#27 – The Handicapper
Bill Smead is a longstanding experienced value investor, based in Phoenix, Arizona, who manages a highly successful mutual fund and has a razor sharp repartee.
Bill Smead has been in the investing business for over 40 years and has seen multiple cycles. He has an idiosyncratic investing philosophy which seeks to buy high quality stocks when they are out of favour. He has a concentrated portfolio of 26 stocks with 45-50% in the top 10 positions. Yet his holding period averages over 6 years. He explains why he thinks the stock market is going down over the next decade and offers his views on the stocks that will deliver great returns, focusing on demographics and out of favour sectors. And he explains how to handicap a greyhound!
When asked the question, did you always want to be an investor, podcast guests fall into two categories. Some, notably John Armitage, fell into it completely by accident. Others, like Beth Lilly, became interested in investing from a very young age. Bill says he always wanted to take on high probability risk. He grew up in a family of gamblers – poker players, players of other card games, and greyhound handicappers (see more below). Bill learned the attraction of taking risk which was well thought out early on.
Bill figured out that there were 5 key variables in a greyhound’s success:
- class of animal – who have they beaten before? This is akin to quality in a stock
- early speed – key to racing
- late speed – as most dogs are bred for early speed, this can be a key differentiator
- post position – there was a certain part of the track that some dogs liked – so if a dog liked being on the outside, an inside position draw was a clear handicap.
- “The Janet Jackson factor” – how have you been running lately. (Bill likes to joke!).
What is interesting is that those 5 criteria for greyhound have morphed into his 8 criterial for stock selection today. But he highlights that the odds on offer were always a critical component – akin to valuation in the stock market.
The Smead Investing Philosophy
Bill’s investing approach is simple but full of wisdom, and he offers some memorable straplines. He believes in low turnover – they own a stock on average for 6-7 years. He likens a stock portfolio to a bar of soap – “the more you rub it, the smaller it gets”.
He thinks about opportunity cost. If you buy a stock at $30 and it goes to 0, you have lost $30. If you buy a stock at $30 and sell it at $90, and it then goes to $300, you have lost $210. Like Buffett, he strongly believes in running your winners.
He has 26 names in the portfolio and 45-50% in the top 10 holdings. Bill likens his role to a movie producer – he is looking for the Academy Award winners and will hold on to them for a long time.
He only sells if
- The stock trades at a maniacal valuation
- They made a mistake in the thesis
- The stock no longer meets the 8 criteria (something changes).
Smead’s 8 Criteria
Over the entire holding period, each holding is required to:
- Meet an economic need
- Boast a strong competitive advantage (wide moats or barriers to entry)
- Have a long history of profitability and strong operating metrics
- Generate high levels of free cash flow
- Be available at a low price in relation to its intrinsic value
Favoured, but not required criteria include:
- Management’s history of shareholder friendliness
- Strong balance sheet
- Strong insider ownership (preferably with recent purchases)
He likes the homebuilders – and was well ahead of Berkshire Hathaway, having entered the positions in mid-2022. Mortgage rates going up were perceived to be a massive threat to the sector, but Bill saw the stocks at 5x earnings and recognised a number of advantages they had vs previous cycles.
- Low level of existing homes for sale
- Homebuilders are no longer land developers – they now build on others’ land which eliminates the balance sheet risk and makes them much less cyclical
- 92m millennials will replace 55m Gen Xers in the home buyers market. They have been late to get started but the demographics are highly favourable. There are 40% more people in the 25-42 age group who are now starting to have kids.
Bill thinks that although these stocks have doubled, they still only trade on 10x earnings and they have a great runway for the next 10 years – the market has been slow to recognise the elimination of the former cyclicality.
Bill owns U-Haul, a play on millennials having to move house more – a $1.5m home in New Jersey costs $0.4m in Kansas City – as companies bid up for scarce labour, especially unskilled workers. It’s also a storage play and Bill thinks Americans are great hoarders.
He is now also a big player in oil and gas. He recognised three years ago that commodities had made a 220 year low vs the stock market, the previous lows being in 1825, 1875, and 1930. He sees oil as being a pariah, similar to cigarettes when the US Congress in 1970 passed the Public Health Cigarette Smoking Act, banning the advertising of cigarettes on television and radio. Philip Morris was the best performing stock on the NYSE from 1970 to 2010 as the price of cigarettes went up 16-fold. He compares Occidental to Philip Morris.
He exited 3 of his 5 growth stocks on valuation grounds in 2022, Accenture (a 20 year holding), Disney (also a 20 year holding) and Starbucks. He kept Target and Home Depot on his millennial theme but recognises that he should have sold and bought back.
The Podcast – A Book with Legs
Bill’s son, Cole, (whom I met in London by coincidence a few years ago) co-manages the fund and also co-hosts the podcast, A Book with Legs. Bill is clearly a great reader and thinks that reading is an essential activity for any investor. One of his favourites was an interview with the author of The Economics of the Parables – author Robert Sirico is a Catholic priest in Grand Rapids, Michigan. Bill cites his optimism and so enjoyed his down to earth conversation that he was on a high for a week after. He also enjoyed his interview with Greg Steinmetz, author of The Richest Man Who Ever Lived: The Life and Times of Jacob Fugger.
ABOUT Bill Smead
Bill Smead is the founder and chairman of Smead Capital Management and created the firm’s investment discipline. As Chief Investment Officer, he is the final decision maker for all investment decisions in the firm’s domestic equity portfolios. He has over 43 years of experience in the investment industry. He graduated from Whitman College in Washington with a BA in Economics and started his career with Drexel Burnham Lambert in 1980. He moved to Oppenheimer & Co as a sales manager in 1989, then to Smith Barney as a PM in 1990. He stayed there 11 years and moved to Wells Fargo in 2001 before setting up his own firm in mid-2007.
Bill recommended the Bible (a first for this show) and two investing books below.
The Intelligent Investor is a popular one with show guests
Bill also recommended A Short History of Financial Euphoria by JK Galbraith which he thinks could have been written last week!
HOW STEVE KNOWS THE GUEST
Steve met Bill at the London Value Investor Conference where he gave a brilliant and highly amusing presentation. Steve loved Bill’s talk and chatted to him afterwards and couldn’t wait to have him on the podcast.
00:02 – Investing insights: Multidisciplinary approach
12:21 – Revolutionizing separate accounts
24:39 – Millennials: A profitable opportunity
34:54 – Cutting to kill: Unfair competition
43:41 – Pivoting to commodities: Learning curve
01:00:50 – Financial euphoria: Lessons learned
STEPHEN CLAPHAM: Hi, welcome to the Behind the Balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an unsuccessful one. Our goal is to inform, educate and entertain. We hope you enjoy this and every episode.
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STEPHEN CLAPHAM: Bill Smead is a value investor who’s been in the business for over 40 years. His firm now manages around $5 billion using a long term concentrated value strategy. Bill likes to own stocks for a long time. His average holding period is over six years and he tries to buy high quality businesses when they’re out of favor.
STEPHEN CLAPHAM: This isn’t a traditional value approach, but as an example, he held accenture for 20 years rather is an idiosyncratic pragmatic, deeply fundamental approach. To investing, founded in eight core tenets which every stock in the portfolio must adhere to. He likes investing themes. He talks a lot about demographics. In this interview, I learned a lot in this podcast.
STEPHEN CLAPHAM: I learned something about greyhound racing, which is more complex than I’d realized. I learned why millennials may move a lot more in the US in next decade. And I learned what Philip Morris and the oil and gas sector have in common. This conversation was focused on stocks and in making money. And Bill has a pithy comment and the bond mall for every occasion.
STEPHEN CLAPHAM: And I think you will find his commentary quite hilarious. I certainly did. I know you’re gonna enjoy this episode. And just to emphasize, we recorded this in the summer, Bill’s discussion of stocks is not investment advice. Please do your own research Bill. Welcome to the podcast. I’m really excited to talk to you and I always ask people, did you always want to be an investor?
BILL SMEAD: Well, I, I always wanted to be someone that took a high probability risks. I, I grew up in a family of poker players, card players, gamblers, greyhound handicappers and along the way, got the bug for taking risks that were well thought out greyhounds.
BILL SMEAD: Yeah, it, it, it ironically the greyhound handicapping was something two of my cousins attempted to do professionally and I was working swing shift at the Crown Zeller back paper mill and Smith bought that, that paper mill and I started handicapping the greyhounds.
BILL SMEAD: Well, I figured out that there were five variables that were the most important in those greyhound races, class of animal. In other words, who, who had they beaten before early speed, late speed post position and what I called the Janet Jackson criteria, which is, you know, how have you been running lately?
BILL SMEAD: And so, so I handicap greyhounds, ironically, in 1985 I was at Drexel Burnham. We brought a, a closed in Fund public, the Z Seven Fund and this guy, Barry Siskin had seven criteria for stock selection.
BILL SMEAD: And that’s was the beginning of us coming up with the eight criteria. So I thought, well, I had this criteria for selecting which greyhound to bet on. I should have a criteria for deciding which socks I should buy. That’s, that’s.
STEPHEN CLAPHAM: Very, very interesting. And how old were you when you came up with these five criteria for the greyhound? And how did you think about what the criteria should be?
BILL SMEAD: Well, it, it, it just evidenced itself, it was an oblong track and early speed was very important because the centrifugal force would cause the dogs to bang into each other going around the first corner.
BILL SMEAD: And if you got knocked off your… you, you, you are not going to win the race and, and you were you’re interested in who was gonna be 1st and 2nd place out of nine greyhounds. So the class, it, it would be like quality, the quality factor in common stock investing. That’s class is, is what that is.
BILL SMEAD: Early speed was incredibly important for clearing that first corner.
BILL SMEAD: Late speed was useful because most of the dogs had early speed. They were bred to have early speed. And so if you had late speed, that was a great differentiator for dogs. And, and so, and then posts position was very important because these, these greyhounds would demonstrate that there was a certain part of the track.
BILL SMEAD: They like to run around and they would, oh, they would, they would find that part of the track. So let’s say they like to run around the of the track, you put them in the one box, the inside box and they’ll work their way to the outside of the track, which means they wasted time.
BILL SMEAD: They, right. So, so if you were in the nine hole and you were a rail runner, you could bet on them if they were an early speed dog because then they could beat the others to the rail. But for the most part, you wanted them in the one or two or three hole.
BILL SMEAD: So did you weight these different factors or it was just an equally weighted kind of it, it, it’s, it’s, it’s funny you say that because in that world, if you are at the track in the 20 minutes leading up to the race, people were putting their bets out.
BILL SMEAD: And what odds you were being given on those factors was a big part in the thing. And it reminds me of, I try to explain to people why David Svenson, the, the, the guy that ran the Yale Endowment was so successful with the pivot that he did in 1999.
BILL SMEAD: So think of it like this, let’s say there was 11 major asset classes that, that Yale’s and D could invest in. Well, 10 of the 11 were deeply out of favor and one and by the way, that’s where we are right now, again, the one asset class was going off at 1.11 to 2 odds and then the other 10 were all anywhere from 30 to 99 to 1.
BILL SMEAD: That would be, you know, everything else. And, and so what happened was, he looked like such a genius because he took an enormous amount of money out of the favorite category, which at that time was technology and the S And P 500 index and he spread that money across the other, you know, the other 10 greyhounds in the race that were going off at huge odds.
BILL SMEAD: And as they succeeded the next 10 to 20 years, he looked like a genius. And that was the, you know, the birth of the popularity of asset allocation.
STEPHEN CLAPHAM: No, it’s an interesting comparison. Now, you mentioned Janet Jackson and you use lyrics to pop songs a lot in your letters and II, I would love to do that, but I find it really difficult. How do you find the right song? Do you just have one of these sort of photographic memories that you can remember the, the, all.
BILL SMEAD: The lyrics, I frustrate my wife all the time. I can’t remember to take out the garbage. And I can tell you everything that went on every month for the last 43 years in the United States stock market.
BILL SMEAD: I can tell you who was winning, who was losing, why they were winning, why they were losing. W which is one of the reasons why I, I’m so adamant about our positions right now.
BILL SMEAD: Ii I, in effect, trusting the rhymes of economic history are, are one of the things that, that you absolutely have to do for, for successful long term performance. And right now, all the capital has placed the opposite of what economic history would tell you.
STEPHEN CLAPHAM: Yeah. No, I, we’re gonna, we’re gonna come to that. But before we get to that, I just wanted to understand how did you start using lyrics in your letters? But it just did, it just happen. Did you just one day you went?
BILL SMEAD: Oh, that was well, II, I love music and I love movies and so you just know that for a large part of your readership, they might not be as sophisticated, a, a, as other, investors might be. And it’s a way for them to, I can work in their world. I’ll speak to them in a language that they appreciate, to understand the concept that I’m working on.
STEPHEN CLAPHAM: It’s very effective. And you also have a podcast, a book with Legs, which obviously from the Charlie Munger quote. How did that come about? What was the genesis of that?
BILL SMEAD: Well, that’s, that’s my, my son called my co portfolio manager. He has driven that whole thing.
BILL SMEAD: You know, Munger’s family called him a book with Legs because he always had his face in a book. And so again, to learn the history of the markets, the, the to understand the math of the markets and understand the psychology of the markets, you need to look at the investing world from a multidisciplinary standpoint.
BILL SMEAD: And the best way to do that is to constantly be. So, you know, we’re on Apple and Spotify and all those places with this you know, audio podcast. And we have a, we have a good one. We’re gonna be working on Greg Steinmetz wrote a book called The Richest Man Ever Lived about Jacob Fugger, which gosh is just a, you wanna talk, talk about a multidisciplinary, just a feast.
BILL SMEAD: It, it’s a great history. It’s about finance, it’s about economics. It’s about religion. I, here I, I was a huge fan of World War One and World War Two when I was in junior high and high school.
BILL SMEAD: I read every book in the library on both of those and I never understood why a guy named Ferdinand getting murdered in Yugoslavia caused a World War until I read the book about Fuger and realized that because of the Habsburgs and the connection between the Papacy and, and these royal families that they were all connected in an incredible way. That again, for a guy from the United States, this was a, a revelation.
STEPHEN CLAPHAM: It’s very funny you should bring them up because I just saw last week and I just put it in my Amazon basket. I was just looking at my Amazon basket.
STEPHEN CLAPHAM: He’s written a book about Jay Gould, who’s one of the original crooks.
STEPHEN CLAPHAM: And you know, I do this forensic accounting course and we talk, we look back at past fraudsters and I, I talk about J go and I hadn’t realized somebody had written about him. So I’ve just put that in my, in my basket. Hopefully, that will be delivered in time for me to take away on holiday. And his was a fascinating story because he tried to corner the price of gold.
STEPHEN CLAPHAM: And I mean, it was like amazing thing. I mean, I’d never come across a story before and I found the story and Ulysses Grant, the president warned him off and he carried on and then the price of gold half in a day in 18 61 I think.
BILL SMEAD: Yeah. So, so Greg, we were just talking to Greg yesterday and it was a lot easier to write the Gould book because of course, all the information he could access in English and the Fugger book, he had to do a lot of his research in German. Now, now he had lived in Germany, his wife is German.
BILL SMEAD: But it so just imagine, imagine you like the Gould book and then just add to that, that the guy writing the Fuger book had to do a lot of massive effort and research in, in German to do the same thing and you’ll love it. It’s only 250 some pages. But I’m telling you, it’s a feast.
STEPHEN CLAPHAM: All right, I’m gonna, I’m gonna add that. I’m gonna add that to my, to my list.
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STEPHEN CLAPHAM: Who’s been your favorite guest in the podcast? You, you’ve interviewed loads of really good authors. I had Richard, you’ve had Richard Oldfield on, I had him on this podcast and he was brilliant and it was quite funny because I didn’t know him, but I bumped into him at a conference and I said, I really loved your book.
STEPHEN CLAPHAM: Would you come on the podcast? And he said, oh, well, actually, you know, the first book sold very well, the first edition, but we reissued it, second edition hasn’t sold at all. Well, so I’d love to come on the podcast and he was brilliant. But who’s been your favorite? Are you not allowed to say?
BILL SMEAD: Well, II, I, the one so called does every single one and I do the ones that he, he thinks that my anecdotes add the most value. So I, I just, I, I’ve enjoyed all of them. They, they’re it, it’s such a great exercise. But book wise, I can just tell you that the Fugger book.
BILL SMEAD: Well, I, I’ll tell you, let me answer that now that you mentioned it a book by Robert Cric, The Economics of The Parables. Robert Cric is a Catholic priest in Grand Rapids, Michigan. And we had the most delightful conversation and his down to earth. Anybody could understand what he was getting at.
BILL SMEAD: Just optimism was, you know, you were on a high for about a week after talking to the guy and I’m, I’m not Catholic but it’s called the Economics of the Parables. All right.
STEPHEN CLAPHAM: Well, we better stop talking about books because I, my Amazon best is gonna be overflowing. But what’s it like working with your son? What’s it like working with coal?
BILL SMEAD: Well, it, it’s awesome and it’s challenging, at the same time, you know, he’s young and the difference between Cole and myself is I’m much more motivated by proving our discipline, right? What motivates me is I want to compete, right? I, I was a frustrated athlete as a high school and college athlete, because I didn’t have the size to be what I wanted to be in athletics.
BILL SMEAD: And, and so I, I just kind of transferred that competitive nature into the investment business and God was kind to me and got me an Ria shingle in 1993 at Smith Barney to run separate accounts. And we were raising five kids and, you know, raising five kids as a commission person is really a lot of pressure to come in on day one of each month at ground zero.
BILL SMEAD: And then to shift the entire thing over to running separate accounts and getting paid on Saturday and Sunday was just a blessing. So Yeah. So that, that was a revolution. Which of course, so for 14 years I ran separate accounts under the umbrellas of larger firms before we started sme capital and started the fund at the beginning of 08.
STEPHEN CLAPHAM: Now, this is an interesting thing because I did a spell working two or three days a week for a wealth manager in London. So they had to few mil a few billion under management and they had a lot of experience in the UK, but they knew much less about international equities and they’d actually outsourced it to a third party who had quite a concentrated portfolio, but then managed to underperform.
STEPHEN CLAPHAM: And they said to me, well, you know, this doesn’t seem very good. And I said, well, that’s really pretty bad.
STEPHEN CLAPHAM: And so they said, oh, well, could you come up with a model portfolio and then, you know, the individual bankers can decide what they want to implement and, and so on and then you can help them. And so I thought, well, you know, do do that two or three days a week might be quite interesting. And what I’ve, and they then asked me to manage some individual accounts.
STEPHEN CLAPHAM: So the banker actually did the buy or sell order because I wasn’t authorized to do that. But I basically said this is what you’re gonna do. And if you, if you didn’t do it, I just said, well, that’s, we’re done now.
STEPHEN CLAPHAM: So they, you know, and, but I, what struck me about this was that the wealth managers tend to be, well, they tend tend not to be as good investors as the fund managers, as professional fund managers, institutional fund managers. But managing separate accounts is much more difficult. I had a nightmare because I was, I started off doing it.
STEPHEN CLAPHAM: It was really successful. So the first couple of guys they then give me more money, which was fine. But then they said to their friends, oh, you wanna give Steve some money? And so the money all came in at different times and when you’re running a fund, you get more inflows, you just buy the cheapest stock.
STEPHEN CLAPHAM: But when your money running separate accounts, you, you know, there’s stuff that you own, but you wouldn’t necessarily buy more of that. You’re, you know, you’re thinking about the exit rather than thinking about it. I find it really difficult. How did you manage Steve?
BILL SMEAD: You? So when we started sme capital, we hired a guy by the name of Tony Shear who had some more institutional experience that, that I had to be a co portfolio manager. And he basic, we started a transition.
BILL SMEAD: I, when I was running those separate accounts, I did exactly what you were just describing. In other words, when a new account came in, I would load up on the things on, on my list that appeared to be far and away, the cheapest and most attractive for purchase at that moment.
BILL SMEAD: And so that was the positive, the positive was I knew how someone did. The first two years they were gonna be with me, was gonna be, determine whether they were gonna be with me for 20 or 30 years. So I was totally sensitive to trying to get them a great experience the first couple of years.
BILL SMEAD: Well, when we started the fund and we still had the legacy separate accounts. But what we had to do was we had to create all identical accounts, a model portfolio and everybody was gonna need to own the model portfolio.
BILL SMEAD: And then secondly, the old setup, the separate account set up. I was both the financial advisor and the stock picker for those separate accounts. So we were dealing with the interface of the service side of the business with the customers.
BILL SMEAD: And that’s why the fund managers have much better concentration because they’re not interacting with the customer at the customer face level. I love the people that trusted us. I, I’ve got people that I’ve been picking stocks for 35 years for and I thank God for them in my prayers. They’re great. They’re still with us and they’re being shepherded by somebody else.
BILL SMEAD: But the symmetry of our accounts creates added pressure, right? As a manager of a mutual fund, people look and they’ll say, well, am I getting the leftovers from somebody else that’s done well or a, and is this meritorious right now to buy into?
BILL SMEAD: And, we’ve been dealing that with that for 15 years and the answer to that question has been, it’s usually a good time to take a look at us when we’re in a little bit of a lull. But other than that, it doesn’t make much difference if you’re gonna stay for 10 or 20 years, it really doesn’t make that much difference when you come in.
STEPHEN CLAPHAM: No, but I mean, that early experience is very, is very important. And if you’ve, you know, so if you, what generally, what I found happened was I did really well and so I got a shed load, more money from a bunch of different people.
STEPHEN CLAPHAM: And I was going well, actually, you know, the portfolio that these guys have done so well in, well, that was 20% ago and now these stocks aren’t as attractive and I don’t have another, you know, I only, I was only doing this part time so that’s not a good strategy.
STEPHEN CLAPHAM: But I just found, I just thought this juxtaposition of having people spending less time, less skilled people. And if, if I just find it more challenging to start from scratch all the time, it’s much easier to run a portfolio and people just buy the whole thing.
BILL SMEAD: Steve, you think that’s bad. We have a bunch of self imposed constrictions on top of that. So you’ve already commented that, you know, we practice low turnover. We, we own a stock for an average of six or seven years. We run a concentrated portfolio. We believe that your portfolio is like a bar of soap, the more you rub it, the smaller it gets.
BILL SMEAD: And so since that’s the case, just think of in effect, what kind of voluntary pressure we put on ourselves, we’re going to let the math of the market work in our favor, which is if you buy a stock at 30 you pay cash, the worst thing that can happen to you is to lose 30 points. If you buy a stock at 30 it goes to 90 you sell it and then it goes to 300 you lost 210 points.
BILL SMEAD: It’s worse, losing 30 points or losing 210 points. You probably saw Buffett the other day said something about, hey, really, it’s been about five decisions we made in the last 50 years that made all the difference in our results. What he was trying to say was that, you know, holding your winners to a fault is, you know, let me give you a real world example, right?
BILL SMEAD: This moment, we were all by ourselves a year ago. Being super bullish on the home builders in the US and Fed, tightened credit the most in a year in US. History. And everybody knows that the mortgage interest rate going up is gonna just kill the homebuilders.
BILL SMEAD: Well, the stocks are trading at five times earnings, but we’ve got this unbelievable combination of circumstances in their industry that are working in their favor. First, there’s no existing homes for sale in the United States. And baby boomers are gonna, thanks to COVID are gonna live in their house till they die. And then secondly, the homebuilders themselves used to be land developers and they quit doing that.
BILL SMEAD: Now all they do is build houses on land developed by somebody else. So their balance sheets are like JP Morgan Fortress like and they don’t take the risk at the peaks and the bottoms on, on their balance sheet like they used to. And then we got 92 million millennials replacing 65 million Gen Xers in the home buying market and they were really slow to get started.
BILL SMEAD: Steve those millennials that, you know, 30 years old is the new 23 in the United States Of America. You know, boys stay boys until they’re 30 now instead of stopping at 23 like they used to. But now all that postponement is boom. It’s, it’s here, you know, you know, everybody talks about fiscal policy is why we haven’t had a recession yet.
BILL SMEAD: Well, how about there’s 40% more people between 25 and 42. It’s just an overwhelming number of people getting their, their adult lifestyle in their thirties and having their kids in their thirties and they’re higher income and more affluent and the grandparents are just dying for a grand baby. So anyway, long story short, those stocks have made a nice move.
BILL SMEAD: They’ve, they’ve doubled since a year ago. But yet they trade at 10 times earnings. The runway. The next 10 years for those companies is outstanding because there, we’ve only scraped the surface of building all the houses we need to build in the United States. And the market hasn’t recognized the elimination of the cyclicality that used to exist in the industry that torpedoed everybody in 06 to 0 12.
BILL SMEAD: So therefore, am I happy to have a brand new customer come into our mutual fund with a big position in those home builders? And the answer is I’m just fine with that. They traded up AAA huge discount to the average stock and they have probably better economics than the above average businesses in the S And P this.
STEPHEN CLAPHAM: Demographic thing when we met in London. And you put up that slide. I was very taken by that because I’d never seen the demographics portrayed in such a, a simple and easy way. And I loved that slide. You had of the millennials and all the things that they were going to buy and we know that things like having, having a child is, well, anybody, you’ve got, you’ve had five children.
STEPHEN CLAPHAM: So, you know, it’s an expensive business. Right. It creates a huge amount of spending, what other knock on effects other than the fact that the millennials have all been renting homes and when they have children, they’re probably going to want to own a home in the suburbs rather than rent an apartment downtown. What other things, I mean, are there other opportunities that spin out of this demographic?
BILL SMEAD: Yeah. Well, we own U Haul and, Southwest Airlines used to have a commercial slogan. You’re now free to move about the country. With the, the way industry is and the Labor market is in the United States. People are gonna spread themselves out aro around the United States. Really? All, all a millennial family needs is water and wi Fi the two Ws, right?
BILL SMEAD: So, so if, if you can buy a house, 3000 square foot four bedroom house for $400,000 in the outskirts of Kansas City, why are you messing around trying to buy one for a million five in New Jersey? It, it, it, it just doesn’t make any sense because your skills travel well, you know, we, we have kind of a Labor shortage in the United States. In fact, the Labor shortage is most severe among unskilled Labor.
BILL SMEAD: Businesses that employ unskilled laborers are, they’re raising the pay about 10% every 6 to 9 months to try to find employees to work in their businesses, whether it be restaurants or or a, a wide range and it’s a good thing, it’s going to eliminate some of that chasm between the, you know, the inequality that we’ve had the last 15 or 20 years, which primarily was driven by technology stock success and, and technology company success that drove that inequality.
BILL SMEAD: But nobody says that in the media, or in the world of politics, that’s what drove it.
STEPHEN CLAPHAM: Well, I mean, there’s a lot of things been driving it to be fair. I mean, a lot of it’s down to financial services as well, isn’t it a lot of it? Down to demographics and, and, and, and people passing money on. But, U Haul. So you, your, your own U Haul but you reckon people are gonna move more.
BILL SMEAD: Yeah, they’re, they’re gonna, they’re gonna move around the country and they dominate. I mean, you want to talk about a wide moat. Most people can’t even name the number two competitor, for renting a trailer or, or a truck to, to move around. And, well, that’s the number two. You’re in the industry. I met people.
STEPHEN CLAPHAM: I know that as a consumer and I know I’m an American.
BILL SMEAD: Yeah. So, so, but they’re small potatoes. I can just tell you they’re, they’re tiny compared to U Haul. But U Haul is basically, using the same property that they, they rent their vehicles from. They’re putting storage units in and Americans are notorious hoarders, by the way, Americans love to buy things that they don’t need and they end up storing them.
BILL SMEAD: And so the combination of moving people about the country and hoarding is another chance for me to make up for the fact that I, I bought public storage stock in 1985 made some money on it and sold it and should have kept it to today. I’d be a rich, rich man if I’d kept those shares from 1985.
STEPHEN CLAPHAM: Ii, I suspect Bill you’re quite rich. But this idea of you can’t own things forever, but you’ve got quite a concentrated portfolio, haven’t you?
BILL SMEAD: Yeah, we, we have 26 names and we, we usually have 45% or 50% in our top 10 holdings.
STEPHEN CLAPHAM: So that’s quite a concentrated portfolio by many people’s standards. What are the, I mean, the opportunity is obvious that you’ve got more of what you love, but you also create a bit more volatility. I mean, what can you just talk a little bit about why, 25 or 26 and not 40 why? 45% in the top 10, not 30%? You’ve come to this from trial and error, I suspect.
BILL SMEAD: Yeah, but I, I read like I got 30 years ago, Buffett said, you get 93% of the benefit of diversification at the 20th security.
BILL SMEAD: Yeah. And Buffett said, you know, is it likely that your 30th best idea is gonna be as worthy as your 10th best idea. You know, it’s, it’s not very complex on that score, but we do this through a mechanism of writing our winners to a fault.
BILL SMEAD: So when someone looks at us, they should look at us like the producer of a play on Broadway or in London, or the producer o of of movies, we audition actors and actresses and we’re looking for the ones that are gonna win the Tony Awards and the Academy Awards.
BILL SMEAD: We want Jack Nicholson, we want Meryl Streep, we want Reese Witherspoon, we want to find them and we want to stay with them for the duration of their career because they just keep winning and winning and winning. And so we sell things that have worked when they get maniacal. So for example, at the end of 2021 we looked and we said, I don’t think growth has ever been this popular relative to value ever.
BILL SMEAD: We’ve got to get out of some of our growth, your names. And we took a look. There were five names, three of which we got out of. We sold our accenture that I’d owned for 20 years.
BILL SMEAD: We sold the last we sold Disney, which we had owned for 20 years and we sold the last of our stuff bucks. We looked at Home Depot and we looked at Target and we decided because the millennials, those statistics you were referencing earlier about what the millennials are gonna spend money on the next 10 years.
BILL SMEAD: And Target and Home Depot are in the sweet spot of that spending. So we decided to keep them and the truth of it is, it had been a pretty good sell at the end of 2021 to have sold Home Depot and Target also and then bought them back now to take advantage of the millennials. But we didn’t.
BILL SMEAD: But anyway, so we will sell maniacal pricing. We’ll sell stocks that we’ve owned for a while that we decide we’re wrong on. Right. We’ll purge what we think we’re wrong on.
BILL SMEAD: And then if some of our eight criteria get violated, like if H and R block loses its moat due to TurboTax or if the balance sheets deteriorate and there’s no way to make it up through free cash flow. We will sell a stock because of, of, of it. Having deteriorated in our, our eight criteria, but that’s the three ways we get out of a stock. So let’s.
STEPHEN CLAPHAM: Talk about the eight criteria over the entire holding period. Each holding is required to meet an economic. Why am I saying this? Why don’t you say, tell us about your eight criteria? You got five things that you must have.
BILL SMEAD: Yeah. Yeah. Think about it, meet an economic need. Just think how much grief that would save everyone.
BILL SMEAD: If they just only bought part of a company that was going to meet an economic need.
STEPHEN CLAPHAM: What about Netflix or Facebook or Meta, whatever it calls itself.
BILL SMEAD: We, well, in their case, well, first of all, people do like to be entertained and there’s good money in entertaining people. So let’s just take Facebook.
BILL SMEAD: He, he, so, my daughter in law called me probably 2011, 2012 said grandpa. I’m gonna put pictures of your grandchild as our first grandchild that I’m gonna put pictures of our grandchild up on the, on Facebook. You should get on this thing. So I signed up, I got downloaded Facebook.
BILL SMEAD: I got on there and so I could look at my grandkids. Well, within about four or five years, I’ve got like 800 high school college, you know, business friends, you name it. I got like 800 friends on Facebook and I need to hire somebody to do the first birthday wishes each day.
BILL SMEAD: Ok.
BILL SMEAD: So is it addictive it, you know, was that a great, business, for a while? The, an, the answer is yes. Now what happened to me in that is kind of an interesting thing. There are great businesses that we don’t want to own. Like my mom died younger than she should have because of smoking.
BILL SMEAD: So I’ve just never had any interest in owning Philip Morris, even though as a value buyer like myself, that’s probably been as good or better a stock to own my 43 years in the business. Peter Lynch, you wouldn’t know who he was if Philip Morris hadn’t been his largest position. And, and by the way, Steve remind me to connect that up. Philip Morris with what’s going on in the oil and gas business right now before we get done.
BILL SMEAD: So there’s businesses I don’t want to be involved in, well, in the process of having those 800 friends, I realized that my college friends were putting their personal politics into Facebook in a big way. And it was, it was a real eye opener because in the 2000 and, 16, was it. Yeah, 16 in 2000 and no 2018 election, a fraternity brother of mine ran for the United States Senate in Montana as a Republican.
BILL SMEAD: And during the primary season, some fellow friends from my own alma mater, put out on Facebook that he was a Trump guy and attempted to smear him. He lost the primary 33,000 to 32,000. This is a highly respected 25 year judge in the state of Montana.
BILL SMEAD: And he lost in the primary 33,000 to 32,000. And then the guy that beat him took Jon Tester three days. It was the last Senate seat called the closest rate in the race in the United States Of America. The guy that just barely beat him, lost in an incredibly close race. So, the moral of the story, if Facebook hadn’t existed, my fraternity brother would probably be a United States Senator.
BILL SMEAD: Now, I don’t care what party you like in politics? Be it left or? Right. Wouldn’t it be a wonderful thing to have somebody you went to college with, be a United States Senator, regardless of what party it is and be able to write him a letter and say, hey, I’m gonna be in Washington DC in three weeks and I’ve got this subject that I could, I have 15 minutes of your time.
BILL SMEAD: And I thought, you know what, I think there’s something wrong here and what I think is wrong, Steve with Fa Facebook is I believe there’s 50 relationships in your life that are really important and Facebook builds your life around superficial unimportant relationships and, and it’s very, very damaging in my opinion. And so I’m not a Facebook fan a as you might be able to figure out.
STEPHEN CLAPHAM: Ii, I have to echo those sentiments. I mean, I’ve never, you know, I’m, I’ve got a Facebook account and we use Facebook to advertise our online school because advertising is very effective, you know, because you can capture the demographics, particularly if you’ve got data.
STEPHEN CLAPHAM: And I, I think that’s really quite cool and I don’t know why people sort of been writing it off, but as a, as a, as a user, I don’t see any economic need. But anyway, let’s, let’s leave aside that the next one is Malt’s competitive advantage. How do you gauge that?
BILL SMEAD: I love you asking that question. We were talking about Morningstar earlier and Morningstar tried to come up with a mathematical formula for measuring moats, in my opinion, was one of the silliest things I’ve ever seen. In fact, I was embarrassed when I looked at what they, how they decided what they have a moat rating. Most moats are virtually intellectual in nature. They’re not mathematical in the slightest.
BILL SMEAD: If you like the taste of Coca Cola better than you like the taste of Pepsi. You are a Coke drinker. If you like walking out of a Starbucks store carrying that cup because that logo makes you feel better about yourself. That is not measurable mathematically. And most moats are like that. If you’re a college educated woman in the United States Of America, you like to shop at Target now, you can’t measure that mathematically.
STEPHEN CLAPHAM: No, I actually disagree because you can measure the returns and you measure the returns versus the peers. And if the returns are higher, you can ask yourself, well, why is that? And if that’s because they make higher gross margins because you’ve got higher selling prices, then that could be evidence of a moat.
STEPHEN CLAPHAM: I’m not trying to defend Morningstar doing it mathematically because I, I agree with you. It’s a, it’s a philosophical exercise. It’s something about the product or about the, but the, we’re in the financial business and we can measure returns.
BILL SMEAD: But, but Steve at the time, we want to be a buyer. It’s almost always a time of tribulation for that particular company. In other words, can they get back their position that caused their normally high profit margins and their normally high return on equity? So le let me give you an example. So Jeff Bezos announces what I consider to be the biggest mistake he ever made in business, which was buying whole foods.
BILL SMEAD: The reason they did it is Amazon is a revenue growth story, the people that like the stock like the revenue growth story.
BILL SMEAD: And so he has to constantly find new sources of revenue to build the revenue growth story. So he looked at the $400 billion of annual revenues in the United States in groceries and said, hey, let’s attack that and, and give people the fantasy that we’re going to be a big factor in that business.
BILL SMEAD: Well, they crushed Walmart and they crushed Target and they crushed Kroger stock. Here was the king of cut to kill J John D Rockefeller was gonna come in and cut to kill and there is no, there is no John Sherman around.
BILL SMEAD: There is virtually no one in the box politic with enough political power to recognize that these widest moat businesses. And we’ve already talked about a few of them so far are cutting to kill and they’re using information in a way that makes them unfair to compete with.
BILL SMEAD: And, and, and so there’s nothing to stop it. But what he did, he woke up Target and he woke up Walmart to kick their competitive advantage against him, which is the logistics business is a nightmare. Just ask fedex, just ask ups.
BILL SMEAD: They’re telling you right now that logistics are a nightmare. It’s not a good idea to deliver at your door at a loss. It’s not a good idea. And, and what he did was he said, hey, you’ve got 1500 stores within 20 minutes of 75% of the US population.
BILL SMEAD: Why don’t you become a big factor in Ecommerce? And so they both did and he woke them up and so we bought into Target and the stock had been torpedoed and all those positive things you mentioned about the, the what usually the moat for Target meant had temporarily disappeared because Amazon was, was cutting to kill and now they have other problems at the moment.
BILL SMEAD: But the truth of it is that was a splendid stock for us. Buying it in the fifties in the spring, late spring of 2017 when Bezos did that.
STEPHEN CLAPHAM: I mean, I, I don’t know whether that was his first move or deciding to set up a logistics business, but I, I’ve had this discussion with Benedict Evans. I don’t know if you know he was the strategy partner, Andre Horowitz and he’s now moved back to London and he’s, you know, in venture capital, but he’s quite a big an author to comment on tech.
STEPHEN CLAPHAM: And I said, look, I’m, I’m a transport analyst, but it was the first sector that I looked at. And you know, this is a sector which is characterized by having a lot of assets, very, very asset intensive and very, very low returns and Labor intensive and Labor in, I mean, it’s intense, everything intensive.
BILL SMEAD: I just mentioned, I just met unskilled Labor prices are going through the roof in the United States Of America and that logistics business of Amazon is completely dependent on hiring drivers and warehouse workers and Labor is going to win the next 10 to 20 years. Labor is going to win and physical assets are going to win and companies that are dependent on, on, on Labor and physical assets are gonna lose.
STEPHEN CLAPHAM: So do you, do you think that’s going to be a massive drag for Beau or his his successor? I mean, do you think Amazon is going to struggle? Are you avoiding Labor intensive companies?
BILL SMEAD: Well, II, a guy I respect a great deal was on TV. Yesterday, Bill Nygren giving the ball case on Amazon and here’s what his team looked at. They comped aws against what other cloud stocks and then they comped the rest of Amazon on a price to sales basis against other people selling stuff. And based on that, he views the stock as undervalued.
BILL SMEAD: Well, first of all, part of that problem is all those other, cloud stocks are massively overpriced because of the mania that we’ve been going through for the last three years, which Charlie Munger called it the biggest mania of his career because of the totality of it. And what he means by that, we’ve effectively been doing the tulip mania and the Southeast at the same time.
BILL SMEAD: We’re in a double whammy mania here, at least, at least maybe triple or quadruple it. We have, we got a chart this last week that’s gonna be in our, our quarterly newsletter and, and shareholder letter and it shows in effect we’re doing a triple dot com top is what we’re doing.
BILL SMEAD: So the tulip mania as represented by crypto and Peloton and stuff like that. And, and then you got the South Sea bubble, which is the NVIDIA and the A I, that’s the South Seas that we’re inviting people to go and invest in companies in the South Seas.
BILL SMEAD: So that Isaac Newton can say, you know, I can understand, understand the heavenly bodies, but I, I can’t understand the madness of crowds and you could, didn’t speak about the Southeast bubble in his offices because he lost his fortune in the Southeast bubble. And here’s the most brilliant man almost ever walked the face of the earth. He lost his rear end in a mania.
BILL SMEAD: And, and so we, we love that by the way back to what you said about the concentration. I meant to mention one of Cole’s favorite quotes is We Love Mae West. She had a lot of great quotes. She says, you know, too much of a good thing can be wonderful. Yes. No, I like that one.
STEPHEN CLAPHAM: So just let’s talk about the bubble because Dren Miller, I got a quote from him here. There’s a 500 year history of asset bubbles well documented in the price of time. Edward Chancellor’s new book, which I haven’t yet read. I feel very bad about every time you’ve got a significant asset bubble. Economic trouble lay ahead when you had 11 years of free money.
STEPHEN CLAPHAM: People do stupid things. All you have to do is look at someone paid $80 billion for dodge a coin which was invented as a joke that can only happen in the world of free money. But the fact that this is arguably the most disruptive economic period we’ve had since the late 18 hundreds and there were no bankruptcies tells me there’s a lot of stuff under the hood.
STEPHEN CLAPHAM: So what are the consequences? There’s the direct consequences that NVIDIA won’t go up another trillion dollars and might go back to a more reasonable valuation. But there’s also some real second order economic effects. What do you, I mean, how do you look at all this?
BILL SMEAD: Well, first, we’ve been short coders and long carpenters for the last three years.
BILL SMEAD: So, so what the antitrust world was supposed to do is gonna be done by the, the open market economics. You know, you want short houses in Palo Alto and you wanna go long houses in the suburbs of Kansas City and there’s just a long list of those pear trades right now that are gonna make sense.
BILL SMEAD: You want to short Labor intensive business businesses, that are, that employ a lot of low skilled Labor. And you know, it’s just very simple.
BILL SMEAD: We got a chart in May of 2020 that showed that commodities were at a 220 year low relative to common stocks in the United States. And we literally pivoted. We went to bed one night as Charlie longer find great companies through our eight criteria at a reasonable price. People, we love to buy broken growth stocks that, that’s way easier life. And we said we have got to learn how to be good.
BILL SMEAD: Ben Graham, investors, the world turned to Ben Graham when Sa Saudi Sunday hit and they cut the Legs off the US, oil and gas industry. Commodities hit a 220 year low. By the way, the prior lows were 18, 25 18 75 and 1930. And this was a lower low than any of those three prior lows. So what it means is assets are going to be more valuable than intellectual property. I it’s easy to think about really?
BILL SMEAD: When you think about the laws of supply and demand, are there a lot of talented people trying to make the next great intellectual property? Yes. Are there a lot of talented people trying to poke holes in the ground to find, fossil fuels? No. Are the people who poke holes in the ground to find fossil fuels being politically shamed in the marketplace? Yes. Are they being ostracized? Yes.
BILL SMEAD: So let me tie this back to Philip Morris. People say, Bill, why are you so overweight in the oil and gas business? Well, let me tell you about Philip Morris in 1970 the United States government and by the way, I, I, I’m in favor of what they did. They took cigarette commercials off of television. They mandated federally no more cigarette commercials no more. Marlboro Man on TV, and radio.
BILL SMEAD: At that time, 42% of American adults were cigarette smokers.
BILL SMEAD: And by 40 years later, we were down to 23%. The price of a pack of cigarettes in 1970 was 20 cents, five cents a tax, 15 cents for Philip Morris. In 2010, it was $5 a pack, $2.50 of federal state and local taxes and $2.50 for Philip Morris.
BILL SMEAD: Now, if you wanna own a stock and you have a drop in adult customers from 42% of Americans to 23% of Americans. What do you think would happen to a stock that had, that happen to them? Well, you think it’s terrible? Right. Oh, there’s gonna be all these electric cars. Nobody’s gonna want to put gasoline in their car. This is a terrible business.
BILL SMEAD: Why would you want to be in that business? Because the price of a package of cigarettes went up 16 fold. They didn’t even lose half their clientele and got 16 times the price. It was the best performing stock on the New York Stock Exchange from 1970 to 2010.
BILL SMEAD: And, and Peter Lynch’s largest position and was one of the reasons why he ended up being such a successful money manager. So, so we’re in exactly that same position in oil and gas right now, the more they shame it, the more difficult they make it to poke oils in the ground, the more there’s gonna be an explosion in price.
BILL SMEAD: And you can see it coming because there’s only four ways to make electricity in the United States Of America right now that are allowed that is wind solar, natural gas and sticking gasoline into turbines, which is what they do in California a lot.
BILL SMEAD: So you could say geothermal, but they’re not gonna put a geothermal plant in Yellowstone Park, which is the best single place to get geothermal energy in the United States Of America. So bottom line is we don’t have nuclear, we don’t want coal fired, right. We’re not building new rivers and building new dams.
BILL SMEAD: So we don’t care what you’re gonna use. The fossil fuel energy for it takes 60 barrels of oil to build a Tesla. Our favorite guy on this is Mark Mills, written some great books and, and Mills points out the more technology you use, the more energy you use and it’s gotta come from somewhere.
BILL SMEAD: So the beauty of it is we now own a ST talk like Oxy, that is the new Philip Morris and Steve. They might just be the Amazon in the industry because they’re going to be the most successful carbon capture company and their carbon capture business might end up being their aws.
STEPHEN CLAPHAM: The carbon capture business should be an amazing business that puzzles me why there hasn’t been any proper research done on it because I can remember talking about this 15 years ago and the UK government in the competition and they, you know, they, they just don’t follow through and it’s all such an, it’s such an obvious route to relieving some of our, our problems that climate change is a, is a, is a massive massive issue.
STEPHEN CLAPHAM: But the, the follow up from the free money. I mean, the one thing that strikes me is that if you’re going to have less people employed in the tech sector, which seems to already be happening.
STEPHEN CLAPHAM: If there’s less venture capitalists deploying this idle money into stupid new ventures, then there’s going to be a lot less money spent on software or not less money, but there isn’t going to be the growth that’s implied. Why do you think that people haven’t sort of woken up to this Steve?
BILL SMEAD: If, if I could hug you at, at a long distance, I’d hug you. Because when the whole Silicon Valley first Republic and signature bank problems cropped up, I felt like I was the only person that was thinking about the 2nd and 3rd derivative effect of this in effect, the free money disappearing is torpedoing this basically unbelievable binge in wealth creation out of nothing that comes from venture capital.
BILL SMEAD: And by the way, the institutional investors, they love to make money on things that the price doesn’t get printed in the newspaper, right? They love private equity, they love structured finance, they love all these things that the price doesn’t get printed in the newspaper or come up on their computer, right? So why is that?
BILL SMEAD: No, because it’s out of sight out of mind. So when the the second derivative is if the venture capital thing kind of goes down the toilet as you can get real interest rates or, or get something in interest and the risk come back into risk assets and the the tortoise beats the hair. What’s gonna happen is new businesses.
BILL SMEAD: But by Apple machines to, to do their business and they buy software and cloud services and they buy advertising from Google and Facebook. The 2nd and 3rd derivative of this thing hasn’t even begun to play out and, and wait till, wait till those stocks start turning sour. It.
BILL SMEAD: When the public traded stocks turn sour it, it, it’s just gonna be a cascading avalanche. It, it’s, it’s going to be a nightmare. We, we think, I, I’ve been thinking a lot about the, the, the RC A, you know, in 29 you had the radio business, the air airplanes and the automobile were the triple whammy, right?
BILL SMEAD: That was the you know, with the dot com was the dot com bubble. So we’ve had, we, we’ve got a tech bubble, we’ve now got a A I bubble, you know, we’ve had a high price to sales bubble. We’ve had a crypto bubble, we had a meme bubble. We’ve had an IP O and spa A bubble. That’s what Munger, you know, the totality of it all.
BILL SMEAD: There’s gonna be hell to pay Steve, there’s gonna be hell to pay. So the history of common stock success over long duration, whether it be Buffett or Peter Lynch or whoever it was, it’s a combination of making good selections on your own and avoiding the damage that comes from the fallout of regularly purging mania.
BILL SMEAD: And I, I thought we were gonna purge it in 22 and literally this Hail Mary called A I it, it’s like you, you’re, you’re down a goal in the, in, in the football game in, in Liverpool and you take a 70 m shot to try to tie the game.
BILL SMEAD: That’s what A I is. It’s a 70 m shot in the football game. And in American football, it’s a 60 yard pass from Doug Flutie to Gerald Whalen to win the game for Boston College. It’s the most famous hail Mary. That’s what this A I is. It’s an attempt to revive a bubble that needs to die.
BILL SMEAD: It, it, it’s the, it’s like it’s the worst possible medicine for the, for the patient. It’s just a nightmare.
STEPHEN CLAPHAM: I mean, I think, you know, like all these things, it’s got a vein of truth to it, which is, there has to be some vein of truth to it.
STEPHEN CLAPHAM: But what, what interests me is if you could just share your experience about ebay, I think it was you bought way after the dot com boom because it’s just interesting to get somebody with your experience and your perspective because, and I don’t necessarily agree with you that, you know, Google won’t get, it won’t get the same growth in advertising from all these start ups.
STEPHEN CLAPHAM: Of course, it won’t. But there’s, you know, it’s got a secular trend where it’s capturing shares. So, you know, there, there’s nuances. But what I think people often underestimate is just the time lags in the system.
STEPHEN CLAPHAM: And so many people listening to this will say, oh, we had the Bear market in 22. Tech had the Bear market. It’s all over. We’re all back to the races and it’s not that simple what happened to ebay.
BILL SMEAD: So, so in 99 my poster child that I made fun of was a guy would go on ebay. He’d buy a once used Callaway driver, a big Bertha. They call it at the time and he’d pay, he’d pay 50 cents on the brand new dollar. And the thing had been used once and then he’d turn around and buy 300 shares of the stock and it would go up 10% the first week he owned the stock.
BILL SMEAD: It was a spectacular stock. So, to your point, Steve, the internet will change our lives. That was the nugget, right? The internet will change our lives. They were right. They lost their rear end. I mean, they got slaughtered. Everybody that bought that line in 1999 got slaughtered. So I made fun of ebay.
BILL SMEAD: But you know what? I really liked the business they had created. They are the New York Stock Exchange of garage sales. That’s what they are, pre owned and new but not wanted goods get bought and sold. They run 24.5% margins and guess what? They don’t have any, they don’t have any logistics expense. They don’t pay the logistics. The seller pays the logistics, right.
BILL SMEAD: So they, they run five times the margins that Amazon’s Ecommerce business does, which allows them to make money. Well, so we bought ebay in 08 and here’s what’s funny, we just had a call this week. We were checking in on paypal because we automatically owned paypal because we got a two for one split of paypal and ebay share in 2015 and we phased out of it.
BILL SMEAD: I think our last sales were like 100 and $50 on, on paypal. It went to 2 70 or some ungodly number. So we thought we better find out what’s going on there. And we, we’re not doing anything with it at the moment, but we just thought it’d be good to. So it, we, we think ebay is a terrific business.
BILL SMEAD: And so II, I remember in November of 20 08, it was not the final low, but it was a super low point. Thanksgiving of 08. It wasn’t the ultimate bottom in March of 09, but a, a broker friend of ours, and his family came over and had Thanksgiving dinner with us and I took him into my, my den and of course, I’d get my butt kicked, right. We started our fund the second trading day of 08.
BILL SMEAD: And I literally got slaughtered for the 1st 14 months that we are a public vehicle literally slaughtered. And so, but I was already bullish because the right ingredients were being thrown into the pot, right. The Fed was friendly. Everybody hated stocks.
BILL SMEAD: You know, Buffett was saying buy American, I am, I, I had, I had all the, the, so anyway, so I took him in the den and I walked him through the value line, which by the way is my primary resource for stock selection for our eight criteria. I walked him through the value line said, ok, here’s the stock ebay was $11. They had $3 in cash, no debt.
BILL SMEAD: They owned 100% of paypal, 100% of StubHub, 30% of Skype and five of the six largest classified advertising, Ecommerce, classified ad businesses in the world, foreign language, Ecommerce and, and so, so here’s what’s funny, they sold 30% of Skype for more than the other 70% sold to Microsoft who, when Steve Ballmer running it, you know, Microsoft when you sit down at the poker game and you don’t know who the sucker was.
BILL SMEAD: It was always Microsoft, right? They bought Nokia, they bought Avenue Q, they bought, they, you know, they bought Skype, I mean, they, they were the sucker in the room always. Anyway, so, yeah, so between the average cost of we sold paypal alone, we, we got about 11 times our money on ebay from that November $11 of 08 price.
BILL SMEAD: And we still own ebay at 45 on that 11 So, it ended up being a lot of fun. So, back to your point, Andy Grove said the best business advice he ever got was from his, city College Of New York professor. He says when everyone knows that something is so nobody knows nothing. So if everybody gets excited about a I, that’s gonna breed a tremendous amount of grief.
BILL SMEAD: No, I’m sure.
STEPHEN CLAPHAM: I’m sure that’s right, isn’t it? I could go on for much longer, but I know you’ve got a fun to run and you’ve got a busy day ahead. I normally ask people if they could recommend a book or a couple of books to a young person coming into the industry. Well, you obviously, you love books as well. So I’m curious to hear what your recommendations would be.
BILL SMEAD: I, I, I’ll tell you exactly the same thing. I tell all the young people when they ask me that question and I get that question a lot. I recommend the Bible, John Kenneth Galbraith’s Short History of Financial euphoria. You can read that book today. It’s 100 and 25 pages. It takes about 2.5 or three hours to read, depending on how fast you read. And you’ll think he just wrote it last week.
BILL SMEAD: It was last updated in 1990 of course, Ben Graham’s intelligent investor, those three books, th th that’s what I recommend to all the young people. And let me tell you at the moment, a, a short history of financial euphoria, you better start there because it, it, it just such a great job of explaining why invest most investors that own common stock right now over the next 10 years are likely to fix miserably.
BILL SMEAD: And, and that’s true whether they own an index fund or not because we think that we think the index, the S And P 500 index will run nominal negative returns over the next 10 years. And, and on an inflation adjusted basis will run very negative real returns over the next 10 years. Much like you, you know, end of 99 to end of 09. So I, I can’t.
STEPHEN CLAPHAM: Let you go without exploring that. But before exploring that, I just wanted to ask you why the Bible?
BILL SMEAD: Well, it’s just the foundation of, of everything.
BILL SMEAD: It’s my own personal worldview.
BILL SMEAD: It, it is based on the truths in the Bible. And by the way, again, Robert Sirico wrote that book, I mentioned to you about the economics of the Parables. He does a great job of flushing out how my, my great economic wisdom that there are I I it it’s just fantastic the way he flushes that out very real time, common sense and useful ways of thinking about economics. We’ll link that in the show notes.
STEPHEN CLAPHAM: But the this idea the AND P is going to have a negative return over the next 10 years. And I have to say, I don’t, I mean, real terms, I definitely don’t disagree with you. I don’t nominal, I’m not, not sure. And I, I’d just like to briefly explore that with you because I’m, I think people have underestimated inflation and in the past inflation has been bad for equities. Is that the reason.
BILL SMEAD: Well, that’s one of the reasons, too many people with too much money chasing too few goods. We’re in a commodity super cycle that started a couple of years ago. The other commodity super cycles were 1971 to 1981 and 1999 to 2008 or 11 depending on which way you look at it.
BILL SMEAD: So what was the 1971 was too many baby boomers, a 75% larger population group than the silent generation behind them. With too much Federal government borrowed money to fight the Vietnam War and do Johnson’s great society that got monetized, chasing too few goods.
BILL SMEAD: The moment the Arabs embargoed oil and the 1999 to 2011 was too many Chinese people with too much money chasing too few goods. Right. We dug up Western Australia, put it on a barge and took it over to China to build condo buildings and it put tremendous pressure on, on commodity prices during that time period.
BILL SMEAD: This time, it’s too many millennials with too much money. This time $9 trillion of monetized federal debt, by the way, asking Jerome Powell to solve a fiscally created monster. In this case, fiscally created inflation to cure inflation. With monetary policy is like going to a brain surgeon to to cure your cancer.
STEPHEN CLAPHAM: Well, listen, Bill, it’s been absolutely fascinating. Amazing listening to you. I hope that next time you’re over in London, we’re gonna get a few beers together because I think that would be great fun. It’s been great fun talking to you and thank you very much for coming on the show.
BILL SMEAD: Tha thanks for having us. Just really appreciate you.
STEPHEN CLAPHAM: Well, I could have chatted for quite a bit longer with Bill if he didn’t have a very busy day ahead of him in Phoenix, Arizona.
STEPHEN CLAPHAM: I really enjoyed our discussion, particularly his analysis of us demographics and how the wave of millennials entering a peak spending period will provide some excellent opportunities and stocks. They may also help support the US economy to a greater extent than I had realized. You can find Bill at Smead cap dot com, sme A DC A P dot com.
STEPHEN CLAPHAM: Thanks as ever for listening and please share with all your friends. Please follow us, leave a five star rating in Spotify or Apple podcast that really helps spread the word. And if you’re that way inclined, the podcast is now also available on our YouTube channel. See you next time.