We are live. This is Value After Hours. I'm Tobias Carlisle. I'm joined, as always, by my co-host, Jake Taylor. Our special guest today, repeat offender. He's back again. One of our favorites. The great... Christopher Bloomstrand. How are you, Chris? What's happening? I'm doing great. I'm doing great. How are you guys? Always good to have you on the show, sir. I'm still on the kombucha.
It's back for another year. Looking fit in tent. It's working very well. Yeah. How's your walking program? It's good. I've kept it up. I'm minimum two hours a day and even kept it up during the annual letter writing process.
A little harder than I did last year. I'm sorry. I decamped now to Florida for about eight or nine days as soon as the letter drops. And I do what I do there when I'm... you know what i do here but you're walking outside where it's a little nicer and for whatever reason we have a bunch of clients in that first don't go to south dakota in the winter they go to south florida so generally have dinners every night
it was great we had a guy in town here um i think he invented celebrex um just brilliant scientist who was out walking and uh a tree branch cracked off and fell on his head and killed him. I mean, just make you think maybe the Charlie Munger approach of fitness, which was do nothing. Avoid all outdoor activities. You know, the handful of days when you were in the military. But other than that, avoid everything. Chris, the letter this year was 168 pages. My notes on it are four pages. So...
I've got some questions for you, but I just want to, from the top, what message do you feel sort of has been missed or what were you trying to say other than...
No, I'm not going to say other than you. Just what we try to say. What's the message? You know, the message is rationality. You know, I kind of belabored the... bifurcation in the market I think as I've done for a couple years now segregated my five-factor analysis of the S&P 500 the components that just simply go into how you measure total return but breaking out the magnificent seven from the remaining 493 companies was was pretty telling i i just think
For the last two years, I look at our portfolio on a daily basis and in any day that the NASDAQ's up, we're invariably down and vice versa. And same thing happened in the 90s. exact same thing happened in 98 99 um and it's gotten really pronounced a week ago monday when the nasdaq was down four
you know, we were flat to up. We had a lot of our portfolios were up for the day, which is a huge disparity. And this is just continuing. We're up a bunch this year. Last year was mediocre i think we were up seven we were up 13 or 14 the prior year but then we made money in 2022 so you know found ourselves way ahead um for 2022 and 23 the market essentially s p was down 18 nasdaq was down 35 or whatever but they fully recovered but were flat
at the end of the second year at the end of 23 and then last year 24 smp was up 25 and change and nasdaq was up a bunch the degree to which seven stocks really and you know a handful beyond that but have dominated returns of late but so we found ourselves ahead and then behind for a three-year period and i i think this three-year period
Takes us back to 2021 which I still believe and I think is gonna wind up going down as the secular peak that's gonna rival 2000 that's gonna rival the late 60s that's gonna rival 1929 2000 I agree with that. That's what I think was the peak too. And so I kind of mark how things are going from that moment in time. And it's interesting. I forgot to tweet it out or exit out or whatever you call it.
mentally sheet waiting for mark march 10 of this year because that was the 25th anniversary of the peak of the nasdaq and it was literally that moment i mean that whole two-year period were There was zig and zag. I'm going to continue to zig and zag, but we went straight up. I mean, I think we were down 10% for the year to date on March 10 of 2000.
Market was up 10 plus. And by the end of the month, we were up for the year and the market was down. And then the next two years, anything in the value world worked really well. And the system, the markets healed themselves. we kind of got back to ben graham's weighing machine versus the voting machine and it feels like that's starting to happen of late and uh wanted to get into some of the reasons for you know why in the letter and
Hopefully in 167 pages, if that's what the count was. I got some of that across. How do you think we get back to 21 so quickly? I feel like the behavior... We may not be back to the... I mean, I think we've gone through the level, but in terms of the behaviors, I feel like... It doesn't feel quite as insane. I mean, there's still lots of pockets of insanity, but 21 seemed like just everything was nutso. I think there's a fair bit of nutso in crypto, but...
Maybe an AI. I mean, I think some of that AI stuff got pretty silly, but I've got one of Chris's quotes in here. Just in relation to the Magnificent Seven. Magnificent Seven contributed roughly 61% of the S&P 500's gain in value over the past three years, despite being crushed in 22. The Seven contributed 16% of sales growth and an incredible 88% of profits.
to the S&P over three years. Profit growth, right? Not a quarter-class quote. Yeah, profit growth. Profit growth. I would imagine, yeah. The marginal earnings came from... Mostly the Mac 7. 88%. Yeah. In three years. That's crazy. And a huge chunk of that was in a video, of course. I had thought that when I did the math, when I was early working on the letter...
You know, those companies don't report earnings for their fourth quarters until kind of toward the end of January and Nvidia is late. So I've still had to assume where Nvidia was going to wind up being because the letter wasn't out yet. But I had originally calculated. Simply using Wall Street's consensus that more than 100%, 106% of profits were going to come. And there was, between the lines, there was a huge, the beginnings of earning misses for the hyperscalers for sure.
And what you're going to wind up seeing is big depreciation charges start hitting these P&Ls. I mean, they've been very cap-light businesses, and that's changed, as you guys know, the CapEx dollars that are being spent. are pretty staggering and with capex despite elongating depreciation schedules from three or four years to now five or six or even seven years meta just did one um
These balance sheets have gotten a lot more capital intensive and you're going to see it in depreciation. And, you know, we'll see the efficacy of search and AI. There's a lot of money being spent and I'm not sure the businesses are yet generating revenues. NVIDIA is getting the revenues and Broadcom is getting the revenues, but this is the picks and shovels. We'll see how efficacious.
search winds up becoming um this is simply an ongoing elaborate you know an extension of what's been going on for 20 years we've had ai um but i this this reminds me of Kind of the laying of broadband fiber, the lighting of dark fiber, and the massive CapEx dollars that were sent in telecommunications. So these businesses have changed, and you talk about what might disrupt. Well...
sustaining margins and sustaining top line growth. The market's gotten it right. Ben Graham's Mr. Market is pretty good. You look at the growth over 13 years or three years. Revenue growth, profit growth. The seven stocks were roughly 35% of the market of the S&P 500 at year end, but their profits were 25%. They'd grown from nothing. Market caps were 8% of the market 13 years ago and they went to 35%
But that's because revenues were growing. Their share of revenues went from 3% to 12%, and share of profits went from almost nothing to 25%. But at a point, they get capitalized at such a premium that when you start to get misses. And history will show you get disruption. There's such a concentration of wealth in seven and another 30 or 40 companies that they're priced for perfection.
You know, I think that that may be what you're seeing today. And certainly, you know, when you go from thinking those seven companies are going to be more than 100 percent of the profit growth to only 88 percent, there were big misses. It gets spun differently. We'll see. That's one of the things that we've discussed a little bit that all of the investment in whatever makes up AI, the computers in the back end, that's all expensed.
by i mean that's sorry that's all that's all capitalized yeah yeah capitalized by the um the big tech companies but then nvidia and broadcom counted as revenue in the in the year that they earn it so that there's a little bit of double counting and at some point that wave starts coming through of the depreciation that
they're talking about spending 300 billion dollars collectively a year over the next few years i don't even know how they can deploy that amount it seems like an extraordinary amount of capital to deploy particularly with no obvious revenue on top of that yeah um well they've they've all said we're not sure we should be doing this but we have to do it it's an arms race and you don't want to be last or left out um yeah
Yeah, the capital cycle being what it is. We'll see if it turns into profits my my bet would be it winds up not and that's probably the spark that Really starts to harm the markets. But when I say the markets again, you're talking about the cap weighted S&P 500. There's such a concentration in a handful of companies Your international markets are doing well this year. I'm really frankly shocked that
small caps when you simply look at the small cap indices are down as much as they are i mean they've been weak since last june and it was small small cap mid cap everything value related when the market broke after march 10 of 2000 that performed well but The performance is coming from international gold. Energy's doing fine. There's some places that are working, helping our portfolio. A lot of Berkshire's up.
I mean, oddly, yesterday and here today with Berkshire being flat, yesterday was the first time since we've owned the stock over 25 years. that the stock traded at just a percent and a half above my appraisal of intrinsic value. You got there last year, traded in November at its high for the year. above my prior year number, but intrinsic value had grown roughly 10% for the year. So it was not above today. Berkshire is fully valued on my combination of valuation yardsticks that I use.
So there's... There's big corners of at least the things that we follow and own that are really, really cheap. I mean, really, really cheap. But then there are some businesses that are not cheap at all and fully valued in some places. starting to get pretty overvalued and i mean that's kind of a microcosm of what's going on in the broad market you own costco over the years at various points and now what do you think when it's at 60 times earnings
And I did my five factor in the letter. We bought Costco trading at 18 times earnings and change 20 years ago, 2004. uh and it was really not trading at 18 times they had on the order of 350 stores warehouses and if you know the business and the system it takes about seven or eight years
for a warehouse to be fully profitable. You need to get enough throughput. You need to get enough members signed up. And so... opening 25 warehouses a year on a base of what was then 350 you had a third ish of the units that were not yet fully profitable and if you simply said well how profitable are these warehouses ultimately
Your earnings were being understated. Your returns on capital were being understated. Well, fast forward, and this has been a great business. The net margin's gone from 1.8% to 2.9%. But the multiple's gone from... 18 and change and and a misstated 18 and changed almost 60 56 and it's closing for the year, and it traded even higher than that. And if you're still only building 25 stores every year, the percentage add is decreasing over time, right?
if if square footage of the system was growing then seven and a half percent today it's growing at two and a half percent so You know, when you break down your five factors of dollar sales growth, change in the share count, there's not a lot of change in Costco share count, change in the margin, change in the multiple and dividends. And, you know, they do pay big dividends now as a proportion of operating income.
Most of it's special dividends, so you've got to normalize that. But you do your same store sales growth, which will be at a premium to the inflation rate. So if inflation's two, call it four. If inflation's three, call it six. add that to two and a half percent square footage growth in the system and you can't get to much more than seven and a half percent revenue growth
The stock compounded it almost 20% a year for 20 years. I mean, the dumbest thing I ever did in retrospect was ever selling a share. And I would trim it to finance purchases of other stuff. and never should have sold it should have bought it at any price but you know who would have known it would trade at 60 times and so i've got a a our five factor over the next five years that simply allows a 7.5% growth rate in revenues and takes the multiple back to
some more normal level. I mean, it's never traded at 60 times before. I mean, it's a business that does 2.9% profit margin, gonna grow a lot slower. Maybe it's worth 25 times, not 60 times. Any number of scenarios of revenue growth you can come up with, you really can't get to a positive return. You break even if the stock still trades at 35 times earnings. And so that's an example.
walmart is another example there are a bunch of companies like that they're big cap businesses that are simply overvalued again much like you saw in 98 and then obviously in your tech bubble and that's the corners of of the stock market, of the US stock market, which is now the largest proportion of the global stock market that it's ever been, over half.
But it's 40 companies. It's 50 companies. It's 60 companies. And outside of that, there's a lot more value. And rightfully so. I mean, there are a lot of businesses that are no longer great businesses. In the small cap world, Toby, as you probably see in your world,
a lot of the better businesses have been bought. And so you look across Europe, what Europe has done. I will say that some of the mid-caps, which are pretty good businesses, they're now small caps. So the small cap's looking better than it has for a while. You never want it going that way. So, yeah, the market gets it right. And I think it's starting to see some cracking with some of the places where you've got overvaluation.
It's never been hard for us to not own things that are outperforming and growing a lot faster. I learned years ago to not screw it up. And when I sold Ross stores, having bought it. at the last bubble at 10 times earnings and made two and a half times our money in a couple of years. Between 2000, you know, between 99, let's say, and 02, sold it at 25 times, let's say.
all of it, never bought it back. And it was a 20 plus bagger after I sold it. So we still have a few Costco shares laying around, but those are only in taxable accounts and they've got $29 per share basis. I mean, we've made more, I mean, we've made. more special dividends once they started paying their five special dividends than we have in cost basis on our original shares and they pay a regular dividend now so you've got
more than half, 60%, let's call it, of operating earnings. It doesn't take as much money to open 25 stores, so the larger proportion of income. They've not tried to go out and make acquisitions. They're not foolish. They're not...
They're not buying Bitcoin. They're not doing some of the things that get allocation circles of management. And so they rationally say, look, the stock is not cheap. It hasn't been cheap for a long time. Why buy it back? They don't buy it back. They buy a little bit back to offset. A little bit of the option shares they issue, but they do very little of that. And so pay it out, which makes a lot of sense. But I'm afraid at 60 times or 56 times or probably down to 52 times now.
Very difficult to think you're going to make money over the next five years or six years or seven years. If the revenues grow at seven and a half, the stock is seven or eight years ahead of itself. How about the index? How do you feel about the index? Do you want to break that down for us? Yeah, the cap-weighted S&P 500.
closing the year at almost 26 times, even taking out the MAG7 at 35 times. Frankly, when I ran the numbers, I was surprised that the residual 493 were still trading at over 21 times. I mean, these are historically very expensive levels. My guess would be that the equal weighted if you could own an equal weighted index as an option in a 401k if you were limited to a sir just a handful of funds but i don't think it's much offered
and equal weighted. Again, it's the seven plus another 30 or 40 or 50 companies that make the index. priced for perfection. I go through my five factor analysis and look at differing, and you guys talked about it a couple of weeks ago when you had John Antoni on, the scenarios in my letter using my factors of taking margins to
different levels. If you're going to get continued high revenue growth, you're getting high revenue growth in the last three years because you've had inflation, because you've had a decline in the net margin. The profit margin for the S&P was 13.3%. At the end of 21, it's 11.8 now. It got down to 11.2 after 2022, and then you've had a little bit of recovery. But if you strip out the seven,
You've had actually a margin decline over the entire three years. But you've had a multiple expansion. I mean, you've got less margin, but you've got multiple expansion. That's kind of how it's supposed to work, but the market went from 22 times to almost 26 times. Historically, that's a very expensive level, particularly if you think what's still an 11.8% margin.
If we have higher interest rates for longer, there's a lot of debt that gets refinanced. The interest burden starts to grow. If you have inflation, that will continue to eat on profit margins. that owns the index, I can't get to making much more than 5% a year for the next 10 years and more likely than not this window of 7, 8, 9, 10, 12 years that we're in. I think it's going to look a lot like the 10 years after 1999 when stocks had done 18% a year.
The S&P, 10.6% a year up to 2021. Again, thinking that's a secular peak. That number is down to 14. So your rolling 10 is gonna drive down, Jake, to your mean reversion to a lower level. I'd rather, if given the choice between the S&P 500 and a 10-year treasury, give me the 10-year treasury at 4.3 because your best case for the index is about 4.3.
Yeah, I think you got to 3,500 on the index. I use the Shiller PE. I use Hussman's method, which is Shiller PE mean reverting to long run mean over a decade. And that assumes no compression in the margins, but that gets a fair value today of 2,700, which is, I don't say that very often because it makes me sound like a lunatic, but... you know it is what it is it's it's tracked pretty well to that to that number over a long time which means flat on the index or 0.5 annually on the index
plus you get the dividend yield of 1.3%, which is just not a very appetizing return from here. So well south of treasuries, well south of the 10-year. Yeah, I think that's... that's a reasonable way to look at it and your dividend yield at one three at year end is uh about as low as it's been it for a moment At the very tippy top peak in 2000, it went to 99 basis points. 99 basis points in 2000, in March.
one three and that's not re and i've got a chart letter of dividend payouts over the last 150 years the payout rate is still 30% income. It's not like these companies have gotten chintzy with their dividend payouts. The dividend payout's the same as what it's been for 40 years, 50 years. It's simply you're trading it.
You capitalize your multiple to earnings as high, which means your multiple to dividends as high. And so people crack me up when they say the company is paying a healthy dividend. No, if you take a stock that has a 2% yield and you cut it in half and you'd maintain the same dollar payout.
per share payout, your yield just doubled to four. Well, the company didn't get more generous. No, you cut the stock in half. I was surprised that all the buybacks effectively did nothing as far as actual share count. Wasn't that kind of a shocking realization? Yeah. If you're a shareholder across the board of the index and you have this period...
after the tech bubble peaked. You had a big share issue in the 1990s because Silicon Valley was very good at giving away shares i mean they were giving away four or five six seven percent of their companies per year and they hadn't figured out you could offset the dilution with buying shares back and then of course plus the accounting they weren't counting it
at that point right yeah it was two or three years later right and so it wasn't an expense now it's expensed and so but when all those when the nasdaq dropped 80 all those options were out of the money we talk about the the budget being balanced well there was no fiscal prudence really i mean you had you had you had a deal with the republican house and the clinton administration
But it wasn't like you really did austerity and tighten the budget. You had an enormous amount of revenues that flew into Washington's coffers from simply the exercise of stock options.
And so after that tech bubble peaked and after you started expensing, they got around to repurchasing shares. And so even in the 10 years... up to 2021 you retired seven tenths of shares per year apple has been a huge repurchaser of shares i mean they're the preponderance of sherry purchases over the last few years but if you look at it over 25 years and this is stunning using simply the divisor for the index companies have spent more than
call it more than half of cash flow from operations, buying back their shares, and they have not reduced the share count. The share count is dead flat for 25 years. That's stunning. So if you're not accreting... uh your ownership with a lower share count and half of your cash from operations is going out the door to buy shares back who's getting rich yeah it's a washington
uh intermittently you know lamb based sherry purchases no you ought to if you want to penalize you know penalize the egregious issuance of shares to corporate insiders and tax them at a higher rate if they're getting money for free Anyhow, we could spend the rest of our segment talking about cherry purchases. Let me do a quick shout out and then let's come back to market level or government debt.
market level debt and leverage for the government. Senator Domingo, what's up? Brandon, Mississippi, Boise, Valparaiso. How's it, Mac? Toronto, Tampa.
toronto tomball tallahassee bendigo victoria what's up early start london edmonton canada toronto kennesaw georgia new london minnesota that's a place castleford yorkshire fort wayne las vegas gothenberg's back in us brunei jupiter nice cincinnati ohio woodlands balina mullen island the wizard william the wizard of wishaw and waterloo well done medellin colombia mendocino mario lake guadalajara
Nokia. Finland. Bremerton. San Diego. San Diego too. German for... I'm just kidding. Stavanger, Norway. Nice. I've got some stats here for you, Chris. Trailing 2024 debt to GDP, 347%. 1231.24 GDP, 29.7 trillion. They're your stats. They seem familiar. Total credit market debt, $102.9 trillion. Is that a lot? Winning? Question mark? Is it a lot? I thought we had debt problems in 2000 when total credit market debt was 250% of GDP and you've been 350% since the financial crisis.
Maybe it's not a lot when interest rates are zero, but when interest rates are at a more normal level, it begins to tax things like profitability. Totally unsustainable.
huge problem the workout of excessive leverage at the extremes you could get extreme deflation which is no fun and have a depression like you had the 30s you could have high levels of inflation either hyperinflation at the very extreme were high levels of inflation like you had in the 60s throughout the 70s but going into the late 60s 70s you didn't have high debt levels the government debt got really high in world war ii and that got financed down
But in 1982, total credit market debt was 140%, 130% of GDP. It's 350%. The interest alone is just a huge tax on the economy. And so I don't, you know, who knows? I mean, you would have said Japanese government debt was really high when it was 100 and then 200 and now 250%, just the government debt alone.
so can we have more debt you know perhaps but you know i'm i'm very apolitical um over my lifetime As I think we all have, you get a little disenchanted with what we see in the United States from both parties and Washington. But I'm cautiously optimistic that we're getting around to austerity. We had to do austerity and we tend to not elect politicians and we don't appoint central bankers that are into austerity. You usually take the...
Yogi Berri is, you know, easier fork in the road when you get to it. And we'll see. I think this is going to be tough. You don't think they're going to all just turn interventionist at the first reel? Well, you'll get a recession. Unemployment is likely on the rise. The consumer's in bad shape. All the free money from the pandemic, the increased SNAP and increased credits for child tax credits and earned income tax credit, that's all gone.
and you take the you take a what's a 1.8 pushing 1.9 trillion dollar deficit uh you're running almost seven percent peacetime deficit to gdp which is just out of control but you know if the government takes in a little over four trillion and spends six the vast majority of expenditures are non-discretionary medicare medicaid um social security uh generally that's the the
third rail that politicians don't touch even the defense spending half a defense is non-discretionary half is discretionary so you know doge has maybe you know they say they've rounded up a hundred billion dollars that's a rounding error in terms of what the government spends and you talk about cutting a trillion dollars of expenditures i'm really appalled
I think the messaging is critically important. If you're going to cut fat, and there's a lot of fat in Washington. There are a lot of places where we spend too much. If you're going to take people out of jobs, though, and maybe we have to do it, the messaging, the optics have to be, look, we really don't want to do this.
But we have to do it. We inherited a mess, not just from the previous administration, but we've inherited a mess from the last 30 plus years of fiscal imprudence. And we're going to... fall on the sword and do this. And austerity is going to come with price. And we might have a bad recession. Unemployment might go up. The stock market might go down. And you're getting that message out of the current treasury secretary. But don't go on stage with a flipping chainsaw.
um and gloat i mean the glee of it all is i find quite distasteful as well it's abominable it's abominable um we have to do this and I'm skeptical that we'll be able to do what needs to be done and we'll be able to suffer the pain because when you get to a legit recession You're going to turn on the spigot. The Fed can, again, take rates back to zero. They've been tightening the balance sheet by almost $3 trillion. But that was largely offset. I got a little section in the letter. I mean you
Yellen was pretty creative in terms of leaning on financing a lot of this most recent years deficits at the short end of the curve and increasing treasury bill issuance. And so hence... a lot of supply of bills pushed up the yields of treasury bills and all that money there was over two trillion dollars sitting in reverse repo that all drained out happened to be an election year but that went from 2.2 trillion down to what's almost nothing today um
But that was offsetting the shrink in the balance sheet. I mean, when you go back to 18 and 19 and we shrunk the balance sheet, which if you go back even further, the Fed balance sheet was $850 billion before the financial crisis and wound up at... 4.2, they got it down to 3.7, but you had a liquidity crisis when they got it down to 3.7. Well, you got it up to 9 trillion. you know now you've run it off by two and a half trillion but that completely got offset by
all that money that was in repo finding its way into a higher yielding treasury bill market. So that completely offs up tightening. Well, now there's no more repo. And so any continuance of shrinking the Fed balance sheet is tightening.
um so uh it all kind of tilts toward more likelihood of recession but to your point about your question about debt it's a problem it's been a huge problem and um at some point you pay the piper um i always kind of thought if you got the extremes of the tail of a very bad deflation or very high inflation it might be not on my watch but after my lifetime and
Here I sit at 56 years old, and I think we're going to deal with the vagaries and the problems that come with excessive leverage probably sooner rather than later.
Reinhart and Rogoff wrote that paper that said that it was 90% was the tipping point. And then somebody found a hard-coded cell in the... Do you remember this? In their research and said that sort of invalidated it all and it made it... I don't know where we've ever landed on 90% being... I don't know if that completely sort of demolished the entire paper or if they were able to talk their way through it, but it sort of muddied what was a pretty good...
argument at the time but it seems to have yeah there was some critical threshold of like a hundred percent uh well that's gdp i think i think that that work and there's a lot of other academic work that supports something around
90 percent but that that's the publicly held portion of the debt so that would exclude the portion held by the central bank and so you're you're not at 125 you're at 100 of debt that's simply held by the public today but you're at the point i go back to that point where i thought debt
in 2000 when you had a 10 trillion dollar economy and 25 trillion of debt that was really the moment where i thought total credit market debt was excessive federal debt wasn't at that 90 yet but total credit market debt was But I think all this academic work that suggests that at a point when government debt gets to a level that the next dollar of debt is decremental to the economy, that the law of diminishing returns kicks in, I think there's a lot of validity to that. And you've seen it.
for the last quarter century in far less growth in real GDP per capita. When you adjust GDP growth for population growth and you adjust it for inflation, you're growing at less than one percent for the last 25 years where you know warren buffett talks about that the great economic tailwind well he enjoyed a huge economic tailwind in his lifetime you go back to the industrial revolution in 1870 but by the time you got in to the post
Depression, you got through World War II, we grew real GDP per capita at over 2%. And we're growing it at less than half the rate. So I think you've seen a slowdown in the economy. And this translates, if you think about it. into the price you're willing to pay for financial assets, you had a lot more growth. I mean, you adjust for population, you adjust for inflation. And a 15 and a half or whatever the number is for the long-term normal multiple.
Well, the multiple is partly derived from how much growth you're going to get out of the underlying asset. And if we're going to have less growth in aggregate, you don't pay as much for it. And so, I mean, that to me becomes more of a headwind against...
And it becomes a big headwind against markets when they're priced at the very high end, whether you're using the shiller or whether you're using simply stated operating or reported earnings. Things are pretty priced for perfection and leverage is a problem. um i just maybe ai bails a sat chris yeah probably i mean just like just like The dot-coms did. If that's the backdrop, what do you think about the earnings growth in those? largest companies. Well,
You know, you talk about the MAG7 making up 88% of profit growth for the last three years. You haven't had a lot of earnings growth in aggregate. Again, you had a margin decline for the non-MAG7. But earnings on the S&P 500 were 208 and change in 21. And I don't know, they're 230 something today. You've had...
25 plus percent sales growth but your profit growth has been half that and that's a byproduct of inflation um and it's also a byproduct of uh you don't have the sherry purchases that you did when the companies that are generating cash are now spending way more money on capex you don't have as much money to do other stuff and if you've got inflation
That is a tax on profitability, and you've seen it in a lot of industries. Manufacturing here and abroad has been weak. Retail, especially at the lower end of the consumer, we own a bunch of retail because we find the stocks really cheap, Dollar General and Dollar Tree. even a Starbucks being cases in point. Again, it's just the broad market. Again, I find the...
cap-weighted US stock market, price for perfection. And that's the last place I think you'd want to allocate capital. And it's not just me. I mentioned Vanguard. I did the whole section and I kind of attributed it to Jack Bogle. But Vanguard's own... Analyst team put out a couple of papers at year end and essentially said for the next 10 years.
Your S&P 500, your cap-weighted S&P 500, the Vanguard 500 index fund and all the iterations of it, is going to do 2.8% to 4.8% a year. In over 30 years, it's going to do an average of... So call it 5.7. Well, you survey the typical 401 investor or you survey the typical endowment fund manager or pension fund manager.
Nobody thinks stocks are going to do 3.8 for the next 10 years. But Vanguard said it. And Toby, it goes back to your math. I mean, however you scan it, it's really hard to make a case. that the u.s cap weighted stock market is the place to be there are places to be but but that to me is not it the index weighted towards the the biggest end of town in the index yeah jt do you want to do veggies you got veggies
Of course. Always have veggies. All right. So this week we are exploring this biological concept called neoteny. I don't know if you guys have ever heard of this before, but it's... Sort of, yeah. It's N-E-O-T-E-N-Y. And I know sometimes the veggies feel like monotony, but that's not what I said. I said neotony. And it comes from the Greek meaning extended youth.
It's when a species retains juvenile characteristics into adulthood instead of fully maturing. And this can often help an organism avoid competition and keep a flexibility. So, basically, Mother Nature came up with a way to have more cards in the deck of evolutionary development by allowing certain environment... environmental inputs to change how much development occurs. So there's a classic example of this, and I don't know if I'm saying this right, but it's the exolotl. It's kind of a...
Aztec sounding word, A-X-O-L-O-T-L. And they're native to the lakes around Mexico City. And there's like, they're these little amphibian looking... They almost look like tadpoles, basically. And they're famous for staying in this juvenile state. Unlike typical salamanders, they never undergo metamorphosis. So instead, they remain in their larval form. They keep their external feathery gills. They have an aquatic lifestyle and this youthful appearance throughout their whole lives.
still procreate as these little tadpoles. However, they thrive when the aquatic environment is stable, but...
they have this hidden genetic switch inside them that for whatever reason, when iodine is added to their water, which I don't quite understand the linkage there, but it activates their thyroid gland. And then they basically like... go the complete rest of the way in development and they turn into uh effectively like mature land dwelling looking salamanders and then they can procreate as a salamander as well uh and so
They lose their gills, they get lungs, they grow limbs to move around on land. And this dramatic transformation is like this built-in evolutionary flexibility. And so it's... It's not just salamanders in Mexico, like actually humans, we have neotenous traits as well. You know, our flat faces, larger heads relative to our bodies, less hair, extended learning phases compared to other primates. They found...
And this author, John Gribben, who actually Munger's recommended several of his books over the years, but he takes it a step further and he argues that humans became distinctly neotenous around 4 million years ago when we split off from the chain. chimpanzees and gorillas.
We basically kept these flexible brain structures that allowed us to adapt better to a rapidly changing environment. And he talks about it in this book called Ice Age, which we actually did a segment on that, season five, episode 10, if you want to. double click on that. But essentially,
our ancestors kind of had these like juvenile like monkey characteristics. We stayed flexible for longer as in earlier development. And it gave us this evolutionary advantage for a shifting climate that was uncertain around that time period. Basically, we move back and forth between the plains and the trees and probably the oceans.
The chimps basically stayed in the forest and developed into full-blown monkeys, and we didn't. And so there's this complicated phrase that biologists like to use, which is autogeny. recapitulates phylogeny. And let me explain. You could just forget about those words. It doesn't matter. It means that the development from a zygote to a baby mimics evolution, but it's been debugged.
Oh, really? It's been debunked, huh? Yeah. Well, then how do they explain then humans having gill-like structures similar to fish or tails similar to our reptilian ancestors? It just looks like it. Okay. Well, thanks for blowing a hole in that one. Autogeny recapitulates phylogeny. Yeah. Well, good job, Toby. You're way ahead. Sorry, JT. No, no, that's good. It was on my grade 11 biology test. I remember it well. Jake, I read Ice Age, but...
You know my wife and my kids, they would tell you that I've maintained juvenile characteristics far into my own adulthood, deep into adulthood. Yeah, now that's what keeps you youthful, right? JT, the reason I remember it is because it was on my grade 11 biology test and the textbook that we used was old. And when I went and looked it up on Wikipedia, Wikipedia told me that it had been debunked before I took the test, but I didn't know it at the time.
All right. Well, fair play. I mean, everything that I say should be taken with a big dose of salt that it might have been updated. That's just science, right? Okay, so let's see if we can torture this into an investing analogy. As everybody knows, early in his career, Buffett followed Ben Graham's deep value net-net approach. He's buying undervalued stocks for less than the working capital, did quite well with that.
But over time, markets changed. Buffett adapted. He evolved from net nets to more Fisher and Mungarian kind of quality companies like Coke, Seize Candy, et cetera, emphasizing durable moats. But all along, he retained this kind of juvenile deep value method. and returned to his roots when opportunities appeared like let's say filling up his his pa with korean stocks korean net nets in the early 2000s so he had these he was able to
revisit these kind of foundational strategies whenever conditions called for it, which is really sort of the essence of neoteny. So I think... Lessons for investors there might be maintain flexibility to shift strategies with the opportunities, never fully abandon a proven basic method. Continuous improvement and learning is the name of this game.
of cycles so know when old strategies become relevant again and Whether you're a tadpole or a salamander or a human thriving by staying young at heart or an investor cycling back to foundational strategies, sometimes the best move evolution ever made was refusing to grow up. You know, I'd say that Chris has demonstrated over his 25 years.
career, a pretty broad toolkit of different businesses and valuation ranges that you're comfortable with, from quality names like Nike and Starbucks in the portfolio, or Costco, like we talked about, or cyclicals in a rationalizing industry. like Olin, for instance. So I thought this would be a good fit for Chris, since he has a pretty broad range compared to a lot of investors. Yeah, there's an eclecticism to capital.
You need to be opportunistic. Pigeon-holing yourself doesn't make a lot of sense. You're always trying to make money and you've always got cash. You've always got dividends. You've always got... occasionally proceeds from security sales, you've got deposits from clients, you've got your own personal net savings, ideally. I want to segue though, I thought about something.
ties back to what we were talking about earlier about the cap weighted s p 500 and you get into buffett i think people should consider and i i get this question all the time because you know warren would sit there at the dais and talk about when asked about berkshire when he would proffer advice on investing he'd always say
The S&P 500 is a marvelous tool because it's low cost low turnover tax efficient Very hard to actively pick stocks. You've really got to know what you're doing and even there a lot of people don't do well with it and you know that evolved and charlie would always say yes but warren i think berkshire will do better and you know anytime charlie said yes but warren berkshire would do better berkshire did better um but at the it
Of late, with Warren's second wife, he'd said a few years ago that Astrid would have a trust set up for her benefit and it was going to own the S&P 500. I think 90% S&P and 10% T-bills. At last year's annual meeting, somebody asked the question about cap weighted S&P versus market cap weighted S&P. And he didn't answer that. He never answered that question. But what he said was, look. There's so much money that's going to be in this.
trust for her benefit, that she doesn't care about beating the S&P 500, it doesn't matter, she'll never spend enough money that's being produced just by the dividends being distributed. But then he said, what i'm glad he said because i've been saying this for a long time and that was and there's this little thing like because you don't you don't want the trustee to get sued yeah so man uh this will this will be an irrevocable trust distributing income and
from a fiduciary standpoint prudent investor rule now prudent investor act in every state you cannot hold a single concentrated position in the security i was an expert witness in a lawsuit an heiress of the gamble procter and gamble family had a charitable trust and i wound up defending the bank because
They had a document that expressly allowed the retention of Procter & Gamble, which was a blue chip, and if you read the Prudent Investor Rule and Act, it allowed for concentrated positions, but they came up with a game plan to slowly diversify. Well, they made the mistake, they being the bank manager of buying tech stocks with the proceeds, but they were two or three months in and P&G had an earnings miss and the stock got cut in half.
And in turn, because the portfolio got cut in half, the income distribution to the donor got cut and there was a lawsuit. And the attorney general in Ohio got involved. And the bank lost. They wound up settling it. But it was a crazy loss because the document actually allowed for a fully concentrated position in P&G.
Nope, you've got to diversify. So there's a requirement. And I think it's similar to Warren's just having bought the energy business from Walter Scott's estate, or in part from the kids, but ultimately in the foundation. wherever it was at that iteration, I presume that was gonna be a very big position. Walter ran Peter Kiewit, and he certainly had assets outside of Berkshire, but that Berkshire Hathaway energy position was huge.
And I think it required diversification. So there's that. I think there's a lot more to Warren saying the S&P makes sense. To me, the S&P makes sense for the family that's gonna sit down and dollar cost average. over a lifetime occasionally you're going to buy some stock when it's cheap sometimes it's going to be fairly priced sometimes expensive but you're going to save a lot of fees you're going to save a lot of frictional costs
And it makes sense if you're uninitiated. It's terrible advice at a moment where you're sitting at a secular peak, where you're 26 times earnings, where the deck is stacked against return when there are way more favorably... priced attractive things to do with capital. If you're a pension fund or you're somebody that has capital today, owning the cap-weighted S&P is a terrible, terrible thing. And he never made that caveat. Charlie was more prone to make that.
that caveat than Warren would have been or would be today. But the unfortunate thing is there's kind of a catch 22 there where in order to like fully believe in why you. should expect to get a 6% over 30 years, let's say. You have to do a lot of work to sort of understand why that would be and what's the argument for and against that.
Chances are, if you haven't done that work, when it does, if you do buy at a secular top, you're going to get spooked out of it at the worst time. That's just how everyone handles securities, unfortunately, unless you're...
kind of a little bit weird really um and so unfortunately i think there's going to be a lot of people who probably make the bad decision in the tough time when they really should be adding they're going to be punching out because it's too painful to watch everything going down and I don't know how to save people from that, but I think that's unfortunately what history shows is the path that is probably the most likely. Yeah, and you think about what the asset gatherers, the...
the old brokers, now wealth managers. I would say if at...
two or three of these seminal moments in time where you're at a washed out panic low, where you're in a financial crisis in 08, 09, when you're in a pandemic of 2020. If you're charged with the allocation and the investment of your customer's capital, if you can walk those people off the ledge from making a terrible decision by selling everything at a low, or chasing into a tech bubble peak at the wrong time, the advice there at the margin just saves, if it saves 1% or 2% or 3% a year.
that's enormous because when you cement a loss in 2002 because you owned a bunch of tech or you cement a loss in 0809 you'll never recover that capital you'll never get it back hugely important And compounding that is that value just tends to recover first and recover fastest and a big portion of values returns come from that early stage of the recovery.
You know, we tend to lag at the end of the cycle when everybody else is having their party. You know, we started selling off in this most recent sort of little drawdown. My portfolio peaked on Thanksgiving.
and it plummeted like a stone for thanksgiving yeah we were i was down i don't know seven or eight percent just in the month of december it was yeah and then but we're up seven or eight or nine or 10 percent or whatever it is this year cover first i think to your to your point though jake segwaying from your um you know kind of back to your veggies and and you know opportunistically investing and being willing to do different things
To me, one of the key advantages we have, and I think active investors that do it well have, is Opportunistically, when you're trading, when you're buying a new position, you've got to finance it. Once I'm fully invested, I like to stay invested. I've written about the hazards of owning too much cash over time.
and i owned a bunch of dollar general bought it really cheap in 2016 or 17 made a bunch of money they were a beneficiary of the pandemic they're typically beneficiaries of bad economies the use of food stamps snap goes up Well, the stock traded from the 60s into the mid-200s, and I was buying energy. I was buying two refiners in 2020, the fall of 2020, and to finance those.
purchases i took dollar general from four percent down to one uh company made the mistake of buying back a bunch of stock and even using debt to buy the stock back at a very full valuation but you know here we are today and the stock's trading i've got my 10-year kind of or five-year expected on where i think dollars
heads over the next five years and using my five factors it's really cheap berkshire you know here we sit we talked about it is trading at my number of intrinsic and i'm in no rush to go sell it
I think if the stock trades at intrinsic 10 years from now, we'll make the return on equity of the business. 10% maybe. Yeah, I mean, you know, but if the stock trades at a discount to intrinsic... and we are and and the business is going to earn let's say 11 on equity might make eight or nine you know whatever it is but there's no urgency to go sell it all immediately but the next purchase i make you know berkshire
has moved up to where that may be my source of capital. And I'm more inclined to use it as a source of capital in a non-taxable environment for a foundation or for a retirement account or for international investors that aren't taxed the same way that US investors are. I'm not going to go sell it in a taxable account where you've got an older client and a very low cost basis. Because I'm a buyer, a big buyer, at the tax differential. You know, if I'm paying...
20% and a 3.8% healthcare Obama tax and any state tax, you know, your marginal capital gains rate for some investors gets up to 30%. You know, at the net of the tax. that I would pay. I'm a buyer. I'm a big buyer of Berkshire. But any position in the portfolio, when I put in a buy order, to buy something i've got to sell something and if we have cash in a portfolio because the deposit has just come in or we're building a portfolio we'll use the cash first but i've got to give our traders
A one, two, three list of what I want to sell to be able to finance the purchase. And for the first time really ever, Berkshire has risen up to the level of it becomes a potential source of capital.
keeps an actively managed portfolio cheap because you're always buying the things that are the cheapest and you're selling the things that are the most dear and in a taxable account world you need to do that intelligently and so we'll use you know wash sales and and and we'll try to offset realized gains and we've done really i think a really fine job of that over the years keeping the tax bill low because taxes are a big drag in a taxable world if you're an active trader but
I thought it was worth saying because I do all this work on Berkshire and I get asked a lot, well, would you ever sell it? Well, the answer is yes. Not urgently, but it's risen to where it's a sell candidate. Ajit sold some last year. I think Ajit's sale didn't have anything to do with thinking that Berkshire was going to tank overnight, but you had legitimate proposals, campaign proposals, and a tax proposal that was going to tax... individuals with over $100 million of net worth.
on their unrealized gains well ajit had i don't know 350 350 million dollars worth of berkshire that he paid for out of pocket berkshire's never given away a single share of stock to an employee warren bought all of his charlie bought all of his greg has bought a bunch of recently. Ajit bought all of his. Nobody was ever giving it to him. But Ajit was staring at, I would guess, a $75 million tax hit if that...
If the election had gone differently and something, a crazy proposal like that made its way into the tax code. And so when he sold it close to its high for the year last year. Why not? I don't think it got reported that that was a sign that Berkshire was about ready to tank. No, it wasn't. But Ajit's a risk manager. He runs an insurance operation. And if there's a potential risk that next year, I've got to pay a tax on...
300 plus million dollar gain asset liability mismatch and you don't have a lot of cash laying around who has 75 billion dollars of cash except for berkshire itself laying around um So they've trimmed the position. There are just times when it makes sense to sell some things, and that's the luxury of being an active manager and leaning on the discipline of asset valuation.
Warren could have loaned him the money at a 15% interest rate. Hey, Chris, we're coming up on time. If folks want to follow along with what you're doing, I'll get in touch with you. What's the best way of doing that? The website, SemperAugustus.com. We have the archive of a bunch of our letters. My overly verbose letters are on there. Don't contact Chris until you've read all of his letters.
Right, right. That's the homework. It'd be stunned how many people do read all those things and then reach out and they wind up becoming clients. um we've got your this this recording when it hits next week we'll put it on and we've got a bunch of the old podcasts i think each of the ones that we've done have been on so the website and then i intermittently am out on um
whatever we call Twitter these days. Mike Saylor was, he's out going to raise $500 million in a perpetual preferred that's going to actually pay 10% cash. Choice words. I had some choice words about that this morning. Yeah, where's that cash come from? So I'm on Twitter, not very often anymore, but...
I'd say the website. High impact when you are. Yeah, it's like a seagull. You're a fun follow. And then shit and then fly off. I think I've been, and I'm not political, but last year when you had the... the biden white house was was pushing on convenience stores about bringing gasoline prices down well that was the most one of the most absurd things you've ever heard if you understand how
gasoline is sold. It's sold downstream by retailers. And there's no money. The margins are just teeny, tiny, tiny. Huge margins. Huge margins. You make all your money in the store. And so I said, Mr. President, bring down the big gulp. And when I said bring down the big gulp and not bring down gas prices,
That got shadow banned. And then so now when I talk about Tesla and its wild valuation and some of the behaviors out of its chairman, I think I'm shadow bound. I think I've been shadow banned by. Both sides of the X-splitter spectrum. That's how you know you're on the right side of history. I guess. I guess. So go to my website. JT, any final words? Well, we should tell people we're going to be gone for the next couple of weeks. Oh, that's a good point. Yes.
Jake and I are traveling through Tokyo and then Shanghai one week in each. So there's no podcast for the next two weeks. Maybe we'll... maybe we'll try to get together and record something maybe we'll try if we have some downtime all right we'll see comment on the
On the trip, maybe. But why don't I? We'll see how we go. Chris Bloomstrand, thank you very much. Always a pleasure. Thanks for joining us. Thanks, guys. Thanks, Bloomy. Folks, we'll be back in three weeks' time. Same... bat time same bat channel i'll send out a tweet i'll see everybody then thanks so much everybody oh i'll try and click it now