Before the recent 10% correction in the 1st Quarter of 2018, we saw more call options compared to put options by 2 standard deviations. We also saw the price at 3 standard deviations above the 200 Day Moving Average (DMA). On top of that, the Stock market is currently priced at levels only seen in 1929 and 2000.

With that said, we have assembled the Mastermind Group to talk about any opportunities that still might exist in the market that could out-perform the S&P 500 index.  For Toby, Hari, and Stig, they talked about individual companies. Preston, on the other hand, talked about the first deep learning, artificial intelligence ETF that’s completely autonomous in its stock selections.

In Today’s Show You’ll Learn

  • If the mastermind group likes two of Billionaire David Einhorn’s favorite stock picks
  • The risks and rewards from investing in cyclical stock picks
  • How to invest in private companies in India
  • About an Artificial Intelligence ETF

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 (automated)

Preston:  [00:01:35] All right guys we got the mastermind assembled again here for the first quarter of 2018. So let’s talk about the format that we’re using for mastermind’s for people that are joining us for the first time is each person brings a topic or a pic to the discussion and then the group goes around and kicks it around and tries to play devil’s advocate of why it might not be a good pick and then the person who’s presenting it provides basically all the pro points on why it might be you could pick. So anyone want to go first. I think Toby told me he wanted to go first before we started the show was that right.

: [00:02:09] Toby I don’t mind going first though Theo went first last on that. Did you guys eat my dust. Give it to you.

: [00:02:17] All right well you do have a very strong background to say that after the last mastermind because Toby recommended gilly And I think that’s up 20 percent since she recommended it on the last show.

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: [00:02:29] Something like that but I think in the interests of full disclosure we also have to mention assured guaranty which has had a bit of the stuffing kicked out of it. I still really like showed guarantee but it’s down Puerto Rico looks like it’s a little bit of a disaster. I think that AIG should guarantee has got to be OK. So I like it where it is. At the moment I think it’s still really cheap and it’s still in my screens where it is just in the interest of full disclosure I’m going to own up to that one too.

: [00:02:54] There you go. OK. Well let’s hear what you got for us today.

: [00:02:59] Pick today is a funny one micron technology. The ticker is in you. It’s one that I have recommended on the acquirers multiple so I recommended this on the acquirers multiple October 1 2015. And at that time it was trading at 14 dollars 56. Right now it’s trading a good deal higher than that. It’s at 42 dollars 49 so it’s up almost three times. And I’m about to recommend it again which might sound crazy but I’ll tell you what I really like it in market cap forty nine billion dollars. Enterprise value is about 53 billion dollars so it’s got about three billion dollars in excess of debt over its cash trades on a very low he just under seven times trades on a very cheap acquires multiple.

: [00:03:54] The problem with this stock is that it tends to be pretty cyclical. So the earnings are up and down a fair bit. So when I recommended it at 14 dollars I think it was trading on roughly the same quarter as Molex trading or five point seven acquires multiple. So it’s up three times on the same as multiple which tells you what the operating income has done over the last two years and a quarter. It’s up three times. That’s what happens with the stock. The operating income is up and down and it’s as close to as expensive as it has ever been. The reason I like Micron so much there are two reasons. DAVID On Haun has a big shareholding in it and holds a super smart investor. He’s had that shareholding in it since I recommended in 2000 and 15. So you know it’s not something that he’s necessarily buying now it’s something that he was buying when it was one third as cheap as it is now but it’s still as cheap on a valuation basis as it was then saw that market it’s in the semiconductor sector which is very boom bust and it’s booming but it remains as cheap as it has been so I think it’s an interesting stock. You know I don’t like really buying things at the very peak of a stock market run up and I don’t really like buying something. Certainly three times higher than I’ve ordered in the past. But if I look in that screen in a market it’s pretty tough to find things I think Micron is interesting.

: [00:05:18] So Toby the thing that catches my eye when I look at this just at the numbers I’m looking at the top line the revenue on it and it seems like the revenue is really all over the place what’s driving these cycles are the semiconductor industry.

: [00:05:33] That’s the nature of the industry. It’s a little bit combusts the very end of the with the consumer end of the industry is always pretty stable but by the time you get through to the manufacturer to the OEM it gets very volatile and that’s where these guys are you know is very subject to cyclical moves and so it’s a stock that does look cheap and it’s actually expensive. And so that’s the main concern. Something like this you know if you do a rough DCF on them and these things are pretty tough to do the discounted cash flow analysis which typically love is they’re always very the DCF moves around a lot ending on the use. But I think if you look at sort of the last five or ten years of growth and you punch those statistics in I think you get fair value for me. Something like this is around 70 to 90 dollars. So I think at forty two dollars it’s worth putting a small part of the portfolio in understanding that it’s a very cyclical stock with discount rate are you putting in to get that price just quoted I’m using a discount rate of 12 percent.

: [00:06:39] So going back to the revenues like the thing I guess I don’t understand is I understand cyclicals but when I’m looking at though the revenues on this you go to 2014 and 2015 you we’re looking at 16 billion. Are there revenues but then 2016 just one year later it dropped cleared out at 12 million and then we saw jumped clear back up to 20 billion here in 2017. So like the revenues practically doubled. And I guess for a company that size it just really surprises me so I guess my concern moving forward is if we buy now at the highest revenue we’ve seen what does this look like if that would drop back down to call it 60 percent of what we just saw in revenue for the coming year.

: [00:07:26] Yeah it’s a little bit more expensive but here’s the thing the revenue has been growing pretty consistently. I mean the nice thing about Micron is it’s got a track record that goes back 30 years something like that. You can look at it in the 1990s it was ending a dollar a share. Now it’s ending 18. This is in a revenue sense it’s close to eighteen dollars a share. You know it’s cyclical but it has grown over that period of time you know it’s not my most favorite stock pick I’ve ever had on the show because it’s just the market it’s getting tough to find stuff out that is cheap. You know what I typically like his trough earnings trough revenue and cheap on that trough. That’s definitely not that it’s cheap and will make Rev’s pick up any income so it’s not something that I’m going to go to the stake to defend.

: [00:08:13] But it’s a you know tough market I think it’s not a bad option but this is definitely an interesting one for me because I assume Micron Technologies headquarters every day I would do this and it’s something Emilyan to me because it was a still important and most Scearce DRAM and NAND which is the storage flash drives.

: [00:08:37] What concerns me and I think I you know why did it go there are really only I was going to be why Google are varying year over year. And the reason being that Bronco is 64 percent of their revenue roughly is from DRAM which is basically an aquarium product is selling to folks like endo and R-squared I think the buyer is huge like are there only a few. And for me do we think in the near term and long term I don’t know how to see the stock. I think you’re looking at a valuation in the market that I see it as it is yet to be seen whether they’ll be able to capture meaningful market share in that storage market. So that’s a bet that they are making because DRAM is a commodity business and recently announced a 1 5 billion dollar investment in building the old lady or memory years and Daxter. How is that dependent on these big guys are having major Urbino up their revenue. And of course it will be.

: [00:09:49] I think that’s all dead right. And I agree with you 100 percent. And I think if this was something that was trading close to fair value and I had to take a view on the business then I’d probably pass. But I do think that a lot of that is already discounted in the valuation. So I think you’re sort of getting paid at this point. You know you get a pretty strong balance sheet. It’s got lots of free cash flow. Not paying very much for it’s a cyclical peak and at some stage it’s going to be a retrenchment in the valuations and it’s going to be a retrenchment in the business that’s getting done and that’s a real risk.

: [00:10:23] But I’ve been saying that for close to six years now and I haven’t seen any of that say if you’re continue in hold what would it take for you to change your mind would it be a specific price action that passes through a certain level.

: [00:10:34] Or I’m just kind of curious how you think through that.

: [00:10:38] I mean as a general statement I always look at my opportunity set and where a particular stock is in my opportunity set. So micron is one of those stocks that is often in the screen just because it tends to trade at about the same multiple regardless of what the earnings are doing but it did disappear like the last 12 months. It sort of disappeared and it’s come back into the screening and so I know it pretty well I’ve seen it regularly over the last sort of 10 years and it’s worked for me when it’s been cheap on this multiple and I’ve bought it and then sort of just rolled out of it 12 months later as the long term capital gains taxes become available. So I bought October 2015 and then would have sold like 2016 or maybe early 2017 to push the tax and it’s back again. So it’s a different proposition when it was trading at fifteen dollars it at sort of three times as much. It’s much more difficult stock to on but it’s not an easy market to find opportunities.

: [00:11:33] So I’ll try to make this question slightly more generic. So we don’t all just peachy on this topic.

: [00:11:42] Whenever I look at the over the past 10 years and I can see and say for instance 2008 2009 he was like two very rough years then you have two years of was a lot better followed by 2012 2013. There was then again bad or 10 15 year old again 16 bad. And now looks like it’s been a good cycle. She also said before so I guess that continuation of the debate that we had with the group here more just in general how do you work with. With stocks and not just in terms of pricing and finding the fair value. I would assume that you can push the capital gains tax to get a lower rate for most stocks because after all the cycles are at least a few years. So which indicators do you look for I guess to figure out where you are in this cycle in which exit and enter and perhaps not just about what the operating margin do you have other indicators that might be more industry specific.

: [00:12:42] Yeah I think so that’s a really good question. Very very hard to do. I think if you look at any stage over the last. After the 2000 no bottom in the first quarter of 2009 at any stage over the last eight years or nine years you would have thought looking at Micron that it was probably overdue for that downswing in the cycle that’s had a few bumps but it’s never had that really long swing. And I think that that’s why it’s continued to trade at a fairly low multiple because there has been that expectation that it’s going to pull back and it hasn’t happened so far. Like I said it’s not my favorite pick and I do feel like it’s 3 a.m. in the Casina and someone from the tribal

: [00:13:28] Effort. What does that mean.

: [00:13:32] So are we being up so much Toby that you had to almost go bagging your stock pick.

: [00:13:37] I’m not going back on it but I will say this this is no. This is not a. I still like AIG and I still like Gilliatt. And if this works out then I’m going to pretend like I knew it was always going to work out.

: [00:13:47] If it does happen I’m going to say I hedged it pretty well on that call that I give you the verbal hedge.

: [00:13:55] All right Horrie let’s go ahead and hear your pick.

: [00:13:58] My big is Fairfax India. It’s not Fairfax Financial. The mother company based out of Toronto a lower rate and what recently started a couple of years back it created a subsidiary called Fairfax India India. As you know it is growing at a rate of 6 or 7 percent. The government doesn’t do anything. It also has huge runways like a couple of numbers I would throw out. Of course we all know about India’s population of one point two billion. Huge population of people below 30 and also in terms of penetration. So a couple of things to keep in mind though market penetration in India is 7 to 8 percent of GDP which is one of the lowest it’s even lower than Ukraine.

: [00:14:47] And insurance is three point two percent penetration. All this kind of screams opportunity as the current Garmon led by ensuring that Modi is probusiness and progressive and is bringing into effect a lot of laws that are bringing India closer to many of the developed economies. Example. We all know how hard it would be modernisation and GST which is global as every sector made in this Oxygen’s. But what we have not heard about is bankruptcy protection law which was not there in India for a very long time. They’re also working on clearing up debts in the banks and they have a huge focus on infrastructure. The ministry focused on infrastructure.

: [00:15:36] Now all these years in fact India ample opportunity to invest and done very well in the past couple of years of their operation. Some of the numbers I was looking at it started in 2015 with the net total asset of close to 1 billion and that’s the capital there is initially and they have to go and do some Barmes as well as raise additional ones. We equally shouldn’t because there are so many opportunities and delayed their total net assets stands at 2 1 5 billion their income or revenue view by 96 percent in 2016 and then 72 percent in 2017. So from 65 million to date is around or 80 million and net earnings also grew between 100 to 50 percent. So this started with the 40 million of net openings that 364 million in net earnings one of the interesting things for folks in the U.S. and for non Indian citizens is it’s really hard to invest in Indian market. There are some restrictions for non citizens investing in India. And Fairfax is a great opportunity for those who are Indian citizens because not only do they buy public companies in India. It’s that wording company but they are able to buy private it’s in India. It’s really hard to gauge their value but it is fair to say that there is much higher than and in dollars that we see today because of this issue of private investments or a few interesting facts about the Bangor International Airport is that it took a real person’s day initially put 85 million dollars in early 2017.

: [00:17:35] But then they went ahead and bought 10 percent extra stake and bid one hundred and twenty five dollars of that in the next round. And that shows the increase in the value and that’s typical in India where land prices are increasing and a healthy rate especially the Byler International Airport is interesting investment because it’s pretty much a monopoly. One of the fastest growing airports in terms of traffic and it’s the third busiest airport in India or Bombay and Delhi. Similarly they have made investments in other companies which are either into speciality chemicals are into financial services. And I suspect that they might make some investments in insurance as well because that’s a growing industry and I know that even Berkshire Hathaway didn’t change Berkshire Hathaway insurance is also very active in India. I don’t know whether they have made significant investments but I do know that they are interested in India as its a growth market. So all this makes me interested in Fairfax in terms of long term only to date selling at around 17 dollars. The stock phrases that are sounding below 6 7 and its value on the balance sheet is 10 to 11 dollars which I suspect is less than the actual value because of their private holdings.

: [00:19:03] I just want to quickly say that the ticker here in the US for buying this is f f x d f anyone wants to know and this is an over the counter traded equity position and something else that I wanted to point out Horrie is it seems like they got a decent letter to shareholders here a PTF we’ll have a link to that in the show notes for people to go through because I think this is a really interesting pick and this is much different than something that we typically talk about on the show.

: [00:19:30] My immediate thought when you started talking about this I was really interested in more the managers the people that are running this company what’s the story on them. Do you know anything about them.

: [00:19:41] Good point. Actually it is one negat do over nothing to do with something that we should keep in mind when we are interesting as braless obviously as in war. However a management team running in India the main guy is Harsha or other one who has a very good track record in India where there is a management fee here. So that’s an interesting twist to this company. So it is a management fee of 3 percent a bull 5 percent turnover rate. That goes back to the parent company which is Fairfax Malinche.

: [00:20:14] So what do they get back Kerry. And I know it’s owned by Fairfax Financial Holdings but the facility in Ain thing in terms of finance operational or is there any kind of value that’s flowing back to the subsidiary and how does this influence me as a shareholder.

: [00:20:29] It really offends me as a shareholder in terms of my next earnings because the earnings is actually going to Fairfax Financial.

: [00:20:39] Yes. So in this situation when I look at the latest interim report there’s a performance for you for the first nine months of 2017 of 84 million dollars that basically comes from them or perform the Moghaddam then sending the transfer back to the parent company. Is that correct. Yes that’s correct.

: [00:20:55] Ok.

: [00:20:56] It’s really interesting because it’s almost like it’s a private equity relationship with like general partners and limited partners but yet it’s it’s kind of confusing to me to be honest with you the way that everything is structured Toby or you understand all that is it seems really confusing to me when I when I look at investment companies usually what I like to do is to buy investment companies at a discount to tangible book say FX tangible book is Ten dollars 50 and the stock closed today at seventeen dollars 86. And the reason that you want to buy them at a discount to the tangible book in the ordinary course is because you have to pay that fee you’re paying some fee for the management of the fund and it’s reasonably fast in this case 20 percent over 5 percent hurdle. The reason that you might want to pay a premium so the premium here is that 30 percent something like that is because you’ve really loved the manager and there’s no other way to get in with the manager and the manager that you would have in this instance is Prem Watsa who I think promotes one of the best investors out there.

: [00:22:00] I love what he does. I think he’s been one of the guys as you know correctly hedged into the 2000 a drawdown so he made little Evanne and he’s been very careful for this whole process for me personally if I was going to invest in something like this. I would want to be closer to Primm and the other investors so I would want to be in a Fairfax parent company. You’re getting into your exposure one step removed from Prem at 30 percent premium to tangible book where there’s going to be a carry going back. So you’re really betting on prem getting it right and making a lot of money consistently over the long term which he has been able to do it. But I kind of think that it is. It’s not asymmetric which is what I kind of look for so I think that this is definitely something that I would invest in at a discount to the tangible book so I’m going to stick it in my watch screen and if it goes below a certain TL’s 50 I’ll take a swing at it.

: [00:22:55] But you’d never get access to this guy on a GP level right.

: [00:22:59] Well you can invest in Fairfax. Yeah Fairfax the holding company you can invest in that and you can invest in that.

: [00:23:05] You’re paying a premium right now so you can get it without the Kerry Hardy whenever I saw this pic I was really impressed and I read through the shareholder letter and for me that just speaks the world about the company and it’s one of those where you just even though if you just skim through it you can really get a feel of whether or not they understand what they’re talking about and you might be like well sure. I mean they’re the management by womanist on them or they’re talking about just the way they talk about capital allocation. I think most people would be surprised how capital allocators sometimes at least on paper talk about allocating the capital and whenever you see the outline that they have I was very much minced. There are a few things that I don’t like it definite don’t like the performance fee and for instance when I look here at the consolidated statement the earnings and I talked about the 84 million before the first nine months of 2017. So the net earnings for income taxes after this is deducted would be 360 1 million. So I mean it’s definitely significant. Once you keep in mind that whenever you look at something like this you have your net realized gains and the investments that wildly fluctuate. It’s just another common tool. Also what you’re talking about before Horrie really depends on you know when the selling and a company can look a lot more profitable whenever they sell and investment has done well and so tell you what it does whenever I bring these numbers up but it seems to be a very high tax that is almost sure to be paid.

: [00:24:30] I know even though it’s above a 5 percent threshold for access to private companies then yeah I mean stick to it mostly offers marketshare and I think it isn’t going up and wanted it to this. You can look at it as a cheap general richer that you’re getting access to the selling points here is access to India and as we mentioned access to Graeme in a way and find the room has a lot of connections in context in India he really knows what he’s doing and the fact that in India I reach mutual fund groups anywhere between 14 to 16 percent. That’s going up an average mujer one and the good mutual funds are growing close to 19 20 22 percent. So that shows the growth potential in India. So I expect that you will not refuse the management fees this stock will do well in the long run assuming that it has the same kind of culture and DNA that WhatsApp brings in and Fairfax Financial. But I also get gobies mind about being careful about buying it at the right price closer to the book.

: [00:25:46] So Hari and this is I think this is just a related question to the companies that you talked about and that’s very interesting because if you look at how the public companies are priced right now India is pretty expensive if you just look like across the board do you have any other verticals if you want to find the right man to invest in private companies.

: [00:26:07] It’s really hard to say investing in private companies. I’m not sure if there are too many of them. There might be some and I’m sure there will be more coming up. There are a lot of investors in the U.S. are leading companies in the U.S. including Berkshire Hathaway or interested in India. So yes opportunities might be available through other Wilco’s as well. But this is one of those Didact that the Coast which is August. I need you.

: [00:26:36] There you go. So go ahead and fire away your pick.

: [00:26:39] All right guys so my pick is air cap holdings and the stock ticker is R and Hebb holdings. The business is to buy lots of commercial airplanes and lease them out to airlines. Right now they have a very diversified portfolio more than 200 customers and 80 countries. A lot of exposure in emerging markets too and it’s one of the world’s largest aircraft leasing companies. It is actually largest independent one. They are more than a thousand aircrafts full disclosure already bought the stock. It was a very significant position. Whenever I look at the industry and the business model you know it’s more or less a spread business. So they ensure financing as they would actually go ahead and buy the plane. They were typically Board rates around 3 to 4 percent depending on the maturity. And then they will lease it out. And right now they have a healthy spread around 9 percent which I found very attractive. So they have these buy in bulk deals with boring and air bus and was also one of the reasons why they can get a discount but it’s more the financing really more than anything. This is also a good deal for the airlines. The lease is responsible for the maintenance and service of the plane and obviously the yield.

: [00:27:56] But they also take the risk of the residual value of the plane. The company is very efficient and kivas fleet leased. Basically won’t go ahead and buy an airplane before they already know that they can sit out it’s Everest at 19 ipen for the latest quarter. And if you look at the competitors US the largest one would be G.E. Capital Aviation Services is approximately twice as big but it’s not an independent company. Most of the competitors are trading at a higher IP ratio. I think the valuation that we’ll get to later would be very interesting for this company. So whenever I look at how the company has issued cheapass and bought back yes it kind of looks like it’s been all over the place. Definite encourage everyone to read through some of the statements where the CEO talks about how he is evaluating whether or not he should buy small planes he should buy back stock and devalue his stock and that’s I think just that you have a CEO talking about the value of his stock like caps like had asked a lot of value to. Now if you look at the free cash flow it looks absolutely horrible.

: [00:29:09] First of all those like all over the place and it looks like the earnings that you see it doesn’t come out in terms of cash flow to the investors. Now this is really an accounting thing the way that you often see this calculate is that you have the operating cash flow was basically the cash flow that you make from the company’s core business. And then you take out the CapEx now for a company like Eric have that would typically mean that you have a negative cash flow because you will be buying a lot of airplanes. Whereas for you selling those airplanes by whenever it’s probably appreciated that won’t be included in that number so if you actually do the math on that you are closer to a free cash flow of around 1 billion dollars. If I look at devaluations just in terms of putting in the numbers I assumed around 800 million of free cash flow was just I don’t think it’s on the generous side. The 3 percent growth. Most likely and have a band of 6 percent and a flat as much lower band for 25 and 25 percent respectively. I end up around 9 kind 5 percent at the current price.

: [00:30:19] Sorry for the lengthy pitch please feel free to shoot. So still my biggest concern whenever I saw this was exactly your last point there was the free cash flow the cap ex on this. So whenever I look at the company and you’re looking at the revenue has just been going wild for the last 10 years it’s just been going straight up. But what I found really interesting was just in the last year you actually saw the revenue contract by 100 million dollars ish somewhere around there. So it’s flat it’s been flat. And when you look at the last year the TTM on this it’s still flat. So I guess my concern at this point it seems like they have stopped buying new aircraft and I haven’t dug into this nearly at the level that you have.

: [00:31:04] But it seems like they’ve stopped buying nuke aircraft back in 2015 their cap ex continues to press higher and higher. And whenever I think airplane business I think a lot of cap ex and the sustainment of that fleet that they’re doing this is very expensive stuff that they’re managing here so I would expect the cap ex to be continue to be pretty high. And I think that that’s where when we’re looking at all the cap ex that they spend over the last 10 years it makes sense to see their revenue keep going like it was because they’re just buying so many new aircraft and it’s just adding to the fleet and the revenues going up. What does that CapEx look like moving into the next 10 years assuming that the fleet stays flat and they’re not adding to the fleet and they’re going to make their revenue fairly flat assuming they’re not going to continue to add to the fleet when we do that. What does the free cash flow look like. You said you think it’s 800 million is that what you said you think the free cash flow comes to.

: [00:31:59] Yeah. And that might even be like on the more conservative side. I don’t know. I mean if you look at the past three years and you also include the proceeds from sales and disposal of assets. You know you get 2 billion one point six billion point five billion. And if you look at the trailing 12 month you should just go into any service you would say it negative more than a billion dollars. So it’s really important to get through the cash flow statements and I really think it’s interesting what you said about revenue and how they look at the cap. So one of the thing is that they would buy your craft and that would be reflected as you know Catholic’s the maintenance whenever they lease it out that will go to Delisi so they won’t carry that. And the other thing is whenever you read through the latest earnings call that the CEO would say that right now he’s not looking to buy more aircrafts because it’s been more competitive. So these won’t be as aggressive policies because it took on some debt both to shareholders if you like by issuing more stock but also in general after the huge acquisition a few years back. So they got to spend some time paying some of that back. And also you find that the stock price is very interesting right now in terms of repurchasing stock and tracking what has happened over the past few years has definitely been true to his word close to a 10 percent buy back despite the investments he made.

: [00:33:23] So like when I’m looking at the casual statement I’m looking at the depreciation. To me it seems like maybe they’re depreciations about 2 billion a year on the fleet would you say that that’s an accurate number. Just so we can kind of then look at whatever their operating income is and then subtract that out.

: [00:33:38] That’s probably true I’m looking here at things the latest 10K I’m looking at here I looking at Morningstar.

: [00:33:45] Yeah I mean I’m ballpark in the numbers here. But I think that you’re 500 to 800 million in free cash flow estimate. Moving forward would probably be pretty accurate. I definitely did not dig into this at the level that you did. I’m curious Tobey would you agree with that conversation we just had our use of looking at the cap ex kind of being the main concern and what that steady state looks like moving forward.

: [00:34:07] I’ll tell you what my main concern with these sort of businesses is these things carry enormous amounts of leverage on not a great deal of equity. And then you have it in an industry that’s pretty cyclical to stick get the baseball bat industry. But my cyclical industry is cyclical and this industry and it doesn’t have to be vigilant. It’s one of those things. Have you looked at this through a period like a recession like two thousand seven on and seen what does the free cash flow look like. What are the customers doing that period of labor to keep on making the time on the leases today. Does it survive through that period.

: [00:34:53] Yeah. So for instance if you look back in 20 0 8 like the worst year they had it was ninety seven point seven there was still a profitable year and I have like one thing I would like to add to all the batting that we did before Toby this is the Hughes position and David Einhorn’s full use is 10 percent which is also one of the reasons why it came on my radar and more recently Monas pop Rye has bought a lot of this company over the past few quarters. Right now it’s Monoprice third biggest holding in the U.S.. So you know he might rather be invested in India as you talked about before. I think it’s it’s definitely stuck with paying attention to.

: [00:35:35] I really like Tobi’s concern here. When we go back and let’s look at 2007 2008 they were doing about one point one one point two billion for their top line. And as soon as the recession hit that got cut in half. So their top line went 50 percent of what it was whenever they went into recession if that would happen today. As I think through this company back then they were one fifth the size of the fleet that they’ve got today. And so now that they’re five times bigger how much more is that going to impact a larger company that’s leasing aircraft.

: [00:36:08] Is it going to be 50 percent is it going to be great or is it going to be less. I don’t know what that is but I think that that’s a really important concern because if we take that revenue down from five let’s just say it’s 50 percent like it was during the last recession and you go from 5 billion down to two and a half billion. And we already said that we think that their depreciation alone is going to be 2 billion before operating expenses and things like that. I think you really get into an interesting dynamic where this thing could be I mean what company wouldn’t be impacted with the recession bit. I don’t know about this one I guess I’m not as excited about it as you are.

: [00:36:43] Yeah I think you and Toby bring us in great concerns and I mean if I look at how the revenue has been developing. You’re right. I mean it’s it’s a rough drop it’s not so that if we had that revenue that you would you would just have the same expenses and just would just be flat. So if you look at the worst year in terms of efficiency it was ninety seven point seven percent. That was by 2008 when it dropped. And of course like since these lease agreements if they should default on the payments they will get the plane back and then could be sold off which is a natural part of the business. But you’re right I mean in terms of recession the price won’t be attractive as it would be today.

: [00:37:26] I was just going to say in support of you. If the company can maintain its current growth rate and I can keep on doing what it’s been doing I think it’s very very cheap on a discounted cash flow basis. Do you think you’re getting enough of a discount that it is well worth taking a swing at with a small position so I think you know if it keeps on doing what it’s been doing it’s worth like a hundred and twenty bucks to a hundred and fifty bucks and it’s trading at 53 dollars. That’s enough of a discount that I would be prepared to take a swing at something like this even. Having said all that other stuff but I do think that you’re risking something like this is close to zero. So you need to sause it like it’s money that you can lose.

: [00:38:04] But it’s not going to be I mean up until 2015 it was that since 2015. It’s not growing.

: [00:38:12] It’s going to slaughter around it’s going to be every year it’s going to cycle you know a few years ago my screens are filled up with the airlines and I was worried at that stage that airlines had one of those cyclical stocks that you look at the peak of the cycle and they look cheaper at the peak and they do at the trough and I’ve got Warren Buffett’s words ringing in my mind. He’s always nervous about airlines. Now this isn’t an airline this is a leasing company so it’s one step further removed it’s much closer to the end of the tail because it’s selling to the airlines. But I they think that it’s enough of a discount on a DCF basis that it is worth taking a really close look at it. It’s interesting it’s just that you need to size this position correctly all right guys.

: [00:38:51] That was all I had for Aer Preston. You know of all the stock picks that we had here in the group I think look forward to yours the most definite the one that was most out there. And I’m saying this as was my cell saying it’s a bad stock. I just really did not expect that expression from you and I guess not from anyone here on in the group so please let us know what is your pick. What do you want to talk about today.

: [00:39:18] All right so let me start off by saying I do not own this but I find it really just an interesting discussion. And I look forward to seeing more of this in the future. So the stock ticker for the one that I’ve got is a I E Q And this is an AI Artificial Intelligence powered ETF and this is a Silicon Valley company that has made this if you just type in a week you into Google it will be the first thing we’ll have it in the show notes if you guys want to go to the home page for the people that created this thing. But every stock pick in this portfolio is being picked by a deep mind neural network machine learning algorithm and they USDAW Watson worthy programming on this and you just said it loose. And this thing started trading on the 18th of October and since its inception in the October timeframe it’s done 9 percent since its inception. And to give people an idea of where that’s out in the grand scheme of things the S&P 500 is done touched 10 percent since that point in time.

: [00:40:31] So it’s trailing the S&P 500 by 1 percent. So it’s in the red as far as I’m concerned underperforming the S&P 500 so far. But let me just say that basically the first three weeks that this thing went on the market it got punished absolutely punished like it just underperformed the S&P 500 every single day almost for the first three weeks and then it was like out of nowhere this thing started taking off. So if you look at it after that first three week period it has done fourteen point six percent when the S&P 500 is done 11 percent. So it’s outperforming after that punishment period and when you look at the price chart on this for that first three weeks I mean it was just like straight down like a straight line down. And then out of nowhere it just started taking off which is kind of interesting as far as I’m concerned.

: [00:41:24] So what I really like about this is when you go to the page with that company has the information about it every day they publish the holdings that the algorithm the AI bot is picking and it’s only equities long equities. From what I understand it doesn’t go short. So it’s only buying long equities and it’s buying anything that it can find in the U.S. stock market and it has a cap of it can only hold 70 pic’s maximum. And I think on the minimum side I might be saying this wrong but I want to say it was 30 or 40 picks on the minimum side. So this is what’s awesome is so you can peek in there and you can see exactly what this thing is holding on any given day and it can pump it out actually into an excel document right off of their web page.

: [00:42:12] And what I found fascinating about this is the number one pick out of every stock that this thing could pick in the U.S. it’s number one top holding is Amazon at four point one one percent. The number two pick that this algorithm this computer has picked is Google at three point six five percent. When you go through and you look at some of the other picks the thing that I was so like whenever I saw that I was like OK so those are like strong momentum picks. So I was like maybe this thing is just you and straight momentum. But then whenever I scrolled down and I looked at some of the other picks and side of the portfolio. Believe it or not it owned GameStop as one of its top 70 holdings and right now it has 70 holdings in it. So this thing is it has purchased GameStop which we all know is definitely not a momentum pick. If anything that’s an anti momentum pick because that thing just keeps going down. It’s coming up in this filter once again with this iPod which I just found fascinating. Now let me just say when I first started looking at this probably a week or two weeks ago GameStop was much higher in its holdings. I think it was holding about a percent of Gamestop and now a week or two later Gamestop is now in its sixty ninth holding position at point two five percent.

: [00:43:35] So it’s been selling its GameStop position because I think it found out that it was catching a falling knife like everyone else who’s purchased GameStop in the last year. But I found that interesting so what’s really cool about this is I don’t think it has a preference to the momentum or a value but I see some of the picks in here kind of resemble both strategies which is fascinating. So the reason I bring this up isn’t necessarily because I’m telling people to buy this because this thing has a track record of about two seconds. But I think it’s kind of a neat tool to just peek in there and see what the heck it’s holding and maybe why it’s holding what it’s got. One other highlight before we throw it out to the group to kind of hear your thoughts on this is when I scroll through some of the holdings I see some various financial companies in here as well. And when you think about holding financial companies right now with interest rates going up that would be a smart decision. So I have no idea when you read some of the information on the site. I guess it’s even taking social media accounts in its data points. There is so many things it’s reading all the 10 ks the 10 Qs it’s looking at all the financial data it’s taking in news stories it’s taking in social media feeds. I mean this is crazy.

: [00:44:55] It’s this year that every day process has more than 1 million filings news articles and social media posts. I mean obviously they’re not telling us how they’re processing it obviously that will be their IP but I think it’s very very interesting how much of the turnover been press like how many times they’re just replacing holdings.

: [00:45:13] You know I haven’t tracked that I’ve peaked in at a couple of different companies and I haven’t seen those companies fall out of the mix in the two three weeks that I’ve been looking at this. Now I mentioned Amazon and alphabet being their top two holdings number 15 is Facebook. They have two point three 8 percent of the portfolio is Facebook. Now the one that I found fascinating that’s not on here is Apple. It’s not holding Apple so isn’t that like for me like I’m just like wow that’s pretty interesting especially with all the news that came out that the iPhone 10 sales have been lackluster and everything else this thing has not. It’s not holding Apple but it’s holding the other three big companies Facebook Amazon and Google. So GameStop and GameStop that it’s a company it’s got a board meeting like a rite of passage for every value investor to come in and you buy a little bit of them stock and you lose some money and you get a little bit smarter.

: [00:46:15] So I just say welcome to the market.

: [00:46:20] So Ari I’m curious to hear your thoughts. Is this something that you’ve heard about out there in the valley.

: [00:46:25] Because this is from Silicon Valley or some other which is there is like it’s exclusive sure is 75 or sensors it’s not cheap. Yeah. And the other thing is it would be interesting to see how different it’s ordering there. So indeed compared to what’s the difference. And then finally I’m asking you about that you found your money in between Dhobi and this. Which one would you choose and which one would you sleep peacefully. Considering Toby hedges my money’s on Toby because what I like about it is that you understand what’s going on behind you can kind of reverse engineer that a lot of them maybe you wonder how they are placing bets.

: [00:47:17] I should say I thought the idea of a quantitative machine learning approach to the market this thing is probably being trained on the value and momentum data which is why you’re going to see those value and momentum picks because those are traditionally the two best risk adjusted methods most robust over the very long term and doing those two things together is going to give it a very interesting return profile. I was totally kidding before about the Gimi. The GameStop line I’m being rude that somebody is going to get GameStop right. And buy that at the wrong time and make some money out of them. And I say that because I’ve done that in lots of different stocks where I had to buy them you know sort of three or five years before I actually found them but they did eventually get that and I probably lost money on balance over them over the whole period. But that’s what as a value investor you kind of have to buy those off the wrong the ugly things where everybody says you’re an idiot when you buy them and then they go down and you’re proven to be an idiot because enough of the time you buy them and everybody says you’re an idiot and they go up so much that then you get to turn around and say you’re wrong. And that one made money. And on balance that’s basically have value works you get to buy these things even though they are falling knobs. Now the fact Watson is there for me that says that’s pretty much a marketing gimmick. And the ticker. I E. Q That’s a mocking me. But that’s OK. That’s part of what business is marketing. But I do think it will probably work. The track record is far too short to say one when. If I look at my value momentum screen and I look at the way that it performed it’s roughly the same thing. It’s up about signing on and it was down about the same amount for that period.

: [00:48:57] So that’s what I would guess that doing volume momentum some 75 a pretty good bet so Preston whenever I did my research I couldn’t see any kind of backtesting at the about the performance of this algorithm in the past and no it’s always improving but the like provided any kind of stats like if you invest this to the eBid or or whatever that would be.

: [00:49:20] So you know my dad and I got in a little bit of discussion about that exact comment. And you know I told him I said I’m sure that they loaded up all the historical data going back 100 years whenever they were developing the base algorithm for this thing. And my dad said No I think it’s just the last 10 years and I said there’s no way that somebody out of the valley would just use the last 10 years. I went in and read the prospectus on this. And in the prospectus it says that the information are basically the way that it’s making decisions is only using data off of the last 10 years. My opinion is that they did up a bunch of backtesting basically loaded the algorithm in there based off of 100 years of backtesting information and data and everything else that they would have fed it. But then once they let it loose here on the 18th of October I think that it’s only polling information for the last 10 years for the pics that it’s assessing today based on the what I read in the prospectus.

: [00:50:21] One thing I would say about this. The good point in time backtesting data goes back to 1963. Every single quantitative system in the world is trained on the same data. There’s a group called Euclidian who did the backtesting for my most recent book The acquires multiple. And I have written this great paper which I’ll give you the link to it so you can stick it in the show notes with I looked at using I trained on that same data to see what it would come up with. Basically what they found was that humans have used this data so much that so much data mining going on already that I can’t really find anything new. It’s not really in the data. And I’ve spoken to guys like Peter Shaughnessy I know you’ve had on the show before you know one of the original corn chips have been doing it for a long time. They got a couple hundred supersmart here. Isn’t that we were grinding on this data all the time. There’s not much left that anybody else can kind of dig out of this stuff. It is possible it is going to do something like if you’ve seen that documentary on go. Yes I kind of comes up with this. You know this move that causes the guys who are experts in this to say you know humans have been playing this game for thousand years and it turns out we didn’t really even know how to play the game because the EU is doing something completely different. It is entirely possible that that happens and this thing does figure something out. So far humans have gone over the data with such a fun time that I don’t think that I find anything new. But it’s a very very short time period we weren’t really known for probably 10 or 20 years who’s doing better.

: [00:51:51] You know my frustration with this specific ETF and I’m looking to see if they have other opportunities out there that do hedging and I’m just kind of surprised that that the first thing that they launched is just a straight long. Maybe that’s a marketing thing so that they can get this out there maybe not have too many products Bonnell everybody into this and if it outperforms the S&P in the first year then they can roll out other products that are completely hedged. Would you think that that’s probably why they went about this the way that they did and it’s only a long strategy.

: [00:52:20] Toby hard to say why they would do that. I personally would not launch a long Onley strategy into this market. You want to launch along on the strategy in 2000 and 9 or 10 and 2007.

: [00:52:34] And yet you know whatever Preston said this and I looked it up. And as Howard said the expense ratio was three quarter percent. I thought this is a pretty smart move because this is a guy so they really don’t have to tell anyone or convince investors what they do because they can just say it’s a dime. We all love that and they don’t need to disclose it and then you would just like administrate a lot of money and get a lot of these. That would make a lot of sense. I think one of the things that would really like to see for any ETF or any kind of Kwon’s strategy is really to say these are the historical results. Obviously the my Chinn’s these the arguments why we think you’ll continue working. I think it sounds amazing when I read that they had a million pieces of information terms of every day in filings and social media posts and whatnot. I think we can all see why move the markets if not social media post then new filings. But if that’s the argument can’t be more detail that I guess I’m more skeptical.

: [00:53:34] I think you are onto something because that’s what this data or information is what made money librarians billion billionaires. So I think the problem with this fund is that investing Locksley how they look at you. But it’s all of what we gather data. So one other thing I want to say is if they want to make it more appealing to the market desperately needs Silicon Valley they should don’t say that this is the best idea works.

: [00:54:06] Jane you’re right they did miss an angle there.

: [00:54:13] Hey I you know I disagree with you on on your other point not the block chain point I think you’re exactly on par there with that. Maybe not today but about a month ago that would’ve worked really well. But I don’t know I disagree with you. I think that this thing’s ability to look at all the data points and then come up with the correlations of all those various data points is something we have never seen before in history and I think all my personal opinion is that Moffett’s quote about the librarian thing is actually going to go up in smoke and I think people are actually going to see that in the coming 10 years. I think that there is a lot of power come in with some of this stuff and I think that this is just the tip of the iceberg of what we’re going to be seeing moving into the next credit cycle.

: [00:54:55] The reason why quant works is it doesn’t panic at the bottom.

: [00:54:58] Well and this is the other thing like if you were going to say that the data points are you know everyone would be a librarian kind of argument and then you go back to Tobys point of the game of Go. It doesn’t hold up. It just doesn’t hold up. I mean watching that video and we’re going to put this in the Schoenaerts if you guys don’t know what we’re talking about here with this game of Go in artificial intelligence you’ve got to watch this. This is mind blowing in my opinion and my expectation honestly is that I think in a year from now if we look at this ETF I think it’s going to outperform the S&P 500.

: [00:55:32] I really used to short used to short a period of time value and momentum can underperform for long periods of time.

: [00:55:36] I would say you need to give it probably 3 5 10 years to really work out. Going on but I’m with you.

: [00:55:43] I agree you agree with me Toby. Yes well let me let’s let’s go around the table statistic.

: [00:55:49] What do you think and Horrie what do you think. What’s your gut tell you.

: [00:55:52] Please go first. Hi decided. He doesn’t seem convinced.

: [00:55:57] Yes especially about e-mail. Oh yeah I heard it. You’ve been mined in machine learning game for chess.

: [00:56:08] What happened to just. Game. Was that a number of backgrounds or was it increased. Well it is. George Soros says markets are gods theory of reflexivity the observer is the opposite of me and in Gears of chess or any other you know there you don’t have the Zahri interacting and doing something back it’s not a complex system.

: [00:56:36] So you and I work any role in those scenarios. But when it comes to a complex system like market it’s different than it was in water. Its economy is a complex system. Stock markets are a complex system. That’s that I’m not totally convinced. I’ve heard the argument that you just feed data into the system and you are sure that this will outperform the market. And as we said I think we have to wait and watch. I’m not saying that it will not do.

: [00:57:06] But I feel we should hold back or is the guy in Silicon Valley looking at all the bilingual and sticky tape holding together all the computers from the back end. So it really is.

: [00:57:18] No and I think that that’s what’s that’s what’s so surprising for me is Hauri is the guy who’s saying that it’s not that I mean he’s closest to this stuff way closer than any of us so that’s really surprising to me. Stig Toby I’ve got a question for you on this.

: [00:57:33] When we look at the way that this opened up on the 18th of October there was a huge spike in the reason I’m asking you is because I know you’ve launched ETF so you understand the mechanics of how these work. There was a huge spike in the price where it jumped 3 percent in the first three days and it just looks like because it was getting so much publicity on CNBC or whatever these guys were all in the news and everything everyone’s buying this thing and then you saw like a really strong correction for the coming two weeks or whatever. Two and a half weeks is that a function of basically the bot receiving all of this money and having to make a position as it’s receiving all these funds early on that it basically had to take a position it was like it had a gun to its head to take a position in a very short amount of time which wasn’t necessarily advantageous for it and then had to recalculate and basically reboot the weeks after that. Would you think that that is maybe why it’s so bad out of the gate.

: [00:58:32] No I don’t think there’s enough. It’s not big enough to impact the market in these stocks.

: [00:58:38] That’s not where I’m going with it. I’m saying think of it like this like if I gave you a million bucks today there’s positions that you are eyeing that are at the right timing for you to kind of step into it. And then there’s other ones that you wait to maybe take a position. You wouldn’t do it all in the very first day but it seems like this thing was forced to take 40 positions on the very first day. Do you think that that could have impacted the way that it performed.

: [00:59:02] These things are built to always be able to buy a portfolio I can buy a portfolio tomorrow morning I can buy one at midday I can buy one at the close. You know the systems are built to buy portfolios all the time and to manage the portfolio. So it’s just that’s just random chance it comes in sometimes sometimes the market is volatile just like the market has to go back very quickly to something that Harry was saying before. It’s interesting you know you say chase and go a closed systems and the market is an open complex system when you look at the back testing which these things have fed. I think that the market actually looks like a closed system to these things and that’s why I say everybody in the world Actis the same data from start to 1963 in the U.S.. It’s an idiosyncratic market. Everybody’s getting the same results value with momentum. It’s possible that gold and chips have more positions available to them than these things. Looking at those limited data sets. You know that’s a concern of mine. It’s like an existential question that I’m always worried about. Does the data set that on looking at training systems on flicked what we’re going to confront in the future. And the answer is probably not. And that’s a real concern for me. But the only advantage I think that I have is that when I look at our systems have been going back to 1963 because I’ve got that data back to 1963 if you’re just a stock picker and you’re in the market your experience is limited to the period of time that you are personally in the market. You can only learn over a fuel mileage you might have started in the early 2000s late 1990s and that’s an idiosyncratic period in the market. Would you be better off having and that act of 1963 is the artificial intelligence less useful because it’s got that long history that a human has a much shorter history and they can make decisions based on anything.

: [01:00:55] You know when you think about their perspective only going back 10 years to make the decisions that it’s making today you think that maybe that’s one of the reasons why they did it that way so they’re not so polarized by the way that everyone else in the markets making decisions that might be just the dice that they’re looking at data averages over ten years.

: [01:01:12] I’d be surprised if through on the going back 10 years I was I was blown away by that bit when I read it in the prospectus. I was I don’t know I was just surprised. I was like you I didn’t believe it.

: [01:01:24] All right guys. I think that concludes our first mice to my group meaning here in 2018. But before we let you guys go we would like to give you guys a handoff to the audience where they can learn more about you. Hari would you go first.

: [01:01:37] Same as the start.

: [01:01:39] All right.

: [01:01:41] We’ll have a link for them in the show notes how about utopia where can people find out more about acquires multiple dot com on Twitter at Greenback’s which has a funny spelling and you put it in a sentence.

: [01:01:52] Yep we’ll definitely do that Toby and you are way too modest author quite a few amazing books. So we’ve got to put a direct link to them in the show notes as well. But guys that was all impressed I had for this week’s episode of The estus podcast Seatle again next week.

Books and Resources Mentioned in this Podcast

Meet up with Preston, Stig and the TIP Community in Omaha for Berkshire Hathaway’s annual shareholder meeting:

Tobias Carlisle’s new book, The Acquirer’s Multiple – read reviews of this book

Tobias Carlisle’s Acquirer’s Multiple stock screener:

Tweet directly to Tobias Carlisle

Hari’s Blog:

Tweet directly to Hari

Deep Learning with Google’s Alpha Go