The Case for Value Investing with Tobias Carlisle

David Einhorn recently said that he thinks fundamental investing is broken. If he is right, there would certainly be significant long-term implications for value investing. We explored Einhorn’s case in several of our episodes and so we thought that it was time we explored the other side of the argument and looked at the long-term case for value. And we couldn’t think of anyone better to do that with than our good friend Tobias Carlisle. In this episode, we talk to Toby about the struggles of value and why he thinks they present a significant opportunity to long-term investors. We also discuss inflation, AI, what Berkshire will look like after Buffett and a lot more.

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welcome to excess returns where we focus on what works over the long term in the markets join us as we talk about the strategies and tactics that can help you become a better long-term investor Justin carono and Jack forand are principles at alyia Capital Management the opinions expressed in this podcast do not necessarily reflect the opinions of alyia capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients ability Capital hey guys this is Justin in this episode of excess returns Jack and I sit down with our good friend Tobias carile to talk value investing Warren Buffett the fusure berer hathway Toby’s views on AI and inflation and much more Tobe is a deep thoughtful and measured thinker that brings humility rationality and a historical perspective to each and every conversation we have with him as always thank you for listening please enjoy this discussion with acquir funds Toby Carlile the man who single-handedly got us into podcasting Toby thank you for coming back on with us sir it’s good to see you guys again the man who I like to credit single-handedly uh got Jack and I in the podcasting business sorry about that look at the look at the Empire we’ve built since then Toby very impressive we always like to uh have you on to we appreciate a check in on uh what’s going on in the value stock Universe sort of what you’re seeing in the markets um what you’re sensing with uh sort of the value growth stock spread and uh you know just have a conversation around a bunch of a bunch of different different topical stuff that I think investors can always learn from um where we thought we’d start and I don’t know if you saw the whole entire interview or quote but um I know you guys were you and Jake were talking about it with one of your recent guests on value after hours um John I forgot his last name starts with an r value value yeah yeah but uh that was a great uh discussion by the way um but this uh this interview that d did with um Barry rolz in which he was basically saying that you know the the markets are broken and and paying less attention to fundamentals and S of the passive investing has kind of like broken the markets from a fundamental investing standpoint and so he’s focused on strategies that are effectively returning cash to shareholders in some way not waiting for mean reversion or multiple expansion because that wasn’t happen in with a lot of his names and then you know sort of looking for these companies that are returning cash so just in general I mean what do you what do you think about the idea of that Mark sort of cares less about fundamentals these days uh so Michael Green has this thesis that passive flaws have reached a Tipping Point or overwhelmed the active investment in the market such that the more space that company occupies in a big index like the Spy or whatever the more flows it gets and therefore the companies that aren’t in the index or have only a little market capitalization so everything’s going to grow sort of according to its size which is um sort of anti-value in a sense that value tends to be you know if you have two companies with the same hundred million do in earnings and one’s on a five times PE it’s got a $500 billion market cap and the other one’s on 20 times P it’s got a$2 billion market cap it’s getting four times the flows of the even though the earnings are the same like everything else is the same it’s just the market cap so they see more flows so their stock price goes up more uh the thesis sort of turns on this the the fact that this like it’s not reversible all of the passive money is coming in from retirement money at some point the retirement money comes out and that causes a beforehand there’s a there’s a crack up boom and then there’s a complete collapse I don’t know about all of that stuff it’s sort of a little bit beyond my pay grade I’m I find it hard to believe honestly but I I don’t um I don’t really worry about it too much the objective is a value investor I don’t really care so much about the stock price performance even after I buy something because the returns for me when I buy are already baked in at the price that I pay whether it’s quoted in the market or not so the returns that I get really there are two sources there’s the dividend yield and or the shareholder yield which is the BuyBacks and capital returns and dividends and all that sort of stuff and then there’s the portion of earnings that are reinvested in the business reinvested at the marginal return on invested capital and you can find over time that that you know that that will give you an output you can sum that to the yield that’s your expected return um whatever happens to the stock price in the interim between when you hold it and when you sell it is kind of irrelevant like that’s the compounding is going on you can be opportunistic can just sit in there and wait um the idea that you would focus more on the einhorn’s idea is that well we’re not getting rewarded for the compounding portion we’re not getting rewarded for the reinvestment at the marginal rate all we’re getting rewarded for well we’re not seeing any Mar multiple expansion so therefore let’s look at the let’s focus more on the yield portion let’s make sure we’re getting enough yield out and that’s how we’re going to get our return which that’s what Buffet has been doing for a very long period of time you know all of buffet Acquisitions like you can look at BNSF as an example of like it’s not a publicly listed company it’s private he’s bought it owns it privately I don’t know the exact figures I’ve sort of Forgotten all of these cuz it was so long ago now but he he got most of his capital back pretty quickly when he bought BNSF it’s true also with the purchase of oxy you know he bought oxy it’s returning Capital the great concern with all of these oil and gas companies is that they tend to do most of their reinvestment at Peak cycle like all the merges and all the action goes on Peak cycle and he doesn’t want that to happen he wants them it’s a good business it’s not a lot of money reinvested in the business it throws off a lot of cash just return that to the shareholders will do very well and he’s he’s so focused on it that he took a slide from one of their presentations and he put it in his own shareholder meeting presentation and he named the CEO said Vicky Golab I think her name is and he said here’s what you guys have said publicly you’re going to return capital I want you to keep on returning Capital because you’ve said that you’re going to do that and so he’s sort of just kind of uh you know Iron Fist in the velvet glove encouragement and the way that he does it like it’s no there’s no threat he’s just saying you’ve made this public statement I’m investing on the basis on a good faith basis of this public statement I expect you to sort of adhere to this public statement that you’re going to return capital I think that that’s a it’s a it’s certainly a good approach there’s nothing wrong with investing that way but it is only one source of the returns there is this other source of returns and it doesn’t matter if you don’t get the multiple reating if you’re getting that incremental reinvestment you can you can do a calculation that that calculation that I outlined before you’re looking at marginal return on invested Capital multiplied by the amount of money that’s reinvested plus the the yield all of the yield that comes out share buyback dividend yield Capital return whatever all of that stuff that is your return whatever happens to the multiple you get that return the multiple has to compress you know commensurate with your compounding for you to not get that return so when I think about this stuff I don’t actually care what the market does I always invest on the basis that the multiple is not going to rer I assume there’s going to be no multiple reating over the period of time that I hold it and for some companies where they are doing a lot of BuyBacks I would prefer it if they don’t rate up cuz I’m going to make a lot more money ultimately if they stay cheap and buy back stock the mle fool used to run this famous ad where they had his IBM which was always really really expensive at this massive multiple and I this is what this is back when IBM was like the IBM was the most sort of the best retaining stock for for a very long period of time was like IBM and Microsoft and Intel and all those kind of companies through the PC boom a long time ago and they would say IBM has sort of rocketed earnings stay at this very high multiple and you would have got this return over like a 10 or 20 year holding period and then they would compare it to Tootsie Roll you know which makes Tootsie Rolls and all that tootsy toots Ro was controlled by a family not a tech company makes a makes it candy that people like to eat not very many people but enough people and they would take that cash and cuz nobody wanted to own the stock either CU that’s a really boring company it was always trading at a really low multiple they’d buy back stock all the time and the mly Fool’s ad would say look at the performance of tootsy roll over this long period of time massively outperformed Iva so do I care if the market recognizes the value that I see in these things after I buy them no I don’t because I’m already buying these things on the basis that I’m going to get this source of return from the reinvestment and and the yield I would prefer it if it doesn’t get rated if they’re buying back stock that’s that’s the best case outcome that means that management is aware of the undervaluation they have the free cash flow there to buy back stock or they have the cash there to buy back stock and they’re thinking about shareholders rather than expanding their own domain which are all three very strong signals for buying something so when they buy back a whole lot of stock with any luck somewhere down the line I’ll be the last man standing they buy back all of the stock I’ll still have my position we’ll take that company private now that it’s not quoted in the stock market anymore I’m not getting the multiple expansion anymore but am I not making any money of course I’m still making money I’m getting the reinvestment and I’m getting the dividend yeld I’m still getting the return so I think it’s a silly argument from both sides uh I think it’s a fundamental misunderstanding of the way that returns generated in the stock market and I think that it’s largely a result of people who think like stock market operators rather than business owners and so I think like a business owner think like a stock market operator so I love it if I think about it at a high level so the idea is if I want to get a return I can get it in a few different ways one is I can get paid dividends or they can buy back the stock I can get it directly from the company two is the company’s earnings can go up and I can maintain the same multiple so I’m getting a return even if there’s no multiple expansion and then three is the multiple expansion and and the idea is those first two are going to happen irrespective of if the market cares about the multiple expansion anyway is that is that kind of the idea I don’t think you can you know they would say that the criticism of the deep value guys and I’m I’m a deep value guy the criticism of the deep value guys used to be what all you’re relying on is this mean reversion in in the multiple like you’re buying at a cheap multiple expecting the multiple go up it’s a it’s a shitty business it’s not going to grow so therefore you’re focused on price return and not business return and I think that that’s a fair criticism but I think that you just don’t don’t rely on the multiple return like you you can do a calculation where you’re not relying on multiple expansion and you can still see what sort of return you’re going to get if you’re getting a satisfactory return what do you care whether there’s multiple expansion yeah and I think that was kind of you know to some degree einor is agreeing with you because he’s trying to find companies where he is getting that return even if nobody’s paying attention because one of his points was in that small cap space right now he doesn’t think near I don’t know if you agree with this you can let me know like a lot there’s a lot less investors paying attention in that small cap space than there used to be and so those people that would bid up the stock after good earnings like there aren’t as many of them there so you don’t see it like he he was saying I get good results from my companies and no one seems to care I don’t know if there are more or less it would make sense that there are less because all of the action has been in big growthy Tech mostly and so all of the young folks who I talk to you when they hear that I’m a value investor they’re just like that’s crazy like why would you kind of consign yourself to the dust bin of History like why would you go out and purposefully not make any money in this market and the reason is cu I’ve been through a few cycles and I’ve seen what happens on the downside of a cycle and I’m not trying to I’m not trying to win every single year or every single rolling three or five or 10 year period I’m trying to survive every single year Rolling three five and 10 year period my goal is to be here at the end of the race to win the race you must first finish the race and so that’s my goal I’m going to get all the way to the end um with all of my chips still on the table so I’m focused on downside risk first I’m focused on cash flows sensible managements robust business models that don’t do really well for six or seven years and then completely the bed in seven in year seven where you know like some credit card type companies where they they don’t know how many rofs they’re going to get through the recession when the recession hits like they’re some banks are like that there are lots of business models all like that I think that it’s possible that it is that there are fewer people investing in the sector but isn’t that like isn’t that why we do this stuff isn’t that what we’re looking for we want there to be less competition I would love it if everybody packed up and went and looked at large growthy Tech don’t I don’t want the multiple expansion I’m going to be doing this for a long time I’ll keep on buying this stuff until I’m the last guy earning all of it I don’t mind doing that at all and I don’t know why other V guys don’t want to do that too yeah you know sort of a hard left turn here but you know it’s a good commercial when Toby can bring up tootsie roll and I still remember how many licks does it take to get to the center of that Tootsie Roll Pop sir stays with you how many is it commercial I I’m still looking for it ifess they were leaving it up to you to figure it out right was that the that was the commercial but um going back to let’s just go back to buffet for a said you know what’s interesting with Buffett like you know he loves dividends he loves companies that are buying back stock actually in his shareholder the letter this year I thought it was interesting he was talking about how because birkshire Hathaway owners own indirectly through birkshire part of part of Apple part of coke part of American Express that the BuyBacks that those companies do actually results in them indirectly owning more of the like the the holding that Buffet owns in the portfolio but also more Brookshire haway stock so it’s this like derivative amplifying almost effect of these BuyBacks um and you he talks a lot about too like how much dividends to your point about Burlington Northern and I mean Apple’s paying a dividend now and you know most of the stuff I think that he holds is probably paying a dividend just how much profits are being generated at Burkshire because it’s just such a massive company with such massive positions um anyways just sort of an observation I think he would say that I think and I think he says this in his letters that the ideal business like the theoretical ideal business is a business that has this unlimited runway for reinvestment and takes all of its free cash flow and reinvests it at a above Market return or a very very high rate of of return and so he would say cease cand is an example of that like basically the Top Line growth in cease candy is absolutely minimal it might be 2% a year the global growth in chocolate is like 2% a year and seas candy in particular has this problem that nobody would buy a box of seas candy for themselves everybody buys it as a gift and everybody loves to get it as a gift and everybody loves to eat them but no one go into a store and buy one for themselves so they have this like there’s a psychological problem with it but having said that you know California and now lots of places in the states people will go in and they will buy box of seas candy and it’s poisonously expensive it’s so it’s crazy expensive when you go to buy it the margins on there are astronomical but they still sell it all out every single year so the prices aren’t highing up they’ve really not grown the Top Line very much in that business but it’s thrown off massive amounts of capital it’s basically built birky Hathaway you know for an investment of whatever it is was 27 up front and then they’ve thrown another 30 at it over whatever the 30 something years that they’ve 50 years that they’ve held something like that whatever it is and it’s thrown off you know billions of dollars that they’ve then like an ordinary investor could have reinvested those cash flows and been fabulously wealthy at the end but you take those cash flows and you give it to Buffett then it just he’s gone and bought other Seas candies that do the same thing and it’s just had this compounding multiplicative effect so I think that that’s the ideal business one that doesn’t require any reinvestment and probably doesn’t pay a de one well sorry sees can’t reinvest but you know the idea is that you it just takes the capital you give it and just reinvests it forever not very many businesses can do that and it’s often the businesses that you don’t want to reinvest in that require the money like they’re the ones that Soaker all the capital all the time but I think that when you can’t find the ones that can absorb infinite capital on a very long Runway then you want one that still maintains the very high returns and capital but returns most of it to you so you can then go and find your own other hard return on invested Capital businesses what do you just while we’re on the topic of uh Berkshire what do what do you think happens to Berkshire Beyond Buffett like I’ve been thinking about that a lot now that monger’s gone like on just a lot of different levels like on the levels of their investment strategy on the levels of like if I think back to 2008 you know when he was able to come in with his reputation and do what he did with Goldman Sachs and you know not only get a good return but like instill confidence back in in the world like what do you think happens to that when when he’s not around it won’t be as good the thing is the thing that makes birkshire unique is that it has this incredible culture and culture is instilled from the top down I’ve been in I’ve been in other business I was I’ve worked in other businesses where there were two entrepreneurs in it and the culture started at the very top with them and it was sort of like an elite business um environment Elite business culture because they were there but it’s just so easy to take the easier route rather than like stick to the hard stuff that it’s sort of it’s inevitable there’s nobody else who can maintain culture like Buffett does it won’t be fast but it will of course it will deteriorate over time at some point it’ll get too cheap I’m sure it’ll be busted up it’ll probably happen in in my lifetime but or or it may not it may may sort of may take a lot longer than that I don’t know but I think it ultimately it relies on Buffett and manga sort of carrying the torture the top and without them there it must deteriorate you think like the annual meeting and stuff will still I mean it probably won’t be be what it once was but it will will it still be an event uh you know I’d say it’ll be it’ll get there’ll be a huge drop off drop off the first year he’s not there and then it’ll shrink every year after that I would imagine a lot of his shareholder base is kind of older too so it’s not you know there’s like that transition you give it to the kids the kids the kids don’t have the same sort of emotional attachment to it did you see just as we’ll move on from the in a second but there was that gift given to it was a medical school in New York City and it was the largest philanthropic gift I think to any academic but the the money came from the a woman donated it um but it was from uh an investment in bercher hathway way back and this guy was like the husband that passed away was one of Buffett’s good friends and anyways it’s paying now full tuition for all medical scho students for the rest of the school’s future I mean it’s amazing yeah which is pretty that’s great yeah it’s crazy by the way just I I know some people who are like this like people who were in Omaha at that time like it’s amazing how much wealth was created um like people who were investing with him early and who were in Omaha like families that came from there like they they’ve generated amazing amounts of wealth off of off of what he’s done extraordinary yeah I mean even the even the the annual meeting every year that the hotel prices go up I’m sure that the hotels make a loss for for 360 days of the year and then five days of the year they make their entire Year’s profit kind of reminds me of Microsoft too like how much wealth was created did you guys just another quick side note here this is nuts um I read this morning in Wall Street Journal article like open ai ai positions like million dollars comp it’s like like the base plus like the accelerated stock options and all that stuff it’s like these top AI developers are getting like 9002 million a year in terms of compensation which is crazy that’s big money that’s real money does it does it rely on open AI having a hundred billion dollar market cap I don’t know it might be tied of that didn’t get into that specific but then I was thinking they are they are California so basically 50% of it you know not if you get it in not if you get it in the options any longterm capital G yeah yeah what do you think about um I’ve been thinking a lot about inflation in terms of value um like do you think I mean obviously I don’t know where inflation is going to go um you know on the last person that should be predicting that but do you think there’s any changes I mean have you thought anything about anything with your investment strategy like if we do get a prolonged period of inflation is is there anything you do differently I mean value tends you know at least in theory people think value is a good place to be in an inflationary environment but do you think about anything with your strategy in terms of inflation I hate to just regurgitate buff all the time but he is the guy who you know I’ve got my de facto NBA by reading birkshire hathway letters so this is sort of shapes the way I think about everything and I read his explanations and I think that’s probably right I it’s not like I’m just regurgitating it because he said it I think through it too but he says that you know the 70s they had a similar problem where inflation was running hot and he says like even though Burk was had this stunning performance through the 70s someone pointed out that gold did as as well as a share of birkshire and gold didn’t do anything and there’s a lot of work and effort and blood and sweat and tears in uh in birkshire and he said the the idea the mistake that everybody makes is that they think that you need to be in things that have you know lots of Hard assets cu the hard assets go up in value but he said what that misses is that if you have to replace those you got to maintain those hard assets you got to replace those hard assets you know you spend a million dollars in year zero and then youn earn 100 200 whatever over the 10 years that you hold them and then you get to the end and you need instead of spending a million dollars now you got to spend 2 million do to replace those assets so all of those 10 years of profits are sort of eaten up by the reinvestment in uh in the hard assets at the end of it and so are hard assets the answer to that I don’t know um maybe if you never have to rent maybe if it’s a mine you never have to reinvest in the mine maybe that sort of works well but I think that the higher return on invested capital businesses possibly do better and maybe that’s why all of the the techy companies have done it’s the fear of inflation that’s pushed up the valuations of all of those things I really don’t know I think you you want to be in you know it’s going to it’s going to be bad for anybody who doesn’t hold a lot of investment assets so it’s going to hit the poor and middle class much harder than it hits the wealthy the wealthy going to notice at all the poor in middle class are going to get smashed pretty hard I don’t think it’s good for anybody um I think that after tax returns after tax after inflation returns are going to be real returns are going to be low for the whole period that we sort of we’ve run this you know the the uh the era of financial repression which I think is what uh James montier called and he wrote this article in 2010 or something like that and he said the era of financial repression when they start these things take decades two or three decades and I remember reading that in 2010 or 2005 or something like that and thinking gee that’s a long time and now here we are in 20124 and really it’s it’s it’s kicking off we’re starting to see the impact of the inflation even though I think the seeds of it was sewn through from 2010 onwards really with banki Penny interest rates at zero and flooding the market with uh with money which has seen you know stocks go to the Moon crypto go to the moon real estate’s gone to the Moon um maybe other things will catch up now I don’t I don’t think there’s really any good way to I don’t think there’s any really way to prosper from the inflation I think that all you can do is just try to keep up after tax after inflation and the way to do that will be only assets which ones I don’t know that’s a tough question to answer yeah it’s been challenging because you know people have stocks and bonds have worked so well for so long um and then you get into a situation where they don’t a little bit and then but then the challenge is predicting the future like we we don’t know um I mean you you may have an opinion I I don’t have a opinion that that’s any anybody should listen to on where inflation is going to go in the future so where it’s going to go I don’t know but yeah what you do when it’s here I don’t know that either yeah yeah because to some degree that to some degree that requires predicting what it’s going to do in the future I mean obviously the investment strategy that’s going to work if it’s going to go back to 2% is different than the one that’s going to work if it’s going to go to seven probably um you know we have had a lot of guys in the podcast and I have come around to this a lot like a lot of guys like Cory hofstein and a lot of guys that always run these types of strategies you know work in all four quadrants um you know they never owned just stocks and bonds they always owned other stuff you know to try to have like more of a total return strategy that does well regardless of the economic environment recognizing that inflation is something that has happened a good amount of the time historically even if we haven’t seen it recently so I’ve kind of come around to that idea um but yeah I don’t I don’t really and I think the problem people get into is when they want to say all right I’m going to go to that strategy because there is inflation and by that time inflation is dissipating Neo year when you’re bouncing back and forth for the spray when you get in trouble yeah I think that’s right I think I think uh trying to predict what’s going to happen is very it’s kind of a little bit of a Fool’s game you want to be playing whatever’s going to happen is is to be prepared for whatever happens rather than to predict what is going to happen because the problem with predicting is that you know I would have I would not have predicted any of the things that have happened over the last few years if interest rates have gone from zero to five five 6% pushing up in the in the short end of the uh the yield curve there and if you told me that stocks would rally like this while the interest rates went up like that I’ve said there’s just no chance and here we are stocks are up a lot show no like the stock spy this year you could it’s a 45 Dee line with hardly any pullbacks and interest rates have just gone up everybody thinks that interest rates are going to get cut and the FED seems to be like encouraging that idea we’re going to cut at some point in the future but the start of the year like last year everybody said there’s going to be a cut before the end of the year this year they say there’s going to be six Cuts here we are in March there will be no Cuts now it’s three Cuts I can easily see that we just keep on going forward like this and when you look at the Mandate of the FED it’s stable money supply and full employment employment is at alltime lows sorry you know unemployment is at alltime lows um stock markets at alltime highs property Market is more expensive relative to median income and it’s been at almost any other point in time in history hard to imagine that that is the kind of Market that you want to cut into but I don’t know like these are these are human beings making decisions not really Based on data I think they’ve got other sort of considerations so impossible to predict what the FED will do and then to work out what you’re going to do based on what the fed’s going to do like Fool’s game yeah well I think um um it is interesting you know usually the FED is cutting once we’re sort of already in a recession and here we’re talking about like to your point things are looking pretty decent and the expectation of cutting it’s almost like maybe they maybe we would be better off for them not to cut and to hold that ammunition for when they really need it um historically they’ve cut when the stock market has crashed like that’s they seem to be trying to prop the stock market up when they so when the cuts aren’t the cuts aren’t a good thing when it happens the cuts are Panic to a crash and they don’t stop the crash like you can look at how many times you can go back to 2009 you can go back to 2000 you can have a look or 2007 and you can have a look at how many times they cut how fast they cut and it does nothing to the stock market because it’s a the The Cutting impacts the real economy and the lag is long the lag is 18 months 2 years 2 and a half years it takes a long time between the cutting for that to show up in the in the real economy and the stock market as well so you know that’s one of the I’ve been focused on the yield curve inversion which is for people who don’t know but the the yield curve is the all of the rates all of the yields on every government issued debt starting from the shortest dated which is whatever it is 1 month 2 month 3 months all the way out 30 year in the ordinary course the 30e yields a lot more than the one month because you got to have your money out and there’s a lot of risk having your money out for a long time there’s interest rate risk there’s inflation risk there’s just there’s some insolvency risk there’s you anything can happen over 30 years one month there’s Le fewer things that can happen so when the front end of the curve the short stuff 1 2 3 2ear is yielding more than the 10year or the back end of the curve then that indicates that there’s some short-term fear or something in the market or it’s it’s the FED pulling up rates because they’re trying to cool the stock market cool the cool the market down which is where we are now we’ve been inverted the inversion started in October 2022 the median inversion is 12 months and then there’s some sort of Hiccup in the stock market that causes the FED to lower rates but we are we’re well but this is the longest inversion that we’ve ever had and at one point it was the steepest inversion that we’ve ever had there’s no sort of correlation between the steepness of the curve and you know the depth of the recession that follows which there’s there like8 for eight there’s not very many instances but 8 for8 instances where there’s a recession following the yield curve inversion so this is the longest inversion but there is a there is a correlation between the length of the inversion in the length of the recession and I think that’s because there’s such a long lag between the interest rates going up and the effects knocking through the real economy so we’ve got the longest inversion on record and at one point it was the steepest inversion on record so I don’t know what happens subsequently but the the event that most closely precipitates the recession is often the normalization or the uninversity failing or whatever the case may be and I thought that that was where we were when svb and those other Banks got into trouble about this time last year I thought well this is the this is what happened when you invert this is exactly what you would expect to see but somehow they just they they opened that btfp whatever it was the bank facility that Banks could access rather than going through the the ordinary window which they had to report they could go use this thing and they didn’t have to let anybody know that they were using it and that soaked up like a trillion dollars they sucked out a trillion dollars of that stuff and there was no kind of broader impact on the economy so I think that all of the old rules have really been thrown I don’t I don’t I kind of follow it closely I try to understand what’s happening but I don’t really use it to predict anything I think the setting that you got to have in the stock market is the market can go down 50% at any given point in time when it goes down 50% your Ford returns have doubled and that’s a great time to be fully invested rather than like trying to pull your money out which is what everybody’s trying to do at that point so that’s I just it’s unpredictable what will happen will happen it will go down 50% sometime in the future when it happens you want to be fully invest that time you probably should be fully invested now you can’t predict it so that’s kind of I just ignore all the macro and all of the economy stuff and just try and buy cheap stocks that have got a lot of yield and the sensible management team that’s buying back stock and will buy back more when goes down and that’s how you become a little bit anti fragile when the stock goes down management team buys back more you’re getting richer faster even though it doesn’t feel like it and ultimately if you survive and you get through to the other side it all works out it’s interesting like the macro is probably something that investors are like the most interested in paying attention to but it’s probably like the least useful in terms of actually running an investment strategy like with with our podcast like the YouTube algorithm loves the macro like whenever we put the macro guys up it’s like the views are way up and every we’re all happy over here and like but it’s not you know and I think it’s very interesting like I I like understanding what’s going on behind the scenes and what what triggers inflation and past inflation cycles and I think all that’s very interesting I just don’t know what to do with it in terms of building an investment strategy yeah 100% that’s where I am too I think it’s really interesting I think it’s really fun to follow I think it gets a lot of clicks and a lot of views and I have a podcast too so I you know I don’t talk about it for that reason I talk about it because can’t really talk about the funds that I run I can’t I don’t really like to talk about individual positions because I every single position that I put on you know there’s some dispute about whether there’s a reason why the stocks are down you know they’re done because people don’t like them and I think that there’s a chance that people have overreacted or the Market’s overreacted which is why the pric is down relative so you know Facebook meta was a good example of that when it was down it was friendless and I used to talk about it a little bit on the podcast cuz I’d talk about one or two stocks occasionally and I’d get all of these things all of these people pointing out all of the business problems with it you know reals is getting eaten by Tik Tok and so on and so on zck locked us sealed us into this we’re in this de you thing with zakar is going to the metaverse and nobody really knows what that is and they’re spending 12 billion dollar a year metaverse stuff and and I like I can see that that stuff too and it worried me too but it was also half price you know and it was a pretty good business throwing off a lot of cash if I’d listened to all those people and got scared out of it then you miss the run on the other side when it recovers too and then once it goes back to where it was and the opportunity is gone then everybody’s like I knew that was going to happen it was too cheap everybody’s driving in the rear view mirror so I just like to buy these things as cheaply as I possibly can and then try not to talk about them too much and then if you can’t talk about the stocks that you own which is really the only thing that I do all the left is macro in the economy which gets really good views on Twitter so and you know and YouTube so you’re kind of encouraged to talk about it even though that’s not the right way to run an investment strategy just so you know though since we’re all about the views over here like the the title of this is going to be something like Tobias Carlo predicts Global collapse after yield Cur inversion I think with like some fire burning next to you probably and like a big chart going down to the right I think that’s probably on YouTube I I’ve also said something like the market will be down 50% like that’s my evergreen setting the mark it’s not a prediction that’s just an observation and you can re once the Market’s gone down 50% like wait a year and run it again and it’ll be me saying the Market’s going to go down 50% which will also be true the market will go down 50% multiple time it’s going to go down 50% five or 10 times before I’m finished I think so I I agree with you 100% but run it do it we’ll take we’ll take the 50% part and we’ll just cut that little part out and we’ll run that as a clip too that just you saying over and over again the Market’s going to go down 50% I think coining back to it saying hey I predicted it speaking of like macro and markets you know this year is kind of turning out to be I wasn’t I wasn’t quite sure at the end of last year I mean it was a good year for large cap growth coming off of a good year for Value let’s say in 2022 you know when you’re looking at Value and growth and what outperformed or or underperformed didn’t didn’t go down as much didn’t go down as much yeah and that that’s the thing like you know okay I mean you could look at the numbers I mean yes value did better but it still wasn’t like it wasn’t like it was positive and growth was like down 15% you know was still it was still down but you know this year’s turning up to be interesting it’s like it’s kind of like back it’s sort of like a continuation I guess of what we saw at the beginning of last year which is very narrow leadership I mean small cap value for the most part is flat for the year the S&P is going to end the quarter uh probably up 10% and it’s like what is the Catalyst like does it does it just you know you hear people that small caps and midcaps there’s a catch-up trade but then for that to happen you know I think you have to have higher growth I mean maybe the fed maybe Ray Cuts would be enough of a catalyst to get some momentum in that area I don’t know it’s just an interesting Market when you have the small midcaps just flat and you know large caps by the S&P 500 up 10% I don’t even know what the NASDAQ 100 is I haven’t I haven’t looked at the NASDAQ this year but I’m sure it’s more yeah I I I couldn’t agree more it’s it was it’s been such a bad you there’s this gentleman Mel samonov who’s written this 200 years of value where he’s gone and stitched together three data sets it’s the one we all use the French data which starts in about 1926 and then there’s the Cal’s commission data which is what Benjamin Graham used to say that he thought that value would do about 15% a year and that was like 1875 to 1925 something like that and then somebody has gone and done this deep dive where they look at old you know to the extent that you could get any published information about anything from like 1825 to 1875 and now looking at dividend yields to determine value and then he stitched those all together and you can see all these crashes at the relative performance of growth and value over 200 years so value is having its worst draw down through to 2020 I think and typically where value has had these worst draw down and worst relative performance in like 200 years at beta which is something and then he said you know typically when that’s happened you get this catchup period afterwards and the catch-up just hasn’t happened it’s done a little bit better at times it’s certainly not losing ground anymore on a consistent basis although that it is sort of running up and then running back down and we we’ve been running backwards probably since the start of the year or something like that I would say so the value guys are suffering I would say that’s probably why there’s are that’s why there’s not very many value guys in small capat Valley it’s just it’s just too hard to kind of live there I think the market um certainly feels like the proest parts of the kind of pre you know when everybody was locked in and everybody was day trading uh but we’re not kind of at that level of froth but we are at like Bitcoin all-time highs uh Nvidia has had this monster run and it’s a little bit self-reflected because they sell the chips back into that Ai and you know everybody in like the all of the other companies that are big are buying their chips from Nvidia so that there’s a lot of um I think there’s a little bit of double counting going on there too because you can you don’t expense the chips when you buy them you you buy them and Nvidia gets to count that as Revenue but all the other companies depreciate those over a series of years so they’re not there’s no equivalent like cost on the other side the cost is distributed over a few years so it looks like we’re having this Renaissance of like lots of earnings being made I’m not entirely sure that that’s happening but I don’t know I’m just sort of speculating about that so there’s a lot of froth on top and then there’s all of these other businesses on the bottom if you look at Ed yardin he publishes these great charts on his site they’re all free I go and check them out here and again you can look at any number of different things but one of the interesting things that he puts up is large cap midcap small cap pees tracked back about 20 something years and you can see that for most of the last 20 years the Pees on midcap and small cap have been at a premium to the PS of large cap companies and in the pandemic 2020 Drop It reversed and now the large cap PES are higher than mid and small cap PES and I don’t know if that’s I don’t know if I just don’t know why why one thing should one way and the other thing should be the other way I don’t know that there’s any like mean reversion I don’t know if one thing should go back to being I don’t know that mid and small should be at a premium to to big or the other way around I don’t think that one of them is right and the other one’s wrong it’s just interesting that it’s flipped over and it could easily flip the other way again at some point in time given that there’s no real reason for it to be one way or the other so I I would much rather make a bet on small and mid here even though I think those pees are reasonably stretched relative to their long run averages even though it doesn’t feel great in small and midcap land we’re getting paid pretty well for the earnings that we’re getting in there we’re getting pretty good multiples in there it’s just that large is getting such massive multiples that it sort of dwars everything else underneath it this is a bloody hard Market to navigate is all I would say yeah it’s in your go interested in your thoughts on on this and it hopefully I’m not putting you in a weird spot here but did you happen to see that Bloomberg piece uh highlighting the changes in the F of French data the adjustments yeah yeah okay I’m just wondering is someone I mean you’ve done a lot of testing um with the acquires multiple your other strategies that you’ve run so you have you know you kind of get the Quant testing thing and I just find it you know let me just read you this so so they’re they do make adjustments and and so one of the things that the article pointed out is that that data isn’t actually coming from like Fama French and like the cry database is actually coming from dimensional um is where those returns are being generated and and there was an academic paper that kind of looked at this difference so um they looked at like two different vintages they looked at like the returns from 1926 to 2005 and then they looked at um the same period so 1926 to 2005 they looked at like the value Factor return of that period and then in 2022 they pulled that same vintage so they pulled 1926 to 2005 and what they found was a point a four basis point monthly difference between the two vintages now that seems like maybe not a lot but the difference was pretty big so a $10,000 investment in 1926 in the first vintage would have resulted about $250,000 ending portfolio balance whereas in the second vintage it would resulted in approximately a 4,000 $400,000 uh portfolio value so that’s a big end number and I’m just wondering like how does that strike you um given someone that’s done testing you’ve done back testing obviously you looked at the F French data like to me I was kind of like really taken back by that cuz I was like whoo this is like crazy that like these adjustments you know and again on the surface it doesn’t seem like it would result in a big number but when compounded over a very long period of time like four basis points is a lot at the end of the day I don’t know what you think about that yeah the I think the concern is that they’ve gone and backdated they’ve gone backwards in time and changed the data and I I wasn’t aware that that was going on I don’t know if other people were aware that that was going on or the disclosure was sort of not right comprehensible like nobody really understood that that was the case and somebody had to write an academic paper showing the extent of the change and it seemed a little bit scandalous like they were oh we’re changing the data now like we all thought this was fixed we thought these were the actual returns and now we find out that the returns weren’t the returns and we’re we’re um you know we say that we’re not going to go back and revise it again and get a completely different answer again and then they have responded to it with their own kind of academic paper um explaining why they have done what they have done I’m sort of a little I didn’t I didn’t get dig right into it but I saw Cliff Asis responded to it and Cliff said you know these guys are competitors of mine so in no way shape or form you know there’s no advantage to me to cover for these guys but he seemed he thought it was benign and he thought they’ve just improved the data they haven’t sort of they haven’t changed it so I I was sort of satisfied with uh Cliff’s response to it because Cliff is much much closer and better at this stuff and has much more resources at his disposal than I do so it’s sort of I thought that was okay but having said that I my I’ve done a lot of testing and I have seen so many different results from all the testing that I have done it’s so you know it’s it’s like that you know you use the the telescope to look into into the night sky and you you you bump the telescope by a fraction of an inch and it changes the Galaxy right so I just I’ve done so much testing there that I really don’t if someone comes along to me and says I’ve got this strategy that outperforms but I just you know maybe maybe maybe I’ve got I’ve tested so much that I just basically don’t test don’t don’t trust any of the testing anyway I just sort of ask is this is this logical that does buying cheap cash flows work over time I think that it does does overpaying for cash flows reduce your returns like logically yes it should like the actual down to the you know number of positions after the after the dot I don’t know so yeah I I it’s a little bit frustrating that that’s happened I’ve published plenty of stuff using that data so uh I’ll probably have to go back and revise it and see if it still works rev revising your revisions rions what do you think like what’s the you guys do a lot of testing too like what’s your you use your own I don’t know you know to me like I just know we run models on valdia we’ve been running them for 20 years they’re not academic based but we never go back and make adjustments or you know we’re running portfolios and those portfolios are being tracked in a real live way so I sort of feel feel like once the data is once it’s out there live in the public Dom and people are making decisions on it or building investment products on it it just seems a little off that like the adjustments and to your point about the disclosures like maybe it was disclosed somewhere in the fine print or behind the I even saw someone which this is crazy to me when I read the Bloomberg piece it was like data provided by dimensional fund advisors was on the site and so then I and I’ve been on the F I’ve been on the Ken French site a lot and so I’m like I never seen I’m like where is that that’s you had to click the source code to find the disclosure so it’s kind of like gez what is going on um so but I think you’re I think that the way you’re looking I think that’s a your response is excellent actually and and it kind of reminds me too I remember like um you know Barons tried to replicate green blast stuff they come anywhere close to that and it was like what data set are you using you know what Market kept cut of so what month of the year are you rebalancing right what what are if you are like in quantitative value when we wrote quantitative value we rebalanced in June but we used the yearend data to give 6 months for all of that because they go back and revise know many many fin fincial statements are revised after the fact too and so you got to find some way to deal with a look ahead bias there’s no foolproof way of doing it you just sort of the way I think about it you’re just trying to get a you’re looking through a very very dirty lens trying to get some idea about what’s going on so you got to be careful about you don’t have a great deal of precision if you find something that outperforms by four basis points over a very long period of time like that could be trading cost there’s any number of reasons why that’s not implementable in the real world so I I think that you know in some ways green green blood’s approach was the right one he just sort of said this is the way that I think that Buffett invest Buffett looks at this quality metric and he looks at this um value metric and he combines them together and I’m going to go and do that and then I’m going to test that and it works and then we replicated that in quantitative value we didn’t get the same results we got different results but we again like when were we rebalancing but we got different results in the sense that we got different yearly returns but we got the same theme like it was true that what he was Finding was outperforming and it was probably beating the market and I think that it’s funny that it hasn’t really worked in live implementation since but that could just be because value hasn’t really worked for the last 20 years or something like that it’s interesting while you were giving that response I was actually before you mentioned Cliff I was pulling up Cliff’s thing on Twitter and you know I can’t read all of Cliff’s thing on Twitter because it’s a bit aggressive but he did say uh you know value back tests have indeed gotten better over time as data has been improving not to make value better that suggestion is obscenely uncalled for it’s exactly what you’d expect if value is real and there were data errors as data errors or noise and make a strategy worse so Cliff has been like bitly defending this stuff and you know Cliff is where I go for I mean Cliff is you know to me is like the person I probably look up to the most in this area so like I figure if he if he’s standing behind this you know it’s probably you know yeah it’s probably not as big an issue as they were making it out to be um and the the other thing I would say too is and I think it’s really important for anybody any investor and I make a lot of these so I I think it’s really important like to for me as well is you always have to be incredibly skeptical of back tests to your point before where you’re were talking about like what companies are you’re including are there micro caps in there there there how is the data is the data clean you know are you data mining to just get the result you want like whenever anyone presents anyone with a back test I think you have to be incredibly skeptical of what you’re seeing because there’s just so many things that go into that and so many things that could be wrong with that and and also history doesn’t always you know repeat itself the past doesn’t always predict the future so to me that that’s a big lesson from all this is just be very very skeptical of any historical results you see and just make sure you understand what you’re seeing I mean there there’s a broader theme than just it’s not even just in finance it’s sort of more broadly that there’s this replication crisis where they find Something’s Got A P value that says that it’s significant in the cohort that they’re looking for but there’s a lot of motivated reasoning too people want their studies to succeed and they go back and they revisit them later and they can’t find the same effect and so it’s no surprise to me that if you just it’s trivial to back test any number of things and that’s what AI is basically doing it’s just a it’s just a a curve fitted to a data set it’s it’s not quite a linear regression it’s a little bit more sophisticated than that but it’s pretty close and then if you just if you if you P the data for long enough you just test every single thing you can find you’re going to find those spirous correl like there you know we I think in quantitative value we talked about spirous correlations and there’s this website that you can go to where they just take two completely unrelated data sets and it’s like Bangladeshi butter production and GDP in the US and they find that there’s a statistically significant correlation between the two and there’s clearly there’s no connection between the two and it’d be like the success of um uh Nick Cage movies and drownings in Backyard Pools like all of these things are are connect connected statistically but clearly not connected in the real world if you test one data set and you’re looking for statistically significant connections you’ll find one and even if you’re even if you say I’m going to test going to break it into two parts I’m going to test one part then you’re going to get some things that will survive that first test and then I’m going to test in the second half of the data some of those Will Survive the second half of the data even though they don’t work at all and then you’ve got all of the other little implementation errors I mean are you trading at the bid are you trading at the ask trading in between is there enough liquidity to absorb your strategy you know the small cap you know the small minus large was like everybody kind of knew that small caps outperformed large caps and that sort of seems to have gone away price the book seem to massively outperform cheap price to book outperformed expensive Price to Book that’s kind of gone away a little bit know they the these things aren’t immutable even though both of those things kind of make sense to me like small per maybe they are riskier so therefore maybe they should earn more in terms of returns cheap price to book maybe that’s value you should earn a little bit more than expensive on a price basis but you could make a pretty coherent argument the other way too big caps are better higher quality so therefore they they tend to outperform expensive stuff has got better cash flows and therefore it tends to outform something like that I don’t know but it’s you have to be as you say extremely skeptical when you look at these things and I think even if you do all of that you’re still going to find stuff that’s not real you’ve never seen a bad back test that’s right you’ve never seen a bad bad because all the bad ones get strangled in the crib only the ones that look good make it out into the wide world just shake out the AI thing a little bit because we’ve had uh Doug and I kind of agree with you I kind of think if it if you’re using AI to build investment strategies or let’s say build portfolios you’re effectively by default I think and correct me if I’m wrong here that like it’s it’s effectively using historical data to construct what it thinks is an optimized portfolio um Doug Clinton from Deep Water who’s a great guy and super smart guy we just had him on the podcast he we talked about technology boom and bust Bubbles and stuff but one of the side projects He has on it going on is since June of last year he launched he kind of uses a consensus AI engine system so he uses open AI um Claude and then Gemini think think if I’m getting those three right to construct and he has all like maybe I don’t know there might be like 30 different indices that he’s running and however he’s defined those strategies and he’s been tracking the performance in real time and obviously it’s uh I mean that’s going to be ultimately at the end of the day it’s not he’s not using it to like he’s built portfolios and he you know he’s starting on whatever June 1st of 2023 was starting with you know Real Time Performance tracking so 5 years from now or 10 years from now or whatever the DAT is that investors can look at this thing maybe need a full Market cycle or two different Market regimes I don’t know but like he’s tracking the effectiveness versus like market cap weighted indices which is interesting AI um or machine learning or however you want whatever you want to call it however they implement it the idea is basically the same they’ve got some dependent variable some independent variable they’re looking at how the change in one impacts the change in the other in every single update and so it’ll it’ll have It just fits a curve and it’ll say when this thing moves this way when this variable moves like this we anticipate that this variable will move like that so the computer makes a prediction and it gets its next layer of data and it says it didn’t move that way we need to make a little adjustment and it keeps on adjusting and for many many things it does seem to be a pretty good way that’s a that’s a good good way of predicting what will happen because there’s a lot of things that the relationship is stable over time the problem with investing I think a little bit is that the relationship doesn’t seem to be stable it seems to change all the time there’s this LW of everchanging Cycles in horse racing betting and also in in investing where when something gets successful and popular everybody seems to pile into it and that seems to stop it from working so the acrs is an is an excellent example of that this paper came out showing that a cruel when you had an unusual when you had bigger crws it meant that um there was an accounting profit being made that wasn’t matched by an equivalent um cash flow and so when the two get very wide it means maybe you’ve got an Enron where they’re making they’re just pretending they’re making these profits because they’re writing up assets but the cash flows aren’t there so it’s not a real profit it’s purely an accounting profit and that has to be you have to capture that in double book Double Entry bookkeeping it’s captured somewhere it’s captured in the balance sheet as an acrel so growing acrs or a big acrel is a little bit of a red flag for Auditors and for for analysts I wrote this paper and it had been an incredibly robust way of finding frauds or finding companies that were going to underperform that had these acrs and of course once they published it everybody started using it and the the effect went away for a little period of time or for a long time but then somebody wrote the story up saying hey this a cruel thing used to work and now it doesn’t work anymore because it got so popular and then it sort of got abandoned a little bit and it’s back to working again because people sort of stopped paying attention to it but it’s a good idea like the theory of it is sound the implementation of it is difficult because it’s competitive and we’re all using the same signals and it is that’s the criticism of value that such a simple thing so easy to go and calculate a price to fundamental ratio for anything why would that continue to work and the answer is in the implementation when you actually look at the portfolio of stuff that you’re going to buy with these you know you just you you look like a lunatic when you put in some of these portfolios because they’re filled with stuff that’s obviously going to go to zero it’s obvious problems with all these companies which is kind of what keeps value Evergreen having said that value does cycle clearly value Cycles we’ve been through a big down cycle we we’re debating whether it Cycles back up the other side even though I think that it does I think it is an evergreen cycle I think it is an evergreen idea and I do think it’s a good idea to buy cheap cash flows and kind of if you don’t know what the future holds would you rather be getting more per dollar of earnings would you pay more per dollar earnings or less per dollar earnings of course you want to pay less if you have no idea it’s the it’s the sort of the you know the aams razor is you you prefer the theory that assumes the least and I think that paying less for your cash flows assumes the least and so I think it’s the it’s it’s the it’s the most sort of I don’t want I don’t want to use the word humble but intellectually humble and like modest in terms of what it assumes so I think that value should work but we’ve gone through a very long cycle where it hasn’t so that’s by no means guaranteed yeah speaking of aam’s Razer is that the uh method you’re taking with the book simpler as better I think I just think that’s a good approach to life basically it just makes it easier to kind of understand when something blows up why it blew up why something works yeah I think a Razer is always slightly misquoted as uh the simpler the better but really it it’s prefer the theory that assumes the least and I think that that’s a pretty good that’s that’s interesting yeah I learned something new for sure I hope I hope I’ve quoted that correctly um just in Jack do you have anything else before I ask sort of this last no that’s fine you can go okay okay um so sort of ending question here what what worries you the most but what also gives you the most amount of optimism you can go anywhere you want with it I think that there’s this kind of creeping authoritarianism around the world and I don’t think that authoritarianism is good and I think that the the the tools that we have to surveil and control people now are just vastly greater than anything we’ve ever seen in the past like you can imagine the Soviet Union with these awesome powers of surveillance or China kind of as an example of a country with awesome powers of surveillance implementing them and I think that there’s this kind of hunger for it in the young people in the US but a lot of the western world and I think that a lot of the world or a lot of the western world is a long way down this path like Canada and Australia are as an Australian American but Australian originally born born raised there’s a lot more of it in Australia it’s much easier to implement in Australia the thing that gives me the most optimism is that there is this uh I think there is a push back in the US and I think that the US was really one of the few countries in the world that push back hardest against a lot of the co restrictions and a lot of that silliness and that kind of gives me some optimism that I do think the pendulum is swinging back a little bit I think it’s a shame that we we’ve had hundreds of years of this liberal Western democracy these ideas of free speech and we’ve kind of forgotten the reason why everybody fought so hard and so long for all of those things you know knocking off despotic Kings and tyrants and you know regimes that kind of wanted to subjugate their people and here we are in the west with all of these our ancestors heart fought hard for all of these freedoms and we’re trying to willingly give them up I think that’s a shame I think that’s a risk but I do think that the pendulum’s swinging back the other way and I think that America is the place that is pushing back harder so that’s the thing that gives me the greatest deal of optimism awesome thank you that was not an investment thing that’s all right man love it thank you man appreciate it thanks for having me guys it’s always a pleasure I love chatting to you guys thank you this is Justin again thanks so much for tuning in to this episode of excess returns you can follow Jack on Twitter at practical Quant and follow me on Twitter JJ Carbono if you found this discussion interesting and valuable Please Subscribe in either iTunes or on YouTube or leave a review or a comment we appreciate Justin Carbono and Jack forand are principles at Bia Capital Management the opinions expressed in this podcasts do not necessarily reflect the opinions of Olivia Capital no information on this podcast should be construed as investment advice Securities discussed in the podcast may be Holdings of clients of l c