Episode #283: Brian Barish, Cambiar Investors, “In The Digital Age We’re De-Physicalizing Things”
Guest: Brian Barish is the President and CIO at Cambiar Investors and is responsible for the oversight of all investment functions at the firm. Prior to joining Cambiar in 1997, Mr. Barish served as Director of Emerging Markets Research for Lazard Freres & Co., a New York-based investment bank.
Date Recorded: 12/16/2020 | Run-Time: 1:13:40
Summary: In today’s episode we’re talking all about value investing. Brian explains his evolution as a value investor with a comparison to the evolution of the NBA. He covers the two tenets he uses, taking an underwriting approach to evaluating a company and assessing the capital discipline over time. Then we hear about a couple of names in his portfolio and what he expects the recovery to look like in 2021.
As we wind down, we take a look around the globe to hear where he sees value and hear what he thinks about the possibility of negative interest rates.
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Links from the Episode:
- 0:40 – Intro
- 1:24 – Welcome to our guest, Brian Barish
- 4:10 – Brian’s article on the performance of value investing – The Virus Plaguing Value (Barish)
- 8:57 – Value underperformance and changing basketball strategy
- 10:46 – Brian’s fade rate aha moment
- 13:28 – The model shift in a digital world
- 16:15 – Intangible value of research and development
- 17:30 – The Lock In Effect
- 18:11 – Liquidity-driven markets
- 21:20 – Price-to-book ratios and traditional value investing
- 23:26 – Cambiar Investors’ old approach
- 25:16 – An underwriting mentality
- 27:04 – Capital discipline
- 29:32 – Over-reliance on single variables
- 31:12 – Applied Materials case study
- 37:01 – Raytheon Technologies case study
- 44:34 – Impact of supply chain disruptions
- 47:09 – Interest rate and inflation expectations for 2021
- 49:31 – Brian’s start as an emerging markets analyst
- 52:16 – Intellectual property formation out of emerging markets
- 54:51 – China, a paradoxical investment
- 57:21 – The meaning behind Cambiar
- 59:26 – How Brian is thinking about interest rates today
- 1:01:11 – The savings imbalance
- 1:04:27 – Value is a philosophy
- 1:05:29 – Brian’s most memorable investments
- 1:09:15 – Brian’s quarterly letter including Anadarko – Market Insights – 2Q19 (Barish)
- 1:12:51 – Learn more about Cambiar – cambiar.com
Transcript of Episode 283:
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, friends, fun show today. Our guest is the president and chief investment officer at Cambiar. A relative value firm focusing on out of favor companies with strong fundamentals. In today’s episode, we’re talking all about value investing. Our guest explains his evolution as a value investor with a comparison to the evolution on the NBA. He covers the two tenets he uses, taking an underwriting approach to evaluating a company and assessing the capital discipline over time.
Then we hear about a couple of names in his portfolio and what he expects the recovery to look like in 2021. As we wind down, we take a look around the globe to hear where he sees value, and hear what he thinks about the possibility of negative interest rates. Please enjoy this episode with Cambiar Investors’ Brian Barish.
Meb: Brian, welcome to the show.
Brian: Thank you. Glad to be here.
Meb: You have the honor of being the final podcast guest of 2020. Listeners, by the way, probably aren’t listening to this until early 2021. If we make it into 2021, by the way, given what’s going on in 2020, who knows what’s left, we got two weeks left, zombie apocalypse, aliens, any predictions on your end?
Brian: Maybe it’ll just finally be quiet. I don’t know, I think we’re just kind of in a waiting game for this very truncated version of life to finally end. I’m going to try to do some skiing. Skiing is kind of weird, you have to, like, reserve a spot to get in line on chairlifts. It’s not a normal skiing experience. See how that goes.
Meb: Well, for the listeners that are doing this audio, they can’t see your background has some snow in Colorado. What’s your home mountain? Where do you go?
Brian: I have a place nearby Vail so that’s kind of the default mountain to go. And Vail is quite wonderful, but we got a lot of places in Colorado that are fantastic. Telluride is fantastic, Winter Park is fantastic, Aspen is fantastic. So I try to get to a few mountains in a normal winter. This is not a normal winter so I’m not super confident I’ll get to more than just a couple. But maybe we get lucky and things open up towards the end of the ski season.
Meb: One of my three bucket list items, I’m hopeful for 2021, is I’ve never skied Silverton outside of Telluride, so that is high on my to-do list. And if things go okay, knock on wood, February, maybe March I don’t know. Well, we could spend the rest hour talking about skiing and the Broncos. By the way, the biggest surprise for me of 2020 is not in the Broncos or, you know, kind of middling along, it’s that their left tackle who, last year, may have… Bronco fan base said they probably just drop him, cut him, trade him, and is the single highest-rated tackle in the league this year. That, to me, of all the things I’ve seen in 2020 is the biggest surprise.
Brian: It’s unbelievable. So yeah, things can change. Yeah, he was considered a major bust but somehow he figured out how to play left tackle in the offseason or something, I don’t know.
Meb: Garrett, if you’re listening, my high salute to you. All right, Brian, let’s get started. I figured a good place to start would be Tim Duncan. I was reading one of your really fun research pieces that we’ll post to in the show note links. And I grew up mostly in Colorado, but also in North Carolina, too, and went to my formative sort of middle-high school years in North Carolina, and we had Wake Forest season tickets.
So this is during the Randolph Childress, Rodney Rogers, and Tim Duncan era. And so as I saw you writing a piece about Tim Duncan and the Spurs and basketball and how things have changed over the years, and then liken it to value, I was hook line and sinker. Walk us through the piece.
Brian: Okay, well, it’s a piece…I called it “The Virus Plaguing Value.” Obviously a play on current events. And it’s a very deep dive by a guy who’s been a practitioner of value investing for basically my whole professional career on what is going wrong? What is different? Why is a paradigm that was working so well suddenly not working? And finance is abstract to a lot of folks and people use sports analogies to make it less abstract.
And, you know, if you grew up in Colorado, you’re probably not super into baseball, Denver is not a baseball town. We have the Nuggets for basketball, they are not one of these, you know, dynastic teams historically. But for some reason, I’m a basketball guy.
Meb: Last year was fun. Come on, last year was a lot of fun.
Brian: Last year was super fun. We could talk about the Nuggets, we won’t talk too much about investing. And we’ll talk about their potential as a dynasty in the medium term. But let’s not do that, let’s stick to investing. So in basketball for pretty much all of the 20th century and a little bit of the 21st, the route to a championship was through having a dominant center. You needed a dominant, big man, who basically could kind of control the paint near the bucket, and, you know, control rebounds, and was just practically unstoppable offensively, and that’s how you won.
And that philosophy, that’s the reason why Michael Jordan wasn’t drafted number one when he came out of college. Hakeem Olajuwon was drafted number one ahead of him. And you know, there’s Hakeem, or Kareem, or Wilt, or Shaq. I mean, you know, you had a bunch of one name guys that are dominant centers, including big Tim.
And what’s interesting about Tim is he’s a great player. He is the last traditional big man to be an NBA Finals MVP, which happened in 2005, ’06 NBA season, I believe, they beat the Detroit Pistons. And since then you have had much smaller guys that have tended to be either league MVPs or Finals MVPs, or both. And no one really buys it anymore, that you need a dominant center to be an NBA champion.
So the Golden State Warriors are, you know, the best team that’s come along in the last couple of decades. No one even cares who played center for Golden State, right? It was about Steph, and Klay, and KD when he was there. And KD is a big guy, but he’s not a back to basket rebounding force. He’s, you know, a perimeter shooter who can also, you know, slash and drive. So what’s different? What happened? How is it that the league went from everybody believing you need a dominant center to nobody believing you need a dominant center?
And the answer is not the three-point line, that’s probably the first thing that pops into people’s minds. That came along in the 1970s and that came out of the ABA, actually. The answer is a very subtle rule change called hand-checking. So hand-checking is where, basically, you could put your hands on the body of the guy that you’re guarding. And you can’t shove them, but you can kind of channel them. And it is a very subtle rule, but it basically let bigger, stronger players obstruct smaller, faster players’ movement around the court.
So a guy like Steph Curry was kind of a slight guy, he would have no chance in the hand-checking era. Michael Jordan was a pretty big strong guy for a guard, he was able to fight through it. But the smaller guys, you know, no way. And what that rule change led to was a revolution. It let these smaller and more skilled guys, more athletic guys move around the court. And suddenly it opened up this perimeter game where now, like, if you can’t shoot the three-ball, you can’t win. And the way you do that is you spread the floor, you generate a lot of movement, and eventually generate a wide-open shot.
So I just thought it was an interesting analogy for here’s a small rule change that completely changed how you needed to think about a sport that is a really simple sport, get the ball in the bucket. And so that was my analogy.
So as a value investor, let’s talk about that for a minute. Value investing was…when I was growing up in this business, which was in the late ’80s, early ’90s, value investing was unchallenged as the superior way to invest. You had decades of proof around it in terms of what kind of investing approach would do best under market stress? It was value. Everybody said, “Okay, the cheaper stuff, that’ll go down less.” And then the sparkly, growthy stuff that has a lot of expectations baked into it, that’ll go down more if you get a period of market stress and economic stress, and people’s expectations start to wane.
But it just so happens that right around the same time as the hand-checking rule was changed in basketball, you saw something very strange happen in the investing world, which is value started to underperform, started to underperform serially. It started actually before the financial crisis. The first full year of this was in 2007. Coming through the financial crisis, value stocks did worse. There was a brief bounce in 2009 when, you know, kind of everything bounced. And then even from 2010 onwards, it just continued, where values underperformed by, you know, not small amounts, like 4 or 5, 6 percentage points a year.
This year with a pandemic and the world under lockdown, the gulf is just absolutely gaping. This summer, I think, both stocks were like 25 to 30 percentage points ahead of value for the year, depending on where you look to the U.S. or outside the U.S., incredible. So as you might expect, I’ve had a lot of spare time on my hands, as we all have with so many activities just forbidden due to the pandemic.
And I tried to work on a piece, and it’s shifting gears here a little bit now but it’s a very personal piece because this really is my journey into it. This is one guy who I thought I knew what I was doing, we had several years where the results weren’t what we were expecting, and, you know, a lot of false positives in terms of stocks in our investment process. And, conversely, a lot of false negatives in stocks where we thought, “Okay, well, that sounds interesting, that’s too expensive,” and they wind up working out great anyway. I just needed to figure this out.
So the starting point for me and kind of the aha moment was I saw this chart that was in 2018 and it was produced by a quantitative group. And what it showed was the…this is kind of a complicated topic for a podcast. But what it showed is what percent of the companies in the overall stock market that had the top returns, measured by return on invested capital, still had top returns one, two, three, four, and five years later.
And there’s a principle in investing called the fade or the corporate fade rate. And what it basically says is that companies with superior profits, they’re going to attract competition, that’s going to drive those profits down. And their returns on capital are going to fade to some kind of long-term corporate average. If you go to business school, you will almost certainly learn this. What this chart was suggesting was the fade rate had changed. And guess when it changed, right around 2006.
You can see if you kind of squint at it that this chart starts to bend kind of up into the right in a smaller and smaller percentage of the top companies are no longer fading down to these long-term averages. They’re staying as superior profitability companies. So it gets more and more pronounced as you get into the 2010s.
This really blew me away, actually, because if you kind of understand the math of being a portfolio manager and building a whole portfolio of stocks, you know, it’s a…portfolio management, and having a diversified portfolio means it’s a probability maximizing exercise. Try to maximize your probability of being right and kind of minimize the damage of being very wrong with a diversified portfolio of stocks.
But if you’re biased against being overly exposed to these top returners because they inevitably fade, which, by the way, a lot of value investors are, including myself in the past. And you’re trying to find laggards that could catch up and make themselves better through restructuring or profiling in some way. You used to be playing a winning game and now you’re playing a losing game. And that is a thought that really got to me. So I tried to explore very deeply, what’s going on here? Why are returns not fading the way that they used to? Was there a rule change like in basketball?
And I don’t know if people can see this, but I’m holding up a smartphone in our podcast, and that, to me, was probably the rule change. This is right on the doorstep of the introduction to the iPhone. You had Blackberries at the time or the hot ticket in phones. And maybe it’s just a coincidence, but I really don’t think so. You start having people not tethered to their desk where they have a personal computer, but just walking around with all this information, all this ability to get information and it’s powerful stuff.
I mean, if you’re old enough, you can probably remember, like, shopping for toys during the holiday season and you’d have to drive around town literally to find certain toys or find certain toys that were priced cheaply. Do you remember that?
Meb: Sears catalogue, I mean, that’s what you had growing up. They would mail you like a phone book catalogue of everything in their inventory. Yeah, and then you’d have to go see if anyone had it.
Brian: Exactly. And I mean, the idea of doing that today in the year 2020 just is, like, laughable. Like, people are like, “You bet, that’s funny.” You look online, you see who’s got it. Is it available, you know, in the stores, or is it available to ship online, how fast can it get here, how much do you have to pay for expedited shipping? And it’s just a completely different way of accessing something simple like a gift for the holidays.
And the power of the model shift can’t really be emphasized enough, used to matter. If you think about the digital world that we’re in, retailing is one of the easiest and most obvious examples. People used to say about retailing was location, location, location. That’s what mattered, right, that helped you as a retailer, to get the most exposure to the customers you wanted. I wouldn’t say it’s completely irrelevant today but it’s getting close because your customer is most likely to access you digitally through their phone or through their computer.
And you’re seeing this phenomenon erupt in all kinds of places where we’re getting a digital wrapper or a digital interface to our procurement of goods, to our experiences as a consumer, to businesses’ procurement of goods, to businesses’ interactions with each other, and the way that the products are designed and information is exchanged.
You know, here in 2020, we leapt forward at a rate that probably wouldn’t have happened without the pandemic in terms of things like video conferencing. And so, suddenly, the office experience and kind of the whole validity of the office tower has changed with telemeetings. And I don’t think we’re going back, not all the way anyway, I don’t think you can walk this one back. So, powerful stuff.
So as I began to explore this issue further…well, I’ll kind of leap to my conclusions, because this will get just too long-winded. The conclusions that I had was that there were three really big factors that a traditional approach to value was just blowing by in the digital age. And the first, brands and intangible.
So this is actually something that’s pretty well articulated by a lot of other value management shops. Intangibles don’t show up on your balance sheet. If you’re an R&D intensive company, it’s expensive, it’s never…converts into shareholders’ equity. And so it’s there, I mean, it’s obviously valuable or people wouldn’t spend all this money to do R&D. But for some reason, it doesn’t show up on the balance sheet, it’s just expensed.
And we can see just through the history of the stock market that, like, companies are spending double or more on R&D today than they were in, let’s say, 1990. That’s just kind of expressed over the whole S&P 500. So that’s missing from kind of a traditional approach to value, which is a price to replace with cost of assets, and therefore, book value-based approach to value.
And there were two other features that I hadn’t seen articulated very much by other investment managers. So one of them in tech investor terms is called the lock-in effect. So this is where you start using your iPhone, and now you got all your photos on there, and all these songs, and all these apps that you’ve bought, and, you know, now you’re locked in, right? You don’t want to lose this stuff, which you would if you used a different phone. And this is very powerful stuff in business software, collaboration software, you know, design software, it tends to have a software feel to it, the lock-in effect.
And then the other concept that I think value managers tend to have a tough time with is something called the liquidity-driven marketplace. So this is actually it’s not new to the digital age, it’s a very old concept. So the Chicago Merc and the New York Stock Exchange, those are liquidity-driven marketplaces, right, that people bought and sold stocks on the New York Stock Exchange because that’s where buyers could expect to find sellers and sellers could expect to find buyers. But it takes on a whole new meaning when location is not important, when the concept of distance is kind of blown away by digital interfaces and we’re just trying to connect digitally.
So, again, Amazon is a really easy example. They have the most liquidity for buying merchandise online both in terms of the number of skews that they have and how fast they can get them to your house. If you think about transportation, you know, Uber has the most customers, and it also has the most drivers. And why does it have the most drivers? Because it has the most customers. And once that liquidity-driven effect kicks in…I’m kind of looking at the image of the lake that’s right behind you. Why is that liquidity going to go anyplace else? It would be very hard to move it. And that’s external to the balance sheet, it’s just you got to kind of see it for what it is.
So those three things, the intangibles, and how important they are, the lock-in, and then this liquidity-driven effect, these are all things where, like, if you’re…you know, I’ll use a different example. Let’s say you’re Visa or MasterCard, you have this ubiquity. Everybody accepts Visa and MasterCard. So if you’re a merchant, why would you take anything besides Visa and MasterCard? It’s just kind of silly. Once you get that liquidity, it’s really hard to dislodge it. So it makes the earning power and the ability to have pricing, and growth, and all these things that investors, whether you’re value or growth want, just that much more robust.
So that was my answer to the question. We’re all connected, we all have iPhones or the equivalent. I mean, who doesn’t at this point? And it leads to this different way of interacting with goods and services, different way that businesses collect their customers. And you have these effects that don’t really translate well to a traditional value approach. That is the virus plaguing value.
Meb: That’s super interesting. And I was smiling as you were going through this narrative at various points. I mean, one, I just remember how passionate the BlackBerry and other phone users were, and how much everyone dismissed the iPhone when it first came out, including myself. I remember exactly seeing it for the first time being like, “Why would I want to log into my fantasy football on my phone?” I remember having this discussion. So that goes to show how much I can see around corners, but I’m on whatever iPhone does now.
Okay, I think what you’re saying makes sense. Now translate this to how this is reflected in to how you go about your investing process. Maybe give us a, “Here’s what we did before, here’s what we do now.” You talk about price-to-book, in particular, as a ratio in this piece. Maybe walk through how this actually ends up impacting your portfolios and how you’ve kind of view value over time.
Brian: If you look at the world of value investing, there are typically three kinds of value investors. There’s classic, there’s deep value investors, and there’s relative value investors. So we will be a relative value investor. So relative is a little more flexible, you could turn us into a fashion style, we’d be the athleisure guys, and the classic value investors, they’d be in a suit, and the deep value guys, they’d be in a bow tie and suspenders.
And, you know, there’s a very seminal piece to value investing that was published in 1992 by two professors named Fama and French. And they determined through, you know, a very rigorous academic work that a low price-to-book multiple, and if you bought stocks that were in the lower group, being a price-to-book as a percentage of the market, that that grouping tended to outperform over time, higher price-to-book multiple stocks.
So this was written in 1992, we’re still very much in the industrial age, the PC revolution had really not even started to happen totally just yet. And it was widely embraced. And it was…this is really important, it was codified in the index construction. So if you look at the Russell 1000 value index, the number one variable, 50% of what goes into a stock, that’s in Russell 1000 value is low price-to-book.
So, you know, book value is shareholders equity, it’s the same thing. And it’s a proxy for the replacement cost of physical assets. That was the primordial determinant of value. And it’s ironic that the Internet was two years away from kind of going mainstream. That happened in 1994 with Netscape, if you can remember back to that. And, you know, we still really didn’t have…not too many people had cell phones, you know, back then either. So lots happened subsequently, to change the landscape.
So we did a lot of hard work internally, and hardly just myself, there’s several people that I owe a great deal of intellectual debt to, they kind of helped reform our processes. We used to look for companies that were inexpensive on one or several relevant financial metrics. And book value might be relevant to, like, a financial company, but it wasn’t too relevant to, like, a consumer product company, or certainly a technology company. People kind of generally understood that.
And we’d look for some catalysts, this could be new products, or maybe improved financial performance, some kind of reprofiling of the company’s business. And hopefully, those would serve as catalysts to propel some upside. And using, you know, some combination of thoughtfulness and some regression type of analysis, you could project a higher future multiple and higher future earnings and embed, you know, some upside in the stock.
That’s how Cambiar used to operate for, you know, most of its history. And, as I kind of alluded to earlier, that approach was generating an increasingly large number of false positives and false negatives. And I could see from this kind of weird chart that I was talking about earlier that something very different was going on in the overall market ecology, that was making an overall approach that favored kind of selectively rotating into laggards a bad plan, where it used to be a good plan, that used to be the way value investing absolutely worked.
So, you know, we went pretty deep. And we identified two kind of basic principles that were guiding lights for us. So the first was to stop thinking about an upside case for a stock driven by catalysts. That, you know, catalysts were ephemeral. It sounds a little event-driven, it wasn’t intended to be, but it kind of sounds that way. And we wanted to do is look a little more deeply and we use the term internally an underwriting mentality. So what the heck does that mean?
Underwriting is a concept that we borrowed from the world of banking and insurance. So if you’re a bank and you’re making a big loan for, let’s say, a new football, stadium you know, a billion-dollar loan, or something, that’s going to go to an underwriting committee, a senior underwriting committee, given how big of a loan that is. And they’re going to look at a lot of factors. They’re going to look at who’s building this, what their financials are, what the projected financials of the project are going to be once it’s up and running. Not only that, they’re going to look at the metropolitan area that’s going into, and, you know, is that area doing well or poorly?
Economically speaking, what are the key businesses there? Are they performing well? Are they performing poorly? Is there anything else that looks just like this coming out of the ground that’s going to represent competition? They look at all those kinds of factors because, if they mess up, and this is a bad project, they’re going to be stuck wearing this loan for a very long time. And I wanted us to have that kind of mentality.
So look beyond the company, look at the externals to the company. Are they in an industry that economic rent accrues to companies that reside in the position that they’re in in this industry? Yes or no? And is competition reasonable or unreasonable? Are these drivers of value in the digital age, like the lock-in effect and liquidity-driven marketplace effect, are they present? Are they relevant? Are they expanding?
And that was a big mind shift internally, and not everybody…you know, it took a while, we had to kind of retrain ourselves, but I think everybody is really at…my company has taken that mindset on wholeheartedly.
The second concept that we wanted to use as a guidepost is something called capital discipline. So capital discipline is not a single variable that you can look at if you’re looking at a company’s financial statements and say, “Oh, there’s the capital discipline part right there.” It’s a series of tendencies by companies and their management. They tend to prudently reinvest in their products. They tend to grow their expenses slowly. They tend to not have a lot of financial leverage. They tend to not engage in speculative M&A. They tend to have some kind of prudent remuneration policy with respect to shareholders.
It’s a variety of tendencies. And as a crude analogy, you kind of know it when you see it, and you know it when you see the absence of it. And there’s very powerful evidence that if you can have a focus on capital discipline, and buy that companies exhibit these capital tendencies and avoid companies that exhibit the opposite, that you tend to outperform.
So getting back to my basketball analogies, the underwriting discipline and the importance of capital discipline, it’s kind of, like, saying that as a basketball team, we’re going to emphasize rebounding and ball movement. You want to play, you’re going to crash glass, and you’re going to pass the ball. Okay, if you want to play iso-ball, you play for somebody else, not us. And that’s what we’ve tried to do from an organizational tone, an organizational temperament perspective is have this underwriting mindset and a capital discipline mindset.
And in value investing, whether you’re deep, or relative, or classic value, there’s an overall philosophy that once you figured out what a company is worth, and you buy it for some discount to what it’s worth, when do you buy it? And how much do you buy? Well, the price will tell you what to do. So you let the price dictate your action. And if you underwrite a stock correctly, that is you really do a great job appraising its value, and its value drivers and why those drivers should persist, then, indeed, price should dictate your action. The price will tell you what to do. It’s a powerful way of thinking.
Meb: First of all, it’s pretty rare for investors to kind of deconstruct their process, like, mid-process and be reflective and then sort of alter it. And two of the areas I’m thinking of as you’re describing this, one, price-to-book has such a shadow, an impact in our industry for decades. I mean, entire companies in the hundreds of billions of dollars have been built, I don’t want to say on one metric alone, but one being certainly prominent.
And then to a sort of cousin of that, I think of narratives driving massive funds and asset classes, like something as simple as high dividend yield. And looking at that in isolation without looking at sort of all of the co-inherited behaviors, I was almost thinking of it in my mind as like a friend that comes over to your house. Okay, they show up late, that’s fine, that’s one thing. Okay, B, they don’t bring a bottle of wine. C, they leave their plates out on the table, they use the bathroom, they don’t flush, you know, on and on, whatever it may be. They get drunk, they offend everyone.
It’s like, all right, one of these is okay, but now that there’s eight, we kind of see what kind of…paint a picture. And it’s the same thing with companies, I think you mentioned a lot of the good or bad behavior best practices. But it’s so curious how many times in our world that a single variable can dominate an entire investment category asset class strategy. And that has a lot of follow on effects of flows, of pushing those valuations one way or the other. I think the way you guys have approached it is thoughtful.
Could you walk through any general case studies, it could be names, it could be sectors, it could be something you think as just sort of indicative of what may be a good example of this process, how you think about finding companies, or even ones that you guys have invested in?
Brian: Well, let me talk about Applied Materials, AMAT is the ticker. So Applied Materials is one of the biggest makers of semiconductor production equipment. And for many years, from the late ’90s through really about the year 2013, semiconductor capital equipment kind of serially underperformed tech overall.
And the reason why was that…so semiconductor capital equipment used to make chips. Your biggest customers are memory but, you know, you also have customers in, you know, microprocessors and analogue chips, and, you know, some flat panel displays. You also use some semiconductor production equipment to make those. And for many years, the growth of those products and the growth of the chips that were involved in those kind of products exceeded the growth in spending on semiconductor capital equipment. So it was kind of, like, you were guaranteed to sort of undergrow tech overall and, you know, no one wanted to do that.
And then starting in about 2013, it has become much more pronounced since then, something began to change. And the something that began to change is Moore’s law, which I’m sure you’re familiar with. But that’s, you know, kind of the notion that you get, you know, roughly a 50% price performance improvement in chips every 12 to 18 months. Moore’s law still exists, you’re still getting a geometric compounding of improvement, but not at the same price, you’re actually having to spend more and more money to stick with Moore’s law.
And it’s a complicated answer but, basically, it’s just getting harder, you’re starting to run into, you know, problems of physics, problems of materials science. Some of these transistors in, like, the most current iPhones, iPhone 12, I think, are at 5 nanometers. So there’s, like, literally 10 or 12 billion transistors on the microprocessor in there. Our semiconductor analyst, his comment is, you know, “Making chips like this, it’s the closest thing to magic that we have in the industrial world today.” It’s just amazing what these things can do and what kind of manipulations you’re doing to the actual atoms and electrons that are moving around.
So people still get, let’s say, a little bit emotional in the way that they trade semiconductor capital equipment stocks. They do correlate a bit with memory cycles because memory chipmakers are the biggest spenders on semiconductor capital equipment. And there was a big sell-off in this stuff in late 2018, early 2019. And that led to a really attractive entry point for us into Applied.
And what you’ve seen…you know, just to get back to a point I was making a second ago or a couple of minutes ago, the growth whereas it used to be that semiconductor capital equipment spending was growing at a fraction of the overall growth of semiconductors and technology, now it’s growing at a multiple. Because with each subsequent generation it’s getting harder and harder to design the chips. In 2020, this might not have gotten a lot of airplay on main street financial publications, but a seminal event happened. So historically there were three companies, Taiwan Semi, Samsung, and Intel, that were kind of the leading companies in the world in terms of what’s called process technology. So the linewidths that they’re making chips at. And, you know, Intel being American, obviously.
Intel has been very, very late with designing new chips now for several years. And this summer, they’re supposed to have moved to 7-nanometre chips this year. Taiwan Semi who makes the chips for the iPhones, they’re at 5-nanometre. And Intel’s been having all kinds of yield problems at 10-nanometer. Intel had to kind of fess up that they can’t seem to get this to work. They’ve tried everything and their chips at 7-nanometers, they don’t know how to make them work. They’re thinking about outsourcing the production to probably Taiwan Semi, might be Samsung, but we think it’s probably Taiwan Semi.
Absolutely seminal event, you basically have a company that for years, decades, really, had the best transistor and process design in the world, bar none, and that gave them this huge competitive advantage over everybody else, admitting they literally can’t figure out how to make chips at the most advanced linewidths. For Intel, that’s very bad. For Applied Materials and other companies that do similar things, it’s very, very good because it’s a powerful proof point that the growth in spending and the complexity issues, it’s just becoming an exponential issue.
Ironically, it really hasn’t run away from a multiples point of view, it’s about a 15 times earnings multiple for a high-quality industrial business with good cash flow and really durable in markets. You’d expect those to trade, you know, in a normal market at kind of 17 to maybe as high as 20 times earnings. We think this is kind of comparable to one of those, if not maybe a little better because you do have this geometric growth in costs. So we continue to like it.
Just understanding…and I don’t want to get too propellerhead-ish here in this podcast. But just understanding the sheer magnitude of the issues that are involved in sticking with Moore’s law, and where companies may find it impossible, that took a lot of work but we, I think, did a very good job of understanding that and not trading around it too much, particularly, you know, just sticking with the overall position. So that’s one interesting story. We’ve had a good year this year, I think it could consolidate for a bit, but we’ll see how it does next year.
Another company, different sector, very different story. This stock I like right now that I think can be kind of a good multi-year hold is a company called Raytheon Technologies, ticker is RTX. So Raytheon is an old-line defense contractor, they basically make radars, and missiles, and guidance systems, and stuff like that. And they merged in 2019 with United Technologies. So United Technologies was kind of an odd industrial conglomerate. They had a business called Pratt and Whitney, which makes jet engines and the engines hanging off the wings of small and large planes.
They had bought many years ago, a company called Goodrich, which makes landing gear for planes, which are really, really cool products from an industrial design and durability perspective. And then they also had some odd duck pieces, they owned Otis Elevators and Carrier, which makes HVAC equipment. So they spun out Carrier and Otis and kept the aerospace parts inside of Raytheon.
So that all sounded fantastic going into 2020. In particular, there’s a product that UTX made, that’s United Technologies, called the geared turbofan. This is a really cool jet engine design. So geared turbofans you’ll find them currently on the A320neo, you won’t find it on the 737. 737 is too low to the ground to fit a geared turbofan under.
But basically, the geared turbofan is an engine where the blades in the front are connected to the turbine, that’s the body of the engine, by a gear. And the gear can allow the blades in the front to spin at a different speed than the turbine that is driving it. And that drives a lot of efficiency, it’s actually the blades go slower rather than faster. You actually want to move a bigger mass of air at a modest speed through the engine as opposed to a smaller mass of air quickly through the edge, so that’s how the physics work.
But it’s a really cool product that is probably going to dominate jet engines for the next 15, 20, 30 years, as long as we’re using some kind of a liquid fuel as propulsion. And, you know, you had a lot of synergy with the defense side, and then the pandemic hit. And the pandemic, you had a pretty good commercial aviation cycle that have been going on for a long-time, huge order books. And this thing has just been absolutely diabolical from the point of view of the aviation industry. I mean, it’s the worst downturn by order of magnitude as compared to, you know, anything we’ve ever seen.
So obviously a lot of airlines have gone bankrupt or experienced severe financial pressure, have needed to be bailed out by their host governments and their customers. And you’ve seen order cancellations in airlines trying to push out the deliveries of planes. But this is one of these stocks where you got to think about, all right, let’s understand that for most companies, the value of the stock is not their earnings in the next 6 to 9 months, it’s their earnings over the next 15 to 20 years that drives 95 to 98% of the value.
We know the next six to nine months are going to suck, basically. But if you look beyond the next six to nine months and out into the future, they have excellent products, they address clear needs. You have a defense business that…you know, defense businesses don’t grow real fast, but it’s fairly stable. It’s in the more interesting parts of defense in terms of electronics and radars and that type of stuff, as opposed to, like, tanks and howitzers, that stuff, very interesting. And I just think a lot of upside on a multi-year time horizon.
You might find this kind of interesting, if you look at the history of defense stocks, they tend to experience a lot of multiple compression, in other words, multiples go down early in a new economic cycle. Now, I’ll be honest with you, I don’t totally understand why that is. It could just be that it’s coincided with a lot of narrative shifts in defense. So if you think about this in the…we had a big recession in the early 1990s, well, that coincided with the end of the Cold War, right? So people were thinking we were going to spend a lot less money on defense over the long-term and so multiples fell.
In the early 2000s, defense stocks, those were old economy stocks, people had this old economy, new economy thing going on back then, so multiples were very low. And then more recently coming out of the 2008, 2009 recession and financial crisis, you had a lot of budget pressure. And there was a sequester, if you remember that, where the budget was kind of taken out of Congress and the President’s hands for a little while by various actions. So people kept worrying in all three of these cases, essentially, about budget pressures that really never materialized to, you know, crush earnings, just the stocks got cheap.
So the same thing is kind of happening now, multiples are very low. I think Raytheon, I think that’s about a 10, 11, now it’s a little higher. It’s probably about a 13, 14 multiple 1 year out. But I think that’s because people are baking in a lot of negativity on the commercial side that I tend to think they’re going to have a very powerful snap back to commercial demand once, you know, we’re out of lockdown for good.
Meb: You touched on a couple of points, I think an interesting one is the natural property of markets to kind of look around the corner and particularly to have a longer-term time horizon. I think it surprised a lot of people if you go back to March, and say, “Hey, we’ll be hitting new all-time highs by year-end,” I think many would have found that to be unbelievable.
The defense and aerospace industry is near and dear to my heart. I come from a family of engineers. If you look out your window, you can probably see the Northrop and Lockheed campuses. I got a brother and an old man that spent a lot of time down there. And like you mentioned, a lot of these have actually showed up in a number of our portfolios over the years as being particularly good stewards of capital and good businesses as well.
You talked a little bit about 2020, thankfully, we’re pretty much done with that year. As you look to the future, you guys manage all sorts of different strategies, not just in the U.S. but also abroad. What does the world look like? What’s kind of the outlook? What are you guys thinking about? What are you excited about? Where is there opportunity? Where are there areas of danger? Any thoughts?
Brian: Let’s talk about 2021 and then we can talk about really the longer term. So 2021, you know, it’s not going to be right at the beginning of 2021. 2012 is going to start just like the beginning of 2020. But, you know, starting in March or April when people start getting shots in their arms, we are going to have a very, very powerful global economic expansion.
There is all kinds of pent up demand for everything, you know, physical goods. I ordered, like, you know, an exercise bike for my house, I ordered it in, like, July, and they still have no idea when this thing is actually going to get made.
Meb: I had a similar story with dumbbells. My first order went, like, four months, they cancelled it. Second order finally showed up, and it’s not in pounds, it’s in kilograms, which is fine, I can do the math, but still, I can’t even complain because it took eight months.
Brian: Yeah, those shouldn’t be too tough to manufacture, right, we’re talking about dumbbells. And you have all kinds of disruptions up and down the supply chain. And the more complicated of a product, the more likely it is to be disrupted. I mean, you know, we have modern products, whether it’s a coffeemaker or a car, right, there’s a lot of chips in it, a lot of wiring. If you’re missing one part, you can’t make the device. So the supply chains are going to get fired up.
One of the effects of Trump and the Trump presidency…and I don’t want to get political in this podcast at all, but he did have this propensity to tweet, right, and to tweet very negative things about China. And you know, “I’m going to put tariffs on this, I’m going to put tariffs on that.” So, you know, we have very global supply chains for all kinds of stuff. And as a producer, you didn’t want to get caught where you’re trying to produce a widget and you have some components that come from Japan, and some components come from China, and some components that come from Mexico. And those components are either in your factory, or in Mexico, or in transit, and suddenly he tweets. And now you have a different cost for those components because he’s thrown tariffs on things, it’s not good.
So manufacturers, you know, are rational, and they rationally concluded, “Look, we’re going to keep inventories really lean. We’re just not going to have a lot of finished product, we’re not going to have a lot of intermediate product around, because, you know, who knows what’s going to happen next.” Well, that has led to inventories for everything, including your dumbbells, being really, really lean around the world. So not only are you going to be restarting these supply chains, but you’re probably going to be refilling inventory channels because I tend to think you’re not going to have the tweetstorms in 2021. So it’s, you know, kind of a double whammy, if you will, in terms of the impetus to produce things.
So that’s probably going to have a strong effect on various kinds of materials. Certainly, some of those stocks have begun to discount that, but there maybe, you know, more to go. That’s had a profound impact…will, I think, have a profound impact, excuse me, on capital spending, and factories being retooled, production capacities being augmented.
And then if you get over to the consumer side of things, there’s got to be all kinds of pent-up demand for stuff. I mean, you know, I’m ready to get on a plane just for the sake of saying I got on a plane. I haven’t been on a plane since March and I think this might be the longest I’ve gone in my adult life by far without getting on a plane. So I think that’s what you’re going to see.
Now from a stock markets perspective, there’s kind of an interesting question about interest rates and inflation expectations. Because if you think about, if you got all these bottlenecks, you got all this demand, and you’ve got, you know, delayed and pent-up consumption, like, how do you ration what’s going to be in the short-term shortages? And price is normally how that works.
So, you know, we may see some fairly strong year-over-year pricing…when we went into the lockdown in March, and that’ll be an interesting moment for the markets. You know, markets are priced for inflation to be gone, like, forever. And I’m not in the camp that inflation is around the corner and that we’re going to have secular inflation. I think that’s going to be very, very tough. But, you know, you may have cyclical inflation, and with the cycle being very, very pronounced in 2021.
Looking around the world, we’re a global investment manager, we do a lot of business investing overseas on behalf of American and non-American investors that want us to do that for them. And, you know, the decade of the 2010s, and even the year 2020, has been a very American-dominated era for investment. It isn’t always like that, it’s been going on for a long time, so it feels like it’s going to go on forever, but it hasn’t always been like that. And the U.S. stock market, it is, you know, very expensive, it’s very dominated by big tech giants at this point. And that’s a different topic entirely.
But, you know, is there some grounds for catch-up outside the U.S? And we tend to think so, I think, you know, signs point in this direction. Europe will probably have a recovery, economically speaking, that’s timed, very similar to the U.S. Europe is maybe a little heavier from a market composition in terms of more physical goods, and capital equipment and stuff like that, that has been very compressed in demand in 2020, but will be very augmented in demand in 2021.
When you get over to Asia, Asia is becoming a little more complicated because you got China, which is by far the largest country, and that’s its own discussion, almost. And then you kind of have everything else in Asia, which is more, you know, export-oriented. So for your listeners, in terms of my own background, I first started out in this business as an emerging markets analyst at the end of the 1980s. I mean, they weren’t even called emerging markets.
Meb: I was going to say that’s when the emerging markets were really emerging. I don’t even think they’ve been coined that.
Brian: They were actually…they were called LDCs when I started. They were less developed countries, third-world countries, that’s what they were called. And then somebody clever coined the term emerging markets. You got to remember the time in history that this was. It was right around the end of…the Berlin Wall fell, that was in November of 1989. And I landed on Wall Street in 1990. And then the former Soviet Union dissolved in 1991. And socialism and communism were disgraced and centrally planned economies, state-led economies were disgraced and capitalism won. And it was kind of generally understood that the American approach to economic development, which was free markets, and open borders, that that was the winning ticket. So that’s how I got started.
So I was…people were very excited to invest in places like Latin America, and Eastern Europe, and parts of East Asia that had been under very status influence. And I was just some guy from Denver that they were sending out to do this. I barely spoke Spanish but somehow got thick in into this. And it was really interesting from doing this at the time I was doing it and being in some of these places. But I got kind of jaded after about four or five years of this. And the reason why was that it was much more complicated than just opening your borders and saying you like capitalism now, and, you know, IPOing some stocks on your stock market, in terms of having an advanced economy.
If you really want to have an advanced economy, it needs to be led by, you know, intellectual property development, interesting new products that, you know, you develop, you research, and that you sell to the rest of the world that are unique. Not digging stuff out of the ground, or, you know, running, you know, kind of monopoly utilities sort of relatively less badly than you used to run them. You know, this is in the mid-’90s now, you know, you’re watching the beginnings of the Internet and the PC revolution at the time and, you know, the wireless revolution. At the time we were going, “Wow, I feel like I’m really missing out on some interesting stuff.” Following these cement companies or, you know, big electric utility, or big bank, they’re very, very, you know, kind of bland, monolithic types of companies.
So what’s changed in…So I got out of that in 1997, it’s when I exited my emerging market career and started doing what I do now. In the last, you know, really half dozen years, it’s a very recent phenomenon, you’re starting to see a lot of IP formation come out of emerging markets. It really wasn’t happening not in a big way until fairly recently. But yeah, I mentioned Taiwan Semi earlier in this podcast, you know, they are…today they’re the leader. They can make things that literally nobody else can make. And they’re absolutely essential.
If you’re familiar with the novel “Dune,” you know, Taiwan is Arrakis, they control the spice, you must deal with Taiwan at this point. And similarly, in China, you know, some people might have heard of the big Chinese Internet powerhouses. So the two that are the most well known are Alibaba and Tencent. So Alibaba is kind of like Amazon and Tencent is kind of harder to explain. It’s kind of a fusion of Facebook, and PayPal, and Activision, and EA. They do games, they do payments, they do social media, and social network, and they do a lot of cool stuff.
And in China or in emerging markets in general, one of the reasons why we call them emerging markets is they lack some of this sophisticated infrastructure that we have. So in the cases of those countries, they didn’t have…China, I mean, they didn’t have a well-developed phone network, people didn’t have personal computers. And they went right by personal computers, people just have smartphones. People didn’t have credit cards, but, you know, your smartphone can pull a credit card number and it can hold various other financial information, why couldn’t you use that as your transaction mechanism?
So they’ve gone right into, you know, electronic and digital payments in a way that’s kind of more powerful than we have, where you have QR codes embedded in chatting apps. So imagine texting your friend and texting, “Hey, I saw this cool new pair of shoes,” and you text them those shoes and there’s a QR code next to the picture of the shoes, and they can just buy it through these chatting apps using, you know, a marketplace app that’s attached and a digital payment capability that’s attached. It’s really cool. And they’ve just gone right past us in terms of that kind of ease of transaction and digitization of the transaction.
So I hope you appreciate for me, for a guy who quit emerging markets, because I was frustrated by the lack of intellectual property formation. It’s just really refreshing to say, “Hey, wait a minute, actually, you were about, you know, 18 years too early on that thought, Brian, and now it’s happening.” Like, they’re really starting to do things that are unique and different and that we’re not doing.
Anyway, so that said, let’s talk China for a minute. It’s a very paradoxical investment at this point. We do have to talk politics a little bit here. So Xi Jinping, you know, he’s not a friendly guy. He is a traditional communist, he believes, you know, more communism is better. And a lot of the actions that have been undertaken by Xi Jinping, and he’s been in power now for a number of years, have been to diminish the potency of the private sector, and make what are essentially state-owned businesses more powerful. That is probably a bad formula, that is not a good formula for innovation. That is not a good formula for efficiency. That’s a formula for stagnation.
So the sad thing is the Chinese people are…hopefully I can say this, and I mean it in the most positive way, they’re really smart people, and they’re really commercially minded. So it’s just a bummer for them that, like, you have this mentality that’s just the opposite of what they innately would seem to want to do.
And I think the kind of creative and commercial capacities of the Chinese will find ways to shine through, but it is offset a little bit by, look, there is a command and control mindset. And, you know, unless something really big changes, and I don’t think anything really big is going to change in the near future, you just can’t have…you’ve got to be tempered in your enthusiasm about China.
Meb: As you mentioned, emerging markets, actually never heard of that phrase, LDC. And so I hit the Wikipedia and it turns out the term, according to Wikipedia, was coined by a World Bank economist Antoine van Agtmael. I murdered his name, I’m sure.
Brian: I’ve actually met Antoine. I think he was a founder of a company called Emerging Market Advisors, so he came up with that name and he gets credit for sure.
Meb: Cool. I would have thought it would have been Mobius, or Templeton, or one of these famous emerging market guys that were early to the story, but who knows? Well, thank you for getting my podcast banned in China now.
Brian: I thought that was pretty tame that I could get a little more specific and that definitely get you banned, but I don’t want to go there.
Meb: We’ve dabbled in a lot. The last thing I’m going to ask you is, first of all, what’s the etymology, while we’re on words, of Cambiar? Kind of rhymes with my company’s name Cambria, which is kind of what the people in the UK refer to as whales back in the day. What’s the Cambiar reference?
Brian: Cambiar is a Spanish verb, it means to change. The idea is that change is constant and that the only thing we can expect in financial markets is for things to change. There was a famous Greek philosopher named Heraclitus, he was a stoic, if you’re curious. And Heraclitus had the expression that you can never cross the same river twice, right? There’s always different molecules of water in the river, the river is always moving. And, you know, likewise, you never have the same set of financial conditions twice.
It does so happen that a fella named Mike Barish is the founder of Cambiar and he is my father. And he ceased to be involved with Cambiar since the year 2000. But the named Barish Asset Management never jumped out as a particularly marketable name. I think you can figure out why. And so he needed to pick something else, not of Latin descent, Barish is an Eastern European name that was anglicized. And that’s just the name we went with.
But it’s a good name for a globally oriented investment management company. Occasionally we get phone calls from, like, stockbrokers in Mexico or Argentina, and they just kind of assume that we’re, like, a Latin American-oriented investment shop given that name. It’s like, “No, no, you’re just using your imagination there.”
Meb: That’s a good lead-in because thinking about change, you know, and thinking about markets, I mean, one of the biggest changes, certainly over the past 10 years, has been interest rates, reaching levels that are pretty darn low, and in some cases negative around the world, which creates sort of a weird setup not just for investment implications, but also allocators, whether it’s individuals or institutions who traditionally put 40% as the benchmark into some of these fixed-income investments that are sub 1% in the U.S. and elsewhere negative.
You talk to a lot of institutions and professional advisors, how are you kind of thinking about interest rates? How does that play out? Anything that you guys are doing, is it creating distortions, opportunities, things to watch out for, landmines, all that?
Brian: So it’s a big, big question. Rates are really low. So the United States rates are…10-year bond is below 1%. It’s been below 1% the entire time since the pandemic hit. And in Europe, if you look at European bonds, in places like…pretty much everywhere, Germany, France, Portugal, Sweden, the Netherlands, Switzerland, they’re all negative out to 10 years. It’s unbelievable.
So why is this happening? That’s kind of, like, my virus plaguing value that one could do. But I think you need to be a bond guy and we’re not a bond shop, we don’t really do fixed incomes. So going there probably is not what our investors or our clients are asking us to do. But we’ve had to form opinions on this because it’s such a big number, such an important number in thinking about the value of stocks and how to think about portfolios.
So let me back up a second. So if you kind of think about it, interest rates are, like, the price of time. If I give you $100 today, or I say, “I’ll give you $100 in a year,” you’re supposed to say today. Because that $100 in a year, it’s not really worth $100, it’s worth less than that because you could earn interest. And so interest, you know, if you think about it that way, it’s like the price of time. Well, what if interest rates are zero? What that says is there is no price to time, time doesn’t matter, you’re indifferent if you get your $100 today or in, like, 12 years.
That’s a really weird thought. If you just kind of just sit back and think about it, and you know, have a glass of your favorite imbibement, like, that is just a really weird thought. And yet that’s happening all over the world. So why is that? There are a couple theories that I’ve heard. And I’m not going to say which one is best, but they all kind of point in the same direction.
At the end of the day, you got to believe in markets. We believe in markets, and you have an imbalance between savings and the demand for those savings. There is too much savings, there are too few places to invest money and get a good return on it, that debt would be the right way to do that investment.
So debt…so let’s go back to my value investing critique. One of the, you know, core issues is we’re saying that book value is a bad indicator. Book value is a bad indicator because we’re entering the digital age. In the digital age, we’re de-physicalizing things. We’re turning that physical experiences into virtual experiences, a virtual store, a virtual office, a virtual social experience, etc., etc. So we need less physical stuff. And because we need less physical stuff, but we still have all these savings, like, where’s all the savings go? And increasingly, it’s just competing for infinitesimally low yields. That’s one theory, so sort of the digital age means less physical assets.
A second theory is what they call a debt trap. So this is kind of the Japan story. We have this accumulation of debt in the economy, it’s getting bigger and bigger. It’s going to get hugely bigger in 2020, right, the government’s going to borrow like $3 trillion, or something crazy like that. And this increase in debt, it’s increasingly less productive. And here’s kind of the weird part. We have more debt, it’s less productive, and therefore, the yield should be higher, lower, the same? The answer is lower.
That’s not what I was taught when I was…I was an economics major once upon a time. And I was taught the opposite. With an increase in debt, you need a higher rate to attract the savings to buy the debt. And evidently, that theory is wrong, that this is systemic debt. This isn’t debt that belongs to any one person or one entity, it’s systemic debt. And because there’s so much debt in the system, and the debt is increasingly less and less productive, we need a lower rate to kind of clear the market. And if you had a much higher rate, the market would just explode.
All the debtors couldn’t make the payments, and therefore the creditors wouldn’t be made whole. And you have a lot of restructurings and that’s awful. So it’s better to just keep the yields down at these really low levels. Of course, we have very sophisticated economists that will argue for that, it’s not the crackpot stuff.
And I’m kind of a little more in the we’re digitizing and we’re finding fewer places to productively channel debt camp than the debt trap camp. But both may be right, both may be wrong. Anyway, it’s very challenging because when you think about…let’s get back to value investing for a minute. Given that the primordial definition of value is low price-to-book, so low price to physical assets, and we’re saying that physical assets are becoming less productive, we kind of need fewer of them, you know, what does that say, right? It kind of says you have a problem, you know, you’re investing in that which we need less of.
So I think value is a philosophy at the end of the day, the philosophy is simple. The philosophy is buy stocks for less than they’re worth. Buy stocks for less than intrinsic value, embed a margin of safety by doing that. And yet, people tend to associate it with this low price to physical assets model. So I think we got to get away from that model, think more about these intangibles and markers of success in the digital era and, hopefully, we can come out on the other side.
But from an asset allocation point of view, I kind of throw my hands up in the air a little bit. I know there are big pensions, big, slow money pools that are out there that have to invest a lot in bonds. And it’s like, okay, you’re investing in 10-year bonds and you’re getting 0.9%. You’re investing in two-year bonds, and you’re getting practically zero. Like, what are you hoping to accomplish with this? It’s hard to say.
Meb: Yeah. Well said. You’ve been doing this for quite a while across a lot of different markets and timeframes. What’s been your most memorable investment, good, bad, in between?
Brian: I have three, two good and one bad. My best investment from my emerging market days was a company called Femsa. Femsa makes Dos Equis beer and a few other beers that you might see if you go to bars that serve Mexican beer. And in 1994, that’s what it was. Mexico devalued the peso and their market just crashed. I mean, crashed, crashed. It was down, like, 75% in dollar terms in about, like, a month. And all kinds of stocks got destroyed, and Femsa was one of them.
And they had just actually, I think, gotten an investment from an outside investor, I think it was Heineken, for, like 10 times the stock price that it crashed to, during what was called the peso crisis at the time. And so I bought a bunch of stock in that, made a ton of money. I probably should have never sold it, but a certain point, I was like, “Wow, you know, Mexico could blow up once like that, it could blow up again.” So that was incredible.
And the other stock that was really memorable just in terms of how perceptions can change around and how fast things can change was Sun Microsystems. So we bought Sun Microsystems in 1997. And at the time, they were…it was trading at a pretty low multiple compared to tech stocks. It was kind of viewed, like, “Oh, Microsoft’s going to kill them.” They had a workstation business and people thought Microsoft was going to kill them. And the stock did, like, nothing for, like, a year and a half. And then all of a sudden, they, like, changed their marketing. And their marketing was that, “We’re the dot in dot-com,” which is idiotic, like, what the hell does that mean?
But they did make a lot of servers, they made a lot of Internet servers, the Internet was exploding. And all of a sudden people were like, “Oh, wow, they’re the dot in dot-com,” and the stock just went bananas. It was up, like, 300% or something crazy like that in the first, like, 6 or 7 months of 1999. It got to, like, 50 times earnings. And I was like, “Okay, I can’t believe this. I’ve been, like, wearing this thing like a badge of shame for a year and a half. Now that they’re the dot in dot-com, I better sell this thing.”
So we sell it and I’m getting calls from clients and they’re livid. Like, “You sold Sun?” You sold my Sun,” like, you know, you get the pun? “I can’t believe it you sold Sun.” And they’re pissed off, one of them fired me on the spot. And I’m like, “Guy, it’s not what you think it is. Like, this is just some dumb marketing plug that they came up with.” And, you know, it kept on going, we sold it in, like, July or August of 1999 and it kept on going until March of 2000, which was when the NASDAQ topped, and then it just crashed and burned. And it actually wasn’t Microsoft that killed them, it was Linux. Linux is what killed them.
Meb: There’s also a great quote from McNealy who, I think, was running it at the time. He basically has a great quote, where he’s like, people that were buying it at the very peak at 10 times revenue, and he’s like, “What were you thinking? ”
Brian: Yeah, that question could be asked of some stocks currently.
Meb: Ten times revenue, that’s cheap compared to a couple of things trading out there today. So who knows?
Brian: Snowflake, and we’re using Zoom to talk right now. Zoom is pretty cool, but I kind of wonder about the valuation. This seems like something people can copy pretty easily.
Meb: Zoom is cool with the exception of today, which is, if you’re watching this on YouTube, which no one does, by the way, everyone listens to this on audio on their phone. But for the five of you that watch this on YouTube, it’s a tiny bit jerky, because of whatever’s going on at Zoom. The virtual background is having a little tough time. Anyway, that’s a blast from the past, late ’90s was a special time. Wait, you mentioned you have a bad one too, what’s the bad one?
Brian: So the bad one is a stock called Anadarko Petroleum. And it came out okay at the end. They got taken over last year if you remember there was, like, a bidding war for Anadarko, we got taken out. Anadarko, I actually wrote…I write these quarterly letters, we’ve kind of turned them into quarterly podcasts because people rather listen than read, as you know. But I wrote a quarterly letter and it was basically an ode to Anadarko and what a miserable SOB stock that was. It was…so Anadarko was kind of a monument to how our thinking had become a little stuck. It was a veritable Christmas tree of catalysts.
They were really good at finding oil, they had all these prospects, they’d talk them up, and, you know, they’re digging pilot wells, they’re finding amazing deposits of oil. But there was kind of a bigger picture, which was that the shale revolution, which started in 2010, was showing no signs of slowing down. It was, if anything, accelerating in mid to later 2010s. And we were just having this kind of chronic oil glut. And they don’t control the price of the products that they sell. And increasingly, the products that they sell were just being produced effectively at lower and lower prices.
So we were stuck looking at catalysts and not looking at kind of the bigger picture, which was that you had this paradigm shift in energy. You and I think are kind of a little bit comparable, age-wise. And, you know, most of my life we were scared that we were going to, you know, run out of oil and have an Arab oil embargo, or something, or OPEC would really stick us, and that time is long gone. There’s been a paradigm shift, things are different now.
So that was a…it was an example to me of when you have this kind of structural change, and the market starts to shout it in your face, you need to recognize it and not get stuck. Anyway, we got bailed out at the end. I mean they did have good assets, we were right about that, they did have good assets. But the bigger picture is just such a problem for them.
Meb: Yeah, I mean, that’s, like, one of the classic lessons of investing and it’s so hard. We all want to extrapolate the recent past into the indefinite future. And there’s a reason we’re not talking on a Nokia phone or laundry list on down of the 1,000 other things. The oil example is so phenomenal of just the creative destruction of free markets, and technology finding a solution, in this case, being the shale drilling, and the charts of oil production in the U.S., like, you couldn’t go back 10, 15 years. And I don’t think anybody would even believe you, maybe a few crazy people in the old patch.
But it’s always exciting and fun to watch how the market, eventually, in many cases solves a lot of these problems. But the challenge is you go…and the fun thing to do is to go back and look at all the of course magazine covers, “Barron’s,” “Time,” all those, and see just what companies they’re talking about, but that’s a good one. Brian, this has been awesome. I could do another hour and a half, we’ll have to, post-ski season.
Brian: Yeah, who knows? Maybe in a nicer version of the world if you’re out here and you want to hit Silverton, I’m into that kind of stuff.
Meb: I will take you up on it, don’t you worry. So I have a vaccine coming from China this weekend so I’ll see you in a month. Just get the snow, I see a storm is coming, so knock on wood. Where do people go to find out everything your company is up to, your thoughts? We’ll add all the stuff we talked about in the show note links, but they want to find more about you guys, where do they go?
Brian: We have a website, cambiar.com. And there’s tons of podcasts and whitepapers, and commentaries, and so forth on there. We are not the biggest firm in the world but we have, I think, a really first-rate production department as part of our marketing group. They do some great work, they’ve won awards for it. So, you know, some of our…we try to make our material very digestible by a broad audience and seem to get a lot of recognition for that. So, yeah, please come check us out.
Meb: Well, your basketball piece is one of my favorites of the year so we’ll definitely link to that and pass along. Brian, thanks so much for joining us today.
Brian: Thank you very much for having me. I appreciate it.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us an email at firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.