to stay in when they can it when they face the biggest correction that they’re ever going to see in their lifetime. So what are your thoughts. Thanks a lot guys.

Preston: [00:40:27] All right. So I really really like this question and for people following the financial news out there they probably can’t help but notice that indexing has really been something that’s been healthy debate and recently indexing is many ways changing the landscape of investing. And right now it’s almost 20 percent of the global stock market that is indexed. And you’ve seen this polarity of indexes for a long time and and least the way it looks like now and the forecasts you can make it’s expected to continue. And so basically what you’re asking about that is what’s that going to mean for us. I definitely think you’re right about the positive feedback loop. I think that index is a factor in what you see right now with the high valuations. But you would also say it has to do with QE or you might also say it has to do with general state of the economy. There are a lot of great narratives of why you see these stock valuations that you experience right now. But yes I do agree that the ups and downs to experience in the market they’ll probably be exaggerated to some extent now. In essence I don’t think it’s different than what Warren Buffett’s Professor Binyamin Graham observed after the Great Recession and I’m sure you can argue even before that when stocks are expensive investors flock to the stock market and they start selling when it goes down.

Stig: [00:41:55] And as you suggest index indexing probably makes this worse. The question is how much. But really back to question whether or not Buffett is doing a disservice to the retail investor. I don’t think he has. And as you also mentioned he’s been saying 20 years 30 years even a longer period of time for holding indexes and not talking about going into indexes right now. But more like general approach to invest in the stock market. And I think that if investors then start selling anyway. I really can’t see how Buffett can be blamed for people not following his advice. And you also don’t like to add is what is the alternative to the stock investor say that he doesn’t invest in index and say that he wants to doing real stock picks instead. So it’s important to keep in mind that even if you pay individual stock it is by definition a part of the market index. You might not buy the market index but someone else’s and they will also be only your stock. And the thing you bring up a really good point about the psychology in the market because we know that people would sell at the wrong time. I do think most people will have a harder time selling an index even though it might sound kind of intuitive to your thesis because at least when you have an index and say that your lost 30 percent then you have lost 30 percent and everyone else has lost 30 percent.

Stig: [00:43:16] It might be harder to hold onto a stock has dropped 40 percent or even just 20 percent because you don’t have that certainty of following the herd. Interesting question. I you know I have no idea what the next recession is going to look like. You know I really can’t even comment on how deep I think it’s going to go. I think any type of you know conclusion that I would draw would just be completely based on biases that I hold. I think it’s going to be deep and a 50 percent or negative 50 percent are but you know that’s based on nothing that’s just based on you know my my feelings future which are worthless. I feel like the central banks have been pumping this thing up a lot and I think that I buy into the raid Dahlia narrative that on the way up it’s reinforcing. And on the way down it’s also reinforcing with the way that credit contracts. So it’s going to be really a function of how well the central bankers can prop this next credit cycle up after this starts to contract. You know you could make the argument that it’s going to be deep because they don’t have the amount of interest rates to drop like they did during the last cycle.

Stig: [00:44:34] There’s a lot of people making that argument and they think that that might be one of the reasons why it could go deep. But for me to be able to say with any type of absolute certainty I have no idea. I really don’t know. With respect to your second question about Buffett you know telling people that the best way to invest is ETF and that might actually cause more harm than good. I don’t know that I’d necessarily buy into that. I think that I think a person either has the temperament or they don’t have the temperament. If they don’t have the temperament you know I think all Buffett’s trying to do if I had to guess with what he’s trying to do I think he’s genuinely trying to help people. I think he’s generally trying to help people get the best return that they can based on the amount of knowledge he expects the average investor to have. There’s one thing that I think that he has learned and that’s that most people have no idea what they’re doing and based on that he’s he’s telling people to invest in ETF simply because the fees are low and you can get the market’s return whether you have the temperament to stay in the market when it starts to contract or you know whether it’s climbing or whatever. That’s completely up to the individual and just having faith and continue to do that dollar cost averaging.

Preston: [00:45:49] And the S&P 500 or whatever ETF they’re trying to attract. So we’re calling in and leaving this great question. We’re going to give you a free subscription to our new intrinsic value course that we just created. This teaches you how to value stocks and how to look at individual stock picks and how to come up with a value and an IRR calculation of what you think the yield will be on that stock moving forward. We hope you enjoy that recourse. And for anybody else to check out the course go to TIP Academy on our Web site you can find it there. So if anyone else wants to get a question played on our show and potentially get a free course. Go to ask the investors dot com and you can record your questions there. All right guys that was all that Preston on I had for this week’s episode on the investor’s podcast. You see you all again next week.

Books and Resources Mentioned in this Podcast

Dshort’s latest analysis of stock market valuations

Preston and Stig’s free index of intrinsic value analyses of popular stock picks

Stig’s intrinsic value analysis of McDonald’s

Preston’s intrinsic value analysis of Gazprom

Join the TIP Community in the discussion about Gazprom

Preston’s intrinsic value analysis of McKesson

Join the TIP Community in the discussion about McKesson