Preston Pysh  6:19  

It’s really interesting that you bring up the Amazon thing. I’m kind of curious how much growth they’ve seen. Are you able to find that number of how much growth they’re seeing for their Handmade Amazon stuff, Toby?

Tobias Carlisle  6:31  

No. It’s fairly new. The offering seems to be. Etsy says that they charge 20 cents to list. Then there’s a 5% transaction fee, then there’s another 3% processing fee, and so on. 

Etsy’s headline number is like 5%. They take 5% of sales. Amazon takes 15%, but some of the folks inside Etsy think it’s not right that they take 5% and to add in all these other fees that comes to $17. 

So even though Amazon seems to be on a headline level more expensive, at a practical level, it looks like they’re a couple of percent cheaper. Just because it’s such a huge site and they can share the stuff so broadly. Etsy is not but it’s a much bigger site. I think it’s likely that they take some share and there are some smaller competitors that are more niche coming through.

Preston Pysh  7:20  

I’m looking at the top line and it looks like they are… Is that right? $818 million for 2019, and the year before that it was $604 million for their top line. How is it looking quarterly? Does it look like it’s slowing down and you’re not getting that same growth rate or something?

Tobias Carlisle  7:41  

They had been growing very strongly. What we’re trying to do here was to find that tipping point where it seemed that that growth slowed and peaked, but I think it was the most recent quarter that shows that they’re still growing very substantially and they’re still making a lot of money. 

I’m just giving you the thought process of looking at one of these things in real time. I would say that I was more confident before the last earnings came out. The most recent earnings make me probably need to go back and have a look at this a little bit more closely. I would revisit it closer to the end of the quarter.

Stig Brodersen  8:12  

It’s a tricky thing. We sent our picks to each other a week ago and we’re recording this on the first of March. As people who have fallen in financial markets would know, a lot of things has happened.

Tobias Carlisle  8:23  

At the lowest point, we were down 15.5%. I think in December 2018, it was closer to 20. 

Stig Brodersen  8:30  

If we specifically look at the Q4 earnings that came out here last Thursday, and the stock popped 14%, which is quite a lot, especially the way the market behaves. I see revenue rose 35% for the quarter at $270 million. It’s quite substantial. They had an earnings beat. 

It’s not so much that it beat estimates by nine cents. It’s just more that, in this day and age where it seems like as long as you just lose billions and billions of dollars, as long as you haven’t grown top line, we can still value a company for hundreds of billions of dollars. 

If you look at the revenue growth rates here over the past three years, so even over the past five years, we are looking at something in excess of 30%. It’s rough. 

Another thing I would like to mention here before throw it over to you is one thing I’ve noticed reading up on Etsy is the offsite *inaudible* strategy that they offer, with which they pay the upfront cost to promote sales listing on multiple internet platforms. 

I’m not saying that this is a viable strategy. This makes me think of when PayPal paid people to refer their friends. They actually just deposited money in their account just to get that networking effect going. 

Though both active buys and sells have been growing in the 20% range and yes, they might be burning a lot of cash, and yes, it might not be profitable to do that. However, if the market just looks at that growing top line and just whatever comes *inaudible* they can see profits and then value that to be worth as much or whatnot. I think this is a stock that’s really tricky to short, to say the least.

Tobias Carlisle  10:07  

Yeah, no disagreement for me there.

I was looking at this previous earnings release, hoping that the earnings release was going to be what I expected it to be. I’d be talking to you about it post the successful exploits from my perspective, but I think the thesis is a little bit broken at the moment.

I think that there’s some evidence that they are struggling for growth a little bit by the fact that they’re going off platform and prepared to pay other platform fees. The users of the site don’t seem particularly happy about it, because those fees are ultimately passed through to the people who sell on the site. 

If a sale occurs off site, they are charged the additional amount. Etsy doesn’t pay that amount. 

From what I can read, people seem to be pretty upset about that. However, the point remains that it is growing at a very high rate and the most recent earnings sort of seem to reinforce the view rather than shown into it.

Therefore, I’m going to wait until we see the next round again, but I still think that it’s extremely expensive and it’s got some problems, so I wouldn’t necessarily be buying it long here either.

Preston Pysh  11:06  

Yeah, I agree with that last statement. I don’t think I would be shorting it, but I definitely don’t think I’d be going long at either.

Stig Brodersen  11:12  

One person who did go long Etsy, who did actually bring that on to our network, that’s Jason Moser from The Motley Fool. On Episode 15, he came on Millennial Investing for a new show. He actually pitched Etsy as a long position, which I found very, very interesting.

For anyone who is very interested in the long side of that, they can go to Millennial Investing. We’ll make sure to link to that in the show notes.

Tobias Carlisle  11:37  

What date did he pitch it? How recently?

Stig Brodersen  11:40  

In all fairness, I can’t remember when it was recorded, but it was published on the 20th of November. 

Tobias Carlisle  11:45  

Pretty good. Pretty good pick there.

Preston Pysh  11:48  

All right, Stig. Let’s hear your pitch.

Stig Brodersen  11:52  

I sent you this pick a week ago. Like I mentioned before, and that was ExxonMobil, stock ticker XOM. At the time I sent that to you guys, it was trading for around $59. Now it’s trading around $51. 

Don’t even get me started on the price of oil since then. Right now, at the time of recording, the price of a barrel of oil has plummeted to $45. 

Let me pitch ExxonMobil here. I think most of our listeners know the company and what they do, but it’s the largest direct descendant of John D. Rockefeller Standard Oil. The company was formed in the current structure back in November 1999, by the merger of Exxon and Mobil. 

It was previously the largest corporation measured in *inaudible* publicly traded company, but that was many years ago. Today, it is still one of the largest integrated oil companies in the world. 

There were a few reasons why Exxon was on my radar. It was one of the most bought stocks by super investors on that *inaudible.* Keep in mind that if you do use that *inaudible* that I’ll definitely encourage everyone to do. It’s a completely free site where you can see what fantastic investors are investing in. 

When you see the companies that invest the most since they were managed for at least $100 million, it is very often larger companies that will show up there, but it was something that piqued my interest and is trading at a $52 week low. It’s absolutely hated, but more or less everyone, which also caught Pinterest. 

There was a little insider buying, which isn’t super significant, but from the CEO and Chairman, he bought back here in February around $60 a share. 

I was thinking for around that price, it might be worth looking closer at the stock. Now, if we do look at the performance over the past 10 years, as most of listeners would know, I am the opposite of a momentum investor, which is also why I’m pitching ExxonMobil.

Annualized return over the past 10 years was 1.9%. Integrated oil companies have generally been more or less flat over the past 10 years.  In the meantime, SPI, the major ETF for the S&P 500, has performed 12.5% in annualized return.

It’s not your most popular pick that I am pitching here. 

Now the company has three different segments, given that they are an integrated oil company. You have the upstream and you can think about that as the drilling. They have the downstream, meaning the refining and going out to the end customer. They have a chemicals division too.

They basically just do everything you can think of whenever it comes to oil and natural gas. They make everything from specialty chemicals to jet fuels and gasoline. You name it, so it’s a very different pick than a pick like Conocophillips that’s a heavy bet on drilling as an example. It’s not an upstream-downstream bet, depending on where the oil price goes. 

It is more sensitive to the upstream segments, so if all prices go down, it’s typically not good for the company but the downstream segment actually makes more money in that case. 

You then don’t get the same fluctuation, everything else equal. It’s the first time in several years that the company reported a year-over-year increase in production. It’s slowly ramping up right now.

If you look at the moat, I wouldn’t say that it has a wide moat. You have other integrated companies like Royal Dutch Shell and Chevron. One may have a little more exposure to natural gas than the other, but it’s not a wide moat franchise, like we like to see for many companies.

If anything, the reason why I did pick ExxonMobil compared to some of the others is that it comes at a very appealing valuation. 

You might be asking what should go well. If we look at the company and that the price just seems to slide on and on, so what would be the catalyst for the business to do better? 

Now, keep in mind, when you look at some of the financial statements for ExxonMobil, that it has purposeful, a bit declining production, due to the lower price of oil. 

In 2018, it made a major shift with a new strategic plan. For what it’s worth, this was all in the plan that will phase out a lot of projects, which is also why you have seen less production. However, now they are starting to ramp up their production.

I don’t think that the current oil price of $45 was the plan at all, in the use of a generic price of $60 for barrel oil. They have a sensitivity analysis in terms of how that would look. It’s expected to be fully implemented in 2015. 

In that case, at that time, the capital expenditures would have been $35 billion. They would look at something like $60 billion in operating cash flows. 

If you look at the valuation, I want to be quite conservative. I also do know that a lot of energy is needed for the world to continue to grow. If we look at the past 55 years, 51% of those years, we actually had a positive GDP growth. 

If you look at the projections of what we’ve done in the past, we’re looking at something like 4% growth. This is more or less my growth rate. Then I’ve just added a little more if this plan is realized in 2025. With that, I get a return around 10%. 

I think that it’s a 10% return that comes with an interesting proposition. I don’t think the downside is that big. It has almost close to a 7% dividend yield right now. I do think that the upside is there, too, but it is a value play. It’s not the most exciting play. I think it’s a solid value play and it’s at cash flow play.

Tobias Carlisle  17:36  

How sustainable do you think that dividend is?

Stig Brodersen  17:39  

I think that’s a great question. If we look at the payout ratio right now, it is just above 100%. It’s easy to say, “Well, if it’s above 100%, then it’s not sustainable.” 

I think that’s the wrong way to look at dividends. If you look at ExxonMobil, it has hiked dividends for 37 consecutive years. It has close to no debt, at least no meaningful debt. 

If you look at the plans for how much money they’re going to spend and the expected future cash flows, you look more important in the history of how it’s been with ExxonMobil through all the different crisis that we have and how they weathered the 2008 crisis, I don’t see the dividend because I could be completely wrong. I don’t see that as the issue. 

Therefore, if you are a dividend investor, I think that’s an interesting enough play in itself, but I actually do think that there’s a little upside to on top of that dividend. Because as a dividend investor, if you don’t look for the payout ratio today, you look at what is a normalized payout ratio for that business.

Preston Pysh  18:41  

Stig, the issue I have with this one and normally I absolutely love your picks, I’m just going to start off by saying that. However, this quarter, I do not like this pick.

Stig Brodersen  18:52  

Dice.

Preston Pysh  18:53  

At all. I really dislike this pick. 

Now why? When I look at commodity companies, in particular oil, I look at it almost like a… I guess I got a really simplified version of how I view investing in a company like an oil company. It’s almost like playing pool and you’re hitting your ball into another one of your balls in order to knock it into the pocket. I always miss that shot. It’s because you not only have to get one of the angles right. You got to get two of the angles right.

I kind of see an investment in an oil company in a similar light. The two balls on the pool table for the oil industry. One you have to have an advantageous price based on your cost to produce. So I got it. This Coronavirus is wreaking havoc on commodities. At $45 oil, that is not good. 

My personal opinion is that we’re going to see that trend continue into the coming months. How long does that persist? I have no idea. Could oil like we saw, I think, in 2015, we got down to like what was it? $25 a barrel or $30 a barrel? It was something crazy, right? This was back in 2015, without even remotely the supply and demand shock that I think we’re about to see with this Coronavirus. 

My expectation moving forward on the price of the commodity, the underlying commodity is that it’s going to go down and it’s going to go down in a major way. I would not be surprised to see a drastic rip to the upside when the demand starts coming back online. All these producers are cutting their supply as fast as they can do it right now because of this virus and the demand shock that they all know is on the horizon. 

I think what you’re going to see on the price of the commodity is you’re going to continue to see a lot of pain. Then whenever we start to see like we’re turning a new leaf on this Coronavirus, that you’re going to see the exact opposite play out as far as the commodity price. I think there’s going to be a huge, long call play there just on the underlying commodity, but that’s a whole nother conversation. 

Therefore, pool ball number one: you got to have an advantageous price. Pool ball number two: you have to have expanding consumption. 

Not only do you need to have a great price margin from how much it costs for you to pull it out of the ground, and how much you can put it on the market for. When I think of a great price today, you’re talking like $70-80 a barrel, versus how much it costs for them to pull it out of the ground. 

However, you also have to have an economy that is expanding and growing in consumption in order to boost that top line revenue and continue to boost that top line revenue. The reason is you can have the most advantageous price in the world, but if no one’s out there driving their car and consuming oil and gas, all these things, your top line revenue is not going to go up. That’s where it kind of makes it tricky. 

Therefore, when I’m looking at where we’re at today, I see a negative in both of those categories. I see that the price is going down and I expect it to continue going down until we have a change with the Coronavirus. 

As far as the consumption, I think the consumption is going to contract in the coming years because I think we’re in a really bad situation in the global economy right now. The velocity of money, just look at a simple metric like that, I mean, there’s only so many boat tours that these billionaires can go on. The rest of the people are just trying to make it paycheck to paycheck right now. 

I guess when I’m looking at those two metrics, the consumption is not expanding. It’s contracting. Price is contracting. I’m just looking at this as being probably a bad call at this point in time. 

I was just talking to a person the other day that when oil hits $25 a barrel, and you read the headline on the Wall Street Journal that oil is going to go to $15 a barrel, I’m going to buy a two year call option on the underlying oil contracts, right? 

Because that thing is going to rip and it’s going to rip in a drastic way in the other direction once a lot of the Coronavirus stuff starts to shake out. 

However, are we there? We’re not even close to being there right now. 

Toby, I’m kind of curious to hear your thoughts.

Tobias Carlisle  23:02  

I like energy as a sector because I think it’s been so beaten up for so long. I never hear any bullish arguments about energy anymore. The arguments are always climate change which means decarbonisation, so oil and gas is going to go away. 

The fracking means that you’re never going to get those really expensive oil prices again, because as soon as the oil price gets up a little bit, the frackers can make money so they go and start fracking. These companies, mostly that’s shrinking. They are sort of trying to buy back stock and pay out cash. They’re not doing a whole lot of exploration.

With all that backdrop, when you look at Exxon, it is now as cheap.I think on some measures, it’s cheaper than it was at the 2009 bottom or it’s cheaper than it has been. 

On a yield basis, the ton of you buying… The last time you got a really good opportunity to buy oil and gas companies was the early 1990s. That was when Carl Icahn took a run at a few of these and Boone Pickens was harassing these companies. 

When I look at that landscape, I think that landscape looks a lot like this landscape. I think that even though the macro is terrible, these companies do look really cheap. I think that there aren’t a lot of options out there for the economy at the moment. We still are going to be using oil and gas for at least a few more cycles. 

When I look at analogies of industries so twisted pair coaxial cable was supposed to go away with the introduction of fiber optics, but the equipment is so good. The equipment keeps on getting better and better than twisted pair coaxial still in almost every building in the developed world.

I think the same thing happens with oil and gas. We will eventually transition away but we’re generations from doing that yet. I don’t think that carbonization issue is a real one. It’s hard to get real flows out of the shell so I still think that the majors  are really the only game in town. 

I don’t mind it as a position. I’ve got some energy in the fund. I don’t mind Exxon as a position.

Stig Brodersen  25:07  

Thanks for the feedback. I would like to address this with renewables. I guess I might have a slightly different perspective on the Coronavirus than most people. Of course, as a person, I’m terrified of the things that are happening. As an investor I’m, of course more pleased with the more attractive options.

However, if I look at the long term impact, I would say that the long term impact on something like renewables is, especially for a company like Exxon Mobil, significant.

Coronavirus, I think this is a shock to the market now. I think it would go away like we have with other pandemics in the past, but I would like to address the renewables because I think it’s important to talk about that, because we can’t be blind to what’s going to happen with oil, given that we have more and more renewables. 

I think that we have ingrained in us an availability bias. There’s this famous example like, do you think that there are more words starting with K, than having K as the third letter in that word? Everyone, I mean, I’m going to tell you what the point is. But everyone would say, “Yes, I think there are more words that start with K,” because that is what we can think of. 

Actually, there are multiple more words with Ks than the second or third letter, whatever that is. The thing is it’s sort of like the same thing, renewables now we talk about the Coronavirus because it captures all the new cycles. 

Had we done this a few months ago, where Exxon Mobil might have been less attractive, low, but still not as expensive as could have been, everyone would be talking about renewables. How can you withstand that? That’s the availability bias kicking in there. 

Let’s look at a country like the US, a super developed and extremely rich country, with a lot of focus on renewables, a lot of subsidies. More than anyone, they must be more or less not using oil, right? No. 11% of the energy in the US comes from renewables. 

Now we talked about renewables, Toby said before that there are a lot of things that just need oil, at least for the next few cycles, perhaps even longer, because it has some chemical properties that you just can’t replace.

If you look at electricity, which is a part of energy, if you look at specifically electricity, that, in theory, we should be able to get more or less from renewables. How much of that in the US? That’s 17%. 

Hopefully, we’ll be in a place where we don’t need fossil fuels. I think it would be great for everyone on the planet, but I think it will take a long time. 

We have a lot of emerging economies, who need a lot of oil to get just a fraction of the same standard leanness we have in the West. That would need oil, which is also why if you look at any projections of oil consumption, it will go up for a long time. 

What’s going to happen is a lot of that will be shifted to natural gas. It won’t necessarily be shifted to the convention renewables because that’s not the energy that we need, necessarily, at least not for everything. 

Natural gas is something that the integrated oil company *inaudible* and it’s a part of what they already do. 

To your point, Preston, about both a low oil price and a lower demand in the future, I don’t know where the price of oil is going. It does need to go to $70 a barrel before ExxonMobil yields a good return for you as an investor. 

If it goes to $60 a barrel, and it may be a stretch, even though I definitely think it’s possible by 2025, you will get a 16% annualized return on today’s share price of $51. 

The reason why I came up with a 10% return was because I was much more conservative with growth in my projections. 

Now when I look at the demand, all the way back to the mid 80s, there’s only been two years where crude oil demand has slowed year-over-year. That was in 2008 and 2009. 

Already in 2010, it was higher than 2007. The sad truth is to increase the standard of living, both for the developed world and for the emerging world, and also for the people who haven’t been born yet, unfortunately for the environment, we need oil for decades to come. That just hasn’t changed. That’s our response to that. Keep on bashing guys. 

Preston Pysh  29:15  

Alright, you guys want to hear my pick?

Tobias Carlisle  29:19  

Yeah, let’s do it.

Stig Brodersen  29:20  

Let’s do it.

Preston Pysh  29:21  

Alright, so here is my pick for the first quarter of 2020. I am recommending Bitcoin. What are your questions?

All right. Here’s my thesis for this one. Stig, we’ve been talking about Bitcoin since 2015 on this show. I just think that you were at a point in the global economy where reality is starting to separate from fantasy. 

What I mean by that is today, 23% of all bonds in the entire world, which you could roughly say the bond market is nearly $100 trillion, it makes the stock market look like a pimple. 

So 23% of all bonds in the market are negative yielding. When I explain a negative yielding bond to somebody, I say it’s the same thing as a contract. 

Toby, will you sign a contract with me that you give me $100, and I guarantee next year, I will give back $97? That’s what a negative yielding bond is, right? I think there’s around $15 trillion worth of negative yielding bonds. 

When you think about how insane that is that people are literally signing contracts that guarantee them to lose money. Guaranteed you’re signing a contract to lose money. To me, that just does not make any sense whatsoever. 

I think that this problem is not necessarily in the bond market. It’s in the currency market that’s driving this. I think that there is a deep systematic problem with fiat currencies that go back clear to the 1970s when a gold standard… I will even go back further than that.

You go back to 1944 with Bretton Woods. This is when the US says, “We’re going to peg the dollar to gold.” Then all these other nations say, “Well, that’s great. We’ll peg off our currency to the dollar. Boom, we’ll have sound money and we can all conduct international exchange in a fair manner. If you spend more than you raise through your tax revenues, well, then you’re going to pay the price for that, because we’re all dealing with sound money.”

This all worked. The US manipulated their money multiplier, up into the 1970s. Then we couldn’t make good on the gold promissory where you bring in paper money and we will swap it for gold. That all fell apart. 

When the US came off the gold standard, interest rates were extremely high. They continued to go higher into the early 1980 or 1981. The 10-Year Treasury peaked at 16%.

This was the point where, even though you come off of a gold standard, you can continue to make your economy progress forward without any incident as long as you have positive interest rates. 

Well, what happens around the globe was everyone starts manipulating their they debase their currency in order to create growth inside of their domestic currency. Long story short, you have that progress for 40 years until all interest rates start approaching zero and now they’re even going negative.

There’s an incentive now for people to take their cash and stick it in a safety deposit box, because they’ll get a higher return than actually negative yielding percent. 

That’s why I think we have a major systematic failure of fiat currency, not just in the US, but globally. When I then look at how is that going to be solved and are countries incentivized to solve it? 

I think the game theory on countries solving this is there isn’t any. They have no incentive to solve this. They have an incentive to manipulate their currency even stronger than the country standing next to them. 

When I look at that game theory that everyone’s incentivized to devalue their currency so they can manipulate and create growth inside of their own domestic country, I say, “Okay, is there something that is decentralized that could potentially fix this or peg this?”

For me, that’s Bitcoin. It’d be really hard for me to get into all the technical arguments from how the technology works for a discussion like this. Though for me, I’ve done a lot of homework on that, how it works, the network effects that take place, and how it will ensure that there’s 21 million bitcoins in the future because of game theory and all the participants wanting to keep that number fixed because they’re incentivized to keep it fixed. 

What you effectively have is digital gold through Bitcoin. The reason I think that it’s really advantageous to own it right now, as opposed to any other point in time. I think right now, you’re at a very unique time where you’re two months from the next four year halving cycle which happens inside of the Bitcoin protocol. 

Once that halving event takes place, the miners that mined Bitcoin, it becomes twice as hard for them in order to mine the same amount of Bitcoin, they get half as much Bitcoin for the same amount of work that they were doing. This drives the price up.

The two other four year halving events that have happened in the past one back in 2016 and the other one back in 2012, it has driven the price like wildfire post having typically taken about a month or two after the four year halving event for the price to start going crazy. 

After the halving event, it typically goes crazy for, call it another 460 odd days. With that on the horizon and coming up with everything that’s happened globally of the economy right now, with all the negative interest rate bonds and there really being no incentive to hold it such as security. I think Bitcoin is going to have a meteoric rise by the end of 2020. I think it’s going to have an even bigger rise in 2021. That’s my narrative. 

I’m really curious to hear your arguments or your questions or whatever you got.

Tobias Carlisle  35:15  

I’ve got two quick questions. One: why Bitcoin and not something else like Ethereum? Because I understand that there are a lot of other things being built on top of Ethereum. 

The second question is, if you know that there’s going to be such a huge run in the future and presumably, this is pretty well known in the market, why isn’t that information already cooked into the price? And so, because when I looked at the chart, it looks like it’s had a pretty… I think it got down to 6,000 to 5,500. Now it’s 8,500. 

If I look at the charts, it had a pretty good run recently. 

I just wonder whether everybody knows that’s what happens if they’re already baking that into the price and front running it.

Preston Pysh  36:00  

What a lot of people don’t understand about Bitcoin is not only do you have the four year halving event, which is what most people talk about, but you also have a thing called a two week difficulty adjustment. 

My opinion is a lot of people think that these are two separate things, but in the way that the protocol functions, these two functions inside of the protocol work in harmony. After the four year halving event happens, the difficulty throughout the rest of the next four year cycle continues to get harder throughout that four year period. 

At the very end of that four year period, you can make the argument that the difficulty is at its extreme level, from the start of the four year happening. When you pull up a price chart, I’m talking more about the last four year cycle, right? 

What you saw was the price in 2017 hit fever pitch at like 20,000, but what happened is you had all these miners that were buying capital expenditures to put more mining rigs online and over the next year, because the speculators basically peaked out. You couldn’t get your neighbor to start buying it because they’re like, “Hey, that’s crazy, it’s going to go to zero.”

You can only grab so many more speculators on to drive the price during the four year cycle, but what happens is with that two week difficulty continuing to ramp up, it gets harder and harder and harder for those miners to capture that spread from their electrical cost to the price that it was trading at when it was 20,000.

They keep buying and buying trying to capture that huge margin, but what they do is they actually drive the price down to what I would call, and I’m sure many people would roll their eyes and hearing this, is an intrinsic value that’s being calculated through… I don’t know if you’ve ever seen this Plan B article. 

I can send you an article and we’ll have it in the show notes where there’s a calculated value of where the price is basically swinging to… it’s almost like you’re pulling a string in a direction during this four year cycle where it swings really abruptly and it swings back the other way. Then it comes to this equilibrium, intrinsic value price. 

For today, in the four year cycle that we’re currently experiencing, that’s around at $8600. That’s exactly where it’s trading today is at $8600. 

If you want to try to pull that price higher, let’s say you had a billionaire come in and buy a billion dollars worth of Bitcoin, the price is obviously going to get bid, but then you have so much mining power that’s sitting there, that’s going to mine the living heck out of that as fast as they can. 

Then because of the competition it drives and because they have to sell their Treasury of Bitcoin, they have to sell that back down into this equilibrium price until the next four year halving event.

Tobias Carlisle  38:36  

How do you arrive at that intrinsic value?

Preston Pysh  38:39  

Well, so it’s kind of interesting. He has an entire article on it, I’m not going to do it any kind of justice on how he’s actually determining this.

However, just to give people a heads up, after the next four year halving, the intrinsic value bumps to 100,000 from where we’re at today at 8,600. It bumps up to 100,000 after May. 

I know this sounds crazy but this model has a 95% R-squared value over the last decade. It’s cointegrated, which means that it’s statistically proven that the price based on the stock, the flow model that he’s coming up with the intrinsic value with is a cointegrated model, meaning that it doesn’t step outside of a certain range. That has been statistically proven over the last decade, with 95% R-squared value. 

Tobias Carlisle  39:28  

It’s not the cost to mine. It’s not some derivation?

Preston Pysh  39:32  

With the sock the flow model, it is a derivation that comes out of the gold markets and commodity markets. What it’s doing is it’s looking at how much stock is there in complete existence today, right? Then how much flow is being dropped into the market on whatever rate you want to use, whether it’s minutely hourly or yearly? 

That stock to the flow rate drives the price to a certain intrinsic value point. So whenever it goes to these four year halving events, that stock to flow tightens like a noose to a much higher level, which then drives the intrinsic value of it higher and higher. 

I think that this was done on purpose for these long four year periods. The reason that I think that they were done on purpose was in order to allow entrenchment into the existing financial rails in order for this to become global money. 

Toby had another question here, the question about Ethereum. What I would tell you one of the reasons that Bitcoin has not had any hacks since the protocol has gone live… Now you’ve had exchanges that have been hacked, which are completely different. That’d be like, if I was going to use an analogy, that’d be like saying, “Oh, Amazon was hacked,” but the person would say the internet was hacked, right? 

Those are two very different things. Bitcoin has never been hacked. Exchanges have been hacked. 

With Ethereum, you have a protocol that, first of all, does not have a proof of work mechanism to it, where the energy cost is driving the valuation. They have what’s called a proof of stake. 

I think this is a severe limitation that prevents it from having the network effect and the price that you have with Bitcoin. 

The other thing that I think is kind of an issue for Ethereum is they have gone through many forks, historically, because there’s a lot more attack vectors inside the protocol because it’s a lot more complex. 

Bitcoin has tried to keep the fundamental layer one protocol extremely simple that any type of expansion is built on a second layer, call it *inaudible*, which happened in the summer of 2017 timeframe, which allowed layer two transactions and basically a layer two network to ride on top of the Bitcoin protocol.

Stig Brodersen  41:39  

I remember when Preston and I started covering Bitcoin. I think we already did that back in 2014. It was pretty early. I remember reading a book about it and I was very fascinated about it.  

Preston, as you know, is much smarter than me. He took a position and I said something like, “It’s the stupidest thing I’ve ever heard.” 

Then at a later point in time, Preston more or less forced me to buy Bitcoin. That’s when we became good friends. So take it for what it is, when you hear what I have to say now. 

I remember back then when we looked at Bitcoin, everyone was talking about Metcalfe’s Law at the time. It was originally presented back in 1980. It was all about how to measure the value of telecommunications networks and how that’s proportional to the squared number of connected users. 

Since then, Facebook and Tencent have shown this progression using Metcalfe’s Law. Until then, yes, there were some deviations from a long term trend, but it was quite evident what it was. 

Now, Metcalfe’s Law would say that here beginning in 2020, we will have a price more than 41,000. Actually, from 2019 to 2020, it will go from the beginning of the year from 21,000 to 41,000. Now, we’re looking at the end of 2020, $74,000. 

When I’m looking at that, I’m thinking back at my statistics classes many years ago. I’m thinking is it so that someone would have an incentive to say, “How can we come up with a model with a high R-square, so I can ‘sell my product,’ whatever that product might be?”

I’m looking at it and I don’t hear a lot of people talking about Metcalfe’s Law right now, because it seems to be broken since the end of 2017, where the price should be $10,000. However, I hear a lot of people talking about the stock to flow ratio, because the stock to flow ratio model explains that it will go up now. 

Now the R-squared for that is higher, so is that what we’re looking for? Then specific to what I’m talking about the halving. I speak to a lot of people and I know I might be biased in terms of the people I speak to. Everyone talks about the price having to go up because of that halving. 

I’m thinking, how is that price set? Yeah, we know that price is set with demand and supply. That’s true. If you say, well, it’s going to be happening, so it’s going to be less supply. It’s like the two second analysis would say, “Okay, then price would have to go up?” That is true.

However, consider this: the price we’re looking at right now is those people who are willing to make that trade. You have someone who’s willing to buy and you have someone who’s willing to sell. 

Okay, so how many people despite that the supply might be half, how many people are willing to sell now that everyone expects that it may go up twofold or tenfold?  

For me, that’s something that I missed in that conversation. I don’t know if we are at a stage where we have to acknowledge that Bitcoin can coexist with the conventional financial system.

It may not be a part of the conventional system. There’s always a need for something like Bitcoin because of the properties that it does hold, but perhaps that utility is not higher than what more or less is right now with some fluctuations. 

Perhaps despite of what the stock to flow ratio model would tell you about what happens to the supply, and then what should happen with demand and the price should go up, perhaps that’s just not valid for Bitcoin, despite what the model says, because the models are just trying to measure what we’ve seen and not the reality. I know that there was a very low argumentation for my concerns about Bitcoin.

Preston Pysh  45:23  

Because the models are looking at historical information that it might not be valid moving forward. Is that the argument?

Stig Brodersen  45:27  

Yeah, that’s in short my argument. It’s harder, like all the models, you have subprimes in 2008. They said there was zero chance of default, because more or less, no one defaulted. However, there was a mistake in the model. 

There was a mistake in the model that said, “Okay, so since no one defaulted, it doesn’t really entail any risk.” There was just because it didn’t occur until that. That was my argument with yes, it makes a lot of sense why you would have something that’s useful in something like Bitcoin. There’s utility and not having is regulated. There’s utility to have something outside of the conventional financial system. 

Perhaps the utility for that is not more than $200 billion. Perhaps it’s not even comparable to the major currencies. Perhaps it’s not comparable to what you see in the bond market stock market. 

The price of gold perhaps is just a very different asset, where you can still explain what happened historically, but it’s just not valid moving forward. I guess that’s what some of the things I would like to hear your thoughts on.

Preston Pysh  46:22  

The reason I think that it’s very valid is because right now, if I compare it to another currency, and that’s how I’m looking at it as it’s a currency, there is no fixed monetary baseline of any currency. 

In fact, you’re seeing the baseline of every fiat currency getting debased at probably the fastest pace you’ve ever seen it in history and in our lifetimes. With Bitcoin, the numbers are fixed at 21 million coins. No matter what you do, that has to be fixed. 

I think that there’s going to be a lot more people in the next two years that are going to start demanding money that has a fixed monetary baseline based on the printing. I mean, look at what’s just happened with the Coronavirus in the US. They’re really not even talking about a cure. They’re talking about what the Fed can do in order to cure the Coronavirus.

To me this is nuts. It’s absolutely somewhat unfathomable. And so, when I think of people that are holding their money in fiat, versus something that has a fixed monetary baseline, I think that the fixed monetary baseline is going to win all day long.

Tobias Carlisle  47:27  

I have two quick questions. One is how has Bitcoin performed in this recent route, as the markets are getting beaten up, because of Coronavirus.

The arguments for Bitcoin, I find them all very compelling. The problem escaping from fiat currency being short all of the world’s money printing and so on. There are other ways that you can do that. You can do that with gold, but I think that Bitcoin does a similar job to gold. I think there’s a good argument for it. 

The issue that I have, and this is where I’m always struggling is I don’t know, if it’s, I don’t know, $8,600 is the right price, or if $860 is the right price? I don’t want to be getting one Bitcoin at $8600. 

Thinking that we’re going to go through all this money printing, and be like the people who bought gold at the very top in 2009, thinking that they were about to get a hole or whenever the exact peak was and thinking that there’s going to be a whole lot of printing. That’s going to be *inaudible*.

Preston Pysh  48:24  

Whenever I look at the comparison of Bitcoin and gold, the first thing that stands out to me is if you received the gold bar, how would you know that it’s actually gold? How would you know that the whole gold bar is gold? You have to melt it down. You have to do all sorts of a whole process in order to know that it’s 100%, solid gold, right? 

With Bitcoin, you just run a full node and you can actually do the exact same thing to know that you received 100% real Bitcoin. I know that that sounds really goofy for people that are looking at this as being literally a digital unit on a network. Like how can you compare those two? 

You could send somebody what looks like Bitcoin, right? to their hardware wallet or to their address, but you can quickly see, is it running on the version of Bitcoin that everyone values the network of Bitcoin that everyone values? Are they running it on some Bitcoin gold network? That is not the same thing, right? 

So you got that, if you’re housing gold, you’re storing it. If you are buying an ETF, you are trusting that an agent is actually holding the gold that they say that they’re holding. 

With this, I can just take physical possession of it, and I can know that I absolutely, positively have that purchasing power in my hand. You can’t go to Starbucks and spend an ounce of gold.

Tobias Carlisle  49:50  

What if a flood knocks out all of the telecommunications infrastructure? Does that prevent you from spending it or what happens in that scenario?

Preston Pysh  49:58  

If you get in a situation, let’s say your internet service providers, say the government wants to step in and stop the internet service provider in the United States, right? You can still sink to a Bitcoin satellite that a company called Blockstream has actually put into orbit. You can still mine You can still conduct transactions. 

There are people with high frequency HF antenna radios. They have already been coded that you can transmit over a high radio frequency, your Bitcoin transactions. 

I think the bigger piece to all this is, if a country would do that. Not every other country is going to do that. You have to have global 100% participation across every single country to try to block this. 

You’ve already got countries like Germany, and I just saw something in Australia literally this morning, that are actually going out of their way to pass Bitcoin cryptocurrency laws that incentivize industry to come to their countries in order to set up shop. 

You then actually almost have the exact opposite thing actually playing out right now. Because I mean, think about it, if this would become a global currency, the person who has the most of it is going to have the most influence moving forward. 

Therefore, I think that you’re actually going to see, maybe the exact opposite things start to play out with some countries. Ray Dalio is really famous for saying, “Hey, show me a security that has zero correlation and that has a high Sharpe ratio, because that’s the holy grail of an investment.”

When you look at Bitcoin over the last 10 years, there has not been a single security that has outperformed it on the Sharpe ratio. Not a single one for 10 years. When you look at the correlation, the correlation to the S&P 500 and so when you look at correlations, -1.0, means it moves in the exact opposite lockstep. A 1.0 dot o means they literally move hand in hand together. 

Bitcoin to the S&P 500: 0.00. Gold: 0.06 correlation. Silver: negative, 0.05 correlation. US bonds: negative, 0.05. Oil: 0.12. Russell 2000L 0.01. It’s correlated to nothing, like literally nothing that is correlated to.

I would argue that the reason it doesn’t have any correlation is because what’s driving the price is the stock to flow, before you’re having a cycle in harmony with the two week difficulty adjustment. It’s absolutely driving the price action to date. 

Now whether that’s going to continue to happen moving forward to 6.0. No idea. But I can tell you, I’m not going to sit back and watch something with that kind of literally the best performing asset in the last 10 years. I’m not going to just sit back and have no exposure to that. 

In fact, I would argue that a fiduciary, if they have no exposure to it, should maybe be questioning how they’re a fiduciary because you’re at the point now where it’s made so much money in the last 10 years. If somebody would continue to sit back with zero correlation to anything with the highest Sharpe ratio that we’ve seen in 10 years to have zero exposure to something like this, it’s maybe negligence.

Risk wise, you’re looking at this thing, the volatility on it is insane. Think that annual volatility on it is something like 66% on our momentum tool. That’s insane. 

How then do you manage volatility risk with your exposure size, right? You could have had in the last four years, if you took the last four year period, and you had 1% exposure to Bitcoin, and 99% in cash 1% in Bitcoin and 99% in cash, you would have matched the performance of the S&P 500.

Stig Brodersen  53:59  

Now we mentioned Ray Dalio before. He was asked about Bitcoin at the Davos meeting on January 21. At the time, he said that he warned about holding Bitcoin because it’s not a medium of exchange, nor a store of value, which I found very interesting in itself. 

The other thing is I 100% buy your argument, Preston, whenever you say, you get a bar of gold, how do you know if it’s real? Then you compare it to Bitcoin and say that’s real. 

That’s the purpose of the blockchain. It can validate that, which we can do not just with Bitcon, but with so many other things now. 

I’m going back to Metcalfe’s Law. That was I was so excited because I understand the rationale behind the stock to flow a month and perhaps that is the driver going forward. 

I’m thinking: do we have enough people who believe in this and that’s why I was so concerned when I saw that breakpoint in terms of price still following that line. Do we have enough people? Is it expanding enough that enough people believe that this truly is the value of Bitcoin? Is that truly the utility of Bitcoin? Because without that, what is the driver moving forward?

Preston Pysh  55:07  

The thing that’s driving it is actually greed.  I think that human nature is actually driving the abrupt price jumps.

After the four year halving happens, what you’re really doing is you’re limiting the number of sellers that were driving the price near the tail end of the four year cycle. As soon as that four year halving event happens, it’s basically nudging the price in a very abrupt way, based on the electrical costs, these miners and what they’re going to demand for their electrical costs that they have. It’s going to drive the price up.

I expect to see this at the end of 2020, where the price starts to run away, then what I think you get is you get speculators that come in and they see, “Oh, my god Bitcoin is up 300% this year,” and then they pile into it.  

I think that that’s what drives it through that last part where it passes through this stock, to flow and intrinsic value. When it passes through that those are the speculators that are driving it. 

Then I think the reason that you don’t see sellers in it is because you have people… Imean, when I talked about this in 2015, it was $220. I took a position. Now it’s at 8000. So that position, and there’s many other people that have taken positions in 2012, 2013, and 2014. 

They’ve locked in such massive, unprecedented gains, that if the price goes to 15,000, back down to 8000, they’re so far in the money from where they initiated their position that it’s somewhat laughable to even think that they would be sellers at that point. 

What I think you have, and there’s some charts out there,  I don’t remember where I saw these charts. What it does is it shows the number of people that purchased and it shows how far in the money they are based on the movement of the Bitcoins on the network. 

All this can be calculated because you can look at every single public address, right? So you can see bitcoins that haven’t moved since 2013 to 2015. They’re stagnant. If you’re removing those sellers out of the market, because they’re so far in the money, that lack of sellers, that lack of person selling is driving the price higher in the next four year cycle is why I guess I think that that’s why you’re seeing the dynamic play out. 

However, the real answer is nobody knows. There’s something that has driven it in the past, I expect to see something similar play out because there’s been literally no change to the protocol. I kind of expect to see that dynamic just continue to play out through the future having cycles until I guess it becomes global money. 

I think it’s a fascinating thing. I think that it’s one of those things that if you are a naysayer, and you think that it’s crazy talk, well, then just ignore it. I mean, you don’t have to have exposure to it. 

If you think that some of the arguments make sense, I would tell you to give yourself .01 percent exposure, if you think that the volatility is just so much risk, just so you can have fun watching the crazy wild ride. 

Though I’m at the point now where I think that this is going global. I think this is a mainstream thing. I think that when you turn on CNBC, and you see people talking about it literally almost on a daily basis, I think it’s actually becoming a real thing. I think it’s something that people should really do their homework on.

With 60 odd percent volatility, if you don’t understand it, you’re going to lack the conviction to stay through the wild ride, because you might have a 20% swing in a day. So if you don’t have any type of conviction or understanding of why it would potentially become a global currency, you’re going to sell the position. It’s not going to work out well for you.  

I’ve really encouraged people to do your own homework. Challenge everything that I said. Don’t believe anything that I said. Just try to do your own homework and understand it. Then maybe that will allow you to look into it more. Maybe you do take a position.

Stig Brodersen  58:56  

Preston is usually right. I think last time he pitched stamps.com. Since then they went up from 46 to, I just checked $141. I think that should be like the norm going forward. We would expect at least triple going forward with your picks from quarter to quarter.

Preston Pysh  59:13  

You want to hear my price prediction because I’m saying it’s a buy right now. I’m expecting this is how much I think this thing is going to move. I’m expecting 20,000 at the end of this year 2020. I’m expecting 200,000 at the end of 2021 is my price prediction on Bitcoin so we’ll see what the heck happens. I know that’s a very absurdly bold call. I hope I’m right. Wish me luck. If I’m wrong, make sure you throw as many stones as possible to my Twitter account.

Stig Brodersen  59:43  

Alright, and if you’re right, it definitely pays off to have a good friend like you, Preston, who would force your friends to buy Bitcoin. But if you want to have our stock pitch sent directly to your inbox, you can do that completely for free and you can just sign up and TIPemail.com.

We also do a show right up of the current conditions. If you are interested in hearing more stock pitches, of course, you can go back and listen to the previous MasterMind discussions. 

I also recently recorded an episode with Toby, where we talked about Southwest Airlines. Since then, the price has only gone down so it might even be a chance to buy into an even more lucrative position right now. 

Really briefly here, Toby, I don’t want to put too much on the spot. How do you feel about Southwest Airlines trading at $46 right now?

Tobias Carlisle  1:00:35  

Yeah, I think it’s very cheap here. It’s a travel related stock and Coronavirus has made everybody throw the baby out with the bathwater, but they’re mostly domestic in the US. I like Southwest. I think it’s the best managed airline out there. I think all the airlines are cheap.

Stig Brodersen  1:00:50  

Fantastic. You can listen to Toby’s pitch at theinvestorspodcast.com/extra. We also have a link in the show notes. You can do a seven day free trial and listen to all of our new extra content that we pump out.

Preston Pysh  1:01:06  

Toby, I know I get so many comments from people just saying they love when you come on the show. You’ve got your own podcast. You got a bunch of things going on. Tell people more about yourself.

Tobias Carlisle  1:01:17  

My day job is running a fund called the Acquirer’s Fund. It’s an ETF, ticker is CIG, long short USD value equities. It’s been getting beaten up in this last little route, but we’re not doing too badly. We’re outperforming on the downside at the moment, which is what the fund is designed to do. I also run a website Acquirer’s Multiple. 

I’ve got a series of books out there, you can find them on Amazon, if you search my name, Tobias Carlisle.

I do a podcast. Different to you guys. But definitely inspired by being on this podcast quite a few times, called the Acquirer’s Podcast. We’re growing pretty quickly. I wish I’d started it earlier. 

Check it out. I have a lot of fun doing and talking to friends of mine who are value fund managers. We just talk about whatever the topic of the day is. 

Stig Brodersen  1:02:01  

Thank you, Toby, for coming on the show once again. 

Alright, guys, at this segment of the show, it’s time to play question from the audience. This question comes from Osman. 

Sender  1:02:11  

Hi, good afternoon. My name is Osman. I’m from the United Kingdom. I’m only 37 at the moment.  I like to think I’ve got a long time left to really sort of sink my teeth into this where to follow Warren Buffett’s philosophy, which is stick money in the market and don’t touch it.

How exactly do you pay yourself? How do you how do you maintain your own personal cash position in terms of your bills, your rent your mortgage, car payments, etc., without having to put down bits of your position or draw down from the market almost sort of profile yourself in a way where you can start to pay yourself on a monthly or quarterly basis to maintain your own personal bills once you see your portfolio grow in value?Thank you. 

Stig Brodersen  1:02:52  

That’s a great question. Warren Buffett has a different approach to why he’s investing. Aside from just enjoying the process and providing for his family. He wanted to compound his wealth and have his wife, Susan Buffett, give it all back to charity. 

Now, sadly, Susan Buffett passed away back in 2004. Warren Buffett later decided to play more than 99% of his net worth to charity, primarily to the Bill and Melinda Gates Foundation. 

Now, you might be saying then, for good reason that you’re not a multi billionaire. So how does this principle of holding a stock forever apply to the rest of us? He would say it’s more than mindset, more than anything else that I suggest you take away from that, quote. 

You want to invest in a company that has such a substantial competitive advantage that you could hold it forever. That is how you should start your investment process. If you don’t want to invest in a pharmaceutical company and plan for them to have a drug approved, then the price of the stock would pop and then plan on selling it off. 

That’s typically not how to think about value investing. Value investing is for the long term. You would want to create a portfolio that won’t be fundamentally changed if the company has a bad quarter or if the company is tanking, which you might argue could be happening right now. 

Then you mentioned that you are 37. I don’t recommend that you spend any of the investment income to pay for household expenses, or similar as you mentioned, before you retired at the earliest. I rather suggest that you spend less than you make to have a standard of living you want and invest the rest in the *inaudible* not to touch it for 30 years or more. 

It’s really the compounding effect that kicks in here. If you decide to wait, now we all have different approaches to how to do this depending on our skill set and personality types. Try and make it as easy as possible for you as you can, which is another way of saying do not consider your investment income as money you have access to before you retire. 

Now if you are set on having investment income before you retire, one solution is to invest in a dividend income portfolio where perhaps 50% to 80% of the earnings are paid out dividends and live off of that. 

This is good, especially if you’re okay with knowing that you might have gotten a better return, if you selected compounding stocks that didn’t pay out a dividend. 

The other solution is simply to sell a fixed percentage of your portfolio every year, say 2%. Treat it as your income. Knowing that the stock market in real terms yields at seven to 8%, you’re still on average compounding your portfolio and have a steady stream of cash flows from your portfolio.

Preston Pysh  1:05:38  

I really liked the idea that you’re touching on here with Buffett’s quote about holding something as long as you possibly can. Like Stig said, you’re trying to buy a company that has just this enduring, competitive advantage if you follow anything Buffett related. He talks about this idea a lot. 

I’m going to read something from the start of the Intelligent Investor, Warren Buffett wrote the preface to the Intelligent Investor, at least the more modern publications of the Intelligent Investor. One of the things that he writes here, he says:

“Whether you achieve outstanding results will depend on the effort and intellect you apply to your investments, as well as the amplitudes of stock market folly that prevail during your investment career… The market behaves, the greater the opportunity for the business like investors.” 

What he’s talking about there is not only do you have to lock in these companies that have these enduring competitive advantages, but you have to seize the opportunity when the market comes along. It doesn’t come along often where it gives you these really juicy prices. 

Let’s just take his investment in Coca Cola, he locked in such a juicy price whenever he purchased Coca Cola, that the dividends that he collects on that investment from way back when he’s owned it for decades. At this point, the dividends that he’s receiving on that principle, are absolutely massive, if you looked at it as a percentage.

When you’re looking at the dividends, at today’s prices, it doesn’t look like that, but when you look at the price that he purchased for that principle, compared to the dividends he’s getting, now, they’re massive. 

If he had sold that position, his capital gains would be massive. So he was able to lock in these really amazing prices, because of the market folly the way that he describes. That’s his verbiage, because of the market folly that he was exposed to at that particular time he was able to lock those prices in. 

I would tell you that it’s both of those things. It’s buying at these really odd, advantageous times where the prices are just absolutely great. He combined with a business that has this enduring competitive advantage, like the Coca Cola brand. 

Just some thoughts to think about. I think that’s what he’s really addressing. If you find that you have a company that you didn’t really get a great price on, the competitive advantage was average, you really don’t have big capital gains. 

You feel like you can plow that money that’s currently maybe sitting in some type of security that represents all those ideas, and you could turn it and put it into something else that does have all those advantages of a great price in a long term competitive advantage. 

I think Buffett would tell you to sell the position and move it into the other pick, but I think those are some important things for people to think about. I think that’s the essence of what he’s getting at with the quote. 

Osman, for asking such a great question, we’re going to give you free access to our intrinsic value course. For anyone wanting to check out the course, go to TIPintrinsicvalue.com. 

The course also comes with access to our TIP Finance tool, which helps you find and filter undervalued stock picks. If anyone else wants to get a question played on the show, go to asktheinvestors.com and you can record your question there. If it gets played on the show, you get a bunch of free and valuable stuff.

Stig Brodersen  1:08:55  

Alright guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro  1:09:03  

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