Stig Brodersen  1:31  

I love that you said that. And Toby, today we’re going to talk about the current market conditions. And we’re going to talk about which picks we can find that will perform well. Before we dig into your pick, what are your general thoughts on the stock market right now?

Tobias Carlisle  1:46  

Well, we’ve had roughly 18 months, two years of sort of volatility and bumping sideways. I think we’re up a little bit over that period of time, but I share Preston’s views and possibly yours as well. I don’t know if you’ve been quite as vocal as Preston has been about the overvaluation, but I think that the market is very overvalued. You can take any measure that you prefer to sort of look at that, but anything like Tobin’s Q, which looks at the replacement value of assets over the market value of assets, which is a measure of what’s the market paying for the assets versus what does it cost an entrepreneur to go and set those up on very long run measures. We can look at that metric going back to the, I think, sort of the mid 1950s sort of time period, or a little bit earlier than that. And that’s saying we’re at historic [numbers], 80% overvalued, which is extremely high. Second only to the dot-com bubble. 

And you get similar outcomes if you look at different things like the Shiller PE, which is a slightly different metric, but it looks at an inflation adjusted 10-year average of earnings. And so, where the first one looks at assets. The second one looks at earnings. [It] tells us a similar story, where you could look at Buffett’s preferred measure, which is total market capitalization to gross national product, again, is just looking at the size of the stock market in the economy. 

And that also sort of tells us that we’re overvalued to about the same scale, so there’s no question that we’re overvalued. The problem is that we have been variously very overvalued and closer to sort of average valuation since about 1996. So that’s just 24 or 25 years of overvaluation. And you could have done very well if you’d been invested in the stock market through that period. 

There have been two horrible crashes through that period, and there’s a chance we get a third horrible crash. That value is not a great way of determining what the stock market is going to do in the short term. [What’s] more [is that] it tells you what you can expect from your investments or from your equity investments over a sort of 10 or 20-year period. And what it’s telling us is that we don’t expect much from them or particularly US stock market assets at this point. The rest of the world is not as expensive, and I think we’re going to talk about that a little bit more as we go along.

Stig Brodersen  3:53  

Yes. We definitely will, Toby. And it’s very exciting to bring you on. You’ve talked about the current market conditions. And then, I also gave you the ungrateful job of coming up with a pick because how can you come up with a stock pick, whenever we talk about the stock market being so highly valued right now. But what you did was you came back to me with a short. Well played, Toby.

Tobias Carlisle  4:17  

Well, I run a fund. I run an ETF that is long-short, so I’m always thinking whether opportunities are likely to come from. And since I’ve been running, which is only three months old at this stage. Most of the money’s been made on the short side, funnily enough, because it’s been that kind of market. And that there are two reasons for that. One has been a little bit of market weakness, but the main one is that value has been particularly weak through that. We’ll talk about that in a little bit. But let’s just…let’s go to my pick. So I get nervous when I talk about something like this because this has been a widow maker trade for a long time. But if I look in my model, and it’s the number one thing in my model. And my model is pretty good at this stuff. I got to go with it. And it gives me no pleasure to say this, but it’s Netflix. N-F-L-X is the thing that I want to be short. 

Stig Brodersen  5:02  

You’re a courageous man, Toby.

Tobias Carlisle  5:03  

Or a silly man, yeah. It makes me nervous, frankly. But we put it on in late June. It’s worked for us since then. And I’ll tell you why we put it on there and why it’s still the number one short in my screen. And I’ve been talking about this a little bit, but you can look at Netflix on a valuation basis. And on any ratio or multiple, it’s extremely expensive. It’s like 100 times plus P/E; high 70s in terms of enterprise multiple; acquirer’s multiple. It’s extremely expensive. On that basis, the only way that this sort of makes sense as an investment on the long side is if it keeps growing at this very high rate, and that’s what you have to bet on. 

It’s already a very big company, and so it has to keep on growing at this very high rate. There are lots of things to like about Netflix. It’s got recurring subscription revenue, which is the holy grail of any business because subscription revenue, you basically know what’s coming in next month. You know what’s coming in the month after, so on the revenue side, this is a great business. And it costs them. The marginal consumer doesn’t cost them much at all. They’re virtually zero. 

The cost to Netflix is the content that it produces, so it has to go and buy these shows that it puts on. Content is becoming very, very expensive by historical standards. So you might hear all these stories about comedians getting gigantic paydays for their specials that they put on these shows. Movies come out, and they don’t actually make it to theaters. Netflix swoops in and buys them. And then, we don’t really know how successful or otherwise they are because Netflix doesn’t share those numbers. 

Basically, what Netflix has [is] the kind of business that Netflix is in is more like a movie studio now. In a sense, they have to produce this really great content. And that’s a really, really tough business to be in. If you pay up for what you think is a really great idea, and it doesn’t work out, then you’ve burnt a lot of money. And this is what happens to the movie studios. And this is why you see a lot of…here’s the 12th Marvel superhero type movie. Here’s a sequel. Here’s stuff that you’ve seen before. Here’s a remake of something that you saw 10 or 15 years ago because they know that there’s a market for it. People recognize the names. 

So, Disney has gone very good at figuring out what people like. So that’s why I say they got their Marvel there, and all of the Disney Princesses if you’ve got little girls. They love all of that sort of stuff. They’ve got Pixar, of course, which makes those very popular movies. And so, Disney, of course, is coming out with its own streaming service. And that’s going to compete with Netflix. And so, they’ve got a lot of great content there. And that content is being taken away from Netflix. So now Netflix is just going to be going straight head-to-head with a great content producer that’s going to have its own distribution in the same way through Hulu and through its own app. 

What has historically happened every time there’s a new technology for delivering content, that technology when it first arrives becomes very valuable. And then, pretty quickly because it gets cheaper access to more people, what happens is the value in that chain accrues to the content [it] produces. So, Netflix in order to compete needs to be a content producer. They can’t get away from that. 

But that’s a really, really tough business to be in. You’re competing with people on YouTube. We’ve all got only a finite amount of time to watch anything every day because we’re working. We might have kids; want to go to the gym; want to socialize. Do other things like that. And so, you got to work out where you’re going to spend your attention. So some people, they find themselves on YouTube. That’s another competitor. YouTube’s content costs are zero virtually. They pay after the fact, so you upload your stuff for free. They run it out, and then you get paid down the track. 

So someone like Joe Rogan, who has a gigantic podcast and produces hours and hours of content every week. There are people watching that instead of watching Netflix. And so, while times are pretty good at the moment for the most part. I think when times get tough, and people are going to rationalize what they watch. If you’re anything like me, I watch it on the Apple TV. So I pull up the titles, and I can go through those titles. Some of those titles I pay for, and some of those titles are just free content that sit there, so I can click on a title and watch what’s underneath that. YouTube is one of the titles on it. 

We’re getting into this stage now, where Netflix is carrying an enormous amount of debt. Every time they report, their free cash flow is negative, so they’re burning a lot of cash flow. And it’s getting worse every time they report. They say that the next one is going to be better, but they’ve never had one that’s better than the last one, so you have to take that with a grain of salt. 

I don’t think that Netflix goes out of business by any stretch of the imagination. I think that Netflix is around here for the very long term. What I do think happens is that it becomes incredibly hard for it to sustain that enormous valuation. And so, what happens is that 100 times P/E, 80 times enterprise multiple will compress back to a more normal kind of market multiple. 

As it happens, the valuation comes down. It could be trading half where it is. It could be trading at 25% of where it is now. And so, that’s the opportunity in Netflix, and the reason that I think now is the time for it is because we’re about to see all of these competing services come out. And Disney is the one, I think, that everybody is watching. If you’ve got little kids sort of, you kind of have to sign up for that content if all of the princesses and you know. A lot of people are going to get rid of something at that time. And I don’t know what it’ll be, but there’s a risk that it’s Netflix. And so, that’s my short thesis.

Stig Brodersen  10:17  

I really like that thesis. So this comes from a value investor who’s now trying to present the bull case for a stock that’s trading 100 times to P/E. I am going to cheat a little here because this is not so much my argument, but it’s actually an argument from Bill Nygren. Our listeners are very familiar with Bill Nygren. We had him on Episode 254. He is from Oakmark Funds, and he manages $17 billion. And one of the picks that he pitched here on our show, that was Netflix. So I’m going to borrow his argument, and I’m curious to hear Toby’s response to this. 

So the way that Bill Nygren compares this is that he’s saying Netflix is like cable TV 30 years ago. A lot of money was spent on acquiring customers before they became profitable. So we can’t really use the P/E multiple right now because it’s not really showing what the true profitability of that customer is. He uses a valuation for instance, the one that AT&T used, whenever they bought Time Warner. And at that time an HBO subscriber was valued around a $1000 per subscriber. If we look at services like SiriusXM, Spotify, HBO NOW, that can coincide with Netflix. And in this survey, Netflix was actually the most important to them and what they would least like to get rid of. It is kind of interesting. Netflix, depending on the types of subscription you have, they’re between $9 and $16. So, if you are like me, you are a premium subscriber, you pay almost 200 bucks a year for Netflix. So, if you use that valuation, just like rough calculation: a $1,000 per subscriber, you have 140 million subscribers. That’s 140 billion dollars, which is also more or less the same as the enterprise value of Netflix. That is one way to justify that valuation. What are your thoughts on that approach to do a valuation?

Tobias Carlisle  12:03  

So here’s my response: I like the analogy, but it’s flawed in the sense that when you got cable, you only got one cable provider, and they punched it into your house, and it was very, very sticky revenue. They signed you up for two years. There was not much you could do. They don’t have any competition in the local areas. I can’t choose between…as much as I would like to put my cable company up against another cable company, I’ve got no choice. The one that I have has a monopoly in this area. I spend more money with them than really that service is worth. Netflix is in a totally different position, where it’s as easy for me to turn it off as unsubscribing to anything, and I can immediately subscribe to something else. 

So, I think that $1,000 may have been the appropriate value of a customer, when they were cable. But it’s a different business now that all of that has been unbundled. And so what, you know, I get my internet from the cable provider. And then, I go to the internet, and I have the choice of any number of these services. 

And there are some that are going to be advertising supported partially like Hulu, so they can be a little bit cheaper. If you go and look at the titles that are out there. There’s so much stuff out there that’s available. And at the moment, Netflix is the brand name that everybody knows, and it’s doing very well. But I can easily see that all it requires for you to sign up to another service is a show that you want to watch that you can’t access anywhere else. That’s why this business is tough. And that’s why it’s going to be a boom-bust business and more like a movie studio. 

If they have the content that everybody wants to see, [it’s a win-win]. If they have the Game of Thrones, you know that’s an HBO show. To watch that you need an HBO subscription, or you needed to buy it through probably Apple iTunes or something like that on an ad hoc basis, so it’s a totally different business to that cable. [It’s] that sticky recurring revenue from cable. So, I don’t know that that valuation is appropriate. I kind of just look at it on the numbers that they’re doing now. 

The things that are good about Netflix is it’s still a great business. The underlying business is still good. Their incremental return on capital is excellent. It still [pays off] very high returns on capital. It’s just that everybody else can see that Disney knows that you can make a lot of money in streaming services, so Disney is coming into it. All of these guys are going to come into it with reasonably deep pockets and lots of great content. And that’s going to make it a very tough business to compete in. The only way for this to go is for the stock price to go down.

Stig Brodersen  14:16  

Very interesting the way that you debunk that argument. Another way of looking at this is to put a value on the growth. So before we talked about, you know, having 140 million subscribers. Perhaps they’re valued at $1,000. Perhaps not. But we also have a lot of growth included. And of course, depending on which type of growth rate you’re going to use, you can come up with many different valuations. With Bill Nygren did specifically was he was talking about a value creation of $25 billion year over year because they have 25 million new subscribers. Again, if you don’t believe that the value per subscriber is $1,000, of course, you can’t use that, but that would actually give you a multiple of six, which will make Netflix a very cheap company. 

Regardless, do you think that growth is very interesting to talk about? I guess to me, there seems still to be room to grow. Year over year, I think they grew 20%. How much more is there in the time to come? Well, probably not a lot in the US. And we’ve also seen some of the growth slowed down in the US. As much as 64.5% already has a Netflix subscription, and no other country on the planet has as many subscribers. 

If we look away from the top five countries, so that would be US, Norway, Canada, Denmark, and Sweden, all other countries have 43% or less. And there’s so much non-English content on Netflix on international channels now. It’s already in 23 different languages. 

Big *inaudible* Japan, for example, only 17% penetration, so I guess that leads me into the other argument. Where do you see growth go for a company like this because that valuation we see now includes a very generous growth? So where do you see that?

Tobias Carlisle  15:55  

That’s the million dollar question for Netflix, and as you point out the valuation at the moment is predicated on this enormous growth rate being sustained. And the problem for Netflix is that a company like Disney has…already has that global recognition. Everybody in the world recognizes Mickey Mouse. There’s a sort of little study the other day. If you put a black circle with two black, little black circles above it, there are Kalahari Bushmen who can identify what that is. They know that that’s Mickey Mouse, so Disney is very well known globally. 

Marvel superheroes are well known globally. That’s going to be the problem for Netflix that there is this competition from a very well known competitor, who has great content assets. All they really have been lacking is the distribution channel, and the distribution channel is not trivial, but it’s not as hard as cabling the entire world. All you need to do is make that offering available, and make it possible for someone to click on your title, and to watch the underlying content, and pay you for it with a credit card. And all of a sudden, you’re acquiring customers globally. 

The problem for Netflix, I agree that it has potential to grow worldwide. But the problem for it is that its competitors have that same potential. And so, it’s going to become incredibly competitive. I see margins are going to come down. Basically, that’s the only thing that can happen. And probably the pressure is more from the content spend than it is from…they’re still a reasonably cheap option. It’s still cheaper than cable by a long shot. 

I don’t know exactly what it is. If it’s $14 or $15 a month, I think, at the moment in the US. I still think that the problem for Netflix is the competition. The very high rate of growth it has seen in the past are probably going to slow down.

Stig Brodersen  17:39  

Thank you, Toby, for your Netflix short discussion. As you said there, you might be a silly man. You might be a very courageous man. Let’s see what happens. We record this August 18, so it’s going to be interesting to see where we’re going to go from there. If anyone wants to keep track of this short position, at the time of recording, it’s trading at $302. If we did put a short on Netflix, when would you sell?

Tobias Carlisle  18:05  

I will revisit it again at the end of September. So it’s possible that we close the short at the end of September because that’s…in the fund that’s what we do. We look at them on a quarterly basis, and make a decision, and so we can trim it back. We’re up a little bit on the position, so we can trim it back, which would mean buying some Netflix, or we could exit the position entirely. So I do it on a timing basis, rather than a valuation basis because I use it. I use the shorts more as a hedge to the long, so there’s a short book. If the short book goes down more than the market, then the shorts are doing what they should be doing.

Stig Brodersen  18:41  

It is interesting what you said there, whenever you say you’re going to close out, or you’re going to buy Netflix because that is what you’re doing. I think I accidentally said when you would sell your position, but you’re actually buying into the position, whenever you do a short. You sell it beforehand, then you buy back hopefully at a lower price. 

Tobias Carlisle  18:57  

Hopefully. 

Stig Brodersen  18:58  

Hopefully, yes. So transitioning into my pick, I was really torn whether or not I should pitch this to you, Tobias, because this is a value investing pick. And I would be like, “Hmm, would Tobias be the right person to speak to because he’s an expert in value investing? Or would it be a very boring episode because he would be like, ‘Oh, Stig! I’m completely there with you. Value investing, now is the time!'” You get the version of discussing the virtues of value investing with a value investor, and then you can make up your own mind. 

My pick is an ETF from ICS. The stock ticker is I-V-L-U, and this fund seeks to track the investment results of the MSCI World Value Index. It’s based on a traditional market cap weighted index, but it does not include the US. That’s very important for me to underline. 

The market cap aspect basically just means that bigger companies have a bigger share of this ETF. The top 10 companies will include companies like Novartis, Toyota, [and] Royal Dutch Shell, just to mention a few. Together, they comprise 19% of the funds’ assets. As there are many shares, there are [also] quite a few stocks: 334. 

Japan is the biggest international market with 40%. UK is second with 15%. The value trade in this ETF is basically built around three accounting variables, namely price-to-book; price-to-earnings; and then, enterprise value to cash flow from operations. The expense ratio is 30 basis point or .3%. 

Since the inception in June 2015, it only returned 1% annually, so it has dramatically thrilled the S&P 500. Oh, my god! So why am I pitching this ETF with such a horrible performance? Well, in terms of the international aspect, this is actually something I’ve thought a lot about after the conversation we had with Ken Fisher not too long ago. And he talked about why he was a top-down macro fund manager in the sense that he’s fishing in the pond. He might not catch the biggest fish, but at least he wants to fish in the pond with the most fish, and that was kind of like his idea. 

So, if you look at the US right now, it’s the third most expensive market that we see out of these 37 most developed stock markets. Only Ireland and Denmark are more expensive. So by buying a value ETF does not include the US, you might already get some telling *inaudible* from that. 

And then, we have the value aspect. Value has not performed well. If we look at the performance just over the past 10 years, we look at underperformance to growth by 32%. This is data I have from Professor French. If you look at the data, it says that value appears to have the sixth worst drawdown ever over this period from January 2007 to September 2008 compared to growth. 

The counter argument that I would have, and I’m sure that Tobias would have a lot more is that if you look at historical returns, you actually see from 1927 to 2017 that value outperforms growth stocks by 4.8% annually, which is just massive. And that is definitely something to consider, too. Before we go more into the weeds of why value investing works. I’m curious, Tobias, what are your thoughts on this ETF today?

Tobias Carlisle  22:23  

I run a value ETF, so I’m a little bit biased. But let me talk about the things that I like to see in a value strategy. And why I’m going to disagree with your pick only for the interests of playing the devil’s advocate because you know I love you, Stig. When I get to put together a portfolio, the things that lead out performance, first of all, making sure that you’re using the right metrics. And so, when we wrote the quantitative value that came out in 2012, we went and tested a whole lot of metrics to see what worked and what didn’t work. 

The thing that didn’t work was price-to-book, and the problem for price-to-book has been basically, there’s a change in that. There are a lot of arguments for why price-to-book doesn’t work. One of them is that the economy has sort of moved to this more asset-like intellectual property. And that’s not properly captured in price-to-book. I don’t love that argument because I think that you should still have a lot of competition driving returns back down to average returned. 

I think a better argument is to follow a slightly technical argument, but let me explain it to you. Basically, what the successful companies who make a lot of money do is they buy back stock, and they can buy back so much stock that they get negative equity. 

Now, that doesn’t make any sense. Very hard to kind of visualize negative equity. But basically, let’s say, you put a million dollars into a business to start that business going. So your book value is a million dollars. You buy some assets. You start operating. You’re wildly successful. 

You make so much money out of that business that you’re able to buy back some of the stock that you issued onto the stock exchange. And so, you can get to this point, where you buy back more and your values go up. Your market valuation is $10 million. If you buy back a million dollars worth of stock at a $10 million valuation, your book value is now zero, and beyond that your book value becomes negative. 

So if you’re a very good business like McDonald’s that has made a lot of money for a long period of time and bought back a lot of stock, you wind up with a negative equity. Now, McDonald’s is a great business. People are still going and buying burgers. They’re still eating at McDonald’s. They’re still making lots of free cash flow. But when price-to-book value tries to classify McDonald’s as a value stock or as a growth stock, it doesn’t know where to put it, because it’s priced to a negative book value. 

And so, that’s a problem that the accounting hasn’t really kept up with the way that some businesses are run with a lot of buybacks. So that’s the main problem for book value. Iit hasn’t been so great at classifying businesses as being undervalued or overvalued. [There are] better measures. I like the cash flow measures, so I like price-to-cash flow. I like price-to-earnings. I like all of those metrics. 

The original reason that people preferred book value was that your earnings can go up and down, and so your valuation, [it] could look cheap one year and look expensive the next year. Basically, what’s happened is your earnings have gone down. 

Book value is much more stable. It doesn’t move around as much. If you buy it cheaply this year, it should still be cheap, or that’s the logic behind it. It’s good logic. It’s just that the accounting has changed a little bit, so it’s not a great metric. So that’s the first thing that I look at. And I think that it failed a little bit on that one. 

The other problem for it is the market capitalization waiting. So this is the question you ask yourself, when you try to set up an ETF is: “How much money can this thing run?” You make it a market capitalization waiting. You can get a lot more money into it, but your performance will suffer as a result. 

You won’t do as well because what has traditionally happened is equal weighting the positions where you put the same amount of money into each one, rather than market capitalization where you put more money into the bigger ones just because smaller companies tend to be more undervalued. So putting the same amount of money into smaller, more undervalued companies tends to lead to better performance. 

And so, those two things. I think this is a very good ETF. I think it’s cheap. I can look at the top holding, so it’s top holding right now is Novartis. That’s a great business. It’s probably undervalued: Sanofi; Toyota; Mitsubishi Financial; Hitachi. All of these are great businesses, likely undervalued. Probably, it’s going to go very well. But my criticisms are just that not a great metric and market capitalization waiting both of those will dollar returns a little bit.

Stig Brodersen  26:21  

It’s interesting that you would say that. The study I’m referencing here is from French. I’ll also make sure to put a link in the show notes. He tests that, too. And not surprising, like you, Tobias, he also finds that price-to-book value is not that good. 

I feel that’s interesting to discuss here because the accounting rules [and] because the economy has changed. It’s just not as significant anymore. But what you see in all these value ETFs, in many of these value ETFs, I should say, is that price-to-book is still one of those metrics that you will be looking at together with price-to-earnings and a few other metrics. 

And another thing I would like to mention for this [is] the price-to-earnings, which also has its own flaws. [It] is probably not the most effective ratio, but still, [it’s] much better than price-to-book. Across the board for this ETF, it’s 10.3. So it’s relatively cheap stocks, at least if you compare it to the border of the US market. 

So let’s talk about why value investing works. I’ve just said this ETF has performed 1% over the past few years, so most smart people would say, “That’s a horrible strategy because it doesn’t work.” Because I’m a value investor, I’m thinking, “Well, that means it’s reasonably priced now. And now, it will start to perform.” So, it kind of like depends on how you look at it.

I have to give credit where credit is due. And that’s also one of the reasons why I want to speak with you, Toby. If you want to really understand value investing really in-depth, this is how I understand why investing works, and then perhaps afterwards, you can comment on that.

Markets temporarily punish some stocks more than others, and they make them trade below the intrinsic value. So as the market gradually realizes that the price compared to the value is too low for some of those stocks, it reverts back to the true intrinsic value. This process is often referred to as “mean reversion.” 

For you owning a value ETF, you can think about it like this, right now, IVLU, they deem that Toyota is undervalued, and therefore owns stock in Toyota. It’s another stock that trades at a P/E around 10. When Toyota is no longer being undervalued because of the price of returning back to the mean, then the ETF will automatically sell the stock, and then buy another attractive [asset] based on their price valuation in the meantime, and then wait for that price to go up and revert to the intrinsic value. So that’s the way to understand value investing. 

You play stocks that are trading at a more attractive level. Wait for it to revert, then replace them with different stocks that’s doing the same process over and over again. I don’t know if I explained the bull argument for value investing too well, Toby. I’m curious to hear your thoughts.

Tobias Carlisle  28:56  

Let’s talk about the logic of value, and then talk about the long term returns to value. So the logic of value is simply that you’re trying to buy something for less than it’s worth. If you buy something for less than it’s worth, that’s really all you have to do. If you do your purchases correct, then you don’t need to trade in and out. You don’t need to sell it to recognize the value. You’ve already got that value. And you hope that over time that holding will make you money. The way that you express that in the stock market is you try to find something trading, where the stock price is at a discount to the intrinsic value. And you either do a full valuation, or you use some price ratio. And you hope that lower price ratios indicate the presence of some value versus a higher ratio. It may not. Sometimes there are very good businesses that can justify a very high ratio. And there are very bad businesses that [have] even low ratios. They’re not worth buying. But on average, on the whole, lower ratios should do better than higher ratios. And that’s what the data shows us, too. 

So the French data that you refer to that’s free for anybody, who wants to go and have a look at this. You can look at different types of data. And you can look at it in the US, and you can look at it globally. So the data that they have…they have price to book value data. They’re going back to 1920. They have cash flow data and earnings data that goes back to 1951. 

When you look at that data, it’s very clear. So then they cut the data up lots of different ways. But the one that I like to use is they cut it into deciles, which is 10. So they take every stock in the stock market, rank them on say, price to cash flow, and then the most expensive ones go into the expensive decile. They call that low 10. And then the cheapest ones go into high 10, then you can look at the performance of low 10 versus high 10. 

So I think that many value investors use price-to-cashflow. That’s a pretty good metric; enterprise value to cash flow, because what they’re trying to do is they’re trying to get…the enterprise value is a good metric because it’s a good ratio because that looks at how much cash they’ve got on the balance sheet. Are they carrying any debt? Because these are real costs that an acquirer has to bear, and then on the other side, they look at free, operating cash flow. It doesn’t really matter. In this instance, I don’t know if they spell that necessarily as what it is. I think it’s operating cash flow because I think that’s an easier metric to calculate. 

You compare those two, rank the stocks, and then you can construct your portfolio either by valuating as we discussed before. That’s the market capitalization weighting or by equal weighting. And so, equal weighting, I think, is how most people are probably constructing their portfolios. 

You put about the same amount of money into each as you buy it, rather than [say], “This is a really big company, I’m going to put a lot of money into this company. This is a small company, I’m not going to put very much money into it.” I don’t think that people are really doing that. They’re probably either equal waiting, or they’re saying this is a better opportunity. 

When they do that, you can check this in the frame of French data. I’ve actually created the chart, and I have it up on my Twitter. I’ll send this through to Stig. I may even update it for the new month. It’s not that it makes much difference, because there’s now 70 something years of data, I think, so one month doesn’t really make much difference one way or the other. But on my Twitter, so that the very long run returns to the value decile and to the value portfolio. 

It has done 18.8% since the beginning of the data per year. The expensive ones, the glamour, and the growth have done 9.1% since the beginning of the data, so value has done twice as well as glamour since the beginning of the data. 

For the last 10 years, glamour has been outperforming value, which is ahistorical. It’s very unusual in the data. It does happen. It happens regularly, but it doesn’t last very long. So this one that we’re currently in is the deepest and the longest underperformance ever.

Stig Brodersen  32:30  

One argument is to say that value has underperformed, and there’s definitely a lot of good arguments for that. However, you could also say that growth has overperformed. It’s sort of interesting if you look closely at the data because if you do that ranking that you just talked about before, what value investing does is that it underweighs big tech. Perhaps that’s a problem. 

I referenced the conversation that I had with Ken Fisher here not too long ago. Ken said, “The US hasn’t performed better than the rest of the world in terms of the stock market if you take away big tech.” If you do that, it’s the same performance.

Is the US not doing better? The US tech is just ruling the world. That’s why it’s better. Of course, if that component has not historically been apart say, for the past 10 years, again, you will see a huge difference in return. So I guess my question for you, Toby, would be: Is that a problem for value investing traditionally if we’re looking away for something like big tech?

Tobias Carlisle  33:24  

Let’s talk a little bit about why it’s underperformed. I think you alluded to this. And I think you’re exactly right. Value has actually done pretty well through this period. It’s not about 13.5%, which is a little bit lower than it has done over the full data set. But 13.5% is a great return. You become a legendary investor if you can do that for long enough. And what has happened is value is actually a little bit more expensive now than it usually is, or it has been over the full data set. I’d say it’s a little bit rich to its long run main. That’s the way I describe it. 

It might be as much as 50% overvalued because you can look at the underlying holdings and see what kind of free cash flow yield you’d get, when you buy them. It’s a little bit less than you would have got ordinarily. Now, there are reasons for that low interest rates. Lots of other things going on. The reason that it has underperformed is that the glamour, the growth, and the tech have done so well that it’s beaten it by such a wide margin. 

As a result that overvalued the glamour, the growth is extremely expensive. By some metrics, it’s more expensive than it has ever been in the data, and that’s including the dot-com bubble if the laws of microeconomics still apply. And I think that this is the question that always gets asked at the top of every stock market bubble: Is this time different? 

There’s always a very compelling argument for why it is, which is why people entertain it in the first place. That’s why they think about it. I have to say that I don’t think that the laws of microeconomics have been suspended. I think they still apply. I still think that you make more money buying the cash flows that you can see now. 

So the way that these tech companies…the argument for these tech companies goes [something like] “They’re going to get so big that no one will ever be able to compete with them.” You can’t compete with Amazon. You can’t compete with Google. You can’t compete with Facebook. You can’t compete with Netflix. That’s the thing, and you’ll never be able to get them back. The thing is that that’s the argument at the top of every single dot-com, every single boon, including the dot-com boon. 

And what happens is that the market does eventually come back, and it goes back into this more normal because…I don’t think that it’s so much people are putting…they’re looking a long way into the future and seeing what these things could be worth a long way down the road and saying, “Well, relative to that theoretical valuation that we could achieve in the future, they still look pretty cheap.” That’s the argument for [the] Netflix run.

Stig Brodersen  35:36  

So, let’s say that we and the audience buy the argument about value investing will now start to perform. You mentioned it a few times, and I mentioned it, too. You have your own value ETF. The stock ticker is ZIG as far as I remember because it’s ZIG, when the market [sank] *inaudible*. Is that correct? 

Tobias Carlisle  35:54  

That’s right. 

Stig Brodersen  35:55  

Perfect. Okay, so that is, of course, the disclaimer. Everyone can go in and look it up, and also [I] like see what is your position, where you are coming from. And they definitely should do that as they listen to this conversation and make up their own mind. We also invited you here because you are an expert within value investing. 

Let’s say that yes, we now think that value investing will start to perform. Would you in that case go for a US-only value ETF, global or international? And why?

Tobias Carlisle  36:25  

It almost doesn’t matter where you go because I think that value globally has been really beaten up. The interesting thing is one of the arguments that I hear is, “What happens if the US starts looking like Japan? What if it becomes this long stagnation?” So [the] Japan stock market topped out in 1990, and it’s 25% below where it was in 1990. So it’s been a very rough 29 years or so in Japan for the stock market investors there, and that’s coming up on a career. 30 years, that could be a career in investment. 

So, there are people who’ve never seen the stock market. As some guy who started on the first, on the top of the market in 1990, and the stock market was still trading below where it was. And the reason that they got to that level is because it was trading at a 100x Shiller P/E. It’s taken a really long time to work off the overvaluation. 

The US got to, I think, 30 something times on a Shiller P/E basis. And it’s taken it…15 years to get back before it got over its all-time high again. Really, whatever happens to stock markets globally, value follows its own idiosyncratic return path. So, value did very well in Japan since 1990. 

It’s been a good place to be a value investor because [for] value investors the way that a return to a value fund happens is you buy stuff cheap. It gets a little bit less cheap. You sell it. You buy a new crop of undervalued things, and that ratchet effect is how you generate returns. The rest of the market doesn’t have that. So I think [for] value [investing], it doesn’t really matter where you get your value.

I think that when you go international, go outside of the States, you get a different mix of companies. So the thing that the States does very well, they have these consumer discretionary businesses like Google, and Facebook, and Netflix, and Amazon that don’t really exist anywhere else in the world. And it’s when you say that the US stock market experts, sort of those big tech companies, are flat or down I believe that. 

It’s really the thing that has kept America going up over the last decade versus the rest of the world that’s kind of slumped. Because cyclicals, industrials, financials, [and] all these other sectors have been pretty beaten up. 

I don’t think it really matters what you do. I think that it makes some sense to have some of your portfolio overseas. I don’t know. You’ve got listeners all over the world, I know. But this is a very pronounced bias. It’s called the home country bias. Everybody puts way too much money into their own stock market and not enough into other stock markets. 

What are the chances that your stock market is the one that outperforms every other stock market in the world? Pretty low. Like where are you at the moment, Stig?

Stig Brodersen  38:46  

I’m in Denmark, and we are happy now because Ireland is now more expensive. But…well, I mean, like I mentioned before, you know? It is Ireland, Denmark, then the US, so you’re right. I mean, my home bias would be Denmark, and it would be the US. Why not look at the 34 other very developed stock markets that are just cheaper? Well, I have this bias.

Tobias Carlisle  39:07  

There are developed markets. There are emerging markets. It’s probably unlikely…wherever you are right now, it’s probably unlikely that your stock market is the one that outperforms the rest of the world. In addition to that, you’re probably working in your own country. You’re probably earning income in your own country. 

So, just from a diversification point of view, it makes some sense to invest internationally or globally from wherever you are. I like the logic of value that it’s just going to find the best value stuff globally or internationally, and then it’s going to hold on to that stuff. Like I think that’s a good hedge. In your own life, that’s a good hedge against your income.

Stig Brodersen  39:39  

For me, as a Dane living in Denmark, I face the same problem as most Europeans that I cannot invest in American ETFs, or if I do, the tax treatment would just be horrible. Like I would pay 43% of tax every year, regardless if I even sell the ETF. You need some pretty decent returns before you would do anything like that. I will stop complaining now about it. 

But I would also say that there are quite a few ETFs that are already available for Europeans. And I’ve come to realize a lot of listeners do not know that. Many of them are traded in Germany in euros, so that’s a way for most people to access it. There’s obviously not as many as you can find in the US, but I just wanted to give that hand-off for you, guys. 

Another question that I actually get quite a lot here, Tobias, is we have so many people who have been following you here on the show. I think you’ve been on the show at least 10 times if not more, and your ETF over the stock ticker: ZIG. They cannot access that. Why is that the case?

Tobias Carlisle  40:39  

It’s a European Union restriction. I think it applies in the UK as well. For some reason, they’re not allowed to. The brokerage accounts can’t even display the ticker. I’m not entirely sure what the reason is. 

There is a process by which the ETF could be made available, but it requires subjecting the ETF to another compliance regime. The regulatory and compliance regime in the States for the SEC is very, very tough. There’s a lot of work that has to go on in the background. That’s what makes the ETF so expensive to operate. 

There’s a cast of thousands in the background, calculating the returns and making sure the money is moved around. Then, to subject it to a second regulatory regime just makes it too complicated for small independent issuers like I am. 

What we would like to do in the future is to create a dedicated European ETF that’s listed in a *inaudible* list that’s listed somewhere. We haven’t got to this level of detail yet, but somewhere in Europe. Germany is one venue. The German *inaudible* is one possibility. It’s not on the front burner right now, because we’re still trying to digest the last ETF that we’ve got out, but that is something that I would like to [do]. And I have started having those conversations with some of the providers in Europe.

Stig Brodersen  41:22  

Tobias, before we round up this show, where can the audience learn more about you and your fund?

Tobias Carlisle  41:55  

I’ve got a website: Acquirer’s Multiple. It’s got a free stock screener for US stocks. You can see the cheapest 30 [stocks] in the most…in the biggest 1000 [market index]. And then, there’s a little paid component to that too if you want to get access to the other screen. 

I have a book called The Acquirer’s Multiple that’s available through Amazon. You can get that in print or in Kindle format that gives a really easy to read summary of my particular brand of deep value investing. 

The website for my firm is acquiresfunds.com. And you can go in, and you can see it in one page. I describe what we do in plain English. It’s pretty easy to understand why we’re sort of traditional grain investors, but we try to have a sort of systematic approach to it. We’re kind of “activist-private-equity fanboys,’ who try to follow those guys. And in that the fund site is acquirersfund.com. 

And there’s a little interview with Bloomberg that I did there talking to Scarlet [Fu] about the fund, and she asked some hard questions about value. It hasn’t been working. It’s been a really tough period of time, but these things have happened previously. Value has had multiple periods of underperformance, and this is what keeps the strategy evergreen, because people lose faith in the strategy. 

Seems like the easier money is made in the high growth tech stocks. The more glamorous stuff has happened 6 or 7 times in the data. It’s underperformed for a period of time. Every single time that it has happened, it has gone on to have a very, very good period of performance afterwards. And so, I don’t know when that period starts. 

We may need a stock market crash to get it going, or it might just start working when people realize how big the differential is between the valuation of the really expensive stuff and the undervalued stuff. 

The stuff that I own, the businesses aren’t going away. Those businesses are here for the long run. They’re throwing off cash flow. They’re buying back stock. And so, you can see all those names if you go to acquirersfund.com. We have a [page]…[where] you can download the holdings. You can see what’s inside the fund. We’re very transparent like that. If you want to pull up the stock, the tick is Z-I-G, as Stig says “ZIG.” That’s all I do. I live in pretty deep value, and at the moment, we’ve got the US one out there. And I think it’s a very good time for it.

Stig Brodersen  44:03  

Fantastic. And Tobias, I know we had you quite a few times here on the show and our audience absolutely love you. And we really, really hope I can say that already now that you will come on again. But thank you again also for this time to take time out of your busy schedule to speak with me here today on The Investor’s Podcast.

Tobias Carlisle  44:19  

My absolute pleasure! I love talking to you and Preston, so I’d love to come back again if you’ll have me.

Stig Brodersen  44:25  

Before we round off the show, we have a very exciting announcement to make. Preston is constantly being asked to cover new topics on our show, and you probably notice that we’re all over the place with all the financial topics that we are already covering, and we will continue to do so. But we would also like to focus more, especially value investing, macro investing, and currencies, which are what we are most passionate about. 

On the other hand, we would also like to cover more topics and add more value, and because of that we are rolling out a network of podcasts. We call it The Investor’s Podcast Network. And here in 2019 alone, we plan to launch three new shows with three brand new hosts. We actually met all three of them at the free TIP live events that we set up all over the globe. And we are honored to say that they’re now joining the team. We didn’t want to just set up new shows for the sake of setting up new shows. We really wanted it to be for the TIP community by the TIP community. 

Our first show was launched not too long ago, August 21st. And it’s hosted by Robert Leonard. Some of you might already know Robert because Robert has been writing great intrinsic value assessments together with us. These are the assessments of different stocks. You can find their website. We also send them out in the newsletter. 

And if you read any of his analysis, you could just tell how smart he is. So, briefly about Robert, he earned his MBA degree in accounting and finance from the University of Massachusetts. And aside from being a stock investor, he’s also a real estate investor. And he is hosting our first show. It’s called Millennial Investing by The Investor’s Podcast Network. So to kick this off, we asked Robert to join us here on today’s show. 

Robert Leonard  46:08  

Thanks for having me, guys. 

Stig Brodersen  46:10  

Alright. So Robert, please tell us about your new show, Millennial Investing.

Robert Leonard  46:14  

Yeah, absolutely. So on my new show, Millennial Investing, I will be interviewing successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation. My goal with the show is to help improve millennials’ financial literacy and help them make better investment decisions.

Now, while this does include the stock market, it doesn’t mean only the stock market. In fact, I’ll be talking a lot about other ways to invest your time and money outside of the market, such as through entrepreneurship, real estate, personal finance, personal development, your career, and much, much more.

Stig Brodersen  46:50  

That sounds great, Robert. And you asked me to co-host the very first episode with you. And then, the second one, you co-hosted with Preston. Could you talk to the audience about what we talked about in the very first episode?

Robert Leonard  47:01  

Absolutely. So we talked about how to pick a brokerage company to invest with; how to actually buy and sell stocks; why compounding is so important for millennial investors; and a bunch more. In the second episode, I sat down with Preston to discuss various different stock market investing and entrepreneurship strategies that millennials can implement. And at the end of the show, Preston takes one of my stock investing questions, flips it on its head, and then provides fantastic advice about entrepreneurship.

Stig Brodersen  47:29  

Thank you so much for joining us. If you would like to subscribe to Robert’s show, we created a guide for you in the show notes. You can of course also just search for The Investor’s Podcast, Millennial Investing, whether you’re on iTunes, Spotify, or wherever you listen to your podcasts. But guys, that was all that we had for this week’s episode of The Investor’s Podcast. We see each other again next week.

Outro 47:50  

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