← Value Investing with Legends
Value Investing with Legends
Robert Robotti - From Pink Sheets to Portfolio Management: Bob Robotti's Value Investing Journey
01:02:23
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- [00:02]
A
Welcome to a new edition of the Value Investing with Legends podcast. My name is Michael Mauboussin and I'm an adjunct professor at Columbia Business School and a faculty member at the Halbrand center for Graham and Dot Investing. My co host, Tano Santos, the Robert Halbrand professor of Asset Management Finance at Columbia Business School and the Faculty Director of the Halbrand center, wasn't able to join us today. It is rare in this day and age to identify investment organizations that employ a classic value investing approach, identifying and investing in securities with gaps between price and intrinsic value, deep fundamental research, and an emphasis on significant margin of safety. Our guest today has not only pursued this intellectual path, he has delivered outstanding returns for his partners over the decades. He has seen it all in markets and is an astute observer of what's going on and where the opportunities may result. What's notable about him as well is that he sits on a number of corporate boards of companies in which he's invested. This allows him to have a seat at the table in the process of capital allocation, both as an investor and as a business person. I am delighted to welcome Robert Rabati, the President and Chief Investment Officer of Rabadi Co. Advisors, a value focused investment firm he founded in 1983. Bob began his career in public accounting and and served as vice president and CFO at Gabellian Company before launching Roboti Company. He earned a BS in accounting from Bucknell University and an MBA from Pace University. Bob serves on the boards of several public companies including Tidewater, Amrep, and is the Chairman of the board of Pulse Seismic. He has also served on nonprofit boards including the Museum of American Finance and was previously on the SEC's Advisory Committee on Smaller Public Companies. Welcome Bob. Thank you very much for joining today and there's just lot of topics I'm really keen to discuss.
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B
Michael, thank you so much for reaching out and this is a great opportunity for me and thank you. Appreciate it.
- [01:58]
A
So great. Let's start at the top. Tell us a little bit about where you grew up, a little bit about your family and whether there are any indications in your youth that you would go on to be a successful entrepreneur and successful investor.
- [02:09]
B
Sure. I grew up in a neighborhood called Ravenswood and it's tucked in between Long Island City and Astoria and Queens. So as I told someone I knew in Garden City on the way home and I met the daughter and the parents were talking to me and said, hey, we know who you are. Your daughter's mentioned us, you grew up in the Shore Right. Was it the North Shore or the South Shore? I said yes. I grew up on the shore, the West Shore. So I grew up a block from the east river, so hardly a shore that you talk about on Long Island. Anyway, that's where I grew up. We lived upstairs. I lived with my great grandmother, my grandparents, my parents, and I was one of four siblings. My grandmother had a dry goods store downstairs. Eventually, my dad started an insurance brokerage business that eventually displaced my grandmother as she got out of the dry goods store business. So I've had entrepreneurs in my family starting businesses. And so it's been an inclination of mine kind of all along, and I guess an intent that I had the opportunity to execute on for investing itself. I really hadn't done investing. That was really not kind of in my belly. Wicked. But that's what really happened. I graduated college with a cpa, and the accounting firm that I worked for was a small firm, 25 people, and the two partners were Pastorino and Puglisi. One of the things they did was audited a bunch of investment firms. And so the one that I spent a significant amount of time on was auditing Tweedy Brown. So here's 1975. It's the opening gun for value investing, becoming known as value Investing. The huge rotation. 73, 74. Market correction, the Nifty 50 stocks. One decision. Stocks didn't matter. The price you pay, you were always going to make money. Maybe there's a rhyme to that. They're down 50%, and then money rotates, and some of it gets into very cheap stocks that have very low valuations. And so whether it was Tweety, who I worked on, eventually working for Gabelli, Tweedy, of course, at the time, did a lot of work with Mutual Shares and Mike Price. So all of the value names from way back when, I knew what they were doing early on. So that was my introduction to investing. So instead of learning the efficient market theory, going to school and getting an MBA in finance, I didn't do that. Instead, I was doing accounting and saw what Tweedy did and how Tweedy did things, and then that was my introduction to investing.
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A
So I'm curious about Tony Pastorino. He's one of the partners you mentioned at the firm where you went to work. And he was both a practitioner, of course, by day, and also a professor in the evenings. Did he play an important role for you coming out of college? And how did you find that? Apply during the day and learn at night.
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B
Balance. Yeah. So Pace University really is. It's an Applied school in accounting. And so it's a great thing. And learning the theory and then doing the practice during the day and reinforcing those two things really accelerates the understanding and education you really get from it. In addition, it was a smaller firm, so I spent some time in the audit department, I spent some time in the tax department. So I did both things. Initially I was thinking about getting my Ms. In taxation. So those were a broad based education in tax and accounting, which reading financial statements and understanding things and be able to ask questions of CFOs specifically. No, no, no, stop. What's the debit and what's the credit? I gotta know what the entry is so I can really understand where you're putting these things in the financial statement. So I can understand what it really is telling me about the economics of the business. So it was a great thing. And Tony was that he is the quintessential accounting professor at Pace Practitioner. So therefore knew what he was talking about. It wasn't out of the books, it was what you do during the day and how it really works. So it was a great education and a great foundation.
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A
So you were exposed to value investing royalty, as you mentioned Twitty Brown and mutual shares early on. What drew you from accounting into the world of investing?
- [05:40]
B
Oh, stop it. I mean, would I rather look at financial statements and analyze securities and buy securities or would I rather tick and foot? Come on. So that's what happened was originally Tweedy, Rat and Riley is the original name of the firm. Joe Reilly had retired. And actually that was kind of critical because when he retired as a partner, he was a 1/3 partner. So he got 1/3 of every security that Tweedy had. So he owned 1,000 securities, you know, all these pink sheet inactive stocks that traded substantially discounted valuations. And he'd come in every day around noon and 1 o' clock and I'd be in the same room. That's where the auditors got put. And so 6 o', clock, 7 o', clock, I talked to him about investing. So Joe was critical in how we did things, what he did and understanding therefore what Tweedy was doing. And you know, in addition, of course to Tweedy Brown, one of the other people in the office was Walter Schloss. Walter Schloss's son is my age, Eddie Schloss. And so therefore I talked to Eddie and actually the first security I ever bought was Technicolor, which is an Eddie Schloss stock and actually wasn't a tweet, treaty stocks, but to See what they did, how they did things and what they owned was an informational, educational process. For me that was phenomenal. And clearly that was a lot more interesting than being an accountant.
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A
One little fun fact is Walter Schloss's granddaughter took my class. So that tradition back to Columbia Business School continues. So how did you find your way to Gabelli and Company? I think Gabelli was quite small. When you were there, how did that work out?
- [06:57]
B
So that's what it was. Tony Pastorino, before he taught at Pace, he used to teach at Fordham. And when he taught at Fordham, one of his students was Mario. So therefore a early student of Tony's was Mario Savelli. So when Mario started his business in 1977, when I guess he was at William Winner, it was bought by Drexel Burnham. He didn't want to work for Drexel Burnham. He went out three weeks later, started his own firm. He needed an auditor. So therefore the Pastorino Puglisi became the auditors. Now I didn't work on the audit, but Tony Pastorino was having lunch with Mario and Mario says, oh, I need a cfo. And he said, oh, why don't you talk to this guy, Bob? So it was Tony's introduction to Mario that was the entry to work for him. And at the time, right, in 1980, when I started to work for Mario, he managed $7 million. The business was predominantly actually a brokerage business, right? Cause he was originally a sell side analyst. And so therefore he had those relationships and therefore had that business. And that was the bulk of the economics. And even when I left in 83, he had only grown the asset management business to $77 million. So it was a small business. And yet since it was a small company, I worked extensively with Mario every day. And so therefore everything he did, not only investing, but also the business operations. And clearly been a successful person and has started and grown a very successful business. But that's what I also say is every day, since it was a brokerage firm, he had a morning meeting and he went through his favorite investment idea and he went through the thesis on it. And so that's what I say. I had an executive MBA program in value investing taught to me one on one by Mario Gabelli. And he paid me to attend the class. I didn't pay him to attend the class. And his approach to investing was value investing also. But there definitely were different emphasis, different directions that he did versus what Tweedie did. So therefore there was also a broadening out of my understanding as to how what this is how does it work and how do you apply value investing?
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A
So you launched Robotic Co. In the early 1980s. What did you perceive as your original edge back then and has that evolved over time? And what, when you think back, were there any formative like wins or losses that you still think about as you were getting going?
- [08:54]
B
So the niche that we did so Joe Reilly had a thousand pink sheet stocks. So we had access to the information on companies and Tweedy had been grown successful. So by 1983, right. The assets under management had grown dramatically. Their ability to compete in this end of the business no longer existed. Well, it existed, but people followed those in. They were in the same stocks and we didn't move the meter anymore. When Tweedy could buy a thousand shares of Martin Corporation, it wasn't going to do anything for their performance. So Tweedy was kind of moving away to do something a little different in the meantime. That opened up the opportunity for us to do what Tweedy had done been successful at before. So it was an entry point in a place where there were securities that were really interest and those securities were cheap securities. So therefore net net working capital, I'm an accountant, I could calculate that and therefore I could identify cheap stocks, because as you did, we bought all these cheap stocks.
- [09:46]
A
Bob, one thing I want to do is make sure that our younger listeners. You've said to use the term pink sheets a couple of times with my gray hairs. I know what you're talking about. But can you tell the audience what pink sheet stocks were like? What was that mechanism and what happened to that and all that?
- [10:00]
B
So securities that weren't listed on NASDAQ on an exchange still traded over the counter. And it was a relatively large market in a significant portion of the market. And what happened was every day the pink sheets would come out and they were these long sheets of paper that were pink in color. And on it would list securities in alphabetic order and it would list the broker dealers who would make a market in it. And if they had a bid or offer, there would be an indication, of course, those prices you held to them because obviously they're subject to change. But it had this extensive information on all of these over the counter securities. Generally, these securities are companies that were established and operating and sold securities before 1933. And so there's the 33 act where everybody has to file if you're going to issue shares, therefore you're SEC registered and all the compliance you need to do on an ongoing basis. So these companies largely had come to existence before that. And as time went on, the ownership of those shares started to get more fractionalized. And so therefore more of them kind of came into the hands of the public. And so therefore there was an increasing number of companies that were not SEC filing. And so when people ask me, what's a public company? Sometimes I used to say, I don't know what a public company is because, you know, if you're talking about SEC filing and disclosing, that's one thing. If you talk about it does trade over the counter, that's a different thing. And so there's a different subgroup of companies. So those companies tended to be smaller companies, much smaller market caps. Frequently there's a control shareholder family families that control those companies. And so they had. The dynamics of the businesses are different than a lot of publicly traded businesses also. But there were very many of these companies that were extremely discounted. Given there is no public market, people don't care about them. They were less liquid at the time. So therefore there were a lot of opportunities. And in John Train's first book on value investing, the chapter on Tweedy Brand is called the Pawn Brokers, because that's what it is. They bought and sold all of these odd securities. Now, of course, it only wasn't them. There was another company, car securities. It was at the company Herzog, Heine Gadul, who is Max Heine, who is Michael Price, who is from the same background of they were all in the pink sheets in a big way. So those other firms were also very active in that market. And that little sub segment was where we then began our business. And that's what happened was so we bought cheap stocks. And of course that's what happens when you buy cheap stocks. You find out that a lot of stocks are cheap for a reason. And that's because they're crappy businesses that you really don't want to own them. They're not in good investments. And so a lot of things did not work out. But of course, what I did look at is, okay, so what did work out? And clearly that subgroup is an area that a lot of people were interested in. So as I mentioned in like 1983, I went to the annual meeting of, I think it was RO Vending machines in Cranford, New Jersey. And who's there but Nelson Peltz and Peter May try to get control of this company, which they eventually did. It was the beginning of what they formed. So I bump into them when nobody would have known who they were. One of the other companies that we identified in 86, 87 was Fillcore, which was the restructured Baldwin United, which had gone bankrupt and came back out as Fillcore, which Leucadia national had gotten control of. And therefore I met the people at Leucadia national and that's Ian Cumming and Joe Steinberg, who have had extremely successful record investing in public companies where had the advantage of the market's efficient, but it really wasn't. And it was substantially mispricing securities and gave them the opportunity to acquire portions of the business, had very discounted prices that were part of the original Leucadia success in terms of how they compounded value. So seeing people like that who were getting control of these companies and what they did and therefore being able to take advantage of that and invest alongside was something we did. And then the other thing we did was a lot of the businesses also were cheap and out of favor because the business was going through a difficult time. And that's what's really happened over time is that's the portion of the market we continue to focus on. There always are businesses that are performing poorly. When a cyclical business is in a poor state and poor situation, it doesn't make money, maybe loses money. People don't own stocks that don't make money. And so we think there's a huge opportunity to invest in those businesses through the down cycle. And that's in large part what we do today.
- [14:07]
A
I do want to shift to investment philosophy. And you've argued that public markets are often dominated by narrative and momentum. In the short run, for sure, but. But the fundamentals ultimately prevail. So how do you define intrinsic value today? I assume there aren't as many net nets around, for instance. And what's your discipline for underwriting through a cycle? You mentioned sometimes you have to ride things through a cycle, especially when that weighing machine tends to run on delay.
- [14:32]
B
Every business is the present value of the future cash flows. And of course the future cash flows in many of these businesses are very difficult to come up with. And so that's what it is when we do look at them, there's a large margin of error that we assume into those numbers. And so therefore we're buying at what we think is an extremely discounted valuation based on what we think is a normalized earnings of the business. And frequently normalized earnings of the business is predicated on what's the replacement value of the asset. Those are assets that we have the expectation the business makes sense and therefore will need to be replaced. Therefore that's A mechanism for pricing out where the profitability of this business should be. So the famous Graham line, of course, is you want to buy a dollar for 50 cents. And what we think is actually in buying these businesses, we think we frequently buy businesses for 20 cents. Now the problem is, when's it going to be worth a dollar? And that's the uncertainty. And more likely than not, it's going to be longer than when we would hope and expect the manifestation of the earnings. Because businesses trade not on asset value, they trade on earnings, power assets potentially lead to what its earnings potential is. And so that's the critical fact of how do you figure out what we want to do? And we're not calculating discount, but we're saying, gee, if we buy a distribution company at two times what we think normalized EBITDA is, we think that's a very discounted price that we're paying for that business. And if we are wrong by an order of magnitude of 100%, we still think that that's really going to be a good investment over time.
- [15:57]
A
So you've emphasized too the rise of passive investing, which really wasn't a big thing when you started Roboti back in the day, and private equity as well. Private equity had little pockets of it, but really didn't go till legitimately the 1980s. So you've argued those things have sort of created opportunities for active fundamental investors. So where are you seeing current mispricings? Are there kind of business models today that you think present opportunities that fit kind of what you guys look for in an investment?
- [16:24]
B
So when I spoke at the Grants conference last November, the talk was based on zombies investing in zombie companies, right? Because people talk about the Russell 2000. It says it's a terrible index because you got half. The companies don't make any money. A lot of them are zombie companies. And that's what we think is that's where the opportunity is a bit. Business that isn't making money has no prospect of making money. And you can buy things for 20% of what it cost to build a business, because no one would build a business or want to own the business because you're not getting a return on it yet if we have conviction that that business has a critical service or business in it, that therefore we think that that capacity will unearth at some time. So another talk I gave was called Value Traps Unchained. So we frequently invest in companies that are value traps and it's a value trap because the assets probably are worth, but they're not generating Anything and you don't know when it's going to happen. And we're not activists to therefore try to force something to happen because we think frequently you can't force something to happen because it really is a fact of the cyclicality of the business and the portion of the cycle it's in. It just doesn't have that capacity. No one wants to step in to say I want to buy a lumber mill in Canada today. And so yet we think you could buy a lumber mill in Canada for far less request to build that. And we think that lumber is a critical building product and that therefore there's a normalized home building activity that we think happens sometime in the next couple years. And that means there's substantially more activity, more demand for lumber. And in the meantime you have an industry that is shutting mills permanently. Shut the mill, sell off the land, it's gone, it will never restart. So capacity is coming out of the market, adjusting the level of supply that it can deliver to less than what the normalized demand for the market is. So that our mind not only gives mid cycle earnings potential for an extended amount of time, it probably means there's outsized earnings potential for some period of time that will generate when supply, demand get to the point where the supply is probably short the demand. And so those are the kinds of things. And yet today, of course, why would you buy a thing that's losing money because prices are below, break even shutting mills and it's Canada and it's lumber and you got all kinds of tariffs going after the thing. So it's got all these things that are all definitely bad news in the short term, but we all think in many cases transitory and largely the lumber tariff in my mind. See, God put the trees that are spruce, pine and fir in northern parts of the continent and a lot of those are in Canada. So he planted him there, he didn't plant him in the south. And so there's a different type of tree that grows there that makes a different type of lumber. And you and I, I don't wouldn't know a piece of lumber if it hit me, but it would hurt, but I know that. But other than that, I don't know what. But there is significant differences between different pieces of lumber that do different things. And therefore the substitution is really not available between those things. So that will dictate over time what happens and therefore where the demand will be. And then therefore, what's the cost to build new capacity? Because you'll probably need new capacity because we Won't be able to supply the normalized demand in a normal building environment.
- [19:16]
A
So again, going back to sort of indexing and buyouts and buyouts historically had been small cap value type of stuff. Has that changed the opportunity set from your point of view or do you still find plenty of things to do?
- [19:27]
B
No, we think there's plenty of things to do. Well, actually, I am baffled. Private equity, it wasn't called private equity. It used to be called lbos. And what LBOS started out as an industry was there were public companies that traded far below what they were worth. Smart people identified that, got control of that business, levered the business up to therefore increase the equity returns and therefore did things that unearthed the value of the debt. So accelerate the realization process in that process. That's what it was. And the returns they made was predicated on the amount of money, the gain that they realized, and the override that they get for managing their process today. That's not what private equity is. Right? Private equity is an asset accumulation business. The incentive fees continue to come down. Of course they are. Because they realized we're not going to get that much incentive fees anyway. I'm building a fee stream of 200 basis points plus in the expenses I do over time. So it's an asset accumulation business. So people putting money into it, how do you think you're going to get great returns with huge costs, lack of liquidity and a business that they're really looking just to have more assets under management. And we would argue that private equity today is a relatively efficient market. Businesses sell at fair value and actually above fair value because it sells to the highest bidder. And so therefore to win a company in the private equity business, you need to pay more than everybody else and they're all informed people at that table there and leverage it up. And of course, the leveraging it up means the equity component in a difficult environment is problematic. Conversely, you have the public companies which we think trade for multiples that are half the multiples of what the private equity is paying for businesses, frequently unlevered businesses, so therefore have a balance sheet that gives them the ability to withstand any issues. So therefore you don't have the financial risk. You pay a fraction of the price. You can buy and sell any day you want. You don't have to be in it for they tell you when to get it, or you sell it at a discount off the mark price, who knows? And that's a lot of companies, right? You've had the number of public companies go from 8,000 public companies to 4,000 public companies. And so that is definitely part of that process of this money moving to be managed by this group of people. That is a very high cost, high price paid as opposed to the public market giving you all kinds of flexibility, much lower prices and better balance sheets.
- [21:34]
A
So Bob, do you take on the specialization versus generalization? In other words, how is research structured at roboti? Do you like sector expertise or are you happy to have more of a generalist model where people can go where the opportunities reside?
- [21:45]
B
Well, you wouldn't know it in looking at my 13F, but I would actually say that we're generalists, we are not industry specialists. And so we are really looking at any business in every business and trying to find out businesses we think are substantially mispriced in the public market. And when we get new industries all the time because different industries get out of favor. And so in the 2004, 5 and 6, we started to invest in the manufactured housing business. So hadn't done building before, didn't do single family, didn't do manufactured housing. It was an entry point and we learned about the business. And then in 09 we bought the builder's first source a distributed of lumber, lumber sheet goods to the home builders. So again, the home building business and all of those things of course over time have meant we've actually built up, we think a reasonable amount of knowledge and information about the home building business and the various aspects of it. And then we do think we have a core competency in that. And a lot of what we do own is in things that are adjacencies or close by, that we think we understand the businesses and we think there's a substantial misunderstanding in the public markets in terms of valuation. So that is an industry that we do a lot in, but we'll look at really any business. So we think generalists. So energy is something I do because energy is a always historical business that always goes through periods of times, it always has opportunities when things are substantially discounted and therefore a new entry point for a business like that. So yes, we actually there's a number of businesses that we are invested in that we do think we have a core competency, but that actually came from originally knowing nothing more than the next guy but just looking at a business. So we do describe ourselves as generalists in spite of what the facts may say of some of the conclusion you might reach.
- [23:20]
A
So I want to make it super clear on a couple points. One is just sort of the quantitative metrics you look at I mean, I think you've ticked off a few of them, but sort of free cash flow through a cycle, replacement costs versus market cap, reinvestment opportunities, normalized margins. Are there sort of a list of things that you like to see and understand before you make an investment? And where can the spreadsheet mislead people? If they put in all those numbers, where do they get it wrong?
- [23:41]
B
I don't have a spreadsheet. And that's what it is. It's almost like it's on a piece of paper. And that's what it is. We want it to be simple enough to. It's not a sophisticated thing. We definitely are not calculating it to the fifth decimal point, that's for sure. And a lot of it is so in distribution to the home builders. So Builders First Source. And then what happened was another company had gone bankrupt, came out of bankruptcy, and from following Builders First Source, we saw this one coming out of bankruptcy and we went to the management of the company. The management of the company was interested in having new shareholders come in and take it out because it never re registered, never relisted. And most of the shareholders were the banks who were originally the lenders. And so the banks had no interest in being a shareholder in a company that was in a weak part of the cycle. Not weak. It was a depression, right? There was home building activity in 0809 was less than it's been in 50 years. And so we got the right to accumulate 22% of one of the competitors. And when I looked at these companies, you can't say, well, if you look at the historical method, when they're at this level, they could do this level. And then the revenues are this. And the margin, no, it's actually a fresh piece of paper that you're kind of thinking as, okay, so what would it be? What are the numbers? What do you think revenues could be? If you have a million home starts, then you should have about this amount of lumber that you're going to need. So therefore, sales should be this. Okay, so what are the margins going to be on that business? So therefore it really is starting almost from a blank piece of paper. There's no historical data. And so therefore, to have modest assumptions that you have a 6% EBITDA margin and you have this amount of revenues, therefore you think when you build a million homes, you'll have EBITDA of a number that's two times what I'm paying for the stock price. And with bmc, it became even easier since they had gone through bankruptcy, when they came out of bankruptcy and then they collected a tax refund, it was a debt free company. So you had a debt free company at the bottom of the cycle with a much lower valuation than the public competitor. We also owned Builders First Source. And so it was a pretty easy calculation that this is worth a multiple of where this thing is trading at today. And clearly with a clean balance sheet, also in a position to be able to do things, because that's one of the things we emphasize that cyclical businesses, if you pick the right one with the right management, with the right attitude, it's the opportunity to be opportunistic when no capital is available, to therefore consolidate, to be acquisitive, to buy assets far below what they're worth and therefore increase the earnings power of the business. It's clear and obvious you can do that. So therefore to be in the right company that's participating in the consolidation and then of course the industry structure is very different. And that's what really happened is in these businesses, it's also like, when does it recover and how does it recover? I don't know the answer to that question. And clearly it took longer, right? Because what you did was in oh, six, you built 1.7 million homes when you only needed 800,000 homes. So you had, you know, half a million homes excess, and over a couple of years, maybe you had a million, a million and a half homes too many that were effectively rented by someone who got a mortgage, who shouldn't have gotten a mortgage and therefore was going to lose the home eventually and therefore had to be reprocessed into the hands of someone who was really an owner. So therefore you had a substantial reduction in activity given this absorption of what you had overbuilt. And so that's where you are. In the meantime, the longer it took, the more disgusted people got, the more the stock traded down, the more I have to get out capitulation, people going away and the ability therefore to start to merge these businesses. And that's what happened was in 2015, it was kind of watershed years. So here you have, it's a number of years after the bottom of the market, but you have a slow recovery. The largest company was Probill, owned by the Johnson family Fidelity. And every year they've been writing a check for $100 million to keep the business afloat. In 2015, they said, that's it, I'm not writing another $100 million check. Get rid of this thing. So they sold the largest company and build this First Source maybe number two or three bought that. And here you had a significant consolidation. At the same time that year BMC that I was on the board of, we reverse merged into Stock Building Supply that Gore's group had taken through bankruptcy and needed an exit. So you have all these really smart people who get involved with these businesses, but they need an exit. And so they're not saying, oh gee, for the next five, 10 years. It really looks like there's a really long Runway of opportunity. It's kind of like I got a gain, I want to book my gain, I want to move on, I want to collect my fee. And so therefore you have rotation. So stock Building, Gore's group needed to do something, so we reverse merged into it. And then eventually what happened was because the business still took longer to happen yet the combination of those two so builders first source today is the amalgamation of four of the five largest distributors. If you look back 15 years ago. So that could never have happened if you hadn't gone through this disastrous time with all of this implosion, cutback, reductions. So a whole bunch of things happened that were fortuitous for us. So when I invested it in 09 and 1011, I didn't see that this was all going to take that long and happen this way. But that's the consolation I have in the short term. Sometimes when I'm losing money on a position is like, ooh, the opportunity is getting so much larger here. And what we've done is substantially increased what the earnings potential of this business eventually is going to be. And so that's what happened in that situation. So you can get an extra little lucky sometimes too, for sure.
- [28:42]
A
Bob, I want to understand too how you construct your investment portfolio. So can you give a just a high level sketch of like typically a number of positions you have, what kind of concentration you have, what kind of turnover you've realized over time and how you size positions. So how do you size positions when they come into the portfolio?
- [28:58]
B
We tend to have very low turnover in things. We own things for a long time because part of it is we buy them too soon. So you got to own them while they go down and buy some more of it when it goes down and when we size them. So for example, this post bankrupt company, when we originally bought it, we bought it at 67% of the portfolio. And so part of it was based on those 15% of the company, actually 22% with some friends and colleagues. So we own 22% of the company. There wasn't that Much more of it to buy. So that determined kind of what we had. But then what happened was as the business started to recover, as a number of things happened when it then reverse merged into Stock Building Supply and became a publicly listed company. And even though the industry still traded at modest valuations, it was still a ratchet up in valuation. So as a result, at the end of 2015, BMC had grown to be 50% of my portfolio. So of course most people would like freak out and go crazy over that, including one or two partners of mine who would call me up and say, how big a position is it? And they would freak out about, oh my God, how could you have such a big position? I said, if it goes to zero, it has no impact on you, don't worry about it. But it's price to value that's really determined. I own this thing, what do I want to do that for? Now that company then in May of 16, was able to do a secondary. And that's why Stock wanted to merge with us. And we were able to get 60% of the company in the combined business. So we did an underwriting because of course Gore's group, Davidson Kempner, the other big shareholder in bmc, and we all signed a standstill agreement when we put the thing together. So therefore we couldn't sell. So there was an opportunity, a window. We did an underwriting. I hated it because the stock had traded up to, I don't know, 17, 18, 19 even. And then we announced an offering. The stock trades down a point of two and then we have to do the offering, we have to do it at a discount. The next thing you know, I'm selling stock at like 15 when it was 19. And I think the earnings power of the business is substantially higher. But I felt the pressure of, oh, there really is such a large position. Of course, then two days later, because BMC was able to do the financing, then Build, its first source, who had levered up to buy Pro Build, said, the window is open, the public market is interested in investing, we should delever the business. And so they a secondary. And so I went back to Credit Suisse who had done the underwriting for bmc. And I knew all the people and I went to them and said, okay, I want to be on the other side of the trade this time. I want to buy it when it marked down and then buy it at a discount because you got to place the stock. So I ended up buying some builders first source at 10 and a half. And so it's one of the best purchases I have in builders first source is the one that. And of course wasn't a risk mitigation. It was like I went from one company to the other company doing exactly the same thing. So maybe there were specifics on each company that might have been a little different, but there really was not much change to it, but there was the opportunity there. It's a price to value equation. Question is like the sizing the portfolio because I didn't go out and make it a 50% position, I wouldn't do that. But the fact that it grew to over time, I really think it's price and value are the real determinants of do I want to sell something, does it make sense to sell something? And therefore that will determine the sizing in the portfolio. So I don't work about the sizing part of it. I work about what I know, what I understand, what the price to value, what the opportunities are. And that's what really more than anything drives how I allocate the portfolio.
- [32:03]
A
And how many positions do you, how many investments do you have in your portfolio?
- [32:06]
B
Well, it's a very odd thing. I have 80 plus positions, but 5 or 70% of the portfolio. And that's particularly because when we started in business 43 years ago, we were in all these pink sheet stocks. So I still own a long list of things that are quoted. And now what's probably the expert market that will never trade, that there's five people looking to buy it and there's nobody looking to sell it. And the price at which they're looking to buy it for is a third of what the thing's worth. Maybe it's actually even less than that. And so I get an annual report which sometimes is an income statement and a balance sheet and that's it. And it doesn't take a lot of time to do a lot of analysis because the valuations are so disconnected from what the prices are that you don't have to worry about it. And there's a normal rotation that happens in that. So every so often the control shareholder, the family or whatever else decides either a let's take a private and so they pay me two to three times what it's worth or they decide to sell it and they sell it for four to six times what it's worth. So obviously if they take it private, they don't pay me the full value. They pay a significant discount to that. So those things kind of get taken out of the portfolio over time. But there's really nothing to do but there's an odd number of a tail that I can't sell something for a fraction of what it's worth, but doesn't cost me any time and effort and doesn't consume as much capital.
- [33:22]
A
Now, you've also highlighted the importance of an aligned patient capital base. How have you built and maintained your clients with time horizons that sort of match your style? And in particular, what have you learned about communication, especially during drawdowns and challenging periods?
- [33:38]
B
So the critical part of the business is to not be able to raise capital. So if you don't raise capital, you don't get a new investor. Therefore, you don't have someone who has to acclimate to and understand. Really, reading the documents, they think they understand what you do, and then suddenly real life happens, and then suddenly they're someplace else. So a lot of the money we have is really that's been with us for decades. And so really as friends and family money, and then one or two people we knew early on. So the capital is really more from compounding than it is from new capital inflows. And we also did have the good Fortune in the mid-90s. We were written up by Henry Emerson in Outstanding Investor Digest. Guy in California read the piece. Love Value Investing came to us and said, we'd like to give you some money to manage. I said, that's great. That sounds great. I have this fund. And they said, no, no, no, we don't do a phone. We would do separate accounts. So I said, separate accounts? They're a pain in the ass. Go away. I don't want to do that. So I chased them away in 96, 97, then 98, 99 comes. So the Internet bubble. Everybody's making money like crazy. I go to the cocktail party. The woman says, oh, you're in the market, right? Aren't you? And I said, yes. They say, oh, you must be doing great. I was up 30% last year, up 30% this year. And I say, well, I was actually down 13% last year, and I'm down 6% this year. I could feel her look at me and say, you must be an idiot. And then, of course, we had the guy who's the doctor who invested us in 95. And then he comes to me in 99 and says, When I first invested with you, I really didn't understand investing, so I needed somebody. But now, actually, I've been investing on the side myself, and I'm making all kinds of money, and now I know investing. And so I'm going to take back My money. And I said, I understand what you're saying self serving to you, but it may not be what you think it is. So those kinds of things happen to us. So then I went back to that firm and I said, that separate account business, do you want to do that kind of thing? So we said, yes, we'll get it to the separate account business. And that firm though ends up being like a phenomenal firm that really understood value investing, indoctrinated their clients, the patience they have, the understanding that you're not going to make 20% compounded something different than that. They would pitch to their clients, they say, listen, these guys that we have, they are going to buy stocks that probably go down. And so initially you're going to think, well, what are you doing? But over time they really do well. And so that's it is they buy things that maybe prematurely bought but trade for much less than what they're worth. So they did a phenomenal job. So that clientele continues to be with us. So that was the other adjunct onto the total assets that we have. This client base that is aligned totally with what we do and how we do things in the comfort we have, including that firm in California, really kept the relationship between themselves and their clients. So I never talked to them and they never talked to me. Of course, in 09, I call them up and I say, hey, listen, I understand how it's noise if I talk to them and maybe confuse them, but I think they want to see the guy that's lost them all this money in 0809 and therefore to give them comfort that we really know what the hell we're doing. So for the first time ever, I met the clients in 09. So 10 years after we had started the relationship given there clearly was damage control or how to communicate, this is what has happened. This is where we are, this is where the opportunity is. This is why you need to stay patient and where you are today because it's going to work out really well over time.
- [36:43]
A
So Bob, let's talk about Tidewater. Maybe you could just start at the top. How did you get involved this investment? And how does this investment sort of demonstrate all the kinds of things that you guys try to look for and get involved with. And in particular, I also want to ask a bit about how you got onto the board and whether that vantage point has also been helpful or interesting from your point of view.
- [37:03]
B
So in 1976, we bought stock in a company called Atwood Oceanics. It was the smallest offshore drilling company. And at the time, offshore was something that happened only in the United States. There were very few places else in the world. So it was a new business that was growing. And of course it was a period of significant growth given 73 oil embargoes, 79, the Shah in Iran falls the price of oil over that period of time. And it was really a great investment for us to have made because it was controlled by Hemrick and Payne, who'd been in business for 80 years before that. Extremely conservative, knowledgeable people, engineering oriented. So it's blocking and tackling, blocking and tackling and not financial maneuvering and whatever else. So when they had control of Atwood, when everybody else was out building new rigs and borrowing money, they instead said, no, no, this is going to end poorly. We're building assets that really are going to be surplus and we don't want to do that. So Atwood didn't do anything. So when oil price imploded from 40 to five and the business imploded, everybody went bankrupt two, three, four times. Atwood went into that with no debt and 40 million in cash. So it clearly was going to survive. But even then what it did was it didn't invest because assets weren't assets. Assets were liabilities. Right. When you own an asset that you have to operate at 20,000 a day even though it costs you 30,000 a day, because losing 10,000 is better than tying it up and losing 15,000 and the asset deteriorates, instead of it's working, it's actually much more desirable. So you had to keep it working. So it was a liability because you constantly had to burn money because burning this amount of money kept you in the business as opposed to you shut it down, you'd burn more business and you're out of business. So that process was really informative for me. Owning hard assets, what's an asset, what's a liability? When do you want to own them, how do you own them, what do you do? All of those things. So really interesting now in that process, I also looked at the boat companies and the boat business was always much worse business because boats cost much less money than rigs and therefore a lot more people have less money and therefore more people get in it, and therefore it's more fragmented and it's more undisciplined. So the boat business is one that, ah, I hate it. Okay, so that's the opening. So in 2015 I'm in New Orleans to go see Methanex, who's moving methanol plants from Chile to GEISLER Louisiana. So given the low cost of natural gas in North America, you can make methanol at very low prices. So it made sense to relocate the plant. So we're going to take a road trip, but we're in New Orleans for a couple of days before we go up to Geisler. And so I say, who do I see? So I'm in the town, I always like to see other public companies. And I said, tidewater's here in New Orleans. Oh, I hate the book business. Oh, oh, well, I'll go talk to them and see what they say. It's generally about the business. So I go see Jeff Platt, the CEO at the time, and have a conversation and I'm like, oh, gee, it's different than what I thought. They've done stuff. The fleet's renewed, it has all this debt and whatever else. And of course, the business in the end of 14, the beginning of 15 had fallen off a cliff because oil prices had gone. The Saudis said that you were want to stop all this growth and production onshore the United States. And so prices fell apart and all the oil service stocks obviously participated in that process, came way down. So it had debt, but the debt was $800 million of bank debt, $300 billion drawn and a billion two of bank debt. So a total of $2 billion of debt, but $500 billion availability in the line of credit. So what they did was they drew down the line of credit. So they're now at $500 million in cash and $2 billion of debt. All the debt, the debt between the banks and the insurance companies was pari passu. So everybody's got to fight equally to get their money back. In the meantime, all the debt is unsecured. So the idea that people lent money to a crappy cyclical business without someone taking collateral, I am sure the day Tidewater drew down the extra 500 million for that line of credit to get that cash, there were five bankers who lost their job. What the hell did you do, put me into that loan? So that process was one in which I thought, oh, gee, the company potentially couldn't negotiate a restructuring so they could preserve value for the equity. Because I got something to give here. How do I do that? And I've got all these people potentially fighting among each other and no one's got preeminent rights or whatever else. So I thought there was an entry point to therefore own the equity, to therefore be able to negotiate some kind of transaction. Now, as it turned out, had they been able to negotiate that transaction. It just would have delayed the inevitable because the business took so long to recover, they would have gone bankrupt again. So it didn't happen. Instead, they come out though, they have $400 million in debt, $400 million in cash, the breaking even, pretty much the bottom of the market. So I'm like, well, okay, I'm buying these assets for far less than what they're worth. I don't know when the business recovers, but we're already four or five years into the downturn, supply is starting to dwindle. And so we're moving in the right direction. And if I got a big enough margin of safety between what I'm buying the asset for and what I think it's really worth, therefore, okay, and I got a balance sheet that's going to make sure that I'm going to be there through the process and potentially is in a position to be able to be a consolidator, given everybody else still has all this debt. What happened was a year later, another company called Gulfmark did the same thing, went through bankruptcy, restructured, came out with 200 billion of debt, $200 million in cash, also modest in terms of its cash flows. And then what Happened was the two companies that merged, and in merging the two companies, they took 60, $70 million of cost out of the combined business. So at the bottom of the cycle, when you're breaking even, to then put those businesses together and take more out of the equation in terms of the cost, therefore, increasing the viability and the positive cash flow that you can get, even the tomas at that low point in the cycle clearly position them. So in the meantime, the board of the company was distorted. There were 10 board members, three of which were the members of the comp committee, the members of the governance committee and the chairman of the board and the chairs were only on those committees. So three guys controlled comp committee, three guys controlled nominating governance. And one of those guys was the chairman of the board. And so the other seven guys were just picking up checks because they were on the audit committee. No offense here I am an accountant having done. But you have to have it to make sure that the train doesn't run off the tracks. But there's no value creating aspect of the audit committee so much. So Bill Martin had a firm, Raging Capital, and they were big shareholders in Gulfmark, so therefore big shareholders in the combined company. And they were pushing for a change and then change in the board and the change in the management. Because the guy who was running the company was not the right guy to run the business. And so he was public with his filings. And so that's what we did was we wrote a private letter to the board saying these are the things that he's addressed that we agree with. Here's some other things too. Clearly there are issues that you can have a much better run business and much better governance if you make these changes. But that was a private letter. We didn't do it publicly. They did nothing. And so that's what happened in October. Then we bought more stock, filed a 13D and then wrote another letter to the board. And that also then disclosed the letter we had written earlier in April. And so between the push that bill had already been given the business, the insider, the board itself had realized that there was a problem, they needed to do something. Then when we filed it three or four days later, two of the directors retired, resigned from the board, and a week later the other one resigned from the board. So we helped facilitate the transition from bad governance, bad management, to good governance, good management.
- [44:16]
A
So Bob, let me ask you, those letters. How much of that is strategic? How much of that is sort of capital allocation? How much of that is related to incentives? I mean, these are all interrelated. But was there a particular theme, for example, in those messages?
- [44:28]
B
It really was what strategy and what's the execution and what do you want to do here? And we don't think that the management was the right guy to execute the business because he really hadn't been in the boat business. And we also think the board had potentially their own agenda in terms of what they wanted to do and how they wanted to do things that we didn't necessarily think aligned with the shareholders. But of course it was still a time in which you really didn't know, but it was a real opportune time. If you did the wrong thing at that time, you would permanently impair the ability of this company to be what it is today. So I'm sorry to go on this long winded story about my whole history with Tidewater. So then what happened was a year later they put in a tax preservation plan. And so through this process I'd become familiar with and had worked along with the head of the nominating governance committee extensively. And so I said, gee, I'm concerned about the tax preservation plan. So I know we have an nol and I know that is valuable. The fact of the matter is I don't know when that's going to be valuable because we're not sure when we're going to make money again. And therefore we don't know what it's really worth. So the present value of whatever that might be down the road is uncertain tomorrow if someone else comes along and wants to combine with you, like, the value of that may dwarf the tax issue. So my concern is that you really don't have anyone on the board who owns the stock. And so therefore to have someone who owns the stock in the room, I have a much higher confidence level that the decision's going to be made that you won't use this as an excuse to not have a corporate event when it really would be clearly in the best interest. So I suggested they go to all the other large shareholders and ask for nominations. So in the meantime, I'll give you some nominations too, for board members, because I do think that that would alleviate the concerns that shareholders would have about the misabuse of the tax preservation plan. And then in that process, it didn't work. The people that I suggested and nominated. And so I guess I felt a little bit like I was being pushed away. You know, here I'd help facilitate the change of the board and the management. And here I got an idea and I'm suggesting it and I'm saying, gee, that's great, but I don't know if it's really being received and evaluated. So I was concerned. So the next year I'm saying, well, I'd like to do something here. I think it really makes sense to do so. As I prepared to file a three nominations for director, they changed the date of the meeting, which was significant because it changed the date at which, if you wanted to file that, you had to do that. So it accelerated the timeline. So now suddenly I've got a real problem. So if I'm going to do something, I got to do it now. And so I call them up and I have conversations with him. I says, I am contemplating doing this and I prefer not to do that. Isn't there some way we can have conversations that we could defer this process and not get into a proxy fight and figure something out? And so as it turns out, they said no. And so I filed my own solicitation for three directors. In the meantime, there were four or five sizable shareholders. So T. Rowe Price owned 15, 18% of the company, Third Avenue Value. Marty Whitman's firm had 6, 7% of the company. Amit Adwani used to work at Third Avenue Value had an equal size position. I had an equal size position. So there's probably a lot of alignment philosophically between those other people and us. So that therefore there was definitely pressure on them. And eventually what we did do is they agreed to add me to the board and I dropped the other two nominations. And so they expanded the board and added me to the board. So. Which is interesting. So here I got on by a proxy fight. Again, I always say I'm an active owner, I'm not an activist. I'm not looking to get in and create value by messing things up because I think there's a long term opportunity. It really is having a seat at the table to therefore deploy the cash flows I think will come for this business to be opportunistic, consolidate the business and to help and work along with management and the board of their processes. You know, that was my intent. And I do think that subsequently a number of the directors over time have come to me and said, when I got on the board, I was told you were an activist. And doesn't seem like you're really an activist. You're mischaracterized here. I said, I think I am. And today I think we work along really well. The rest of the board, it's really all come together. Well, I think there's a lot of alignment in terms of how we think management clearly is a critical path. You know, I think he's aligned in terms of how he thinks about capital allocation. And that's what it is, is really supporting him in that effort. So it's not a fight. I've known him for a long, long, long time before he was here and I knew him when he was in a different position. So therefore we have a long relationship. And I think he thinks about capital allocation very similar to kind of how I do. And therefore I'm there to help and support whatever he wants to do.
- [48:51]
A
Let me drill down a bit on that. There are two questions I want to ask, then we can move off. And you don't have to apply this specifically to Tidewater. Can be broader. How should one think about capital allocation? For example, returning capital to shareholders and buybacks and dividends versus reinvesting the business. So first question I want to ask is just about how should one think ideally about capital allocation?
- [49:08]
B
So I've heard a number of your talks recently. We talk about dividends and buybacks and really kind of being the same thing. I always object to that. I object to the classification as you got excess capital, you could pay dividends and buy back stock and you could do one of those two things. And the way I think of it, buying back stock is more like you could do M and A or you could buy back stock. Those are very much comparable activities that you have somewhat comparable measurements for. In my mind. If you don't have mergers and acquisitions that logically make sense, that enable you to buy assets for less than what their cash earnings ability is, or you can't buy back your own stock because it is trading at a discount, then you've got excess money. And if you got excess money, you might think about paying a dividend. So I think it's more like the falling out of I don't have this opportunity, I don't have that opportunity. And of course that buyback, it's just like if I buy back the stock and the stock's trading at full value or more than full value, it's just like paying too much for an acquisition. You could destroy a lot of capital. So dividends can't destroy capital. Buybacks and acquisitions can destroy capital. But the analysis is of course it's the same thing. It's kind of like that acquisition. Does that increase the earnings power of the business and commensurate more than that increases the denominator and the number of shares outstanding. So the per share value is higher, right? Because you always want to the per share value, you know what I mean? The aggregate value of the business worth more, but the per share worth less. And if not, well, my stock, is it trading at a discount? If it's trading at a discount, a big enough discount, well then that's a way for me to buy a business I know extremely well at a very discounted price. So therefore my risk level associated was minimized in the process. So therefore that accelerates the opportunity. And so that's the way I think about the comparison between how to allocate capital and how to think about capital.
- [50:42]
A
The other quick question I want to ask is about incentives, which is obviously we always want to align executive pay with sort of long term value creation. But it just seems like it's tricky to get incentives. There are all sorts of unintended consequences. Some executives seem to have a North Star that others don't have. Is there a good way to think about lining executive pay with KPIs?
- [51:02]
B
Having been on board since 04 and having been on comp committees that entire time and working therefore with management, who are people. First off, what you really want is you want an executive who thinks about the business like he owns the business. You don't want to give him a carry and you don't want to hit him with a stick because you can't do that. He is going to do things every moment. He's going to be making decisions. So you want the right person who thinks the right way, and then therefore you can kind of reward him when that happens and it all kind of comes together. But I can't control him in that process. And thinking I can design a system that controls him could be a fool's error and create all kinds of unintended consequences. So the thing I would say is, first off, you got to get the right guy or the right woman. And I've had that. I've been the chairman of a company with the CEO, like he downsized the business. We didn't ask him to downsize the business. He identified that we needed to do this and he did it. And so he took the business down dramatically in terms of the headcount. And so therefore he did what you needed to do without us having to give him a carrot or hit him with a stick and tell him what to do. Because even if I know the business pretty intimately, and I think I know these businesses pretty intimately, I think I have a knowledge base on the business that's much broader than most directors knowledge because I live and breathe it and I have my money invested in it, I still think I don't know the business well enough to really say, you need to do this. You have to do that. You can't do this. He knows better than I do, and I have the ability to kind of assess his abilities to understand the right thing. Now that's not always the case. I've been on the board of a company with a CEO, didn't know anything about the business. It was a disaster. But fortunately the business was discounted enough. The opportunity was so great that it didn't matter. Buffett's comment, you know, you want to have a business that even a fool could run because you may end up with one. Occasionally you do end up with a fool, but every decision is a mosaic. And so if I don't have the right management, but I got a lot of other pieces to it, it still may be a really good investment. And I'll put up with that at least for some time being to get to the point where I think it will all come together and galvanize the problem.
- [52:57]
A
In the investment community, there's been a ton of focus on artificial intelligence, in particular generative artificial intelligence. Do you anticipate that that will affect your investment process, whether it's idea generation or primary research? And do you think that'll affect the dynamics of Traditional businesses as well.
- [53:13]
B
I actually think I can see plenty of applications for traditional businesses. I see plenty of applications in Tidewater's business for us to do things with artificial intelligence, because there's a lot of data and information to analyze that data and information and understand what do we do in terms of preventing maintenance on the equipment, the effectiveness of the equipment, the cargoes we move, the efficiencies, how do we do things and move things? Of course, there's a lot of data and information that we make sure we need to have because you need to have the data to therefore artificially intelligently analyze the data to therefore come up with. This is an idea, this is a solution. So conversely, the seismic company that I'm on the board of, there's no direct benefit. So much for us to use artificial intelligence. However, our customers, the oil and gas companies, clearly will use it extensively and make much better decisions. Now in the decisions they need information. And one of the pieces of information they need is they need seismic data. And we have the seismic data they have to license from us. So I think their work on artificial intelligence, our customers, and we can't tell them what to do because there's no way we're going to go to Canadian Natural Resources and tell Murray Edwards what he should do because he's going to kick us out the door. But he'll figure it out. And when he figures it out, if he doesn't have that data, he has to come back and license it from us. So it will make our data more valuable. But we're not really a direct participant. We're like one remove Tidewater's business. No, there really are things that we can do better when we have that information. So I do think it will change substantially how businesses operate eventually. It'll do something for the investors business for sure. In the short term, it probably is a negative. So like the other day we got a note from Tidewater. They went through all of the websites that analyzed the earnings report for Tidewater and had all the commentary in terms of what they said. And I was at a dinner and they were at that topic came up. The gentleman next to me said, oh, what do you think? And I said, well, all that information, the right questions weren't asked, therefore the right answers weren't given. And so therefore you've taken what is historical backward looking, what the rate did, what the utilization was, and I don't know how you projected it to the future. And yet the stock, the stock, and this is, you know, definitely how markets are today. Tidewater stock on the day it was going to report traded up 3.5%, something like that. After the close, they released the earnings stocks down 6.5%. So it wipes out the gain for the day. And it's down another 3%. It opens the next morning, stock's down like 10% off the previous close, closes the day. I don't know if it was up 7 or 8%. And so the markets are moving. And I'm sure that's artificial intelligence just looking at something and analyzing something and coming to a bad conclusion and therefore thought the earnings were bad, pushed the stock down and eventually when it settled, they kind of looked at it, they said oh no, this is pretty good news information. And so therefore it traded up. So therefore in the short term, I think it's really going to make bad decisions because it's garbage in, garbage out. And there's a Baruch line that's high attribute to anyway. It says data and information are no substitute for thinking, especially when there's a change in the thinking. And therefore that process and experience and understanding how businesses work, how people work, because people are a critical part in every business because they're a big piece of it and how they are and how they are driven and how they're wired is predictable to a certain extent. So I do think it will clearly add value over time. I do think in the short term it probably is more of a negative than positive. And that reemphasizes the flow of funds, is determining the pricing of securities. And it's not someone doing the analysis, thinking about the earnings. What did it say? What does that. I think it means for the earnings for the next year to 3 to 4. How do I fit that into the equation? Is it buy? Is it, is it a sell? I think it's. Michael Green quotes the number I think he says used to be in 95. He said 80% of decisions were based on an individual security position. Today it's 10% and it's probably, who knows, maybe even less than that. So what is driving buying and selling and therefore determining pricing is not thoughtful, intelligent analysis. I think.
- [57:06]
A
Now you've long engaged with the value investing community. What do you think business schools are still getting wrong about real world investing as they teach?
- [57:14]
B
So I don't take any classes in finance, so I don't know the answer to the question. But it is interesting because again, what we do really are. I've listened to a number of the talks you've given recently and you talk a lot about intangibles and the growth of intangibles. And intangibles is a much larger portion of the balance sheets and the economy and whatever else and how to think about those and how to factor those in. And of course I think to myself, well, that's really a nowhere relevant conversation for me since we don't really own those companies. Businesses have hard tangible assets. So the subsegment that we are active in is a different segment the market that still plays back to where we were in the past. And so tangible businesses with tangible assets are somewhat different than the bulk of the investable world is today, clearly.
- [57:55]
A
So we're in the final segment. I'll ask Tano's question on his behalf. When you look out, what worries you about the future and what excites you about what's to come?
- [58:04]
B
So one of the things that actually is good, I think the discord in the world and the disconnects and all the stuff that are kind of bad, including geopolitical and Russia's invasion of Ukraine and all of these things, is the risk of that happening was there in 2021. All of these bad things that have happened, those were clear and unidentified risks that could happen. The fact that they manifest that means once it manifests, then you direct your attention to how do you deal with that, how do you correct that and what's it look like. And at some point that's not a permanent situation. So I do think that a lot of negative things, including tariffs, right? So I believe that the tariffs as done to date are extremely ill advised. The reason we don't have inflation is because of China, right? It wasn't Volcker who cured inflation, it was China who cured inflation. They made everything for less than the rest of the world. So Ross Perot was wrong. It wasn't Mexico. It was a great sucking sound. It was China was the great sucking sound. And for 40 years, years they've sucked everything out of the rest of the world. And now today they actually have a problem because they do have a recession. And therefore you don't see it in the numbers because what they do is they overproduce things and then dump it around the world and therefore depress the prices every place else. And they run in losses. Clearly the steel industry, that's half of the steel production in the world, loses money because you're paying for imports of iron ore and you're importing them and they're driving up the price and then you're driving down the price of steel. So it's fully Predatory pricing. And that's affecting a lot of the industrial businesses we're investing in. But it's also meant that the Fed has, in spite of what they've attempted to do, they've been successful in getting inflation down because China is dumping all those things and therefore depressing all these prices and mitigating the risk of inflation. So that wasn't the question you were asking me. That's the diversion that led up to the answer to that question. I think.
- [59:48]
A
Well, it was more about what are you worried about and what are you excited about.
- [59:51]
B
So all of the things that worry a lot of people, I'm less. What I am concerned about is last year China's deficit with the entire world was significant. Right. So that's why I say the tariffs were ill advised. Instead of fighting with the other guys who are in the same position we are, we should be working together with the rest of the world because there's a common economic enemy and that's China, and all of us are getting hurt by China. So collectively there's a larger likelihood that China then responds to that as opposed to if we're poking at this guy and pushing at that guy and pointing at that guy, he's like, well, that's good because they're not pointing at me. And there's a common element. And of course that is a concern too, because I do believe that the fall of the Soviet Union was predicated on a decade long war with the Soviet Union by the United States. And economically we drove them into the ground. The concern that China is in a position given who they are, what they are and what they do, and there's no doubt that, you know, Chinese businesses, it was kind of like when I was a kid, the Japanese stuff, if you got it, it broke. And then Japanese became very good at doing things and do it very efficiently. The Chinese are in the same process, they are becoming very efficient. They know how to do things. And so therefore to think that, oh, they're a second tier, they're not. And in many ways they're probably in certain cases definitely better than us. And so therefore that idea, and therefore almost this idea that therefore from a geopolitical point of view, also it's not an economic point of view. The idea that we collectively think together about what they're doing and what their intent is and that they don't drive us out of business and there's not an impossibility that if you look out 20 years, that there's risks of that happening. And so that is a concern and that's economic, but clearly it's bigger than economic. I don't think they're in for the economics. They're in for something else.
- [61:29]
A
And Bob, what are you reading or listening to these days? And is there a book or are there books that you would recommend to our listeners?
- [61:36]
B
I'm not a book reader. I really don't read books. Instead, I read annual reports, 10Ks. I talk to companies. And so that's really my information is kind of what's going on in businesses and what I can glean from that. There's some great books out there, but that's just not what I do.
- [61:50]
A
Well, we'll call it there. Bob, thank you very much for joining the Value Investing with Legends podcast. And to all of you, thank you very much for tuning in and we'll see you in our next episode.
- [61:58]
B
Thank you. Thank you so much.
- [62:00]
A
Thank you for listening to this episode of the Value Investing with Legends podcast. To subscribe to the show or learn more about the Halbron center for Graham and Dodd Investing at Columbia Business School, please visit Graham and thank you.