IFB188: The Value Mindset and Why Stocks Are Like Trees

Welcome to the Investing for Beginners podcast. In today’s show we discuss:

  • Why we gravitated towards value investing
  • Where to find debt schedules
  • Why stocks are like trees
  • How often do we calculate metrics such as P/E, P/B, or P/S

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Announcer (00:02):

I love this podcast because it crushes your dreams and getting rich quickly. They actually got me into reading stats for anything you’re tuned in to the Investing for Beginners podcast led by Andrew Sather and Dave Ahern with a step-by-step premium investing guide for beginners. Your path to financial freedom starts now.

Dave (00:32):

Hi folks. Welcome to Investing for Beginners podcast. Tonight is episode 188, and tonight we’re going to do a little bit of a nerdy, geeky numbers metric type podcast. So if you are not up on this, we have a back to beginning series listed on our website, and you can go there and listen to some of those podcasts. They will help fill you in on some of the acronyms and terminology that you may not be super familiar with. So if some of these things that we’re talking about tonight are a little confusing to you. Please go back and listen to those and then come back and listen to this episode. All make a lot more sense. We’ll try to make it as simple as we can, but some terminology may be a little bit unfamiliar to some of you.

Dave (01:17):

So if with that, I will go ahead and read the first question. So we’re going to do Andrew, and I will do our usual give and take, and we’ll answer some questions tonight. So the first one here is you mentioned in your podcast that you both look up to Peter winch and Benjamin Graham as investors; after reading both the intelligent investor and one up on wall street, it seems like your investment strategy is leaning more towards that of Benjamin Graham. Are there any reasons you choose the value approach overgrowth and stick with it in the future? Andrew, what are your thoughts on that?

Andrew (01:51):

Really good question. Yeah, this is a continuation of last week’s question. So appreciate you, Lewis, for writing. And again, I guess I was lucky in the sense that I was exposed to the history of the market without really looking for it.

Andrew (02:10):

And so I got that education. I got that tuition about how the market functions before losing money and experiencing it for myself. So I know Benjamin Graham’s, maybe we could start there. Dave Benjamin Graham has a great description of the market. He talks about Mr. Market, how there’s so much emotion in the market, and how the market itself doesn’t really behave rationally, and it kind of moves up and down. And so for me, reading Benjamin Graham and knowing that you’re separating the idea of there’s the business part and there’s the stock part, and the stock part can be crazy even though the business is being rational.

Dave (03:00):

That’s a perfect Analogy. And I think that’s one of the things that stuck with me, and that’s why I think I was more; I gravitated more towards the Benjamin Graham idea. He is very much all about logic and using numbers, and being rational. And his description of Mr. Market is in chapter eight. I believe the investor an intelligent investor. And it is one of the best chapters, one of the best books about investing. There are some great takeaways from all of the information in that book, and chapters eight and chapter 20 are ones that both really spoke to me and Warren buffet. And the idea of being rational when things are going crazy in the market just appealed to me. I can’t remember who it was who said this now, but there was a phrase that I think I might’ve been; Charlie Munger said that value is investing either stick with you or it doesn’t, you just kind of get it, or you don’t.

Dave (04:02):

And for me, value investing just kind of stuck. And it was one of those things that as soon as I started reading about it, it just really made a lot of sense to me and spoke to me, I guess if you will. And the idea of finding great investments that are selling for a discount or on sale really kind of appeal to, I guess, my cheapskate nature. It was kind of struck me in one of my favorite Buffett quotes because he likes to buy his socks. Like he likes to buy his stocks on sale. And I, cause i’m kind of along the same lines. I love what about wall street? I love Peter Lynch, and he’s got a great investment outlook. He had a great performance throughout his career, and those are all great things, but for whatever reason, Ben Graham and Warren Buffett, Charlie Munger, those guys kind of, I guess, sung to me more so than Peter Lynch did.

Andrew (04:59):

I mean, I, I’m not going to pick one. It’s like picking your children. I feel they’ve all given valuable lessons. I think Peter Lynch’s is a lot more bullish and maybe focuses more on, on the winners and some of the other guys, I, I, I wonder if, if something that made it ring in my head, what is the fact that, you know, when, when I had to early experience to the market, my early twenties and before I started taking it seriously, just the whole environment around the market was a very post-financial crisis. And there was still a lot of mistruth wall street

Andrew (05:43):

And those memories and those scars were still very fresh in that environment. And so for me, I guess I’ve always had a conservative approach when it came to finances, and similar to what you’re saying, Dave, how that kind of part of value investing spoke to you. To me, it was; it was a lot about reducing risk and not wanting to be caught up in a financial calamity, like what we saw in 2008, 2009. And so, you know, going back, I guess, learning from those grades, also being able to learn about, I guess I’m a history buff. I never realized I was until I started finding it interesting in investing books, but learning about the nineties and the.com boom and how much craziness happened in the market and how far it crashed and then repeated that the housing bubble. And so you start to learn about all these cycles, and you start to understand and realize that when you have certain stocks, certain groups of stocks that they’re doing very, very well, like too good to be true.

Andrew (06:57):

Well, a lot of times, it’s not meant to last and, and it doesn’t last. And so I think that history mindset has seen similar things, no matter which decade you look at, there’s always these, these certain outperformers that rise and crash spectacularly. When you have that history as a backdrop and the context, it helps you start to be more conservative and look for ways to protect your money and just kind of err on the side of caution. And so for me, when I look at stocks, and I try to find a margin of safety emphasis on the safety, I’m hoping that these stocks will grow 10%, 15% a year. Still, I’m not necessarily banking that being a 100% fact because I want there to be some cushion just in case; hey, maybe the stock doesn’t, didn’t grow 10%.

Andrew (07:53):

Maybe the business couldn’t compound 10% a year; maybe they only compounded 8% or 7%. But if you pay a decent enough price, that will be enough to drive a lot of great returns. And so I liked that idea instead of stretching that every little thing we can, and this company needs to kill it in the next two years; otherwise, it’s all going to crash like a house of cards. I wouldn’t say I like that kind of mentality, and it doesn’t sit well with how I like to think about even envisioning myself if I buy a stock. I envision having the stress about what happens next quarter because I’m doing this activity. Is it adding value to my life at that point? And it’s hard. And, and, and, and it kind of draws me away from those types of stocks.

Dave (08:45):

That’s, that’s a great insight. And I think a lot of those things you’re talking about are a lot of the same feelings and emotions that I had when I first started getting into the market was right after the great financial crisis. And there was a lot of negativity and a lot of distrust in the markets. And I think I probably seized on that. You know, another thing that I think about the question here, and this is something that I’ve been thinking about a lot recently, is the, I guess, the division or the apparent division between the value approach and the growth approach. And one of the things that I’ve seen a lot of conversation about, and I’ve been thinking about this a lot, is that Charlie Munger said this recently, he was on he was speaking at the daily journal meeting a couple of days ago.

Dave (09:46):

And one of the things that he said, which I thought was an interesting take, is that all investing is value investing. And by that, he meant that you’re always looking for a great company, but you’re looking for the opportunity to buy it for less than it’s worth. Because the idea is is that if you can buy it for less than it’s worth, then at some point it will return. It’ll revert to the mean, and it’ll grow back to where it’s actually what; it’s a value for think about it. I’ve mentioned this in the past, but think about buying an iPhone. If you go out and buy an iPhone and the phone is, is valued at six or $700, for example, and you can find it on sale for 500 bucks for the same phone, everybody in their brother was going to jump all over that unless you’re a Samsung user.

Dave (10:34):

Then, of course, there’s the flip side of that. If the same, very same phone is selling for 20 to $3,000, very few people would really want to buy it. And I think of the stocks in the same way. I want to find that $700 phone that really could grow to be worth $3,000, but I want to pay 500 bucks for it. And that’s kind of how I look at investing in Charlie has said this in the past. And I agree with this; Warren is not Warren. Buffett’s not a value investor in the classic sense. He’s more of a quality investor. He’s trying to find these fantastic companies that he can buy at a fair or reasonable price. And then it’s going to either grow into that valuation, or it’s going to grow beyond that valuation. And that’s kind of what I’m trying to do. And I think maybe that’s what Andrew is trying to do is trying to find these great companies that have a margin of safety but are maybe selling for less than what they’re worth. And we’ll grow into those values at some point in the future. And that’s, I think, really what I think about when I think about investing and this whole divide between growth and value; I think sometimes it gets, it gets played up a little more than it really should. And it really re should at trying

Andrew (11:54):

To find an approach that works for you and try to find quality companies at a good price. That’s really what it comes down to. You have to incorporate growth into how you’re valuing the company. And so, to take your metaphor one step further, if we have three different models of iPhones, you have an iPhone 12, nine, and seven or something. Each of those will be valued differently because each has different features, and one will be better than the other, right? And so, if stocks have better growth prospects and they do grow faster than others, they’re going to demand that premium price. And so, as an investor, it’s not looking across the board and saying, wow, you know, whatever metric I’m using says, this stock is cheap. Still, rather it’s looking at each stock individually and then comparing them all kind of in the aggregate and saying, how much is this company probably going to grow?

Andrew (12:52):

And so if I’m looking at the stock and a more matured industry, you better believe I’m going to pay a lot cheaper of a price. As far as you know, for looking at price-earnings or any price to free cash flow, any price-based metric, I’m going to demand a much lower price for that compared to something that maybe is, has all the tailwinds in the world, going for it, growth with this market, stealing market share all of those things. That’s going to be allowed to command a premium price. And maybe my margin of safety on that high growing stock is still within expectations that are, that are reasonable enough where it’s not so detached from reality. You know, I’m not banking on the stock tripling in tripping, tripling its profits in the next two years or something. That’s, it’s still within the realm of tangible reality.

Andrew (13:46):

If you look at a tree as a good example, some branches might grow faster than others, but generally, you can quantify how long it’s going to take a tree to grow. And so look at stocks the same way. You’re not going to have a magic bean stock, but you know, there could be something in the middle where some grow faster than others, and that’s where you make adjustments, and you kind of work from there. That is very well said. And I love that. I love that analogy of the tree and the different I-phones; that’s a fantastic analogy. So that was good stuff. All right, you’re welcome. All right, let’s move on to the next question. Your investment strategy states that you screen for companies with Wolpe ratios and road debt, the equity, et cetera. What if these metrics are well because the company is declining as opposed to being undervalued?

Andrew (14:37):

How do you know which one is which, and, or what are your thoughts on that? So it’s good timing. Cause I wrote an email about this today in the sense that let’s take, let’s take the first part. So low PE ratio, just real quick, PE stands for the price to earnings. You’re taking the price, and you’re comparing it to the earnings. So if we go back to the iPhone, you’re taking the price, and you’re comparing it to the iPhone model. And so that PE can change because it’s based on one thing earnings and those earnings move from year to year. And so particularly like a really strange year, like 2020 was you might see a company stumble or have a crazy inflow of cash, but it’s a temporary situation. And that’s going to push the PE a lot higher or a lot lower simply because there was one different year.

Andrew (15:39):

And so you have to look at the context and, and you, you know, in a situation like this, where the year was strange, and we had outside factors that affected everything that may or may not be reflective of a business that has changed or not. So when I think of maybe a business environment that’s changed, I look at cruise ships. I think it’s pretty obvious that their long-term prospects have changed. They’ve had these very expensive assets that depreciate; they lose value. I mean, anybody who’s ever owned a boat knows how expensive they are to maintain and how much they lose in value. Imagine having a bunch of those, and that’s your business. And by the way, you haven’t been able to make any profit off because nobody’s allowed to ride on it. That’s a situation of cruise ships in versus maybe a retailer where people haven’t been buying makeup or people haven’t been buying jeans, but you know, one day in a post-pandemic world, people will probably still do that stuff.

Andrew (16:45):

So, you know, you have differences there. You know this how that’s not anything to do with numbers, but it’s looking at the individual company and its situation. And so I think whether you’re looking at a price-earnings ratio or looking at the debt to equity, and you’re looking at where these things move over time, you have to try to take the big picture into effect. And you really won’t know the answers to those questions unless you find out how a business, how the business works, that particular business, what drives it, what makes us successful? What, what makes it fail? And so that’s why we, we go back to having a circle of competence and learning about these businesses, reading the annual reports because that’s how you’ll understand the big picture and you won’t get there most of the time with the numbers,

Announcer (17:38):

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Dave (17:50):

Looking at the numbers Is sometimes just the first part of it. And Andrew’s conversation about looking at the big picture is exactly the way you have to look at it. You have to; you can’t look at it just on a quarterly or yearly basis and make that decision because as Andrew was saying, those, the prices and the earnings move and the prices will move every day, and the earnings will move every quarter, and it’s not a static thing. And so it’s something that you have to work at over a longer period. And that’s the only way you can get some context to what’s actually going on at that particular period you’re looking at. And a perfect example, like Andrew, has said is this last year 2020 as we will; it was a crazy, goofy, partially awful year. And when you look at many, many companies in different industries, there were lots of companies.

Dave (18:48):

The one that sticks out in my mind is Disney. Disney had arguably a fantastic year in the stock market, but their financial performance was lackluster at best outside of Disney. Plus, simply because there were no movies and the parks were shut down, those were large portions of their income. So when you, if you take that, if you just looked at Disney, if you took 2019 prior and didn’t look at anything and then just looked at 2020, you w you look at that, and they’ll look at the stock price and wonder what the heck is going on. Because if you look at the numbers for Disney, it’s brutal, but then it’s awesome if you look at the stock price. There, there has to be more context that you have to put into the analysis than just looking at one specific ratio or a school of ratios over a shorter period.

Dave (19:48):

The other part of this that you have to think about is that you have to think about what industry a particular company is in. For example, if you’re looking at the insurance industry, for example, or looking at FinTech, either one of those industries has a characteristic. If you will, the insurance companies, by and large, are considered, I don’t know, boring, and they’re not exciting, high growth, high revenue, high revenue, growth type companies. And so, by and large, you’re going to see more conservative P ratios. For example, with an insurance company, if you look at the FinTech industry, they have exploding growth, super-high margins, and they also have very high PE ratios. I was looking at PayPal a few days ago, and their PE ratio was a scintillating 72. So it was quite high. And I think Square’s was like 2000 or something crazy like that.

Dave (20:48):

So they’re very, very high. But anyway, my point with all that being is that a lot of it will sometimes have a bearing on what sector it’s in. If you’re looking at banks, insurance companies, something a little more middle of the road, not super exciting, not high growth type things. You’re going to see more conservative numbers. If you look at something that has to do with technology, you will see much higher ratios because the markets are bidding those prices up because the revenues are exploding. And they’re very, very high. You look at Facebook and Microsoft; for example, their PEs are, I think, 26 and 35 ish or so, don’t hold me to those numbers, but there are more conservative. But if you looked at Google, it’s in the high thirties, low forties, which is much higher. So there’s, there’s going to be a range there, but you have to look at the big picture, but you also have to look at the sector as well as a lot of those things will help you, I guess, narrow down that, that focus of whether the company is, is doing well or not doing well.

Dave (21:55):

And the bottom line is you have to read; you have to look at the financials you have to read through the reports and all that information, because that will give you the full picture of, so follow what Andrew was saying, telling you that’s, that’s the way to go.

Andrew (22:09):

That was good; that was a great way to summarize it. In the last part of the question here, he says, in addition to your current portfolio, do you have any money in ETFs as a safety net? What are your opinions on investing in ETFs on top of individual stocks? Dave, you go first.

Dave (22:26):

I do not have any money in ETFs outside of A few bond ETFs that I own. So I do not have any stock ETFs at the current moment. I think you need to do what is best for you and what will work best for you. Etfs are a great option for people; I will call it more of a defensive mind. In other words, they don’t want to be active stock pickers. And if you don’t want to be an active stock picker, then ETS is absolutely the way to go for you. They can get great returns. They don’t require a lot of effort and a lot of maintenance on your part. It’s one of those things that you can kind of set it and forget it kind of thing. And if you look at your 401ks, most of your 401ks will be ETFs or index funds, any of those kinds of things. And there’s nothing wrong with those. And finding the key is to find an ETF that’s going to fit your particular investment needs and find one with low fees so that you’re not paying a lot of extra money out of the earnings you make to maintain the ETF. And, you know, I’ve, I’ve recommended it to my sister-in-law and my sister that want to have individual

Andrew (23:46):

Stock exposure, but they don’t want to pay a ton of attention to that kind of stuff they want to; they want me to do it for them. So I’ve recommended that they buy ETFs for most of their money and then have other, other single investments in stocks. And that’s, that’s the way I’ve thought of it. So, curious to hear what Andrew has to say about this I’ve mentioned before, and if not on the show, definitely in the emails I have outside of the emergency fund, I have over 95% of my net worth in the stocks that I recommend for the Eli there. The e-letter has the real-money portfolio where I’m putting $150 a month into each stock pick. And then outside of that, I have my retirement councils all in the same pics. So I don’t have ETFs at the same time.

Andrew (24:40):

I kind of understand that. Not everybody’s as into it as I am. And so I know people like Andy Schuler, he’s written on the blog, how he has ETFs when he wants exposure for an industry that he’s not too familiar with yet. I know Braden Dennis from Stratosphere; he has ETFs recommended with his newsletter as well. So, you know, there’s no right answer, no right solution. And it comes down to what you’re trying to achieve and what you’re comfortable with. And so ETFs can be great for diversification; as long as you understand some of the positives and the negatives of ETFs, you can decide whether it’s a good thing for you to have them or not. And for me, it’s no. All right. So we’re going to move on to the next question. We have a great question here from Jeff. He wanted to know how often we should be recalculated ratios, like price to earnings, price, sales, or price to book.

Andrew (25:38):

Is this an exercise that you do each quarter after reports are released, I love the material and appreciate Dave’s time to share your knowledge. Andrew, what are your thoughts on Jeff’s question? So I generally look at a company in my portfolio when the 10 K is released, the annual report. It will be once a year. And, you know, if it comes to recalculating the ratios, I’m not so much recalculating valuation ratios unless I’m considering buying it or selling it. If it’s just something in my portfolio and I’m happy with it, then I might check on the company and make sure nothing too crazy is happening, right. They’re not like all of a sudden loading up on all this debt, or they’re not having serious problems with, with driving sales and the business, those types of things, as long as that’s not happening, generally, it’s just going to be let this thing float down the river.

Andrew (26:37):

And so I don’t have a set schedule for that kind of stuff. I can see if somebody wants that, but you know it kind of comes down to what’s your, what’s your, what’s your long-term goal with this? You know, are you trying to, are you trying to kind of squeeze the juice out of this fruit and are you trying to, you know, play the reversion to the mean game where you’re jumping in and out of the stocks is as they bounce quickly, and then you’re, you’re buying them when they’re cheap, and then you’re getting out when they’re fairly priced. And are you doing that over and over and over again then? Yeah, you probably should be recalculating as frequently as possible, but if you’re playing the longer-term kind of, I’ll lie that compound maybe pay higher prices for that, then you probably don’t need to recalculate that as much.

Andrew (27:29):

You want to align what your behavior is with what your goals are and how you’re trying to achieve them. And so that, that requires a little bit of thought, but nothing that’s too impossible. And so in this particular case, and I think for most investors, they probably don’t need to be checking up every quarter, unless something like super scary happens, like, you know, Disney just announced they had to close all their parks. For example, then you’d probably be checking in a lot more frequently than if the business was just happening like usual. Yeah. That’s a very good point. And I would admit before 2020; I was more along the lines of what Andrew would do in 2020 to change that. And I, honestly, read all the quarterly reports. I listened to earnings calls and paid a lot more attention to the quarter-by-quarter results of the companies that I own than I did before that.

Andrew (28:37):

Some of that was just because I’m a nerd, and I like to do that, and I’m a glutton for punishment. And some of it, I didn’t spend a lot of time recalculating ratios that I would only really do if there were something drastic going on and I wanted to have a better financial sense. It was more along the lines of just trying to keep a, I guess, a hand on the pulse and understand what was going on with the company. So I would read, I would read through the quarterly reports, and I would read through the transcripts of the earnings calls just to get a pulse of what was going on with the company. But I didn’t; I didn’t spend a lot of time recalculating metrics or recalculating intrinsic values unless, as Andrew said, there was an opportunity to sell or buy more of the company.

Andrew (29:28):

And I wanted to see kind of where it was with that. Otherwise, I just left it alone, but I did; I did pay more attention than I have in the past, for sure. It kind of actually ties in with the other question we had earlier because, you know, if you’re recalculating these things. The company has some unsustainable jump or some really quick change, which’s very temporary. Then if you’re recalculating, you might think it’s all of a sudden an opportunity when it might not be so, you know, businesses sure. They share the business worlds fast, but a business isn’t going to grow again; go back to the tree. It’s not going to grow.

Andrew (30:09):

It’s not going to grow to the sky overnight. Even some of the biggest changes in the business and the biggest growth are not going to happen overnight most of the time. So I think it’s, it’s important and especially important. Well, it’s important for everybody. It doesn’t matter who you are, but whether you’re somebody who does this full-time, or you’re somebody who’s just kind of the weekend warrior, we all have a limited number of hours in the day. And we all have a limited amount of time that we can research. And so you want to be smart about what you’re focusing your efforts on, and if recalculating ratios like this isn’t moving the needle for you, then it’s probably not something worth doing very well said. That’s excellent advice. All right. Let’s move on to the last question here. Hey, I’ve been bingeing your podcast for about a month now, and I wondered what a good tool to find out when a company has to have their debt paid by one of the podcasts I’ve been warning so much; Austin is. Andrew, what is your thought? Is there a good tool out there that I’m not aware of?

Andrew (31:17):

The tool is to roll up your sleeves and dive into a 10 K. I haven’t seen the tool. Maybe, that’s an opportunity for some aspiring entrepreneurs out there. I haven’t seen one that, that lays that out simply like that. So what you would do is you would go to the annual report or 10 [inaudible], you’re going to have to sift through over a hundred pages or so, but if you can, can go to the section where they talk about contractual obligations, there’s a table there, and then we’ll show you how much debt is due for each year. So, you know, what’s due 20, 21, 2022, and how much interest is due in each of those years. And that’s really where you can find that out. And I don’t know where else to go for that. I don’t either as a control F an option for something like that.

Andrew (32:11):

Yeah. And there present the control F and that you’ll just search. And I usually type in the obligations, and that will get you there. Awesome. Yeah, I wish there was a tool, but no, there isn’t.

Dave (32:24):

And Andrew’s way is the only way that I know of.

Dave (32:26):

all right, folks, we’ll that is going to wrap up our conversation for this evening. I wanted to thank everybody for taking the time out of their day to write us these great questions. And we hope you guys are getting some good knowledge out of our conversations, and we are helping you guys As much as we can. So without any further ado, I’m going to go ahead and sign us out. You guys go out there and invest with a margin of safety emphasis on safety. Have a great week. We’ll talk to you all next week.

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