Podcast Summary
Focus on businesses with strong balance sheets and durable returns: During uncertain markets, prioritize businesses with good balance sheets, avoid excessive debt, and add high-quality businesses with pricing power and sustainable models to portfolio.
During uncertain and challenging macroeconomic conditions, it's crucial for investors to focus on owning businesses with strong balance sheets and durable returns on equity. Chris Blumstrand, the founder and CIO of Semper Augustus, emphasized the importance of avoiding excessive debt and leveraging the portfolio. In the face of market volatility, investors can either sell well-run businesses with good balance sheets to buy more leveraged ones, or they can use the opportunity to add high-quality businesses to their portfolio that typically have high valuations but offer long-term value. The market's unpredictability highlights the significance of owning businesses with pricing power and sustainable business models.
High valuations make it hard to find attractive buying opportunities: Investors face challenges finding value stocks due to high valuations, but opportunities exist in undervalued companies like Dollar General during economic downturns
Despite reasonable organic growth in some businesses, high valuations have made it difficult for investors to find attractive buying opportunities. The speaker mentions Costco as an example of a business with a high valuation, and questions the real value of the depreciation of its fixed assets. The speaker also mentions that the economic downturn has presented opportunities to buy undervalued stocks, such as Dollar General, which historically performs well during recessions. The speaker's firm has been holding onto Dollar General for several years and has recently reduced its position to free up capital for other investments. The speaker expresses surprise at the current market conditions and believes that some businesses that were previously considered good investments have become too expensive. The speaker also mentions that they had been very cautious in the previous year and had only added one new business to their portfolio. Overall, the speaker's message is that despite the current economic downturn, it is important to be selective and patient when investing, and to look for opportunities to buy undervalued stocks.
Government Intervention and Economic Uncertainty: Investors must adapt to unprecedented government intervention and uncertain economic conditions. Focus on sectors and companies that thrive in various economic environments, like tech and e-commerce. Consider debt levels and potential business changes when evaluating long-term opportunities, such as Disney.
The economic downturn caused by the COVID-19 pandemic has led to unprecedented government intervention, and while the legality of these actions is uncertain, investors must adapt and make informed decisions about which companies will thrive in various economic environments. The speaker expresses concern about the high levels of debt and over-leveraging in the economy, which could lead to a significant decrease in GDP. Despite these concerns, some sectors and companies, particularly those focused on technology and e-commerce, have defied expectations and continued to perform well during the crisis. The speaker also mentions Disney as a potential long-term investment opportunity, as the company's ability to bounce back from the economic downturn will depend on the pace of economic recovery and any permanent changes to their business operations. Overall, the speaker emphasizes the importance of considering both the macroeconomic picture and individual company fundamentals when making investment decisions.
Tech companies' high valuations unlikely to sustain growth: Despite being worth 20% of S&P 500 in 2021, certain tech companies may not deliver the same revenue growth and returns due to peaked profit margins and unsustainable valuations.
The high valuations of certain tech companies, specifically those that were collectively worth 20% of the S&P 500 in 2021, are unlikely to deliver the same level of revenue growth and compounding returns as they did in the last decade. The speaker used the example of Microsoft, which he had predicted would underperform for the next 15 years in 2000, but bought at a cheap price in 2006 and sold too early in 2010. He applied the same logic to these tech companies, using various growth rate scenarios and assuming no margin expansion or multiple expansion. Based on these assumptions, it is mathematically impossible for these companies to grow at a rate that would maintain their current valuations. Additionally, the speaker noted that profit margins for the S&P 500 peaked in 2018 and are unlikely to return to those levels, further limiting the potential for these companies to deliver the same level of returns.
Investing in cyclical sectors like energy can bring opportunities but comes with risks: While dominant tech companies have shown resilience, broader market returns may not match. Energy sector offers potential long-term gains but carries risks. Successful investments require market timing and identifying the right opportunities. Owning good businesses with solid fundamentals can help mitigate risks.
While a few dominant companies in the tech sector have shown remarkable resilience and outperformance during the recent market turmoil, it may be challenging to replicate such returns in the long term, especially for the broader stock market. On the other hand, sectors like energy have experienced significant volatility and potential opportunities for long-term gains, but carrying higher risks. Historically, our firm has had success with cyclical investments in the energy sector, but timing the market and identifying the right opportunities remain crucial. The speaker also highlighted the importance of owning good businesses with solid fundamentals, which can help mitigate risks during market downturns. However, the returns from such investments may not match the exceptional performance of the tech sector in the recent past.
U.S. Oil Industry Shifts: Dependence on OPEC and Financial Instability: The U.S. has become a major oil producer but still imports a net 8M barrels a day. OPEC countries rely on oil revenues and keep oil off the market during oversupply. ExxonMobil and other major oil companies struggle with financial instability and unsustainable dividends.
The oil industry has undergone significant shifts over the past two decades, with the United States becoming a major player and reducing its reliance on OPEC. However, despite the U.S.'s energy independence narrative, the country still imports a net 8,000,000 barrels a day. OPEC countries, such as Saudi Arabia, are heavily dependent on oil revenues to fund their budgets and support their populations. During periods of oversupply, OPEC typically keeps oil off the market to maintain high prices. In contrast, the U.S. has been ramping up production, leading to a glut and a collapse in crude prices. Companies like ExxonMobil, once considered the best capital allocators, have struggled to adapt, leading to financial instability and unsustainable dividend policies. The inability to cut dividends, even during times of crisis, has left companies like Exxon and Olin handcuffed and unable to free up much-needed cash to weather the storm. The small independent oil and gas companies have been struggling for years, and the coronavirus crisis has only worsened their situation. Despite these challenges, highly regarded investors continue to hold stocks in companies like Antero Resources, which have already seen significant declines prior to the current crisis.
Oil and Gas Industry Crisis: Bankruptcies and Drop in Stock Prices: The oil and gas industry's cyclical profits and net capital destruction make it a risky investment, but survivors of the current crisis will likely make significant gains once demand returns.
The oil and gas industry faced a severe crisis due to a combination of factors including OPEC's decision to pump out more crude, the conflict with Russia, and the enormous amount of debt financing the industry. This led to a massive wave of bankruptcies and a significant drop in stock prices, including ExxonMobil trading at $30 a share compared to $100 a few years ago. The industry's cyclical profits and net capital destruction over long periods make it a risky investment, but those that survive the capital structure and liquidity challenges will likely make significant gains once demand for oil and gas returns. Berkshire Hathaway, known for its value investing approach, has been relatively quiet during the COVID-19 market period, with no major purchases announced and a focus on sales of banks and airlines. This contrasts with Buffett's aggressive actions during the 2008 crisis, but the longer duration of that crisis and lack of immediate federal intervention allowed for different strategies.
Berkshire Hathaway's Pandemic-Affected Investments: Berkshire reduced airline positions due to gov't aid, shrunk NY bank position due to regs, faces competition from PE firms, unsure of cash position investments, airlines face unprecedented challenges
Berkshire Hathaway's investment strategy has been affected by the unique circumstances of the ongoing pandemic and government intervention in industries like airlines and banking. The speaker notes that Berkshire reduced its positions in Southwest Airlines and Delta, and shrunk its New York bank position due to regulatory reasons. The airlines are currently seeking government aid, making it difficult for Berkshire to make investments in that sector. Additionally, private equity firms have a large amount of capital ready to deploy, potentially outbidding Berkshire in deals. The speaker also mentions Berkshire's large cash position and the uncertainty of how it has been invested. The airlines, which Berkshire had previously held off on investing in due to their history of financial instability during recessions, are now facing unprecedented challenges due to the pandemic and government intervention. It's unclear what Berkshire's moves have been in response to these developments. Overall, the speaker expresses excitement to see how Berkshire navigates these complex and uncertain circumstances.
Investing in a Deflationary Economy: Focus on businesses with pricing power and strong balance sheets during potential deflation and austerity. Be aware of deflationary pressures from unprecedented government and corporate debt.
The current economic climate, as influenced by the COVID-19 pandemic and the subsequent federal reserve and treasury interventions, presents unique investment opportunities and challenges. Some businesses, particularly those in the retail sector, remain cheap despite significant recoveries from their lows. However, the speakers believe that deflation, possibly lasting for the next decade, is a more likely outcome than widespread business failures. Therefore, investors should focus on businesses with pricing power and strong balance sheets to navigate this period of potential deflation and austerity. The speakers also caution that the unprecedented levels of debt being taken on by the government and corporations may lead to deflationary pressures. This environment calls for a long-term investment perspective and a willingness to adapt to new economic realities.
Economic landscape post-pandemic: Increased leverage for businesses but potential deflation: Despite increased leverage for businesses post-pandemic, potential deflation could lead to financial struggles. Velocity of money is not working effectively, and high federal debt produces diminishing returns. However, overwhelming debt may eventually lead to inflation or hyperinflation.
The economic landscape post-pandemic will result in increased leverage for businesses, including those considered financially sound. However, the speaker warns of potential deflation in the coming years, which could lead to significant financial struggles for companies. This contrasts with the common belief that inflation would be the outcome due to the large amounts of money being injected into the economy. The speaker explains that the velocity of money, or how quickly it's circulating, is not working effectively, and at high levels of federal debt, the incremental use of debt produces diminishing returns. The end game, however, is expected to be inflation or even hyperinflation due to the overwhelming amount of debt. The speaker uses historical examples, such as Japan's experience in the late 1980s and the United States' experience in the early 2000s, to illustrate these concepts.
Economic Measures Post 2008 Crisis Led to Money Supply Expansion but Declining Velocity of Money: Post-crisis economic measures expanded money supply but resulted in stagnant economy due to declining velocity of money. Look for businesses selling essential goods/services, strong pricing power, and capital efficiency for long-term growth.
The economic measures taken after the 2008 financial crisis, including bailouts, quantitative easing, and increasing the federal debt, have led to a significant expansion of the money supply, but the velocity of money has declined due to an overbuilt capital stock and global excess capacity. This has resulted in a stagnant economy and a potential for deflation, despite the ongoing efforts to boost inflation. Another key characteristic to look for in businesses for long-term growth is the ability to sell essential goods and services, as these are less likely to be impacted by economic downturns. Additionally, companies with strong pricing power and capital efficiency will be better positioned to weather economic challenges.
Businesses selling essential goods expected to thrive during economic downturns: Essential businesses with strong pricing power and manageable debt will perform well. Long-term demand industries may face disruptions. Geopolitical changes could impact manufacturing locations. Government asset takeovers could affect company valuations.
Businesses selling essential goods and services, such as food, beverages, and consumer goods, are expected to perform well during economic downturns, especially those with strong pricing power and manageable debt levels. On the other hand, industries with long-term demand declines, like airlines and parts suppliers, may face significant disruptions. Additionally, the relationship between countries, particularly the U.S. and China, could change, potentially leading to a resurgence of manufacturing in the U.S. and Southeastern regions. Another concern is the possibility of governments commandeering assets, which could significantly impact companies' valuations, such as Starbucks, which heavily relies on growth in China. Overall, the economic landscape is expected to be disrupted, and businesses and investors should consider these factors when making decisions.
Economic landscape shifting towards insularity: Expect declining exports and imports, negative trade balance, and need for cost reevaluation and cautious debt management in a changing economic environment
The economic landscape may become more insular following the COVID-19 pandemic, leading to significant implications for world trade. According to the discussion, exports and imports are expected to decline precipitously this year, resulting in a negative trade balance. This is a shift from the pre-recession era when global trade and supply chains were a significant fabric of the global economy. As a result, businesses need to reevaluate their cost structures and be more cautious with debt and balance sheets, especially if deflation sets in. The speakers also emphasized the importance of understanding the changing economic environment and being prepared for potential market shifts. Overall, the discussion underscores the need for businesses and investors to stay informed and adaptable in the face of economic uncertainty.
