March 2, 2020—Fear Grips Investors as Coronavirus Causes Global Stock Market Rout. What’s an Investor to Do?
US Treasury Yields Hit New Lows as Investors Panic-Buy Safe Haven Securities. Should You be Buying Bonds Here?
Intuit Acquires Fintech Company Credit Karma for $7.1 Billion. What’s the Strategic Rationale?
Berkshire Hathaway Releases Warren Buffett’s Annual Letter to Shareholders. What is Warren Thinking These Days?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Welcome, ladies and gents, to episode 56 of The Absolute Return Podcast. I am your host, Julian Klymochko.
Michael Kesslering: And I am Michael Kesslering.
Julian Klymochko: Today is Friday, February 28, a pretty wild week. Wanted to touch on a few things.
- Focused on the fear gripping investors as Coronavirus caused a global stock market rout. What is an investor to do? We got your bear market playbook for you.
- S. Treasury yields hit new all-time lows as investors panic-buy safe haven securities. Should you be buying bonds here?
- Intuit acquires Fintech company credit karma for 7.1 billion. What is the strategic rationale behind this deal?
- And finally, Berkshire Hathaway released Warren Buffett’s annual letter to shareholders. What is Warren thinking these days?
Fear Grips Investors as Coronavirus cause Global Stock Market Rout
Julian Klymochko: The stock markets suffered their worst week since 2008-2009 global financial crisis as the S&P 500 plunged nearly 15 percent on Coronavirus fears. Now the markets rout began really on Monday after news that the virus was spreading outside of China pretty rapidly. Then investors started to fear that this corona virus pandemic was evolving from a Chinese crisis to a global and potentially out of control problem, and that’s what really got investors on edge here is just the whole uncertainty of it all, and the virus’s effect on the global economy.
The equity index fell into correction territory at record speed, taking just six trading sessions to fall more than 10 percent, which is the threshold for a correction, from an all-time high. This was the fastest decline on record. As I said in the history of the S&P 500, fastest to go from an all-time high to down double digits. Now this market rout wiped off 5 trillion from global equity values. So all investors, all equity investors certainly being punished this week. We saw it in shares of manufacturers, banks, utilities. They have all dropped double digits. Of the 500 companies within the S&P 500, four hundred and ninety three have declined. The seven that rose in value where: Newmont, CME Group, E-Trade, which is subject to M&A deal. Clorox, Cboe, Gillead and Regeneron Pharmaceuticals. Now, conversely, the list of the worst performers were dominated by companies that are basically hurt the most from this whole Coronavirus, the disease being called COVID 19. These companies include cruise lines, airlines, oil stocks, etc. I think a really interesting aspect to discuss here with respect to this tremendous volatility and it really is substantial because the VIX, which is the volatility index, hit nearly 50, which I don’t believe we’ve seen perhaps since 2008-2009. But for example, a normal VIX is roughly 15 and anything in excess of 30 is a pretty panicky situation. So to see it as high as 50, that certainly should ring alarm bells and is definitely proof that there’s a lot of panic and fear in the market.
I remember back in 2008, I believe the highest it got was 80. So this isn’t unprecedented in terms of the VIX hitting nearly 50, but certainly it is very, very extreme. Now, the trading volumes on SPY, which is one of the biggest ETF, if not the largest ETF out there, it is the S&P 500 ETF Trust. These volumes jumped 300 percent on average, so you had just a ton of back and forth trading throughout the week as markets has continued to go down and down pretty much every day. I believe two or three days this week, we saw the largest Dow point drops on record. Now, those are between around the 4 to 5 percent range, which obviously is not even near the top 20 in terms of percentage drops. But in terms of points, you know, above a thousand Dow points, that’ll get you into the top 10, certainly. Oil prices, I mean, they are certainly a victim of this as well. They plunged to multi year lows with Brent crude on course for its worst week since the global financial crisis, and the other interesting aspect is high flying tech stocks. Now, those really powered the recent rally to new all-time highs in 2019 and earlier in 2020. Investors have really bet that those market darlings would continue to rise. However, this week, those were some of the worst performers being Apple, Microsoft stocks such as that.
Outside of the market action, I wanted to touch on what exactly is the market up against here in terms of the coronavirus. Well, globally, about 83000 people have been infected with this disease and nearly 3000 have died.
I should note that the people who have died are largely the elderly. The largest mortality rate were those above eighty-five years old. So basically, if you’re young and healthy, you’re most likely to just, you know, get over it naturally. And how this is spreading, new cases are really slowing down in China, but the market is really, it’s concerned because they started accelerating in countries such as Iran and Italy, for example, it spread through a mega church in South Korea. Then there were hundreds of sick people on a cruise ship docked in Japan. So there are these hot spots throughout the world and people are super concerned that it is effectively going to spread globally.
Some specific numbers on China, and this is really where the heart of it. This is where the virus outbreak started and where the vast majority, more than 90 percent of the infected are. Now, this week, on Friday, China reported 327 new cases. Now, this is the lowest since January 23. So I just wanted to get attention to the fact that in the core of this outbreak, new cases are really decelerating, which is certainly beneficial to investors. But even if the epidemic in China peaked a few weeks ago and new cases are on the decline, it appears that investors don’t take that to heart and they’re really just freaking out in terms of what’s happening outside of China.
Michael Kesslering: Yeah and it does make sense, too, for investors to be a little bit critical of the numbers coming out of China. We have been a little bit critical of some of the GDP numbers that come out as well as in North America. Really, there is only a handful of, you know, cities that are really actually testing for the virus. So it is a little bit difficult to find out how many cases you have if you are not testing for it. But moving back to market specifics, and I’ll start out with some negative news and then move into more positive news. But what’s interesting about this sell off really is in its breadth is Josh Brown, who pointed out in his blog, the reformed broker. As of Wednesday closed, 98 percent of the S&P had fallen below its 10 day moving averages. So that implies that the trend factor had broken down substantially over the week. But also one area that investors have looked at to kind of contain downside risks was in low volatility stocks, but those were actually down in line almost…actually a little bit more than the market.
So using a low VOL ETF as a proxy for those returns, they were actually down in the 12 percent to 13 percent range as opposed to the S&P. But then moving to a little bit of good news is that the S&P still is up over the last 12 months. It is up 6 percent, and then the TSX is up 3.6 percent over the last twelve months as well.
Company specific bright spots would be, I guess, Zoom, the video conferencing company that IPOed in 2019. We covered that on this podcast, their competitors to Skype and it was up actually over this week, 3.1 percent really just on sentiment of more meetings moving to video conferencing as opposed to in-person meetings.
Julian Klymochko: Yeah, it is kind of ridiculous in terms of these names being pushed around by short term traders because you look at the market performance specifically of the stocks outperforming. You have Clorox, you have Zoom, something like Netflix and they refer to these companies as the “stay at home basket” because some traders are expecting that if the virus was to spread and then, you know, you have a fairly short incubation period. But in order to contain the virus and prevent more people from getting infected, many companies would go to have a stay at home work type environment, which would likely be short term. And you got to take in terms of you think in terms of long term equity value. Is two weeks of slightly increased revenue going to have a material effect on the present value of those future cash flows? Right. That is kind of something to consider, not just a short-term play where you are looking to flip it to the next guy tomorrow at a slightly higher price.
Michael Kesslering: Yes, certainly and it really does not reflect on the long-term value of these companies, as you had mentioned. One other bright spot is that tracking merger arb yields. They have increased from 5.6 percent last Friday, by our calculations, to 7.1 percent this Friday. So, I mean, a good entry point for merger ARB situation. Which also looking at the merger arb index has had a lot less volatility than overall stock markets, which is a positive attribute of that strategy.
Julian Klymochko: Yeah, the other thing to mention in terms of, you know, merger arb yields widening, your junk bond spreads widening – those came under pressure. And I should mention that there’s all been a lot of critics of junk bond ETFs specifically saying that they wouldn’t be able to handle a market crash. But I think this week really proved that they definitely can handle it because you had record redemptions of the junk bond ETF. And really, it’s somewhat like the tail wagging the dog where you’re not seeing the underlying liquidity within the underlying junk bonds. But that liquidity is manifesting itself within that junk bond ETF, which I think is an incredible thing, so it appears that junk bond ETF has actually increased liquidity just because the underlying bonds don’t really need to trade. Just the overarching ETF needs to trade. And so that’s a really interesting dynamic, and it’s also, you know, proof that the criticism of some of these ETF is blowing apart, blowing up within a bear market that really just hasn’t come to fruition.
In addition, other spreads widening out. You had, you know, high yield bank loan, high yield loan ETFs. Those yields were widening, but counter to that, you know, obviously had Treasury yields hitting rock bottom.
Corporate bonds, government bonds really rallying here. You had a bit of gold rally as well. However, it was volatile; But nonetheless, the question really is what is an investor to do here? And I always want to tell investors that they really should take a long-term timeframe when making any asset allocation decisions. It is never a good idea to make a wild financial decision that could throw you off your financial goals when you come across an anecdote or a negative headline. Certainly, the media tends to amplify these negative news and the negative swings. But many people, you know, if you don’t have the thick skin, they tend to be reactive and diverge from their long term financial plan. I think it is interesting to compare this big swing to something like private equity. Where if you consider that the S&P is down 13 to 15 percent. Well a private equity fund, since they have significantly higher leverage and more so focus on smaller cap names, they would be down likely 30 to 40 percent just over the past week or two. But they don’t have to mark their funds to market and they don’t have to shove it, the media is not shoving it in investor’s faces, you know, 100 times a day, so people are somewhat oblivious to the price action, and it keeps them invested. And number one, that is the most important thing to do in a stock market crash is don’t sell everything because everyone who does that, you miss the subsequent rebound. You lose a lot of great investments with solid long term prospects just due to, you know, short term emotional bout.
Interesting analogy here and perhaps one of the worst pandemics on record was the Spanish flu, which happened in the late 1910s. December 1917, the Dow Jones bottomed at sixty-six. Yeah, that is right. These days we are having a thousand point swings from a range of twenty-six, twenty seven thousand. But back then the Dow was only at sixty six points. That’s where it bottomed in this pandemic, which was a magnitude or a number of orders of magnitude larger and more serious than this Coronavirus pandemic, the Spanish flu actually infected a 500 million people around the world and with an estimated death toll between 50 to 100 million people. So certainly one of the nastiest pandemics you could ever imagine. Certainly, you know, thousands of times worse than the Coronavirus is capable of producing, however, say you are around to invest in 1918, the year after the Dow bottomed. Up until then, over the past hundred and one years, you have a twenty eight thousand percent return. Now, obviously, that is longer than any regular human being’s investment timeframe. But nonetheless, the main point here, just being having that long term frame of mind when making investment decisions, not thinking, oh, you know, I think the market could be lower on Monday or next week or even next month or next quarter.
You should be thinking if you are, say, 40 years old, how will this affect my investments when I’m 65? How is it going to invest or affect my investments in 25, 35, 40 years, which is a truly long-term timeframe? So that’s really what investors should be considering here. What is an investor to do? We always like to promote the idea of risk management before it is too late. Making a highly diversified portfolio style, you have your stocks; you have your bonds, but you should also be considering uncorrelated assets, whether it be gold, whether it be hedge funds, venture capital, digital assets. The really important thing is to have uncorrelated return streams within your portfolios. But nonetheless, in terms of Coronavirus, I think that we will get through this and we will go on to exceed all-time highs at some point in the near to medium term, because you just got to remember that with respect to the coronavirus, the majority of people who are affected have no major problems or complications. As I indicated, it is largely the elderly, who are already very weak and sick, that are dying, which is obviously very unfortunate from the human perspective, but nonetheless, from our markets only perspective, stay invested.
S. Treasury Yields Hit New Lows as Investors Panic Buy Safe Haven Securities
Julian Klymochko: As stocks tank this week, the yield on the U.S. 10 year Treasury note fell to its lowest on record, hitting one point one five percent and investors sought refuge from this coronavirus panic. These declining yields indicate that the market participants that are buying these bonds expect economic growth to decline and ultimately the Federal Reserve to go ahead and cut interest rates. If we look at what the market is implying in terms of rate cuts now, the futures market is pricing in a 100 percent chance of a Fed rate cut in March, so next month, it looks like a rate cut is likely.
Now, price action from an equity perspective is not officially part of the Fed’s mandate, but they do point to tightening financial conditions, which is just another way of saying, look, stocks and corporate bonds are getting smoked here, so we’ve got to step in and support the market under the guise of the so-called Powell Put. As it stands, the Fed’s benchmark federal funds rate is currently set between 1.5 percent and 1.75 percent. Now the market is starting to price in a four rate cuts in 2020. That is right, so one rate cut in March and additional, three rate cuts behind that largely due to this drama surrounding the Coronavirus. If these four rate cuts are affected, this will bring the Fed funds rate down to a range of 0.5 to point seventy five percent. So interesting implications on the bond market. What are your thoughts? Do you think investors should be buying bonds here at one point, one five percent yield when the government has a mandate, the Fed has a mandate to depreciate dollars by 2 percent per year.
Michael Kesslering: Yeah, yeah. It is certainly an interesting predicament. And I mean, as well, Powell came out this Friday afternoon saying that with a statement saying that the Fed will act as appropriate to support the economy. Early, just noting the threat that coronavirus poses with regards to economic activity. As well, he did mention that the Fed is really looking at the longer lasting economic effects of the virus, such as a hit to consumer confidence and demand, and that they are not as worried about short-term impacts.
But get just given their, I guess, moves to that. It is all but assured that they are going to be making a cut in March. You know, that does seem to be somewhat short-term thinking. So there is what the Fed says and what they actually do, so it’s important to kind of see through and look at their actual actions, and they are definitely looking at the stock market as well as the president of the United States as well. But if they are cutting, that should be good for bond prices in the short term, but as you had mentioned, the mandate is if you’re looking at the absolute return of bonds, the mandate of the Fed is to have inflation in the 2 percent range. And, you know, when you look at you can make arguments about the core components of CPI and whether true headline inflation is what inflation is for the rest of everyday people.
Julian Klymochko: Yeah.
Michael Kesslering: Other health care, tuition, things like that are, increase substantially
Julian Klymochko: And the Fed does utilize PCE instead of CPI believe, which PCE is quite a bit lower. So perhaps a bit of cheating there by the Fed, who knows.
Michael Kesslering: Absolutely, but all that’s meaning to say is that there is a high probability of interest rates coming down in the next couple of months so that we really just have even lower interest rates in North America, and I’m sure Canada would be soon to follow.
Julian Klymochko: Yeah, it’s a really good point, because what the Fed does, basically the Bank of Canada generally is forced to follow, not necessarily step by step, but directionally very similar. So we can expect rate cuts from the Bank of Canada in 2020 as well. Unless you have an astounding rebound in markets, which who knows could happen. But in terms of a spectrum of probabilities, look like rates are going lower.
Now, I wanted to look at this entire coronavirus, stock market tanking, yields plummeting down to all-time lows. I want to take the 30000-foot view of this whole current drama that’s going on in the markets, because it’s important to know that every year, you know, you have something that causes angst amongst investors and causing them to sell stocks, buy bonds, etc. And so you have these wild swings and I just wanted to go over the past 10 years what we’ve seen in the markets that have caused corrections, bear markets or just 5 percent drawdowns. Now, in 2010, everyone or most investors were frightened of a double dip recession. In 2011, there was the U.S. debt downgrade, which I believe on an intraday basis, the S&P 500 did hit bear market status. So that’s north about 20 percent decline. In 2012, there is that European debt crisis with, you know, Grexit was a big one where Greece was going to leave the euro, and you had a whole bunch of drama there. You had European bond yields spiking to very high levels. Then in 2013, it was the taper tantrum out of the Fed. 2014 another outbreak, this time it was Ebola. 2015 you had the oil price plunge caused by Saudi Arabia not cutting production. 2016 Chinese currency devaluation, which the market freaked out about, 2017 when Trump became president.
I remember when he was elected overnight futures tanked six to seven percent, only to rebound the next day. 2018 that was a recent one, Q4 fed over tightening, the S&P on an intraday basis, peak to through decline north of 20 percent, so another bear market on that one 2019 the U.S. China trade war and lastly, 2020 coronavirus. So what is important to focus on is that each year there’s some sort of drama, some sort of uncertainty, something that is headline risk that causes investors to sell. Then six to 12 months later, investors have completely forgot about that and they are on to the next thing. So in terms of thinking on a spectrum of probabilities, which is all, you know, investing and what you have in terms of expectations of future returns, that’s how you should think about it. On this spectrum of probabilities is, you know, how is this going to play out? I think it is highly likely if you look at what is happening to the Coronavirus, given that it is not very lethal, it does seem to transfer pretty well. However, containment in China looks to be being successful. If we look on that on a probability weighted basis. I think it is likely in six to twelve months we are going to be talking about something totally different, a new sort of drama that the market is infatuated with. Perhaps in six months people have forgotten about coronavirus. Next, it is Bernie Sanders, who is going to crash the stock market. You never know, or perhaps it is something that no one else has thought of yet. I mean, who thought of the coronavirus six months ago? Clearly was not on anyone’s mind. It was the US-China trade war, and have you heard anything about the trade war lately? No, I certainly have not.
Michael Kesslering: When you mentioned what the next risk will be, I mean, you bring up Bernie Sanders. Well, I mean, four or five months ago, the major risk is, Okay, what’s the major risk of Elizabeth Warren, you know, with in terms of economic development, if she gets elected.
Julian Klymochko: She was leading in the polls and now she is pretty much out of it.
Michael Kesslering: Exactly, so there will never be a shortage of reasons to be fearful.
Julian Klymochko: Yeah, exactly and if you want to look at this from the bright side. You know, attractive businesses that are fifteen percent cheaper than they were just, you know, week and half, two weeks ago. But I should mention that, I indicated earlier this year that S&P 500 specifically was at an all-time high record valuation on a number of metrics, whether it be even EV EBITDA, EV to sales market cap to GDP, etc. So you had very elevated valuations and the market has come down from that, making valuations more reasonable and the number one predictor of future returns are starting valuations where you’re able to buy. So if you do have a long term view i.e. 5 to 10 years, I guarantee you if you buy stocks today in 10 years, you won’t even remember this whole Coronavirus thing.
Intuit Acquires Fintech Company Credit Karma for 1.7 Billion
Julian Klymochko: Accounting and tax filing software, a company Intuit announced the acquisition of Fintech start up Credit Karma for seven point one billion dollars, which is a pretty massive deal in the private Fintech space, certainly. Intuit will integrate credit karma, and it is currently more than 100 million registered users Intuit suite of products.
Some of these products include QuickBooks, TurboTax and Mint to those are pretty popular amongst customers. Intuit is fairly acquisitive, they have made 31 acquisitions in their history. In terms of valuation on this deal, seven point one billion, which certainly is a huge number. However, not that much bigger from their last financing round in 2018. There was a $500 million dollar financing, four billion valuation, so almost a double since then.
I wanted to chat quickly about the strategic rationale behind this deal. So Intuit is buying Credit Karma really to tap their customer base and offer just a range of services integrating that into their product offering and tried to upsell those users into Intuit more premium paid services. They can also grow its wider business by tapping a set of new consumers, and these are mostly younger consumers, which is where Credit Karma was tilted to, and clearly Intuit wasn’t as successful in getting that younger type customer. What are your thoughts on this really slam-dunk Fintech deal? Certainly, for the investors backing it.
Michael Kesslering: Yes, certainly. I just wanted to first compare it to a deal that we talked about last week. Morgan Stanley’s acquisition of E-Trade, and really what it comes down to, as you had mentioned, is the acquisition of consumers and of their actual customers. And so what you see in this deal is that Intuit is paying about sixty seven dollars per customer. Now, you compare that to Morgan Stanley’s acquisition of E-Trade, where they paid about twenty five hundred dollars per customer. So in that situation, E-Trade customers there, they’re able to sell them a lot more value, add services at the E-Trade level as opposed to Credit Karma customers, and that comes down to Credit Karma main business model is they give you your credit score for free and then they serve you ads for credit cards and loans. And if you end up, you know, accepting one of the credit cards or getting a loan through one of those ads, they get a referral commission. So that’s really what their business model comes down to, that is their main business, but their other business is what I think made this an attractive acquisition for Intuit, where their other business is in the tax filing industry, where they will file your taxes for free. Now, TurboTax offers free tax filing services. I myself have used their tax filing services, but they are always trying to upsell you throughout the process, whereas Credit Karma really does not care about upselling you. They just want your data to serve you ads for credit cards and loans.
Julian Klymochko: Yeah, I think I’d pay the 30 or 40 bucks a year option, which works fairly well for me. I mean, they make it real nice and simple to do your taxes.
Michael Kesslering: Absolutely, so that is one difference, there is a quality difference between Credit Karma and the TurboTax offering. But this was really shaking up the tax filing industry, offering it for free as all of their competitors, so whether it be Intuit and some of the other competitors were charging ultimately for their tax filing services. From an antitrust perspective, there has been rumblings that there could be some concerns over industry overlap as it’s estimated that in 2019, TurboTax percentage of the online tax prep market was 67 percent, whereas Credit Karmas had only 2.5 percent, but was growing very rapidly. So that could pose an issue for antitrust concerns here.
Julian Klymochko: Certainly raises red flags, in my opinion, when you have that concentrated market share.
Michael Kesslering: Especially because the explanation of that this would be good for consumers, explaining that to regulators can be very difficult when you are buying a free offering.
Julian Klymochko: Oh, yeah certainly when it competes against your paid offering.
Michael Kesslering: Yes.
Julian Klymochko: And then, you know, commenting on recent FTC action. One interesting analogue here is when Schick tried to buy shaving startup Harry’s and they went, the regulator blocked that one. Now, this was an similar because Harry’s like Credit Karma had very low single digit market share. However, the acquirer Schick had, you know, 40 or 50 percent.
Michael Kesslering: They were incumbent.
Julian Klymochko: Yeah, exactly and so the FTC came along and blocked that. You are right in thinking that could be a major risk on this transaction.
Michael Kesslering: And even just from a messaging perspective. Is looking back, as soon as this deal was announced, both CEOs from both Intuit and Credit Karma were immediately in the media with a very clear and a very concise story, about how selling this story, and how this was not a defensive acquisition and it was an offensive move by Intuit. That was going to be great for consumers and just how prepared they were in terms of messaging, you know, it did not pose any antitrust risk. Makes me believe that they are quite worried about that.
Berkshire Hathaway Release Warren Buffett’s Annual Letter to Shareholders.
Julian Klymochko: Now, I don’t know what you’re up to last Saturday morning, but I certainly woke up early to read Warren Buffett’s annual letter to shareholders, which was released last Saturday and had a lot of wisdom, which is why investors like to read it. He touched on a whole host of topics.
Number one, he once again went out and communicated to the market what he is looking for in terms of deals, acquisitions. He stated that they constantly seek to buy new businesses that meet three criteria. First, they must earn good returns on net tangible capital required in their operation. Second, they must be run by able and honest managers. Third, they must be available at a sensible price. So Warren Buffett always sensitive to valuation, but he also wants quality and good management as well. Another thread that I thought was interesting that he discussed was in terms of things that they don’t care about, in terms of management of their equity portfolio, which is in the hundreds of billions of dollars. So they don’t care about Street upgrades or downgrades. What analysts are thinking on the stock. They don’t care about quarterly beats and misses in terms of quarterly corporate performance of their investments. They don’t care about speculating what the Federal Reserve may or may not do and that has no implications for their investment process. They don’t care about potential political developments and they don’t try to speculate on that. And lastly, they safely ignore economists and market strategist forecasts, which I believe is, you know, should be taken to heart by regular investors. I mean, he comes out with his annual letter each year with just great wisdom that investors can study and you can really unpack a lot and learn from that. The other thing that I that I really enjoyed reading about this week, and it sort of dovetails into our whole discussion on should you buy treasuries here with the 10-year yield at 1.15 percent, and when he commented on it, it was actually trending higher at 1.3 percent. But he indicated while he’s not into forecasting, he does believe that stocks will outperform long term bonds over the long term.
And he also expressed an unattractiveness of buying treasuries at 1.3 percent when the government’s actively trying to depreciate your currency at 2 percent per year, effectively guaranteeing you a negative real yield on those investments. The other thing is, I mean, he is nearly 90 years old. He is 89 years old, and he did talk somewhat about succession, which is unfortunate, sad part about this whole thing.
And other than that, he did touch on some corporate governance aspects as well. He did mention the skyrocketing compensation of directors, which have had negative consequences in terms of turning them into, yes-men. Perhaps not overseeing management, but more so just looking to agree with them and withhold that incredibly high salary, which I mean, for a handful of meetings per year, can be as high as three to four hundred thousand dollars per year, which is certainly a very well paid, cushy job, wouldn’t you think?
Michael Kesslering: Yeah, and so the theme so far in 2020 and the investment world has very much been focused on ESG being environmental, social and governance. And he really kind of addressed those three issues, but did it in a way that, you know, I might very much preferred it wasn’t very in your face. It was for a couple of examples. So talking about Berkshire Hathaway, Energy BHE, he talked about how they achieved self-sufficiency in Iowa, which is quite interesting. While also acknowledging that there is baseload power needed for when those turbines are not turning, but as well, he mentioned with specific to BHE in contrast to how other public utility companies are operated, how BHE has never paid Berkshire a dividend and has retained 28 billion dollars of earnings, which have then been reinvested back into the business. And when you contrast that to the public codes in the utility space, really they’re just income plays where their pay-out ratio will be, you know, exceeding 80 percent of retained earnings. So there really isn’t that reinvestment back into it, which from his perspective at Berkshire, he’s looking for places to put his money so he doesn’t want a dividend coming back to the Holdco.
As well for corporate governments. You touched on that a little bit, in terms of, skyrocketing compensation for independent in “quotations” directors. And he really has a negative view of independent directors whose fortunes aren’t linked at all to the performance of the company that they sit on the board of and this is his big point and that I’ve never invested their own dollars in the stock. Now they receive options packages, but they are not actually investing themselves into the company.
Julian Klymochko: Right, because the directors ultimately represent the shareholders, not management. Their role is to supervise and, you know, hire and fire management where necessary. And, so his attitude is completely correct, such that perhaps the compensation is too high and really changing the main role or main incentives of what the role of these directors are.
Michael Kesslering: Absolutely, It is really just comes down to incentives. And in terms of ESG, the first two factors are predominantly what’s focused on, whereas governance is a little bit less focused on in terms of looking at the factor, but governance is something that is an issue and it is something that I would very much agree. That in terms of a company having a good governance score, typically, you would look at their independent directors and this really goes in the face of that, a director that actually has skin in the game will probably be looking out for shareholders, which they themselves are. They will be looking out for them in a better way, but as well, in classic Buffett fashion. He had, you know, a few jokes about his and Munger mortality, but what I found interesting was the explanation in terms of succession planning. But also how his shares will be liquidated to the market upon his death, where he estimates that it will take about 12 to 15 years for the entirety of his ownership to be sold out into the market, which is effectively them being given to by his trust, to the various charitable organizations. Then they have a plan in terms of deploying that, which would involve selling the shares. But I did find it interesting because that is an overhang on the stock is how these shares will be dealt with after he passes away. So I did find that quite interesting.
Julian Klymochko: And they detail Berkshire’s share repurchases, so they did view this stock as slightly undervalued last year. Perhaps it is even more undervalued in this market environment where they can put more than a few billion dollars to work in repurchasing shares. The other interesting thing I should note is that last year Brookshire paid 1.5 percent of all American corporate income tax, which is really just a pretty huge number. Then sadly, there was no sexual innuendo this year. He typically has some good jokes, some good comments that are always, always entertaining, but unfortunately nothing this year. However, I encourage everyone to read the annual letter to Brookshire Hathaway shareholders. If you have not had a chance to read it yet, many pearls of wisdom in there and it is a quick and easy read.
And that’s it. Ladies and gents, for episode 56 of The Absolute Return Podcast. If you enjoyed it, please leave us a review. Leave us a comment on Twitter. You can reach me @JulianKlymochko, K-L-Y-M-O-C-H-K-O, and Mike; they can reach you on Twitter at?
Michael Kesslering: You can find me @M_kesslering.
Julian Klymochko: Of course, you can check out additional episodes at absolutereturnpodcast.com and we will see what the market has in store next week. Perhaps we have a big, big bounce. Who knows? I mean, I think the markets down 7 days in a row and these highly volatile times. Historically you have had these bear market rallies intermittently between these large declines, which we have not seen yet. But, you know, hopefully that comes to investors soon and financial conditions are much better, But we shall see up until then, we’ll chat with you soon and wish you best of luck with your investing. Cheers.
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