Hello, and welcome to The Australian's Money Puzzle podcast. I'm James Kirkby, the Wealth editor at The Australian, and welcome aboard everybody now. Issue Issue of the Week, Issue of certainly one of the biggest issues of the year. Hasn't happened for a long time. Chief executives behaving badly in many different ways. Does it matter to you as an investor? We want to look at that today. It does matter, by the way we can show you in many ways how it does matter.
What if you had shares.
In Quantus, for instance, and you would have paid a price for the reign of Alan Joyce, who was so good for so long. But in the end, of course it was ruling like an emperor in that airline and he was beyond question, it seems, and it's caused all sorts of problems, including political problems. But put that to one side. There were issues right across quantity after the nature if you like, and the sort of rain that he had where he was the king and the board
really seemed to roll over for him. Chris Ellison at Mineral Resources Big Lithium Play. Lots of our listeners would have interest in lithium. He is under investigation for an alleged tax fraud. This is just like an old fashioned I would have called it a small time way of thinking, doing little deals on the side. We haven't seen that for a long time with in billion dollar companies, and
there it is. And then of course of the spectacular case of Richard White of Voice Tech, where that stock lost billions of dollars because the CEO was invested in a sex scandal. Now these aren't typical CEOs. Keep in mind, these are larger than live CEOs, and they often create the company and run the company, and they completely How they behave is integral to how the company performs.
You could eat on musk.
Can we think of Tesla without eton musk mosque at the Trump Valleys? Do you think that matters as an investor? Is it relevant to you? So you can see how there's layers in this. Roger Montgomery is a regular on the show. He's also a regular contributor to The Australian's Wealth Section and indeed this week he has written on this.
And when I saw the piece which he sends me earlier in the week, the minute I saw what I rang him and I said Roger, we have to do a podcast artist, and you are the person to do it.
Oh are you, Roger.
I'm really well, James. It's always great to be talking to in person.
I'm trying to think of a period where we had CEOs. I mean, do we have to go back to do we have to go back to the nineteen eighties and the and the bonds and the cases and all that. And by the way, folks, their scandals were all financially right there, they were just financially really.
We've had congo line examples of CEOs behaving unsatisfactorily or inadequately. And as we get into the talk today, we'll probably discover that boards have a lot of explaining to do. You could go all the way back to Enron and Worldcolm, as far back as you even further back to those that you mentioned. There's been ABC Learning Centers, We've had mfs, We've had all Co, Badcock and Brown.
Credit Corp.
I was the first fund manager in Australia to launch a class action against a public company because of failure to continuously disclose information that was happening in a company. In the Credit Corp case, Timber Corp. We've had great Southern plantations and most recently wise Teken before that quantus And in all of those situations, or in many of those situations, what happens is there's a personality in the business.
They might be the founder of that business. In the cases where a founder has built a very successful business and they've brought directors underneath them, often the directors will fit a debt of gratitude to that founder, that chairman, or that CEO. Then, of course you have the examples where they've grown the business, or CEO comes in, they've grown the business. They might not be the owner, but
they've done a phenomenal job of that business. And what happens is the media lavishes praise on that particular person. That particular person men starts to drink their own kool aid, so to speak, and then they become they become bigger than ben hers so to speak. And then the directors again fawn over these directors, and they're scared, they're scared to actually stand up to them. James, if you'll indulge me, there's a terrific quote from a University of San Francisco
professor back in two thousand and one. Is named is Richard Pantillo, and he famously mourned the loss of the corporate moral compass. And if I can quote him, he said, in theory, publicly traded corporations have shareholders as their kings, boards of directors as their sword wielding knights who protect the shareholders, and managers as the vassal who carry out orders. In practice, in the past decade, and he wrote this, remember in two thousand and one, managers have become kings
who lavish gold upon themselves. Boards of directors have become fawning courtiers who take coin in return for an uncritical yes man function, and shareholders have become peasants whose property may be seized at at management's when. And I think a lot of listeners today can relate to that. The shareholders are the owners of the business. But in many cases, when a founder decides to offer some shares to the market, those shareholders aren't considered at the same level of ownership
as the founder of that business. And that's where the problems begin.
Yes, and that's the problem, of course, that when these people and they are we have some I want to talk about some companies that are for listeners, that are very for the present is very important and by the way, there are no scandals that we are aware of, none, whatever. But they're marvelous companies, but they're also terribly linked with one person.
We think of something like.
The Goodman Group, which comes up all the time because not only is it a top class property trust her Reef, it's also a play on AI for many people, a company which isn't listed like Mecca Joe Horgen, she's she's completely personified that company's But the issue is when you have one person that personifies the company Richard Branson at Virgin marvelous example, Jerry Harvey at Harvey Norman, how does the board ever get around that, especially if these people
are If these people are, they're they're charming, they're strong, they're brilliant, sometimes they're charismatic. You've made the point that with all these with this particular issues, the three issues we've listed in particular Quantus Minreis mineral resources, and also wise Tech. You mentioned the professor and he's talk about how it seems seemingly there's this structure, but in effect
it's completely the other way around. Indeed, you mentioned in your piece which I was talking about earlier, that there's in recent there's this a big push for independent directors. So the theory was, bring in people who were really smart, really good, a really good lawyer, a really good account and someone who's already been through the hoops in another company. Put them around the board, and then the CEO is answerable to these people who dominate the board. That looks
good from the outside. The problem is sometimes these people have no clue of what's going on in the company and their only window is the CEO who talks their own book. How do you get around that?
Yeah, Look, most boards, despite the conger line of disasters that we've seen, despite that, most boards actually adopt conventional wisdom and sound practice when it comes to procedures and structures for their operations. They meet regularly. If you look at the best and worst companies, they or companies where nothing's gone wrong, and companies that have imployed, they held the same number of meetings. So it's not meetings that
changes the outcome. There's an argument that you should have members on the board who are invested heavily in the business, but there are very famous examples. Ge as an example where there's been great success and the board of directors had little or no money invested. And then on the subject of independence, which you raised, James, the conventional wisdom says that you need plenty of independent directors. You don't want to have too many mates or insiders, because that
muddy is the board's operations. It can also corrupt the decision making process. But then Warren Buffett once said, if you have too many people who are independent and their professional gig is being an independent director, then their bread is buttered by the fees that they receive for being independent directors, and so they don't want to rock the
boat because they don't want to lose their income. And speaking of Buffett as an example today, Birkshire Hathaways eleven board members, but once upon a time it had seven. Three of them had the Buffet surname. Three of them were very related.
Oh was that good or bad?
We can have some incredibly admired companies that have done great things and there's very few independent directors.
Your point is that the insiders.
Define it. Berkshire Hathaway.
Indeed, and I think this is the really important point. If following standard governance protocols doesn't protect investors from the sort of things that we've seen at Quantas and Minreres and at wise Tech. Then what is it what needs to change because those prescriptive tools haven't prevented people from losing a lot of money by being invested in businesses or companies where there's been a corporate failure or a scandal. And I think what needs to happen is you need
to acknowledge. And we talked about it right at the start, or you mentioned it in your introduction, it's about personalities. Boards are social systems, and in so sociology, a social system is a group of people that combine sounds like a board to create a functioning society with goals that sounds very much like what a board does. So they're not just formal structures. They're a dynamic social system exactly the same and more mature version, but exactly the same
as a sand pit in a kindergarten. And there's going to be interpersonal dynamics that greatly influence the effectiveness and the outcomes of what happens in that sandpit or board meeting. So the prescriptive stuff is vital, but really it comes down to the personalities and a couple of key ingredients that those personalities need to bring to those boards.
You had an idea that the boards would run better if they all had a basically a performance review every year of personality.
Let's talk about that for a minute.
Yeah, I want to talk about it, because here's the thing.
Who would do it? We do it.
As I was writing the article for the Australian Wealth Section, I realized that the founders and the CEO, they should have publicly listed companies where there are lots and lots of investors who are depending that their superannuation is depending on their success or otherwise should be willing to submit to individual accountability and performance evaluations. Now, as I wrote that, I could hear CEOs, some of whom you've mentioned, saying, yeah,
that's not going to happen. Stuff that I own them. I own the most shares. I am the CEO. I built this company, I listed it on the ASX, I've made it the great success that it is, and the rest of you can all go and get lost. There will be people who behave that way, which is precisely that treatment of shareholders as peasants that Richard Pontillo described earlier.
That's that's where you will see really smart directors leave the board and arguably shareholder should probably do the same thing because eventually it's going to come a cropper.
Yes, eventually you pay for this, don't you. Yes, that's right, okay, And just a quick word about the how important for you were you when you're assessing companies and you're putting money, a large lix of money often into companies.
And obviously I know you.
For a long time and I know that your quant quantitative analysis is always very important to you. But the chair and the CEO, now this is a thing the two companies come to mind. Tesla has an Australian chair, Robin Denim, and she she's been in all sorts of trouble for quite simply getting it on Muscowet's way. She's also in trouble because she's chaired the Czech Tech Council, yes, which should have been across the wise tech thing ages ago.
That's one person. The other person is Richard Goider, who was greatly admired, had run West Farmers, was the chair of Quantus, while Joyce was particularly in the later not running that company in the optimum way for anybody. So how important is that dynamic and what can be done to improve that situation, but they they'll become chums.
You mentioned there's a quantitative or a measurable aspect to investment analysis, and you're looking at the outputs of the company and the inputs as well the money that's going into that particular business to produce those outputs. But it's much harder to analyze that qualitative aspect, particularly if a great board has a culture of open descent and it values diverse perspectives to help avoid groupthink and to help enhance decision making. How do we as external shareholders actually
assess that. It's really difficult. You can ask questions, you're probably always going to get the answer you want to hear, but ultimately that's what it comes down to. And unfortunately, sometimes the founder or the CEO has a personality or a celebrity status or a weld status at billionaires, and it makes challenging them almost impossible. But that's what you really want to find. You want to find a culture
of open descent. Open descent, Yes, yeah, indeed, and I think if you can have that, then we wouldn't have the situation at Wise Tech, We wouldn't have the situation at Quantus. Nothing would have happened that merited headlines in newspapers that would have been nipped in the bud much much earlier.
All Right, we'll take a short break and we'd be back in a moment with some of our listeners' questions. Hello, and welcome back to the Money Puzzled podcast. James Kirby with Roger Montgomery of Montgomery Investment Management, fund manager. I'm sure you all know him, though I should introduce him properly to you at this stage. Okay, lots of questions, Roger, and they're pretty interesting. I just quickly read this is not so much a question, but it was a comment
we I had. I've been talking about a piece I had read in the Wall Street Journal which was so good, and it was by the chief scientist at Facebook, and he, of all people in the world, completely downgrades the excitement around AI and written, James, I know you have and so, and he says that where we're at the moment, that AI in terms of intelligence is at the same level as a household cat. In other words, he's saying, be very careful. It's highly developed advanced computing and retention, but
it's not thinking. So Steven's question is I was thinking about your comment on and this was about yan Lecuon. By the way, yan l e c u N, who is the chief scientist that metas comparing the intelligence of AI and the cat. I just asked chat GPT to calculate the cash transfer value of a UK defined benefit scheme using the variables years worked, salary, etc. It gives me an approximate answer and second and showed the mathematical formula.
I personally don't know any cats that could do this, said Steven.
That's true, but both are right. Both are actually right. It's producing that answer, but it's producing it based on a probability analysis of what the next word should be, and it's looking at stuff that's already been written by humans and then pulling that in and consolidating it for the user. Look scouring the internet to find the answer, so to speak, and where it doesn't find the answer, where it adds libs. It's using probability to work out what the next word is likely to be. And it's
not thinking and so it's not making a decision. It's just following a protocol and that is quite different to a cat. And with respect to hype around AI, look, I think I think that artificial intelligence there's a lot of use cases for it. I use it, most people I know use it, but we use it in a limited fashion. And more importantly, we don't pay a lot of money for it. So there's a couple of issues here.
Share prices are currently reflecting the technology being transformational not only for life on Earth, which it may be, but transformational for all shareholders in all businesses that are related to AI. And what we know from past experience is that not all players are going to make money, not all players will survive, yet they're all being priced as if they're all going to be enormously successful. Now we've seen this in the past. We saw this with the
advent of the motor car. If you'd been in Germany in eighteen eighty I think it was eighty eight, if you've been there when Carl Benz drove the first horseless carriage I think it was called the Benz patent Malta Vagan, and he drove that. You might have spotted that this was going to be transformational for life on Earth.
But even if you.
Had, and by the way, not everyone did. Famously, Henry Ford's lawyer told Henry Ford. We don't need a motor car. What we need a faster horses and so not everyone picked it, but let's say you did pick it. After that event, there's been something like sixteen hundred car manufacturers in the United States, of which four exist today, and two of those four were bailed out during the global
financial crisis. So really there's only one or two that are profitable that still exists, and shareholders lost a ton of money. The same can be said for television. The same can be said for commercial air travel. Commercial airlines have now been running for something like eighty years, seventy nine years, and in those seventy nine years, the total aggregate and I did the calculation using the official data of the IOTA data, the total aggregate profit of all
airlines that have ever operated commercially to transport people. The total profit today is twenty billion dollars. And that seems like a lot of money, but let's remember Microsoft does that in three months. This is eighty years.
Their shareholders haven't made a lot of money, only a handful of winterers.
Yeah, that's right, So it's really hard to pick the winners.
Having said that, you like next TC, don't you and you like McQuary technology, and you're in them, aren't you.
Am I right, we're in McQuary or have been in McQuary rather. And the reason for that is that we think that data centers are going to capture the line's share because they're upstream providers. So you got upstream and you got downstream downstreamer that people who try and adopt the technology to make products to then sell and upstream are the supplies of the picks and shovels. And we think, and the numbers bear this out that the upstreamers they're
making the line's share of the money. At the moment in AI, the biggest use case, the biggest commercial use case or the most popular commercial use case for large language models, which is the chat GPTs and the perplexities of the world, is chatbots or companion bots. So these are people who might be lonely for various reasons or don't like talking to other real people, and so they keep they subscribe to a chatbot to keep them company. That's the biggest use case at the moment.
At the moment, just on the investment side, then, is there any stock stocks that you think have a potential to be the long term winners.
Well, I think all of.
Them, at some point in the next few years are going to are going to have a valley through the sorry a shadow of the valley of death moment, and I think out of that will emerge there'll be some sort of correction. It's and I think that I'm guessing,
completely guessing. I don't know, trying to predict these things as a fool's errand but if in the next couple of years we have some sort of correction, then out of that will emerge some winners, and those that are less likely to win won't receive ongoing funding and they'll they'll fall over and disappear. And it's then that you'll be able to, I think, be more certain of a great return on your money from AI.
See the big superfones are certainly stopping large words of cash into data.
The prices data centers are fine, but it's the AI, the LM producers perplexity. I mentioned a moment ago. It had a valuation earlier this year of about five hundred million US dollars. It did a funding round in March I think it was or April, and it was valued at four billion dollars, and it's now looking to raise some more money at eight billion dollars. So that's a
big jump in value in less than twelve months. And its last official run rate for revenue was ten million dollars, So an eight billion dollar valuation for ten million dollars of revenue. Now there are that it's increased its revenue to fifty million, but eight billion for fifty million of revenue. There's a lot of optimism built into that price.
There's a lot of optimism built into that price.
Okay, So listeners, I think, I mean, look across this, it does seem well Roger's talking about the offstream and the difference between the language modular creators, but the data centers being something of an approximate for the pixel shows in the boom.
Is that a fair thing to say that?
I think that's fair, And it's worth remembering that there are people who believe that large language models are going to lead to artificial general intelligence, or what's called AGI. And there are other experts who say, you know what, for llms to turn into to evolve into AGI, there literally is not enough energy on Earth to produce the
computing power for that to happen. So that's a widely debated point, and I think some of the optimism in share prices at the moment are bidding on large language models becoming AGI or becoming artificial general intelligence.
That's why Google has bought directly into nuclear power, directly into the Three Mile Island, believe it or not, of all the plants, of all the nuclear plants in the world of the Harrisburg one.
Yeah. Yeah.
Google's purchase of nuclear nuclear power plant is an attempt, I think, to capture some of the energy that's needed to do that, and they're aware of it.
Thank you, Stephen for that marvelous question. Could have been a whole show. We'd come back to it. We come back to it readily. Just a quick one from Sean on the show last week, so market the crashes and the crash of eighty seven. I saw no real info in this episode, just a lot of reminiscence about nineteen eighty seven, Okay, Sean, the idea I think of that, no,
I know that. I think the show what we did, Sean, was to try and remind people what a crash is like, and most people have never really seen one.
That.
Of course, a ferocious downturn in COVID, but in many ways that was entirely explained by COVID and we recovered
quite quickly. What a lot of our listeners on the show have never experienced is twenty five percent in a session or fifty percent Yeah, but we both have or fifty percent over two years that we got we got once upon a time in two oh nine, and I just wanted to have someone on the show to articulate what it's like, folks, because I'm just saying to you, as a shared investor, if you are really worried and you find it's double churning when you get up and
find the market loses three percent in a night or four, just remember it can go ten, it can go twenty, and you should be able to accommodate that and know that it can happen. Okay, short break, will be back with the last three questions, which are very interesting from Tommy, Paul and Fred. Back at the moment. Hello, Welcome back to the Money Pozitle podcast. I'm James Kirby with Roger Montgomery,
fund manager and author, regular guest on the show. Tommy says, longtime listener, first time caller, thank you, Tommy, do annual capital growth rates for Australian property accurately reflect the value appreciation of the land underneath the underlying land, rather distorted by the neglecting the cost of capital improvements.
Great question.
Yeah, yes, it's a.
Really good question, isn't it The land out there isn't really going up in the same way, is it.
What do you think, Roger Well?
I think it raises an interesting and interesting discussion about where value in property lies. And we have to go back, James, We have to go back maybe ten or fifteen years, and I wrote an article for you talking about property in that light. And if you look at the very long term returns and one hundred year returns or eighty year returns for as CBD office tower, then you might be surprised to hear this, but pretty much all the rent that has ever received from owning one of those
buildings is eventually poured back into its upgrade. In CBD buildings, we have A grade buildings, B grade, C grade, D grade and so on. And everyone with any kind of big brand wants to be in an A grade building,
particularly if they're employing thousands of people. They want to be in the newest, latest, greatest building, and those buildings don't stay A grade forever because eventually technology changes and newer buildings that are constructed with newer technology that surpass the A grade building of ten years ago, fifteen years ago, or twenty years ago, and so they have a limited
life where they're A grade buildings. Then they become B grade and then they don't earn as much, and so eventually the owners have to pour money back in and engage in what we call capital expenditure to upgrade the building to make it competitive again. And so with a CBD office Towler, you have a postage stamp of land that appreciates and you have a very large building that depreciates,
and those economics aren't great over the very very long run. Now, people do make money out of office buildings, but they make it tactically rather than strategically. So they're saying, Okay, prices are really low. Now I'm going to buy one of these buildings. I'm going to do really well because I think prices are going to recover, and they make
a tactical profit out of that. But if you owned a building for as long as the bricks and the cement lasted, you would find that over time you'd be pouring back pretty much all of your rent into upgrading that building. What you really want is a big piece of land and a tin shed on it, which is like a Bunning's building. That's what you want. You want Industrial industrial property, I think makes a lot more sense
economically from a business economics perspective. Industrial properties make more sense than CBD office towers because you've got a lot of land that is appreciating and you have only a cheap shed that is depreciating.
It's so interesting. And in residential that version, obviously is the landlords who have a row of pretty beaten noboard houses that never change and are rented for generations. And it's the same sort of thing in the middle of the city.
Very interesting.
Okay, we must get through the other questions, but thank you for that, Tommy's Paul. Are Australian and other share markets approach in long term pe value peaks?
Don't they correct? At this point? What does history tell us? If only we.
Could answer that in a reliable fashion, Paul, but Roger will have a goal.
The short answer is no, it has nothing to do with the valuations by themselves. It will be a change in the PE ratio, which measures the willingness of people, the popularity or willingness of people to pay for a dollar of earnings. The more popular or the more willing investors are to pay for a dollar earnings, the PE expands.
There is a relationship, a correlation between interest rates and PES, but there's also a correlation between sentiment and PES, and sentiment all else being equals, sentiment is going to drive what people are willing to pay for a dollar of
earnings if interest rates remain constant. When interest rates go down, that acts like I think it was Warren Buffett who said that that interest rates are like gravity on prices or on pes, and so when interest rates go up, the gravitational force is much greater and the value the present value of future income goes down. PES go down because people leave the stock market to put their money into safer securities that are paying a higher interest rate, and so or what they perceive to be safer and
paying a higher interest rate. So that process of moving money out of the stock market into interest bearing securities because interest rates have gone up, that reduces prices. That selling pushes prices down, and then prices follow the intrinsic value. The intrinsic values because the present value of future earnings goes down as interest rates go up.
But to try and to.
Say that old peas are very high at the moment, now there's going to be a correction, that's wrong. And you only need to look at Robert Schiller's cape chart. You can google that. Just type in Robert Schiller cape chart and it'll be the first it'll be the first entry on Google or the first listing you can pull up that chart, and what you'll find is that there have been lots of times in the past where the cape ratio has been high and it's just kept going higher.
So no, you wouldn't say that just because peas are high, that the market is going to correct. That's a mistake that only young players keep making.
Remember your young pups. But here's the thing.
If there was a bell that rang at the top of them, I could pull, everybody would know, and we'd all be out, and we'd all be worthy and we'd go back in at the bottom.
But it doesn't work like that.
And as Roger says, when you see these headlines, and it's a great old trick, you see it in media all the time. This ratio, some ratio is gone high. Be careful the last time it happened to stop market crash. Yes, but there's no evidence proof whatsoever.
It'll crash again because of one ratio or another.
I think, as Roger alluded to, it's sentiment. Really all you can have all the ratios you like, it's sentiment that on the day that turns a market. I think the best one two for that is nineteen eighty seven. So one of the reasons I used that crash because it was the one that had no clear, outstanding explanation except for the fact that the market had run so high. Okay, and other crashes we knew why, COVID, GFC.
Et cetera. Yeah, we might.
I was just gonna say, James, it might be that there's a huge amount of global debt which hasn't worried anyone year for many years, and then suddenly everyone starts to worry about it because there's a refinancing of it. Or China decides to annex Taiwan, it decides to put all of its ships and all of its planes over the top, and suddenly sentiment changes. And that's more likely than just the fact that peas are high.
Yes, exactly the sentiment rather than the actual numbers. Okay, final question from Fred. We'll try and do it quickly. It is impossible to see how my superfund is really doing against the market because tax is a distortion. Tax may exaggerate the returns if the tax rate is negative due to franking credits, for example. In addition, the tax on super can very lot, depending for example, if the fund is in accumulation or pension. Isn't it difficult and
dangerous to discuss returns on investment without acknowledging the tax overlay? Yes, Fred, absolutely it is. Do you think it's in particular issue for super funds and their returns and their state? And those advertising panels we see on the highways telling us that such a funded nine percent for ten years in a row or whatever?
Are they miss leading? Do you think, Roger?
Look? I think, James. The reason why it's done that way is precisely because of the points that the question eraises, and that is that everyone's tax is different. Imagine an advertisement for a fund's returns that took into account everyone's different tax rates. The numbers would be so small you wouldn't be able to see the.
Ad yeah, or even the bands.
Yeah, absolutely, And so what we do is we take that out of the equation and we let people make their own assessment of what the return would be for them given their tax rate they deal with. Everyone deals with their own taxes, and we just present the numbers pre tax but after these but before personal tax rates, because we don't know people.
If you're in.
Pension phase in your superannuation fund, you're not paying any tax. So the advertised return is your return up to one.
Point nine million.
Okay, I thank you very much, fed So I hope that's useful to you. None of this was advice. It's all information. And the last piece of information there was that you want to see those returns before fees, but actually on taxes, it's just not feasible to do it after text because of the tax bands, because of the tax position, because of the fact that you don't pay TEXT when you're retired, and you pay half your income in tax if you make a good salary before you're retired,
as all many of our listeners would be aware of. Okay, Roger Montgomery, thank you very much. Marvelous to have you on today or as a pleasure.
Jame's glad to be with you again in.
Person, and thank you very much for listening. Let's have some emails the money Puzzle at the Australian dot com dot au.
Talk to you soon.