IFB25: Tulip Mania, Intrinsic Value, and the Student Loan Bubble

Tulip Mania
Dutch Tulip fields in springtime


Welcome to session 25 of the Investing for Beginners podcast. In today’s show, we will discuss bubbles and how they pertain to student loans and whether or not we have a bubble in the student loan arena.

  • Whether or not we are in a student loan bubble
  • Different types of bubbles in the past
  • How investments can impact your thought processes in regards to school.
  • Determining your best intrinsic value and return on investment for a college education
  • Finding your way during bubbles by practicing value investing strategies

Andrew: Yeah, so I kind of personally see a bubble that is going on right now, I know it might be kind of a crazy idea, there are some people who agree with me. Experts are putting their name out there, claiming this to be true.

I am not the kind of person to say that yes, this is going on, but this is the way that I perceive the world.

I see a sort of bubble going on with the student loan space; I just see it if you look at it the way that prices for education and colleges have risen, and the amount of debt that is accumulating at my age and for my generation.

We haven’t seen the effects of people defaulting or anything like that as of yet. But it’s no secret, you talk to the media or online, or out in the real world. The return on investment on a lot of college education these days is not what it used to be. And with the growing costs and the ease of borrowing it’s becoming awful as the days go on.

It’s hard to say if it will ever pop or if it’s going to be more a deflate thing. Or it could even continue into the future. Obviously, student loan debt is different in the sense that it’s not excused in bankruptcy, as all other debts would be.

It is interesting to watch this play out. But I think it makes for an interesting lesson. Number one we can look back at history and see where there are other parallels. Number two, it’s happening right now so something that we can observe.

Third, there is something that we can do for ourselves or for our children that can mitigate this.

And number four, it does give extra insights into how intrinsic value kind of works. And how I see the way that some of these big financial decisions that we make as individuals draw and have a lot of similarity to the types of decisions you should be making if you’re going to buy individual stocks.

And it is not black and white and drawing that to light today can potentially help some people that are, having some trouble conceptualizing everything that we talk about. When we talk about intrinsic value and buying at a discount to that value and having a margin of safety and getting the best part of buy low and sell high.

I look at the student loan bubble, and it makes me want to look at past bubbles. If you want to understand the stock market, understanding how Mr. Market works, you can find that in episode 20. It’s a great way to find confidence in the fact that you can realize that the future is always uncharted and everything is going to be new.

There is always these dependable cycles or seasons. These things that are predictable and consequences and effects of a financial market. Something that is as big and expensive as the stock exchange.

One of those things is bubbles; there is a great movie that I watched years ago, I don’t remember what exactly the name of it was. Shia Lebouef was the main character; there is a scene where he main character is inside this old Wall Street dude’s apartment, and there is some painting on the wall.

And it’s mostly making up this bubble, and the character asks about it and gets a whole lesson about how all the different bubbles, I don’t remember if he talked about the Tulip bubbles which are the first recorded bubbles that we have ever had.

How these bubbles always happen, greed always happen, and this hysteria starts to engulf the market, and we start to see the market take a form of its own and becomes this uncontrollable beast that originally could make a lot of people a lot of money. But as soon as the bubble pops, even more, money losses, more people lose more money than was originally made and a lot of the wealth that was perceived to be done ended up not materializing for a lot of people because it just vanished.

I think the Tulip bubble is a great story. It is this idea that there was a Tulip in Holland, this Tulip bulb and for whatever reason, this flower became so valuable. Demand grew for it so high, and it’s not clear if everybody was sharing on their Facebook wall and that’s how it caught on.

For whatever reason, the demand was so high, prices shot up, and it became the most valuable asset you could own. More so that whatever their currency was at the time.

People were buying it up and buying and selling it like crazy. It turned into what we now call Tulip Mania; it took the form of pretty much every other bubble we saw in the market

Which is where you see this exponential growth that just screams up to the stop, and then it slowly loses momentum and then it just crashes down hard. Just like everything we talk about with Mr. Market and the way the stock market works and you want to be on the investor side as opposed to the buy side.

Focus on price instead of focusing on timing. All of those lessons are there because of phenomena like this Tulip bubble and other bubbles that we have seen in the past.

While I am not necessarily saying there is a stock market bubble now, I have talked on my Twitter how I think that social media is a bubble. I believe there is some bubble forming within the student loan space.

We saw the bubble in the real estate; you can’t buy property with a stock.

We saw a real estate bubble, and we saw the real estate bubble crash at the same time. It’s possible that we are seeing a lot of the same forces today. And the scary thing is you never know how long a bubble will last.

But what you can know is that the bubble will pop, you have seen it happen before, and it will happen again.


Dave: Yeah, absolutely you are right on the money about that.

You know that is the thing about that I find interesting about the phenomena of bubbles is that there are so many different variables that can go into the creation of one and when one pops. You can see it through the history of the stock market.

And in society and the economy in general. When you talk about the student loan bubble or not bubble. I have heard over the last two years, there has been more conversation about maybe the bubble, maybe not necessarily the bubble but indeed a growing potential crisis with the student loan situation.

Because of why you go to school, and the cost of education and the cost of going to school has become so expensive. I will throw out some numbers for my own experience, granted I am a lot older than you are and probably a lot of our listeners as well.

I started in college in 1985, yes I am dating myself. The school that I went to which was a small private school in Phoenix, Az, the hourly rate they charged for each class was $65 an hour for credit. That is how much cost at that time.

By the time I graduated, which was five years later and yes took a little longer it was up to $165 an hour. So it shot up during my time at school. During that time I accumulated almost $35,000 in student loan debt in my five years of school, which is a drop in the bucket to some of the stories I hear today.

When I was at the bank, I would hear stories of $150,000 to $200,000 in student loan debt. My initial impression was that it was probably a medical degree or something along those lines. But no, it was a for a liberal arts degree, and I thought “oh my God” how are they ever going to pay that back?

You talk about intrinsic value and you think is that worth the price? Let me back up just a second here, some of this that Andrew and I are talking about in regards to student loans, we are by no means advocating that people do not go to college, that’s not what we are advocating.

What we’re trying to use this as an example of thinking about whether this is a good situation for you. If you are going to be going to a school that is super expensive, the question I would ask is that going to be worth it for you in the long run?

Is the intrinsic value of what you are going to be acquiring going to be useful to you in your post college career, whatever you are choosing to do. Unfortunately, if you are choosing to go into social work for example, and you acquire $150k to $200k in student loan debt, social work doesn’t pay as high so is it worth it to you?

Is it going to be worth it and that is where the numbers come into it. Where this ties in with the bubble, as the bubbles increase, and as the mania increases, everybody has to go to college, and everyone has to take out a student loan.

Because as Andrew has mentioned earlier, there is an ease in getting the money. The banks are more than willing to give you that loan. Let it build for 15 to 20 years, and all of sudden you are out of school and have a new job and they are paying you $40k a year, with student loan payments of $800 a year.

The next question becomes how are you going to pay for that and live? How are you supposed to find a place to live and afford that and the student loan payment? You can’t, and that is where the crisis starts to gather momentum. This is what they have been talking about on the news for the last few years that there is a growing crisis with the student loans because the debt that people are taking on becomes so enormous.

Colleges have raised their prices to be unheard of levels, what used an affordable state college for you to go to has become the equivalent of trying to afford Harvard or Yale, but you’re just trying to go to the University of Wisconsin.

It’s not the same education, but it is becoming the same price as they Ivy League schools. This is where a bubble could form, and that is what the government is talking about and how are they going to deal with this.

Are they going to forgive everybody’s student loans? Well, they can’t do that because there is such an industry that has built up around this that it would bankrupt quite a few banks, not to mention other businesses.

There are so many factors that go into this, and when I talk about bubbles I am going to let Andrew talk a little more in depth about bubbles, but I just wanted to bring another perspective to what I was talking about in regards to student loans.

Andrew: That does sound high to me for 1985 numbers that big of a student loan. I consider that significant, in today’s terms. It’s amazing, again there have been bubbles in the past, and I want the listeners to understand that this is something that is more frequent than maybe some of us realize.

Whenever you have a bear market, there is usually a bubble that formed before that. I think some great bubbles to look at where “the too big to fail” in 2007, and the tech bubble in 2000. That, when you talk about the Goliath of all bubbles, you speak of stock prices that just went through the roof.

Valuations were completely ignored, there are several people quoted during that time that valuation is silly and we have new metrics, new numbers and new ways of evaluating businesses. Of course, there was one particular fund manager who said that and his fund ended up crashing and going bankrupt, and he lost his job.

The stocks that he was investing in and he was talking about that were using these “innovative and advanced” metrics all did crash and go bankrupt. It’s a story we have seen before, we have seen throughout history empires collapse, all these types of cycles.

Somethings human beings have been great at pushing the limits towards. And some things we are just in a more natural state of the way things are. The fact that values fluctuate and go up and down. And become absurdly high in some cases, or instead of just ignoring that or just sticking our heads in the ground, and saying this is something that we just forget about.

Instead, we can take advantage of it, and also understand how to avoid getting swept up as everybody else does.

I think the student loan thing really can make for a beautiful metaphor or doing that. Dave, you touched on how some students, and it’s unfortunate. Get into the type of debt that is common to doctors and lawyers, yet they don’t have that same earning power to be able to dig themselves out.

Dave Ramsay has a great podcast about finances and his kind of uses the metaphor of having a shovel, so you have all this student loan debt. A lot of doctors and lawyers they might have hundreds of thousands in student loan debt. They might be making like a half million a year; they have a massive shovel so they can dig out of that debt a lot quicker than somebody else can.

I think for people that have common sense for finances, and a bigger viewpoint of some degrees makes sense. Some of them do, and some don’t make as much sense. And some makes sense at a certain price, and others don’t.

You can apply that same logic to stocks in the stock market, and that’s how you can make these intrinsic value decisions and buys, and be able to pick and choose between stocks.

If you have, let’s use the example you were referring to earlier. A student loan debt of $200k and you’re going to graduate from college and make $40k. If you’re making the median or even $5k a year over the average, but you paid $200k to get that extra $5k, compared to someone who didn’t go to college.

How many years is it going to take you to pay off that loan with the extra $5k? It’s going to be so many that you are going to say at that degree at that price is extremely overvalued, so I am not going to buy it.

That is the same logic that Dave and I are trying to talk about when we look at companies, our favorite Amazon. A company that such a high P/E their profits are so small yet their price is so large that it’s just going to walk on water and explode profit out of nowhere. Or you’re just going to have to wait until you’re rolling over in your grave until you start to see the expected return that you should be seeing.

When on the contrary you can easily find, for example, I tend to lean toward the stem fields because I am an electrical engineer. Let’s say you can pick up an electrical engineering degree for $30k instead of $200k and that pays you $20k above the median. Now all of a sudden that looks like a great deal because you’re getting a degree that is undervalued compared to a lot of the other degrees that are out there.

The potential return on investment, that extra cushion of earnings that you will get compared to somebody who didn’t get a degree. You can kind of look at that as a margin of safety that is an expected return.

You can see how those type of ideas translate in the same way and the same area as the stock market. There are stocks, I still see it to this day, even with a great bull market and stock prices continuing to grow. And with an arguably improving economy in the past several 4 or 5 years. Even then I still see undervalued stocks and strong buys on the Value Trap Indicator, and even if I don’t know what the future holds, maybe that won’t be true in five years.

student loan bubbles

You will always be able to find undervaluation compared to the rest of the market. That is just the way it is right now; it’s virtually impossible that all stocks will be all the same value at the same time. It has never been seen, and probably never will happen again. You can take advantage of these little discrepancies and see that this stock is undervalued compared to its peers and the overall market.

That can be a compelling way to again, limit your downside and also give you outstanding return potential, not only in the coming months and years. For a long time and compound during this period, and that small little advantage, when compounded over enough years, can be huge gobs of money and make a big difference in your total portfolio return.

Dave: It absolutely can, last week we talked about that with the examples of the dividend growth investors that were just average, ordinary people. The sums of money that they were able to accumulate over the lifetime of their investing was just incredible.

These are real people and the actual number and things that can be done. Everything that Andrew was just talking about is straight out of the value investing playbook. That is something that Andrew and I believe in very fervently, and we’ve talked about it numerous times, the reason why we talk about it is that it works.

There are opportunities to find great values out there and finding the intrinsic value, and a margin of safety, emphasis on security. Those are all critical investing tools that you can use, especially during bubble season.

When the market is getting overheated, and people are getting frantic or super excited about something, and prices are rising.

These are when using your calm head and being logical and rational about things. Using the theories and strategies that Andrew and I have talked about.

That is when they can help you, limiting your downside. We talk a lot about the Margin of Safety, emphasis on safety. When you are talking about bubbles, looking at a lot of the great value investors tarping the years, in particular, the last two bubbles that we were mentioning when Andrew was talking about 07 and 2000. A lot of the great value investors, Buffett, Munger, Pabrai, Greenblatt, Klarmann, they all sat pat during those times or when they did buy things it was very minimal.

It’s because from experience they saw that people were going crazy and doing, frankly dumb things. The fund manager that Andrew was talking about got full of himself; he thought everything was secure, easy to buy stocks because everything was just going up.

It is easy when that kind of thing happens, but that is also when you are going to lose everything. That’s what can happen when you are not being patient, diligent and doing the things that when you are going to get burned.

I had someone tell me a long time ago. If it’s easy to be skeptical because it shouldn’t be easy. He’s right it shouldn’t be easy, doing what Andrew and I talk about is not easy, but it’s the right way to go, and the safe way to go.

And when you are investing safety is all about doing the right things to protect yourself from downside risk. It’s not about going for the big home run; it’s about finding the safe things that you can invest in because those are the ones that are going to compound your wealth over time.

We’ve talked about this time and time again, about these frankly, boring companies that have great intrinsic values that are a lot of occasions are beaten up by the market and downgraded. But those are the ones that are bringing home the bacon, so to speak for the people that invest in them.

Coca-cola (KO) is by no means a sexy company, but it is making a lot of money for my friend Warren Buffett. I think what Andrew was talking about was so spot on and it’s such great advice and something that you should seriously consider when you’re thinking about investing your future in regards to a student loan.

The examples he was giving about the different degrees that you go into, again we are not advocating you not go to college, but we are advocating that you think about the price of that education versus the value that you will receive for that price.

When you think about the stocks that you are going to invest in, that is investing in your future as well. That’s what we are here to help you do, is to learn how to do that.

Andrew: I love to harp about dividends and how investments are primarily cash flow streams that you are creating for yourself in income streams. And I think that the central value metaphor that I am trying to present today reinforces that brings this kind of visible evidence.

Even think about when a company is hiring you, every employee needs to contribute to the bottom line and create profits. Ask anybody who is in HR or finance; every employee is going to have this range, this salary range that they are willing to pay. Your ration out these raises and promotions to keep these people loyal to the company as long as they can.

That is the price the company is paying, but there is an intrinsic value of how much profit you’re bringing to the enterprise with however many hours you work. They are making those types of intrinsic value decisions with every employee that they have.

It’s up too; you can kind of close your eyes pretend none of this is happening, whether you want to admit it or not, the game is out there. The saying goes that everything is negotiable. In a sense a lot of things in the world, the value of that is negotiable as well. Beauty can be in the eye of the beholder; demand can push prices up and down.

If you can learn that skill for yourself, learn it from principles that have been proven. If you just look at the track records of some of the most successful investors, Dave just mentioned a list. This is just a great social proof and learns how they value companies. Don’t find out how the reporter who just jumps on CNBC, puts on some makeup, suit and says all the talking points and goes home from their 9 to 5 to forget about it.

Don’t take their intrinsic value calculations, don’t make the analysts, buy side or sell side, the ones that again are just going there for a 9 to 5 and then going home. Be careful what your intrinsic value calculation is, and make sure that it is a prudent one and one that is based on the right principles and then uses that logic, basic common sense, and intuition.

Find the big companies like the boring businesses that Dave talked about. The ones that aren’t receiving that much attention but a look at their balance sheet shows they have a lot of assets, not many liabilities and their earnings are growing year over year. Sure, they’re not doubling, but we see excellent growth.

Those are the types of things that you want to look for, and those are the kinds of things you won’t see in headlines, blog posts, internet news papers, tv. They’re not going to write those articles because it is not entertaining.

Nobody wants to read about numbers on a 10-k, so that’s why there is a lot of potentials there. For the student, pun intended I guess, who has the patience to dig into these numbers and understands that this is a skill I can learn, master and then I can use it in the stock market.

Take that time and evaluate the assets that are out there. I think there is so much potential for somebody out there who wants to do it, and I think you can do it.

Take my story, I was fresh out of college just starting my own 9 to 5 career, and I didn’t know the thing about the stock market. All I knew was that there is some channel with red arrows and green arrows with people that talk fast. All these numbers that fly across the screen and it reminds me of Sports Center.

That was my experience with the stock market. But then I ran into a mentor at my job who kind of directed me on the path. He said to me you are going to start to make a lot of money now and in his own experience, he was able to do some great things with his wealth by investing.

He taught me some basics like dollar-cost averaging, diversification, the idea that you want to have a long term plan. I started to dig into this and thought this makes sense. Gradually I was able to gather knowledge, pick up a book and find out that this makes sense and not as annoying as I thought it would be.

Within in a short time and I don’t want to say I was some expert within a year but I want to say the concepts aren’t so complicated that you have to get a Ph.D. to understand them. There is a lot of real common sense that is waiting to be unlocked.

Once you read it and it opens up your eyes, that’s really how this works, and there is so much opportunity here. There are entire industries where the people who labor and the companies that take our investment money from us, they don’t necessarily want us to pick our stocks and manage our portfolios.

Through all that and seeing all the different potential and seeing how a lot of these real successful investors all agree with each other in this field called value investing. It gave me a lot of hope, and now I have started to see the potential within my portfolio.

You start to see dividends, and numbers of shares that have been reinvested. That stock number continues to grow, a total value of the portfolio continues to grow. You see opportunities still out there, and you know just the way that it’s been two and half years since I started the eLetter, that’s the personal IRA account that I started that’s going to track all the newsletter recommendations that I am making every single month.

Even in that short period, I have seen stocks prices rise and fall, extremely fast. Even though we haven’t seen a crash like 2008 or 2000, you still see these stocks quickly move in and out of favor. When the next bubbles “pop” you will see that happen at an even greater scale.

To be able to stand up and have my feet planted on the ground and say all this could go on and has happened, yet my portfolio remains high, and I remain confident in my portfolio, and I know it will weather the storms because I put the foundation on the roots down.

We strive for this peace of mind, and I think having the right strategy, having your portfolio built on the idea that you’re going to be able to weather the storm and limit your downside, really separate yourself from the chaos and insanity that is the stock market.

It really can bring this feeling of relief and confidence that moving forward I have a great strategy that will make me potentially significant returns in the long run. Once you understand that and internalize it, that is a great place to be.

Before we wrap I did promise, not that I have all the answers, but I think there’ one thing especially if your thinking about your kids or your grandkids and you’re concerned about the student loan bubble. A quick, simple thing you can do in five minutes, I made a Youtube video about this around 2014, you can open a 529 account. This is a college specific savings account and the process you go to open one of them is the same as you would if you were opening a regular brokerage account.

One to trade just stocks, or IRA or Roth IRA. It is all the same process; you can buy whatever funds are offered for that 529 plan, and it has some tax advantages as well. That’s one way you can set some money aside for somebody you care about and want to help.

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