Episode #163: Albert Meyer, Bastiat Capital, “You’re Held In Higher Regard When You Don’t Dilute Shareholders”
Guest: Albert Meyer is founder and president of Bastiat Capital where he draws on decades of experience in forensic accounting and equity research. Before founding Bastiat Capital in 2006, Albert worked with David Tice, who managed the short-only Prudent Bear Fund, as well as Martin Capital. Albert received global attention for uncovering one of the largest Ponzi schemes in history, the Foundation for New Era Philanthropy, along with noteworthy accounting irregularities at Coca-Cola, Enron, Lucent and Tyco. He applies his expansive knowledge to disciplined, resolute and transparent management of the Bastiat Capital portfolio on behalf of the firm’s clients.
Date Recorded: 6/7/19 | Run-Time: 1:17:28
Summary: Albert begins with his backstory as an accountant and his time in academia with the ultimate transition to the world of investment management. He then gets into his early days in the investing world and the work he did that eventually became public, to uncover the Ponzi scheme at the Foundation for New Era Philanthropy.
Meb then asks Albert what the path looked like when he decided to start his own firm, Bastiat Capital. Albert discusses the evolution from running a research service to having demand for him to manage assets. Albert follows with Bastiat’s investment philosophy, where he dives into his process, looking at company business models, financial statements, corporate governance, and why he gets into the details of items like equity based compensation.
The conversation then turns to Bastiat’s portfolio, where Meb asks about portfolio positioning on a high level and where Albert sees opportunities today. Albert discusses positions in things like Microsoft, Google, and Apple, as well as some Chinese stocks. He also explains how through complicated accounting rules, it may actually be easier now than in the past to hide accounting shenanigans.
As the conversation winds down, Meb and Albert discuss Albert’s ideas on social security and African development.
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Links from the Episode:
- 0:50 – Welcome Albert Meyer to the show
- 3:46 – The Meb Faber Show – Episode #161: Brandon Zick, “In Row Crops You’re Generating A Lot Of Current Income”
- 3:55 – How did Albert’s interest in investing come about
- 5:31 – Discovering the New Era Ponzi scheme
- 10:16 – Albert’s work on Coca-Cola
- 14:18 – Cola War II: The Bottler Battle; On Pepsi Front Line, It’s Getting Dangerous to Go Solo
- 14:56 – Albert’s work on TYCO
- 18:11 –Bastiat Capital
- 18:21 – The Stock-Option Nightmare
- 18:57 – Investing philosophy
- 19:54 – Options overhang and why he avoids it
- 22:03 – Employee compensation and options
- 22:20 – An Open Letter to Goldman’s CFO on Employee Compensation
- 23:10 – Why Goldman Sachs Should Change Its Compensation Culture
- 27:20 – Other factors that Albert considers when building a portfolio
- 31:33 – Big opportunities he is looking at today
- 33:27 – Sentiment around Chinese companies
- 35:18 – Albert’s investment ideas and how he approaches value investing
- 40:46 – GE
- 42:00 – How the landscape for modern account irregularities has changed
- 45:20 – Buybacks and dividends
- 47:41 – Is it harder for companies to hide shenanigans?
- 54:10 – The dilemma with social security and retirement savings
- 1:03:10 – Social Security Get Me Out!
- 1:04:30 – African development ideas
- 1:09:45 – Planet Money – Episode 651 – The Salmon Taboo
- 1:10:07 – Great investment resources
- 1:11:24 – Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, Second Edition (Schilit)
- 1:11:44 – Most memorable investment
- 1:16:10 – Best way to follow Albert: Bastiatfunds.com
Transcript of Episode 163:
Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions, and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey podcast listeners. It’s full-on summertime here in Los Angeles, and we got a great show for you today. Our guest is the founder, Chief Portfolio Manager, CFO of Bastiat Capital, where he draws on decades of experience in forensic accounting, equity research, has received global attention for covering some of the largest Ponzi schemes in history, which we’ll talk about today. And before founding Bastiat Capital in 2006, he worked with another pretty famous short seller, who we’ll talk about, David Tice, who managed the Prudent Bear Fund as well as also working at Martin Capital, and also as a professor. Welcome to the show, Albert Meyer.
Albert: Thank you, Meb. Thanks a lot for the privilege to be on your show. And I just want to thank the folk at SumZero for facilitating this call.
Meb: Awesome. We love those guys, good people. You’re live from outside of Dallas, Texas. You don’t sound like you’re from Dallas. Where are you from originally?
Albert: I was born in South Africa.
Meb: That’s high on my to-do list. I’ve never been to Africa. Travelled all over the world. That’s got to be a 2020 thing for me to do. When did you head stateside? I know you started out, where was it, at Deloitte in your career? Let’s go way back. Let’s get the Albert origin story.
Albert: Yes, I was with Deloitte & Touche in Cape Town, and became a chartered accountant. And then, after four years, I went into the world of academia. After teaching at the University of Natal, which is on the east coast of South Africa, I came to Michigan and taught at Spring Arbor University, passed the CPA exam. Obviously, I was a chartered accountant, and I taught accounting and I ran CPA review courses.
So I passed the exam, but they wouldn’t certify me because I had to work two years at a Michigan CPA firm, even though Deloitte & Touche in Detroit vouched for me after checking with the Cape Town office. And so I just threw my hands up in the air. Indiana had no problem, which is kind of strange. You can be a CPA in Indiana, but not a CPA in Michigan. So I left Michigan, left teaching, and started at Martin Capital in Elkhart, Indiana, and eventually found my way down here at David Tice in Dallas.
In 2002, I started my own research business, Second Opinion Research, and four years later, I started Bastiat Capital. It’s a funny name, Bastiat, but it’s named after Frédéric Bastiat, who was a French economist, and he had this quaint idea that if we limit the size of government and we freely trade with other nations, we will prosper. So that’s the kind of idea I like, so I named it after him.
Meb: I’m smiling because 2019, the tariffs, it seems to be a big topic these days.
Albert: Yeah, exactly. Protectionism and big government is the order of the day, so I’m very much out of fashion with Bastiat’s philosophy, but I’ll stick to that.
Meb: We just did a fun podcast on institutional farmland investing, and that was certainly a front and centre topic. I’m actually getting ready to head to your old stomping grounds in Michigan, close by. I’m going to Grand Rapids next week for a CFA chat. But let’s kind of walk forward. So you worked in accounting and as a professor. And were you also interested in the investing world, or how did that kind of germinate? Were you kind of in your spare time thinking about it, or how did it originally make the shift towards the investment side of business?
Albert: Well, obviously accounting is very much related to the world of finance. In fact, the faculty of finance and the faculty of accounting are sort of normally integrated, or very close to one another. Because the only reason we have financial accounting is so we can produce information. That, as the academics will tell you, provides decision-useful information. So everything was always in that context of, “How can investors use this information? And how can it be relevant and reliable for them to use?”
So that was always part of my life. But after I discovered this and exposed this New Era Ponzi scheme, I received quite a lot of publicity everywhere, in the New York Times and The Wall Street Journal. And Frank Martin at Alcon Indiana called me up, and came and saw me, and tried to get me to come and work for him, but I was very happy in teaching. But after exposing that, and getting a letter from Deloitte & Touche in Detroit saying to the licensing board…they license addresses, so it’s not the professions fault. They still wouldn’t license me. So I thought, “Well, I don’t make the rules,” and I called up Frank Martin. I said, “You still want me? I’m ready to change careers,” and so that’s how it started.
Meb: So for the younger listeners on the podcast, I’d love to hear just kind of a summary of New Era. This was probably, I’m trying to remember, mid-90s at this point, so some of the younger people may not have been born yet. But for the people who are on the younger side, tell us what this was. What led you to discover this and then eventually make it public?
Albert: Well, there was a guy in Philadelphia, Jack Bennett, who ran a foundation, New Era Philanthropy Foundation. And he told colleges and charities that, “If you get a list of donors, and send the money and the donor list to us, we will invest that money in treasuries and use the interest to pay our overhead. And then we’ll call up the donors and make sure that they understand your mission, etc,” made it sound very official. And then he said, “There’s a very wealthy man who will match your gifts, and I’ll return the money.” And he called his seminars the Templeton Institute, but he told people, “You’re not allowed to try and find out who this wealthy donor is.” So everybody just fell for it.
And I thought, “You can’t double money in six months unless you’re running a Ponzi scheme.” And I wasn’t that convinced that there was a really anonymous donor, especially if he doesn’t want… the secrecy of the whole issue. I read Ponzi’s biography, which helped. Because when I told people, “You’re getting involved in a Ponzi Scheme, “They didn’t know what I was talking about.” So it helps to read instead of watching TV, to grab some books and read it. So maybe if I hadn’t read Charles Ponzi’s biography, I would have been just as much in the dark. But anyway, that helped set me.
And it took me a long time, because I couldn’t get the financial state. It wasn’t today’s world where everything’s on the internet. You had to write to the IRS, and you here ask for the 990, and they wouldn’t give it to me. Then I had to send them $75 per photocopy fees, etc. I wrote a lot of letters. I wrote letters to the Attorney General in Philadelphia. I wrote a letter to the AICPA. I wrote a letter to the IRS and the SEC, and I made 150 long-distance phone calls just in one month alone, trying to build a case to get the authorities and the right kind of people to investigate New Era.
When I got the balance sheet, that absolutely just blew it up. And that’s when the Wall Street Journal decided, “Okay, we’re going to write a story on it.” And I said, “You know, just write a story on it. Because once you put this out in the public and the light of day, everybody’s gonna say, ‘But this looks like a Ponzi scheme.'” If you’re taking money from investors, and you invest it for 6 months, and we’re talking about $20 million in that year, you’re going to have $300,000 to $600,000 in interest income. Interest rates were high in those days. And yet his income statement showed $30,000 in interest.
And, also, when you take money, and you leave it for six months, and invest it in treasuries, you’re gonna have liabilities and investment in treasuries, and he had no such thing on the balance sheet. But if you run a Ponzi scheme, no interest, no liabilities. So it was clear to me that this was Ponzi scheme. And The Wall Street Journal wrote the story, and the whole thing just collapsed after that. But some heavy hitters were involved. I’m not gonna mention the institutions and the names. But that was pretty embarrassing.
Meb: We had actually tweeted out last week, we were trying to start doing some favourite investing tweets, and I think it might have been Chanos had one. But he said, “You’d often be surprised when we identify a fraud or a company that essentially goes to zero over time.” He’s like, “There’s always some famous names and some big names along that company.” And he’s like, “You can never use that as a reason not to be sceptical of a company or a stock’s prospects.” And a lot of people are. They’ll say, “Well, so and so owns it, so it must be fine.”
Albert: That’s a good argument or a good point, because people said there were some very high-powered people involved. And they did make that argument, that so and so, and this institution and that institution. The advantage I had over everybody else is I didn’t know. They mentioned these important people. They meant nothing to me. I was totally objective and a total outsider from South Africa. And I just looked at it, and I wasn’t influenced by these big names who were involved in it. But I just used my accounting knowledge and my auditing knowledge, and I told the university, “You need to send your firm of auditors down there to audit the company. Because if they come back and say it’s legit, well, then you can sue them when you lose your money.” But Mr. Bennett said, “You send lawyers or auditors to me, and you’re out of it.” And they said, “Well, we’re gonna get a million back. We’re getting $500,000, getting a million back. We can’t afford to lose that kind of money,” so they didn’t send the auditors. Well, due diligence. That’s what you have to do.
Meb: So eventually, you started with Martin and Tice in turning your gaze to some of the public market equities. There was a couple names that certainly you were involved in doing the research behind. I don’t know which would have come first. You mentioned Tyco being a pretty famous one. And also you wrote about Coca Cola, which may not be as familiar to most people what may have made you queasy. But I’d love to hear about both those.
Albert: Well, Coca Cola was really my best call, even though it was a bit obscure, and it really never got any publicity except in The New York Times. But again, my knowledge of accounting and the rules of consolidation quickly helped me to see through the problem. Because you had Coca Cola, and Coca Cola spun out various bottlers, and we’ll just use Coca Cola Enterprises as an example, CCE. So they spun them out and turned them into a public company and raised I don’t know how many billions, say $6 billion.
Now, Ivester was a partner at Ernst & Young, and he became the CFO of Coke. And he told Ivester, “I have the 49% solution. The 49% solution is if we own 100% of Coca Cola Enterprises and we sell bottling plants for them, we can’t recognize the profit. If we sell 51% of the company on IPO, then we can recognize 51% of the profit.” They sold bottling plants, they sold syrup, they sold packaging, they sold…everything had to be bought from Coke. And they could make a profit on that, and they could recognize it.
And the balance sheet of Coke was pristine. Coke made return on assets of 15%, and CCE made a return of 1%. Now when you make 1% on your assets, you know you’ve overpaid for them. And what they did is obviously they overpaid three times book value, so they had goodwill on the balance sheet. But they didn’t call it goodwill. They called it franchise rights. And they said each bottler has a franchise to distribute Coke products in various regions. So goodwill was called franchise rights, which made it sound less objectionable. And then I thought, “Why would they pay three times book value for these assets?”
And I went to the proxy of Coca Cola Enterprises and I looked at the board members, and Warren Buffett’s son was on the board and he owned 8%. Warren Buffett owned 8% of Coke. So I think if they overpay for a bottling plant, I don’t think he’s gonna raise his hand and say, “Oh, I don’t know.” And then you had the guy who was the President of the Olympic whatever, he was a Coke sponsor. You had another lady who was the president of a college that was supported by Coke, millions of dollars of donations, and so on. You had this long list. And when you added the stockholder…the one was a trustee of Emory University, and they owned a billion dollars worth of Coke.
So if you added the Coke holdings together, how much they got invested in Coke compared to CCE, you know one thing. They’re not gonna complain about the price of a sale of a bottling plant to CCE. They’re going to be happy, because there’s going to be a transfer of cash from CCE to Coke and some serious profit.
Well, I looked at that, and I said, “They’re stealing from their children.” And you can’t steal from your children, because eventually they’re going to run out of money and then Coke’s gonna hit a brick wall. And so that was part of my analysis. It got far more complicated. I did call a few Wall Street analysts, and I would look at a footnote that only somebody who understands consolidation of financial statements could make sense out of it, and I would say, “What do you think this footnote means?” And they said, “Oh, I don’t know.” When they told me, “Oh, I don’t know,” then I realized, “There’s nobody who really understands what’s going on here.”
So I wrote a paper on it, and my boss sent it to Jim Grant, and Jim Grant wrote a story on it. The New York Times got hold of it, and they did the front-page article on it. That was on August the 4th, 1998. So you can look at Coke’s chart. I think it was in May 2015. The price was then 88, but we had a stock split, so 44. I think it was only back in May 2015, that’s from 1998, that the stock went back over 44. I think that chart doesn’t show dividend, so you might have to adjust for that, but it was 10 years of dead money. I think Buffett told CNN, “I should have sold Coke in 1998, but I owned 8% and I just didn’t know how to get rid of it with such a big holding.”
Meb: That’s one that I think is less, probably, well known than a couple others that you’ve talked about more modern, and certainly would be a biggie, which was Tyco. How’d you originally come to get interested in those guys?
Albert: Well, I was at David Tice, and we only wrote short reports. Barron’s had Kozlowski on the front page and an article on it. And there’s one little line item that…granted, the balance sheet looks a bit like a rat’s nest. Well, I’d love that. I love balance sheets that looks like rat’s nests. So I just did an analysis on it. And I looked at the acquisition accounting, which, in those days, you could use pooling of accounting and you could use purchase accounting. And purchase accounting allows you to accrue for future liabilities, and you basically create a cookie jar. There were just a whole lot of issues involved, and all I did was I just highlighted them.
But Tice’s clients started to buy put options on Tyco. And CNBC noted that and said, “I wonder what’s going on with the put options on Tyco,” and one of Tice’s clients did something they weren’t allowed to do, but they faxed the report to CNBC. And CNBC took it and said, “Oh, this is the Coke guy. He’s accusing Tyco of accounting irregularities.” Well, I never did that. And the stock just tanked. And it broke the record of the highest number of shares sold on the New York Stock Exchange since 1988, when that Union Carbide chemical factory blew up in Bhopal, India. So it was pretty hectic, man. I got a lot of abuse, which I just wear as a badge of honour, really.
Meb: If you’re a forensic accountant, and you’re talking about short selling, you almost have to like the abuse. The media and people tend to pull their hair out. And it’s almost always the bad CEOs or people that are doing bad things that often would be like, “Oh, their short-sellers are terrible,” and yada yada.
Albert: I did my job. That was my job. But I protected myself in that I didn’t even have a brokerage account, and I didn’t short the stock. So I was deposed by the SEC because, obviously, they wanted to see the trades I did to see if I was front running my own research. And I told them, “If you can find a brokerage account in my name, my son’s name, my wife’s name, any family, then send me to prison. Because I can tell you, under oath, I have no brokerage account and I do no trading on the research, because I work for Tice. That’s it.” So they were quite amazed. But, no, I didn’t do it to try and make personal gain. I just did my job.
Meb: It’s interesting, because the cult of being able to expose…and I think probably a lot of this has to do is with Madoff. But it seems like the environment over the past decade, first of all, it’s actually a pretty good business to be a whistleblower on some of these fraudulent companies. We had tried to mention a few on the investment side to the SEC, but they didn’t seem too interested. But being able to expose some of these frauds, it’s always surprising to me that people still try, in this day and age, to try to get away with some of these things, but people are crazy.
Albert: You’re quite right, because I’ve sent the SEC a few examples and they just blow it off.
Meb: One would like to think that eventually the business model and reality will prevail, but who knows. So, okay, you kind of continue on, and at some point, you say, “You know what? I think it’s a good idea to go start my own shop.” Walk us through kind of how you made the transition to get your own gig going to be an entrepreneur.
Albert: Well, in 2004, I wrote an editorial for Barron’s on stock option accounting. And there was a guy in Houston who read it, and called me up, and said, “Wow, this is fascinating. I want to subscribe to your research.” Up to that point, I just had institutional investors, because it was very expensive. He bought my research. And then after about two years, he called me up, he said, “Albert, you should be managing money. And if you do, I’ll be your first client.” So then I kicked the idea around, and I thought, “Yes, why not?” That’s how I decided to start Bastiat Capital.
Meb: So the interesting part for most of what we talked about today, thus far, is listening to kind of these companies that are doing the wrong thing. The genesis of your firm is actually a little bit different on the long side. You wanna talk about your general philosophy and framework for how you think about investing?
Albert: Well, again, because of my accounting background, I start with the financial statements and I do a very thorough examination of 10 years of financial statements and analysis. And just one small point which a non-accountant might ignore, or even an accountant might think, “Well, it’s not that important,” but I hate stock options, obviously. If you’re an employee, take it and run. That’s fine. It’s not illegal. But as a shareholder, I don’t like it. So I would look at the stock option overhang, and companies like, let’s see, Merrill Lynch had a 28% overhang, CISCO, 22%, Moody’s, 14%, and so on.
Meb: What does that overhang mean for the listeners?
Albert: Yeah, sorry. The overhang is the number of options outstanding divided by the number of shares outstanding. So if it’s 28%, it basically tells you that even if Merrill Lynch were to grow its earnings by 28%, by the time the options of this are exercised their earnings growth would be zero. So you’re basically diluting shareholders in a massive way. And so I stayed away from companies with option overhangs of more than 5%, and that means that I avoided a lot of pain in 2008 and 2009. And I still, to this day, if it’s more than 5% overhang, I just pass on the idea.
Meb: So just kind of perspective. Is that something that is fairly commonplace, a 5% overhang? Is it like 1 out of 10? I imagine in some sectors, like you mentioned financials but also I’m sure tech, some of these companies actually probably have a fairly substantial. What’s kind of the broad perspective on that?
Albert: Well, it’s quite surprising, and I’m not going to take credit for the trend. The use of stock options has become far less prevalent, and they’ve been replaced by restricted stock units. Now, to the granting of options, they normally take into account that some might expire useless, so they might issue 10,000 instead of 2,000. So if it’s RSUs, Restricted Stock Units, they might only issue 2,000 rather than 10,000, because there’s no risk of expiration. So it has actually become far less prevalent.
And restricted stock units, the accounting is basically simple and there’s no smoke and mirrors. You issue the stock at the market value, you grant it at the market value, and you expense the market value at the date of the grant. Whereas, with options, it’s the Black-Scholes and the binomial method, and 110 other different ways to understate the true expense. So it’s not unusual nowadays to find companies with less than 5%, or no options like Microsoft, and I don’t think Apple either. Apple and Microsoft, no stock options, just restricted stock units, and the overhang is usually quite low, about 2%.
Meb: You start to get into issues of incentives too. And the common discourse in the media, we’re not going to get started on this, but there’s a lot of grumbling about, certainly, executive compensation, and people trying to be short term focused, and share price and options. You had a great open letter to the CFO of Goldman. And I’m gonna read a quote and let you riff on it after that.
But you said, “For the past 25 years, we’ve taken a keen interest in equity-based compensation both in the way the accounting rule makers have botched the rules relating to reporting practices, as well as figuring out the real economic consequences of equity-based comp. It was a bad idea 25 years ago, and nothing to date has convinced us otherwise, despite reviewing extensive material on the topic and analyzing in great detail the equity-based comp plans of more than 1,000 companies.” Maybe talk to us a little bit about what you mean by that, and kind of what’s a better way of doing it?
Albert: Well, first of all, they issue stock to employees, and when they exercise, employees can’t take the stock to their local car dealer to buy a Tesla, because they want dollar, they want green notes, and so they cash out. Employees cash out the options, and they take the real cash home. So it’s not really an incentive. In fact, when Forbes published something also on my research on Goldman, somebody who worked at Goldman called me up and said, “You know, I used to work there and we all hated options. We all hated stock. We wanted cash.” And so the best incentive is just pay them in cash and tell them, “You can buy our stock.”
And most companies have employee stock purchase plans where you can buy the stock at 15% discount, at the price at the beginning of the quarter or end of the quarter, whichever is the lowest. So, already, you have the opportunity to buy the stock at a 15% discount, which is quite nice. So, “Here’s the cash. Buy the stock. And we’d appreciate it if you hold it for three to five years.” That is very simple and very straightforward, and there’s no smoke and mirrors. And that’s how you incentivize them.
You don’t incentivize them when you give them options when the stock is $170 and 10 years later it’s still $170. You actually find that there are certain periods, like 2017, for instance, when the market ramped. So if you worked at a company, you got stock in 2015 and you cashed out in 2017, you might have made a lot of money. But if you got your options at the end of 2017, you might find that you’re basically underwater, or you’re not doing that well three years later. So it’s sort of like playing the lottery. There are certain years where employees really make out like bandits, and there are other years where nothing happens for a long period.
I do the calculations where I calculate what employees got in gains, and I took it back to revenue, and I work out a percentage. And I calculate, “What if a company had just paid bonuses equal to say, 7% of revenues, and then use the cash to buy back the stock?” You actually shrink the stock count, and you’ll actually land up with higher EPS, a better multiple, and better quality of earnings.
Meb: On top of that, I mean, the ability, you know…If you’re an employee, the fact that companies, in general, if they’re giving you options… I mean, your life is already highly leveraged to that company. And we talk a lot about having concentration risk, and in-home country bias, and all sorts of other stuff on this podcast. But working in a company and then going and having all your money in the company’s stock, it’s like doubling, tripling, quadrupling down. For a lot of people, they’d probably be better off, and certainly there’s big examples of this, Enron being an obvious one, all the people that had all their retirement in Enron stock, when it went to zero, it can often be a really foolish idea.
Albert: Exactly. And in the ’90s, well, this company still exists, Fastenal. And Fastenal had 85 million shares in 1988 with its IPO, and it had 85 million shares in 2000. And the reason is they didn’t issue options. They now issue a few RSUs. But Fastenal routinely had a higher P/E multiple than Microsoft, and Fastenal sold nuts and bolts. And the shareholders, investors appreciate it when you don’t dilute them. They give you a higher multiple. You’re held in higher regard when you don’t dilute shareholders.
And it was funny, because when I was at Tice I did this analysis. Assuming that Microsoft paid employees a 50% bonus in cash, and then took all their stock purchases and took the share count down, because now you have no stock issues to dilute shareholders, and calculate a new EPS number… At the end, I think it was 99, and took the EPS and timed it by Fastenal’s P/E, which was higher than Microsoft, to show that Microsoft would have been so much better off never to have issued stock options.
And the intern that worked with me on it actually went and worked at Microsoft in their Treasury Department, and he took my research with him and he showed it to the CFO. And, within a year, Microsoft got rid of stock options. They actually got JP Morgan to buy the employees out, to buy the employees’ options. And Bill Gates told Barron’s, “The biggest mistake I made in business was to give employees,” not himself, he didn’t give himself options, “stock options.” So that was quite telling.
Meb: All right, so we talked a little bit about a couple accounting ideas. What else are you looking for as you build? Because you’ve been doing a long book for over a decade. It’s done exceptionally well. Talk to us a little bit about any other kind of inputs you have into how you build a portfolio, and the framework for kind of how you build your process and philosophy.
Albert: Well, obviously, like all money managers, all investors, I look at the business model. I absolutely want to understand what they do, and who their competitors are, and what are their competitive advantages, etc. So that’s a very important part. I look at corporate governance. I study the proxy like I study the financial statements. I Google the names of the directors. When you have 40 pages to explain why you’re paying the CEO $50 million a year or $40 million a year, well, that’s really off-putting. Whereas Berkshire Hathaway has, I think, two paragraphs to explain how much they pay their employees. It’s amazing. It’s amazing.
If you think the amount of time and effort that goes into putting together stock option programs and the accounting, the fact of the matter is, if you want to really understand stock-based compensation accounting, you can get a roadmap document from Deloitte & Touche, which is 623 pages. So 623 pages, whereas if you pay cash, you dispense with all of that. But, anyway, so the business model’s important. The corporate governance, the proxy, terribly important, and then the financial statements.
Then I do a five-year earnings model that acts as a bit of a roadmap. So I want to try and project what they might earn in five years’ time, and what they might be paying dividends, etc. And every quarter when the earnings release comes out, I check out the numbers to see that I’m still on track, because my earnings models are modest and conservative. And if they don’t meet my estimates, well, then I’m really concerned, then I’m really concerned. So that’s how I monitor things.
I’m not top-down, although, at the end of each quarter, I give a little summary of my view on the economy, the global economy, the U.S. economy, to try and understand the inverted yield curve, and all things like that. And Buffett said it’s never helped him, and I don’t think it helps me a lot, but I don’t wanna be in the dark. So if you tell me what’s going on in the economy, I think I’ve got a pretty good handle on that. But I’m more bottoms-up. I’m more looking for great companies to invest in.
I really don’t want more than 30 companies in the portfolio. But it’s quite difficult to build up a portfolio of only 30 companies, because we buy in small increments as we build our positions. And some companies just run away from us, and we’re never able to get a full position. So we have about 50 companies in the portfolio. So it’s fairly concentrated, but not overly concentrated.
It’s in all industries, except we are currently not in energy. I went up to North Dakota in 2011. And I came out of the airport, and I was driving. This train picked me up and they were about, I don’t know, 30 or 60 miles from the airport. So you’re driving on these rural roads, and you just see flares everywhere. And I said, “Wow, there’s oil wells and they just burning the flares, the gas?” He said, “Yeah, we don’t have the pipelines yet so they’re just burning it,” and it’s just everywhere.
In fact, when I took off from the airport here in Dallas, they had oil rigs in the airport property itself, they were drilling for oil. And I thought, “Well, we’re gonna have a glut, you know. How can one predict the price of oil when there’s such an explosion of drilling and exploration going on?” So I got out of energy in 2011, and I certainly don’t regret it, and I’m still not able to predict the oil price. So I’ve learned that some things you can’t predict, so you just stay out of it. So there’s certain industries you’re heavily capital intensive, and some that I stay out of. I don’t invest a lot, about 10% in foreign stocks, but quite happy just to invest in the U.S. companies.
Meb: It sounds like the energy, the old Warren Buffett quote of the too-hard pile. I see that you have a couple overweights in certain sectors, information technology and financials. We’d love to hear a little bit about any particular names, or holdings, or thesis on some of the things you see as big opportunities today, or anything that you’re particularly excited about.
Albert: I own a few of the usual Microsoft, Google, Apple. Everybody owns that. I think they’re great companies. I think that Washington trying to break them up, that’s just political posturing. It’s just a lot of nonsense. So I’m quite happy owning those. I do own some Chinese stocks, which might cause some people to raise their eyebrows. But Tencent, Tencent is a very large cap on the Hong Kong Stock Exchange. So is Baidu, Tencent, and Baidu, and Alibaba. Baidu is not that big and Baidu spun out IQ, which is sort of the Netflix of China. So we own some Baidu and IQ because of the spin out. And we own Alibaba and Tencent.
So unlike most people that I talk to, I’m very positive on China. I visit the China’s Xinhua News Twitter every day, and people said, “Oh, that’s Chinese propaganda.” And I’ll say everything’s propaganda, but you just have to look at the facts and get rid of the propaganda. So China’s Xinhua News Twitter gives me some great information about China, and I’m totally impressed. I’m totally impressed. I don’t know. Senator Romney spoke about China in a way that we got a war on our hands, and I just totally disagree with that whole outlook. To me, China is a great country doing lots of things, lifting people out of poverty. And with 1.4 billion people, if you own these tech stocks, these real large-cap tech stocks like Alibaba and Tencent, I believe it’s gonna pay off. We’ll see. But that’s sort of my only exposure, really, to foreign companies except one or two others.
Meb: China’s an interesting battleground. You have people certainly on both sides. We’ve had guests that are hugely bullish on a secular level, certainly, as Chinese stocks in the U.S. have been hugely under-represented in the indices relative to their actual weights. And that’s starting to take effect over the past few years, so a major tailwind. But it’s funny. You go back to pre-financial crisis when a lot of the Chinese names were super-expensive, and everyone wanted the BRICS, and India and China. And media couldn’t get enough of the Chinese story, and then Chinese marketed very poorly. And by the time that a lot of these companies get pretty cheap then everyone, all of a sudden, thinks that all the Chinese companies are trash and you can’t invest in them. It’s just funny to watch the sentiment around it.
Albert: I might just add that I don’t invest in companies on the Shanghai Stock Exchange. I like it if they listed on the Hong Kong Stock Exchange, and better still if they’re also an ADR in the US. The Hong Kong Stock Exchange, Hong Kong’s British. It has the British culture. It has the British legal system of checks and balances. A lot of the directors on these Chinese Hong Kong companies are British-educated, and QCs, and so on. They’re pretty well-educated, sophisticated people on finance.
So, basically, they have to be listed in Hong Kong, and preferably an ADR, and they are. Well, Tencent’s not on the New York Stock Exchange, but neither was Nestle for decades. I think Nestle’s on now. But it’s a $450 billion company, and I’m happy owning it. It’s a Hong Kong company. So, yeah, I’m not saying I’m going for the little, small caps on Shanghai. Obviously, I’m not into that level, but I think China’s doing the right thing. Well, I won’t say what we’re doing wrong, but China’s doing the right thing.
Meb: Yeah, well, politicians are gonna politic. As you look to the portfolios, anything either…? And I know you’ve been involved in the SumZero community. We’d love to hear about your experience there. It’s always interesting the way that people have shared ideas, whether anonymously or real identity over the years has certainly changed. I mean, it used to be you would have these investment manager dinners, or you would have groups of people at conferences, or you mentioned investment research being published, and including the sell side but also paid by side stuff. Then, I mean, I remember back in the day of Raging Bull, in places like that.
But we’d love to hear about your experience there, and also this concept of sharing ideas and bouncing them off people. But we’d love to hear any ideas you have in the portfolio that you would consider to be different, or weird, or atypical, a name that people probably…most people have probably heard of Microsoft and Apple, but maybe anything, something that people may not have heard so much about.
Albert: Wow, that’s difficult. Mainly because I like to keep my cards close to my chest, if you know what I mean. I’ll just say that Alumina and Intuitive Surgical, those have been big hits for me. ASML, which is a Dutch company has been very good, and Taiwan Semiconductor. So people might not have heard of ASML, the Dutch company, and Taiwan Semiconductor.
Meb: What’s the main thesis for a lot of these? Is it pretty simple, basic thought process? Because there’s a couple camps. I mean, you’re an accounting-based framework. And so a lot of people listening to this would assume, probably, and you can tell me either way, incorrectly or not, that a lot of people, when they think of accounting variables, they think what you’re doing is just buying P/E ratio 5 stocks. And I’m guessing that’s probably not what you’re doing. But we’d love to hear more about some of the thesis on, you don’t even have to use a specific name, but kind of how you think about it. Because the way that people approach value is very, very different than the way a lot of people think value is practised.
Albert: Well, I think some companies sell above the so-called value parameters for a very good reason. And so if you purely value looking for 12 P/Es you’re going to miss really good companies trading at high P/Es for very good reason. Now, seeing I mentioned Taiwan Semiconductor, let’s just understand the rationale. They’re very profitable. And you say, “Well, they’re a contract manufacturer. Why should a contract manufacturer that manufacturers for these large companies have any pricing power over them? Because their profit margin’s 33 to 35% for a contract manufacturer.”
Well, it’s because they do it so well, they don’t have to change their pricing to try and get business, and they’ve never made an acquisition. All their growth has been organic, which I also like. Their tax. I think their tax rates, at the time that I did the first investment, was 5% corporate tax. So, again, which helps their margin, 5% corporate tax. So I really liked their organic growth model, the highly profitable growth model, the low taxes, and their whole management structure, and obviously no stock options. So that was very attractive to me.
Then going through the 10K, they mentioned ASML as being the supplier of their semiconductor equipment. And I thought, “Well, maybe that also gives them an edge, because they’re using a superior machinery and equipment,” so that led me to ASML in the Netherlands. ASML has another advantage, which you only find…you might find it in other European countries, but I know it’s in Norway and I know it’s in the Netherlands, where they have a second layer of corporate governance.
The second layer of corporate governance is really very good. Because I think Buffett said, “We don’t want Dobermans on the board. We want Labradors,” so in the sense that directors just acquiesce with whatever their CEO wants to do and they’re not really the true protectors of shareholders. And the second layer of corporate governance, in Norway, that corporate committee consists of former mayors, professors, judges, trade unions’ leaders, and some employee representatives serve on the corporate committee, and they get paid very little, 50,000 kr a year or something. But they take fiduciary responsibility for the acts of the directors. And that extra layer of corporate governance is very good. And obviously, there are no stock options, and very reasonable compensation, and very low taxes in the Netherlands as well.
In fact, after we bought ASML, maybe seven years later, Intel and two other companies actually took a 15% or 20% ownership interest in ASML. Basically, I’m looking for companies like that, that just have unique characteristics, that takes away any concerns about the way they manage and so on, and with some serious competitive advantages. ASML has a serious competitive advantage. It was spun out of Philips, in case people don’t know. That was many, many years ago. Philips was the big Dutch sort of GE company, and they spun ASML out.
Meb: GE may not be the best example now that it’s trading single digits, right? I haven’t checked it in a while.
Albert: Well, right from the beginning, one of my first clients gave me a portfolio with GE stock, and I immediately sold it. And they said, “Why are you doing that?” I said, “Because the company exists for the purpose of enriching insiders. That’s all they do. They just keep racking up debt, racking up debt.” I mean, when M.L. took over, the price was $50-odd per share. In March 2009, it got down to $5. And then they issued options to 9 of the executives that, within 9 months, those options added $20 million to each executive’s wealth.
So just while others were panicking, they were getting options priced at $5 to $8 and with no risk. And when the stock bounced back to $11 or $12, they had gains of $20 million each. When I see that, then I realize, “This is not a company that’s trying to take care of shareholders. They’re just taking care of insiders.” And so I was always just selling out GE. As soon as I got a portfolio and it had GE in it, that was the first trade, get rid of GE.
Meb: As you look around, you’ve been doing this for a while, as you look around, you spend most of your time on the long book, but I imagine you still see some bad behaviour. How has kind of the way that companies deal with modern accounting irregularities? Is it something that’s been consistent over the decades? Do you see much less of it? Over the years, is there much less outright fraud and people kind of change the CEO’s way they do it, or is just everyone a good behaved CEO at this point? So how’s it kind of changed over the years?
Albert: Well, as I’m no longer a short seller, I don’t see as much. Because when I see something that I don’t like, I just move on. But when companies start giving you non-GAAP EPS, that is a form of accounting fraud, really, because consider the items they add back. It’s always stock-based compensation. So I won’t mention the name, but there is one company I follow closely, because, to me, it’s a matter of time, and it’s just gonna collapse. I don’t know if it’s gonna collapse, but it does not trade on fundamentals, but we’ll leave it at that.
The main thing is, in 2018, they recognized a stock-based compensation expense of $1.2 billion. If you calculate what the employees took out in option exercise, it came to $4.8 billion. And I think they only made $500 million in pre-tax income, of which about half was gain on marketable securities or strategic investments. So when half of your pre-tax income isn’t actually related to your operations, and your employees walk away with $4.8 billion, and you only recognize $1.2 billion as a stock-based compensation expense, how can you add it back to try and create some numbers, and then you boast about terrific numbers? “Wow, we increased the EPS. Non-GAAP EPS went up by 15% or whatever.” It’s just a smoke and mirrors show.
And, at the same time, the share count goes up by 5% so you’ve got 20-plus% revenues. But if you calculate the revenue per share, it’s only about 15% or 16%. So there’s massive dilution taking place, stock-based compensation, which is the reason for that. And with employees walking away with bags full of money, you want to add that back.
And then a lot of your growth in revenues came from acquisitions. Well, if you’re going to make acquisitions, it means somebody else did the R&D, somebody else did the development, etc., and now you buying that, and FASB says you have to amortize that expense. You could either develop that in house that expense, or you can buy it. If you buy it, you have an amortization expense. But they add that back because they say it’s non-cash. But when you bought the company, you paid cash, so non-cash or cash doesn’t matter.
And when you add back amortization of these intangibles, and you add back stock-based compensation, and suddenly you’ve got earnings, and then you boast about the increase in earnings, to me, that’s just… And the media, they just buy it wholesale. Even Wall Street analysts, they just buy it wholesale. Again, the companies that do that, I’m not interested. I’m just not interested. I just don’t understand how anybody could be investing in companies where the share count goes up 5% per year, terrible dilution.
Meb: I think a lot of people, when we’re speaking specifically to dilution, Munger always says, “Look for the cannibals.” He wants a decrease in share count. This concept, Warren and Charlie talked about it a bunch in the recent Berkshire meeting. The media, I think, really struggles, particularly the politicians, with this concept of buybacks. But I’m like, I often say, “Look, everyone demonizes buybacks, but what’s the alternative on the opposite side where companies are, often as a shareholder, issuing tons of shares?” A lot of investors don’t look at it because that information is not as easy to find as, say, dividend yield. You go to Morningstar, type in a stock, somehow you get a dividend yield. But if you have a 2% dividend yield and you’re issuing net 5% a year in shares, you essentially have a negative yield. And so I think the main reason for a lot of people is that it gets confusing, but it’s harder information to find, but not if you look very far.
Albert: All I’ll say on buybacks, I think they’re great for my type of companies that don’t issue options. I adjust my cash flow for the cash that the company spent on buying back the stock that they’ve given to employees, because that’s not free cash flow. You have to buy that stock back to combat the dilution. Free cash is only after you’ve gotten rid of that stock-related stock buybacks. But once you’ve done that, and if you invest like me in companies that have very little dilution, then stock buybacks are great. They keep reducing the share count. And if they pay a dividend, it means there are few shares they’re paying out on dividends, so the dividend growth is not that high.
Then for people to say, “Oh, they’re buying back stock? That’s not good for the economy.” I don’t know whose logic that is. Because when I, as a shareholder, sell my stock and the company buys it back, I’m sitting with more cash, and I’m going to go to Aspen or wherever. I don’t go to Aspen, but, you know, I’m gonna spend the money in the economy. And if they pay me a dividend, I’m going to spend the money in the economy. So what’s the difference? It’s just pure political posturing. And, again, as soon as politics comes into an issue, just common sense leaves the room. So I have no problem with stock buybacks. I don’t like it when they borrow money to buy back, and lever the balance sheet, and so on, but I stay away from debt-laden companies as well.
Meb: It’s funny, because this cycle we haven’t quite really had a big, long, fat bear in 10 years now. We started to last quarter, but some of the highly leveraged companies would be interesting to see how it plays out. As you look around the landscape, do you think it’s gotten harder to hide the shenanigans, or they just do it in different ways as far as the CEOs and companies? I mean, I was laughing as you were mentioning GAAP accounting and all this stuff. And WeWork has been inventing some interesting new accounting measures recently. But do you think it’s gotten harder? Do you think it’s just the same old scumbags doing it a different way? What’s your perspective?
Albert: No, I think it’s actually much easier. And I don’t wanna criticize FASB, because it’s my profession. But when you have to produce a 600-page document to try and explain stock-based compensation, then there’s something wrong with the rules. And for revenue recognition, Deloitte’s put together a 208-pages book on revenue recognition. If you go through revenue recognition, they will tell you that the company may negotiate a discount for existing product in view of future upgrades.
So they sell the item, or the software, or whatever, to the client, but they give them a notice that, “This might become obsolete, because we’re gonna do upgrades. And, because of that, we’re gonna give you a discount.” Well, what happens to that discount? Because it’s not a cash discount for early payment, all that. It’s a discount because the current product’s gonna be upgraded. So that discount you can put against sales and marketing, and you could capitalize it and then amortize the cost capitalized to obtain revenue contracts.
I’ll explain to you the beauty of that accounting rule, because they also say…and this is mind-boggling, but you have to read 200 pages to find this little paragraph, that vendor sales and marketing staff may enter into side agreements with customers. It’s like saying, “You can’t sell tobacco to teenagers, but you can have a side agreement with the parents.” They’re side agreements, the sales and marketing stuff. So basically what you can do is just over-invoice and then offer a nice big discount, and then not put that discount against sales but put it against sales and marketing.
Now, you say accounting is counting, but do they show net revenues or do they show gross revenues? If a company doesn’t show net revenues, then straight away I get suspicious. Then I look at the sales and marketing line, and I look at that as a percentage of revenue. If it’s twice that of their peers, then I know there’s some, what I call, creating revenue by journal entry, creating revenue by journal entry. It’s all legal. You’ll find it in the 208 pages on revenue recognition. Apart from the fact that the sales and marketing as a percentage of revenue will be much higher than other peer group companies that don’t do that.
But another way that one could pick it up, but because we don’t account for cash flow like European companies, it’s almost impossible to find. Although, if I were to invest in this particular company I’m talking about, I would call IR and I would ask them for information of the cash they received from customers. Because under the direct method of cash flow preparation, statement preparation, which they do in Europe, either by footnote or in the main cash flow statement, they don’t start with net income and reconcile to cash flow from operation. They actually give you cash received from customers, cash paid to employers, cash paid to suppliers, cash paid to bankers, and cash paid to revenue authorities, and then cash flow from operations.
So they cover cash from customers. And if the cash you receive from customers is materially less than the revenue you recognized, well, then obviously, you were creating some of that revenue by journal entry through these negotiated discounts and costs that you capitalized to obtain the revenue contract. So, yes, that’s just another example how revenue growth could totally fool you if you don’t understand that you need to check and see, “Is there a possibility that they’re recognizing revenue purely through a journal entry?” The debit, the rebate, the discount is not going to revenues to give you net revenues. It’s going to the sales and marketing line. So there’s just one example.
Now, when you buy a company, you have goodwill, and goodwill is not amortized. And you might say, “Well, that’s okay.” But I say if you want to start a shuttle service to the airport, and nowadays it’s not such a big business because we got Uber, but you can buy five vans, and you can spend a ton of money on advertising, and start your business. Or you can buy an existing business with five vans, and you’ll suddenly have a lot of revenue and profits.
Under the purchase agreement, you could tell the seller, “I’m going to pay you 5% of royalties on the revenues.” If you do it that way, then you are actually matching your cost against your revenues. But if you buy it upfront, and you put the excess book value against goodwill, then you’re getting revenues with no matching cost against it. And suddenly you have some pretty good income, because goodwill is not amortized anymore. And FASB leaves it to management to tell us where the goodwill is being paid or not. And I say that a much better way is to look at return on assets, and look at your peer group return on assets. Now, that’s very laborious, so I just use a sort of 8% rule of thumb. If a company acquires a lot of other companies, and their return on assets start dropping below 8%, then I know they’ve overpaid. Then I just say, “There’s a very big likelihood that they’ve overpaid for these acquisitions.”
So how much do I have to write goodwill down so that I’ve got the lower assets to restore the 8%? And then I say, “well, basically, if it’s not gonna happen this year, it’s gonna happen next year.” Quite often, I would just say, “I’m not buying this company. This lower return on assets tells me that they’re overpaying.” And unless I can see some serious growth in earnings, then, yeah. And on stock based compensation, 623 pages, there’s plenty of opportunity to create numbers, unfortunately. But that’s the case.
Meb: Everyone always wants to make it so complicated. I was remembering the phrase that WeWork used when they put out their revenue and earnings was community-adjusted EBITDA, which I had never heard before. That’s sort of a new one in 2019. So I wanna take a little departure from pure investment ideas at this point. You do a lot of really thoughtful writing. And there’s a couple topics, I’ll kind of let you choose which one you want to riff on. If we have time, you can do both. But you’ve written on some ideas, you mentioned Norway earlier, but surrounding some African development. And you’ve also written on some ideas about the dilemma with Social Security. Either of those front and centre on your brain these days, that you’d like to expand on?
Albert: I’d love the opportunity to just put through an idea of Social Security, which again, you cannot discuss with people because they get political about it. And then common sense just gets out of the window. But I did a little calculation. I went back 40 years, and I assume somebody earned 80% of Social Security earnings. Let’s go back 40 years, only $30,000 of your salary attracted Social Security. And so they keep moving it up. I think now it’s $128,000. Anybody above $128,000, you don’t pay Social Security on that. So I took 80% of that and calculated what a person would have paid on Social Security, what the matching contribution would have been, put it in the S&P in that year, whatever the S&P was priced at. And I came out to about $1.3 million that somebody would have had in 2015, if they had started doing that 40 years ago.
And then I looked at what was the average Social Security check, which was $1,350, I think it was. And I checked with Allianz, and they would sell me an annuity that would pay me that plus 3% per annum increase for $300,000. So basically, if you retired in 2015, you were $800,000 to a million dollars short of what you would have had if you didn’t put your money in the government fund, but just put it in the S&P in a locked account. I posted that on a little website that discussed it. And some guy said, “I’m an engineer, and I did the calculation. I would have had $3 million.”
So obviously, people are retired today. And that’s another problem that we always hear, that Americans don’t save enough, they don’t save enough. Well, if the government takes 15% of your wages, because that’s your contribution, your employee’s contribution also belongs to you, and it just goes down the black hole, then how can you say? It’s very difficult. And the other point is, if you were allowed to put that money in a locked account until you’re 65, with a lot of restrictions to it… So the devils in the details. But it’s just diverting it to a locked account, S&P 500 and ETF, say. If you were allowed to do that, and you die at 65, your heirs, your children will inherit that. Now, if you die at 65, they do a little dance in the Social Security Office, because they’ve just gotten rid of a liability.
So when you talk about privatizing, it becomes a total nightmare. But a much easier solution would be just to say to people under the age of 25, young people, “We are gonna give you an opportunity to opt out. You have a choice. You make the choice, you opt out. And for the next 40 years, you have to pay that money into a Charles Schwab account with a certificate that they will give you to say that it matches 50% of your wages.” And you can’t touch it under no circumstances, because that’s the big fear that people won’t do it. And then when they’re 65, they’ll become dependent on the state again. But if it’s a locked account, untouched, so they invest that, and you start small, with young people under the age of 25. And, slowly, you wean half the population off Social Security. And people say, “Well, how can we fight these wars if we don’t have money and the Social Security?” Yeah, I know. Social Security taxes just goes into the war fund, and it gets spent on defence and whatever. But at the moment, you’re only taxed on $128,000.
So the anomaly is that somebody who earns $58,000, a household with two kids, $58,000 would maybe pay 7% average rate. And then if you add the 15% to it, it’s 22%, if you include social security. A household earning $275,000 might have a 14% or 12% average rate, 14% average rate. But if you add their Social Security taxes, which only based not on $275,000, but only on $128,000, their average rate will also be 22%. So the rich earning $275,000 have a 22% average rate, and so has the household that earns $58,000.
So it’s very simple. You give people the choice to opt out if they’re under 25. And then you just increase the $128,000 to where it would be sufficient to make up the shortfall. That’s not gonna come from workers, employees under the age of 25. And so you slowly wean. And some people are gonna say, “Social Security is the most wonderful social program ever invented by mankind,” and they’re gonna stay on it. That’s fine. They can run for politics after that, because government programs are great programs.
But some people say, “No, I got a JD. I haven’t got it, but my son’s got a JD from a very prestigious university.” And yet the government says, “You’re not smart enough to take care of your own retirement.” It just doesn’t make sense. Why do you spend all this money to educate him, and then you tell him he’s not educated enough to take care of his own retirement? No, give him the option to opt out, put the money in the S&P 500, in an ETF, two ETFs, just leave it there, can’t touch it. And we’ve solved the Social Security problems. So that’s my little Social Security spiel.
Meb: We spent a lot of time on this podcast actually talking about this idea. And on Twitter, I say, “Look, our government, our systems really need to be incentivizing people to be investors and celebrating it.” And that is, in many ways, like the real path to compounding wealth over long periods. And the key word being, of course, long periods. And so many people, the main problem with that is obviously the behavioural side, where if you could lock something up for 10, 20, 40, 50 years, the amazing amount which it grows, owning businesses, is astonishing.
And trying to figure out structures that incentivize that, I think, is one of the biggest opportunities and challenges our country’s facing. And so I agree with you. We’re trying to build a private solution there. I can’t quite figure out the right structure yet to come up with an idea that locks the money down. Again, low cost investing, but also that avoids having to pay taxes on it as you go, which historically sounds like an annuity. The problem with annuities is they usually charge 2.5% a year, and destroys a massive amount of… So if we can put our heads together after this, Albert, and come up with a good idea.
Albert: If 15% of your gross wages go into a locked account, and you get a certificate from Charles Schwab that verifies that, and that gets attached to your tax return, then the problem is solved.
Meb: Australia does a bit of this.
Albert: Yeah, because you’re getting out of Social Security, but you’re just putting it into private. If it’s the S&P 500, it’s the 500 best companies in America. You’re investing in America. I mean, there will be years, there will be the 10-year-period of the last decade and that. But if you do it over 40 years, you’re going to do lots better than just putting… And then Social Security, the problem with Social Security is they change the rules on you, “You can retire at 55. No, you can retire at 65. No, you can retire at 70.”
And then the biggest fear, and a lot of young people have no idea, but they’re gonna start means testing you. So somebody like my son who is a big saver and everything, he’s gonna have $5 million odd when he retires. They’re gonna say to him, “Oh, my goodness, you don’t need Social Security. We’ve means tested you right out of it.” So they change the rules on you, and they also increase rates, and all that. So really, there’s a no brainer. Just let me, as a young person, put my money in the S&P 500 for 40 years, and I won’t touch the money. There’s no question about it. You’re gonna be better off than putting it into Social Security. And the government wouldn’t have to have a Social Security Administration all that nonsense in 40 years time.
It’s a slow but sure way of solving the problem, because it’s a problem. They’re running out of money. They said, “By 2033, we’re going to run out of money.” They’re never gonna run out of money. They can print it with gay abandon. But the fact of the matter is, it’s not a solvent trust fund like it would be if it was invested in a secure retirement account in the S&P 500 for 40 years.
Meb: Well, if you come up with a private solution, let me know and we’ll launch it with you. The closest I can come is launching a mutual fund, super low cost, invest in a basket of ETFs, or whatever.
Albert: Well, no, that’s not gonna work, because, first of all, the government grabs 15% of your wages, so that leaves you with very little to invest in these funds. And that’s my whole point. That’s why I say 25. You gotta start some way. So anybody under 25, by the end of 2019, will qualify. So that’s the issue. You’re not trying to get them to save on top of that 15%. You’re just trying to get them to divert the 15% the government grabs every month, and put that into that S&P 500.
Meb: I’m not hopeful that they’re gonna solve that.
Albert: Well, obviously, because it’s gonna be politicized. And I actually started a website, “Social Security: Get Me Out Now,” which I’m hoping that somebody who’s really good at Facebook, and community, whatever, can take that and say, “Listen, guys, we just need to mobilize. If 500,000 of us sign on to this idea, every politician in the country is gonna start taking this seriously.” And, of course, when the media says, “You know, there are 500,000 people who’ve signed on. They want the right.” Or not even 500,000, “200,000 young people, they want the right to opt out.”
As soon as that story hits the mainstream media, it will be 2 million by the end of the month, and 10 million by the end of that. So it will just become, “Well, we can’t afford not to push that idea, because young people want to opt out.” So that’s what I’m hoping for, that some sort of activist at some university, some young kid who knows how to work Facebook. The people in Egypt, young people in Egypt, used Facebook to change the government. So I’m saying, “Hey, if they can do it in Egypt, they can do it in America. Take Facebook, run with this idea.” And the government will just say, “Okay, under 25, you can have the right to opt out.”
Meb: Yeah, you may get some inquiries from some of our listeners. I’m gonna warn you. Let’s talk…
Albert: I know. I know. I know. I know. I know. But politics and all the political intrigue will just overshadow all clear common sense thinking on the issue.
Meb: So, as you look back, we’re gonna wind down with a few more questions. I’d love to keep you all day. But talk to us real quick about your African development idea. You’re proposing some ideas that I thought were pretty interesting there.
Meb: Okay. Well, I lived in Africa for 40 years. And I know that they don’t attract a lot of direct investment capital, attract about $40 billion a year, but it goes to three countries, Nigeria, South Africa, and Angola. So there is a total death of foreign investment in Africa. Although China is doing quite a lot of investments, because they have to feed 1.4 billion people. And so they’re looking towards Africa to provide them with the produce. So they’re very smart, but there’s a problem with investing.
And the problem is that governments change, and industries are nationalized, and the political situation is very unstable. And so I thought, “How can one get a stable environment in which to invest?” And I looked at Hong Kong, where UK had a 99-year leasehold. And people who invested in Hong Kong did not invest in China. They invested in the United Kingdom, because it was a protectorate of the United Kingdom. When it was handed back to the Chinese after 99 years, it represented, I think, 19% of the total GDP with only about 0.6% of the population. So it was hugely successful.
We also looked at the Panama Canal, which wasn’t there. And it had to be built, but Panama couldn’t build it. And there were some politics and gunboat diplomacy involved. I know. So, that aside, the only way that you could build that, and get the money, and get the investment was for the U.S. to take a lease on that piece of land. And they built the canal, and they paid the Panamanian government $250,000 a year. And it was a hugely successful investment, which would never have taken place without that lease. And so I proposed to the government of Sierra Leone that they lease Sherbro Island to the Norwegians. Now, the Norwegians have over a trillion dollars in a sovereign wealth fund. So if they were to, let’s say, gamble, 2%, $20 billion, it would make no difference for them, and use that money to invest in Sherbro Island, which is off the coast of Sierra Leone.
And then hoteliers and other people will get involved and also invest, and it will become sort of a haven for Norwegians to go in their very harsh winters. And they could build a university there, hospitals, airport, everything. So a lot of economic and social development, which then could spill over into the rest of Sierra Leone. So that is my idea. And of course, people say, “Well, that’s colonialism.” Again, just politicizing it becomes colonialism. But it’s win-win for both. Because once the development is done, and the lease runs out… And, of course, Norwegian will be paying them lease payments every year, which is like additional revenue, which they never would have gotten. And the politicians in Sierra Leone can send their kids to the university, and the Norwegian schools and universities, and nursing training centres, and they can get treated at the Norwegian hospital.
So there’s a lot in it for politicians too, but that’s not the whole reason. The reason is to give investment capital. And I thought, “If you can get 20 of these, what I call sovereign cities, all over Africa, that would be a trillion dollars of investment.” Now, people say, “Well, that’s not gonna work.” Well, I’ll tell you a little thing. There is only one way to get ships from China to India and, say, the Suez Canal, and that’s through the Straits of Malacca, by Singapore. And it’s pretty narrow, and it’s very easy, in times of stress and trouble, to just shut it down. Especially the U.S. could just shut it down.
So China has been working on a different idea. They’re gonna build a canal through Thailand. But once they build a canal, they need a port on the other side. And Sri Lanka is ideal situated for that port. So they made a deal with Sri Lanka on exactly the same basis as my idea, “Listen, we will develop this port. But we don’t want change of government coming in and saying, ‘Oh, we’re going to push out the Chinese and get the Americans to run this port.’ So we want a 99-year leasehold on this port.”
And they signed a 99-year leasehold on that port in Sri Lanka which they developed, beautiful development, incredible development. And so when you hear about the canal that’s gonna go through Thailand, that you’ve heard it here first. That’s exactly the reason why they took out the 99-year leasehold, because it fits their plan to get rid of the Straits of Malacca and that choke point, and go right through Thailand, at the narrowest point in Thailand, through to the harbour in Sri Lanka. So that’s really my in a nutshell.
Use the same model. Take Africa. You’ve got lots of land, you’ve got lots of resources, just 100 square miles or whatever, lease it to various countries, preferably non-political countries, or just the European Union, Singapore. Lease it to Singapore. They’ve got a sovereign wealth fund to Norway, to the European Union, non-political. You have these sovereign cities, 66-year leasehold would be fine. And then after 66 years of trillion dollar investment in Africa, the continent will be in much better shape than it’s now.
Meb: I love the creative ideas. I was smiling as you’re describing this, because Norway…I listened to a fun podcast this week on Planet Money, NPR, where this is new to me. But Japanese never ate salmon sushi before Norway kind of figured out a way to market, and they had a massive fish surplus and convinced the Japanese to start trying and loving salmon sushi, which is my favourite sushi. It’s not even close now, which is kind of funny.
Maybe they’ll listen to podcast and get creative about it. Albert, as we start winding down, a couple more questions. The first one being as you think about kind of your career, you’ve been a professor, a money manager. And let’s say some of the younger people listening to this or just pros alike, what are some good resources as far as investing that you think would be helpful? Obviously, listening to this podcast and reading your investment pieces and writing on your website. But are there any books, are there any that you look back that were really formative for you, or any other idea as far as resources you think would be helpful?
Albert: I don’t think the kind of books I read on accounting theory will be useful, but if you buy Buffett’s…not, “The Making of an American Capitalist.” But I think Lowenstein wrote a biography on Buffett. If you buy that book on Amazon, then they say, “Other people also bought these books.” And so, suddenly, you’ll have a choice of a lot of investment books, and you have reviews, you read the reviews. And really, you can’t read enough. I mean, I don’t think there’s a book you could read and say, “Well, I learned absolutely nothing from this.” So it’s not one particular book. Buffett’s biography was pretty good. It’s a pretty good place to start. But just read as many investment books as you can lay your hands on.
Meb: Having a curious mind is good advice. I think the only accounting book I’ve ever read was Schilit’s old, “Financial Shenanigans.” I only read that because my professor in college made me, so.
Albert: Yeah, well, you learn something, I tell you. Everybody has something to teach you. And I just read a lot. And I don’t necessarily read just accounting books or investment books. I read everything, just whatever I can get my hands on.
Meb: So, as we wind down, our closing question has been for the past year to ask all the guests what has been their most memorable investment over their career. It could be good. It could be bad. It could be silly. It could be painful. Anything come to mind?
Albert: Well, the most memorable for me was when my boss, who was a Buffett devotee, Frank Martin, in Elkhart, said “Albert…” And I’d just arrived, just arrived there. And he said, “Albert, I want to invest in Coke. Buffett owns 8%. I can understand the logic, you know. It’s an American icon. It sells a product that everybody loves all over the world. I’m not really concerned about the business model. But why don’t you look at their accounting?” And I think he just gave it to me thinking I’m just gonna come back and say, “Yeah, well, it’s just terribly profitable, nice balance sheet. Everything’s peachy, clean. Yeah.”
And so when I showed him what I did, he was just totally astounded. And that’s when he sent it to Jim Grant and all that. So, to me, that was obviously very memorable, because I just used my knowledge of consolidation accounting, which can get very opaque at times. And you really need to understand it to help me see through the whole 49% solutions scheme. I wouldn’t call it a scam. But it basically was just a way of transferring wealth from CCE shareholders and all the other bottlers to Coke through the bottler sales at three times book value. And that’s not a business model. That’s not a way to run your business.
Meb: How did he receive it, by the way? When you came back and said, “Actually, you know, I don’t think this is a great idea.” Was he like, “You’re an idiot. You just joined. Are you kidding me?” Or was he pretty positive?
Albert: No, he sent it to Jim Grant. He had a high regard for Jim Grant, as we all do. And Jim Grant read it. And he published it. And I was at a Jim Grant conference, and he introduced me to somebody to say, “Yes, Albert Meyer, he was responsible for the best edition I’ve ever published on Jim Grant, when I featured his Coke research.” Frank Martin was very much in my camp, and he sent it to Buffett as well. He sent it to Buffett and he sent it to Jim Grant.
And after Jim Grant published it, Connie Hayes at The New York Times, having just written a big puff piece about, “Vaunted Bottler Strategy of Coke,” read it. And she said, “Wow, this is totally different from my perspective,” and she got Melody Petersen, who’s now at the L.A. Times, to take my research and write a story on it. And the board of directors, some of those people came down and absolutely pummeled The New York Times, and Connie Hayes was an independent mind. And she said, “Oh, well, I must have touched a raw nerve.” And then she really got into Coke. In fact, she wrote a book on Coke. Can’t remember the title now, Connie Hayes. And there’s a whole chapter on Coke’s accounting, and it’s not a flattering book at all.
Meb: It’s funny, Buffett should have sent you a box of See’s Candies and said, “Thank you for bringing this up,” and you should have sold it.
Albert: I think, I don’t know, maybe he felt I was just a short seller or I was just…because it’s not about accounting. I mean, Coke’s selling syrup. It’s not about accounting. It was complicated. And only if somebody had sat down with me, and I really went through all the intricacies. Because, in the end, when CCE ran out of money, Coke gave money back to them, and they called it marketing support payments. So the flow of money then went from Coke to CCE, you know, $10, $20 million a quarter, and suddenly it was over a billion dollars a year.
And that’s when people suddenly woke up and said, “Yeah, well, they were stealing from their children. And now their children’s ran out of money. So now they’re gonna give back to them.” And I called it profit equalization payments. Because funnily enough, if you calculated the EBITDA margin of CCE before that transfer, it was 6% or 3%. And it’s all over the place. But as soon as you added the marketing support payments, it came out to exactly 15%. It was almost like Coke underwrote the EBITDA margin at 15% and say, “Whatever you make doesn’t matter. Because if it falls short of 15% of EBITDA, we will give you marketing support payment to top it up.”
So it really got unstuck. And the board member wrote a big article on Coke’s secret accounting formula. After that, Buffett said, “I should have sold it,” because that went to every board member on the S&P 500 companies. So that’s when everybody figured out, “Yeah, when you start giving money back to your bottlers to try and keep them at 15% of EBITDA, you have a serious problem.”
Meb: So if people wanna find out more about you, what you’re up to, follow your writings, what’s going on, what’s the best place to go? Where can they find you?
Albert: Yeah, bastiatfunds.com. So it’s Bastiat Funds, not Bastiat Capital, because some gal at Oxford University, who must be a libertarian like me, decided to take Bastiat Capital as a domain name. So when I tried to register Bastiat Capital, she’d already taken it, and I was too tight-fisted to try and find where she was an offer up some money for it. So I’m just using Bastiat Funds. But if you put Bastiat Capital in Google, we come up. So that’s our website. You’ll find interviews there, and writings, and etc., etc., fact sheets showing our performance, and so on.
Meb: We’ll add the links to the show notes. Albert, this has been a lot of fun. Thanks for joining us today.
Albert: I’m honoured, and thank you for the opportunity.
Meb: Listeners, we’ll put the show links on mebfaber.com/podcast. You can find all the archives on there. And shoot us feedback. We love hearing from you at email@example.com. Leave us a review. We love to read them, good, bad, in between, on iTunes, anywhere else. Subscribe where good podcasts are sold. Our current favourite is Breaker and RadioPublic. Thanks for listening, friends, and good investing.