Bill Nygren: “Value Investing Principles and Approach” | Talks at Google

Bill Nygren: “Value Investing Principles and Approach” | Talks at Google

October 9, 2019 29 By Kody Olson


[MUSIC PLAYING] SAURABH MADAAN: Hello
and welcome everyone. Today, we have a very special
guest with us here today, Bill Nygren. A quick introduction for Bill. Bill has been a manager
of the Oakmark Select Fund since ’96, Oakmark [INAUDIBLE]
2000, and Oakmark Global Select Fund since 2006. He is also the chief
investment officer for US equities at
Paris Associates which he joined in 1983. He served as the firm’s director
of research from 1990 to ’98. Bill has received many accolades
during his investment career, including being named
Morningstar’s Domestic Stock Manager of the Year for 2001. I would just add a
footnote to that. A lot of people who’ve
earned that distinction, if you talk to them 10 or
15 years down the line, there are very few who are still
performing as strongly as Bill has been. He holds an MS in finance
from the University of Wisconsin’s applied
security analysis program and a bachelor’s in
accounting from the University of Minnesota. Just personally
speaking, I’ve read a lot about investing over
the past few years. But I think Bill is
unique in his ability to talk about the story of
value investing in technology. So we are very, very honored
to have you here with us today, Bill. Thank you so much
for being here. BILL NYGREN: Thank you. Great to be here. SAURABH MADAAN: Excellent. So I thought we might
begin by just asking you to talk to us about what got
you started in value investing. And maybe we can pick
up the story from there. BILL NYGREN: Sure, I,
as a kid, was always more interested in
numbers than words. And that quantitative
bias led me to baseball as an interesting,
because baseball, the same situation
recurs so many times. You get good quality statistical
samples and statistics mean something. Somebody who hits 300 is a
better player, more valuable, than somebody who hits 250. And so I was always interested
in baseball statistics. And growing up in St. Paul,
Minnesota, in our newspaper, the stock quotes were
always right next to the baseball box scores. And I was very interested
in because there were all these numbers, and
they moved around every day. When I asked my dad
what they were, and he said they represented money,
it got really interesting. So I started getting interested
in all kinds of different ways that you could put
capital at risk, and whether that was in
things we’d call gambling, like slot machines. There was a family
trip to Las Vegas, where we were visiting
one of my cousins who is in the Air Force. And my dad took us
across the street to, I think it was a
Kroger grocery store. And my older brother
and I– he’s like kids, I’m going to show you why
you don’t want to gamble. And he put five
nickels in his hand, and starts putting them
into the slot machine. The first one that he puts
in, seven come back out. The next one that goes
in, more comes out. And this object lesson
gone awry was turning me into a slot machine fanatic. It took him half an hour to
get rid of all the nickels that came out. And it was like he was
getting madder and madder. I’m like, dad, you should
stop, we’re way ahead. And he’s like no,
I’m going to show you this is stupid, and keeps
putting the money in. So that fascination then was– why was gambling stupid. I knew my dad was smart. And you start investigating, you
see that the casino keeps 15% of the take on blackjack,
and 1-1/2% on craps, about the same on blackjack. Horse racing is something in
the upper teens percentage. Then there are these
things called stocks, that if you did
average in stocks, your money was worth maybe
8% or 10% more a year later, rather than less. And that distinction between
gambling and investing, putting capital at risk
either way, but in investing, expected returns were positive. And from the time I
was in high school, I started reading everything
I could about investing. I’d go to the local library,
take a couple of books home. And back then, the
investing section was probably just this wide. So it wasn’t heroic to think
you could read everything about investing
that was available. And as I read about
investing, and of course, all kinds of
different approaches, the ones that made sense
to me were the value ones. Because I grew up
in a middle class family, going
shopping with my mom. And if grapes were
on sale this week, we’d buy more than
we usually would. And if cherries
weren’t on sale, we’d wait until they went on sale. So this idea that
as a consumer, you could get more for your money
if you paid attention to price was something that was
very appealing to me. And of course, that’s
what value investing is, is being patient and wanting to
make sure that you’re actually getting more value than you’re
expending to make a purchase. I thought that if
I wanted investing to be a career that
it only made sense that I would learn the
language of business, which to me was accounting. So I got an accounting
degree as an undergraduate. It still surprises me today
how many people go into finance and don’t have a good solid
understanding of accounting. I think it’s been very
helpful through the course of my career. Then got a master’s degree at
the University of Wisconsin, was part of their applied
securities program. Worked a couple of years at
Northwestern Mutual Life. And during that
experience, really learned how important it
was that if you’re going to be a valuable research
analyst to portfolio managers, you have to have the same
investment philosophy they do. And what they did at
Northwestern Mutual was quite a ways away
from value investing. So when I’d look at
a company and say, hey, nobody on Wall
Street’s recommending this, the assets, the
real estate they own looks like it’s worth
more than the stock price, they would say, well,
let’s wait a while, let’s see if we can get a couple
of Wall Street recommendations on this first. And then a year or
two would go by, and the stock would
have gone up somewhat. It was becoming a
little more popular, and they’d asked
me about it again. I’d be like, well,
at this price, it’s not very interesting to me,
because it’s no longer a value story. I can’t tell you the real
estate is worth more than we’re paying for it. SAURABH MADAAN: Hold on, let’s
just pause there for a second. Because this reminds
me of something that I had to ask you. And maybe it will be
entertaining for the group as we move forward
through the conversation. So I’m going to phrase
my question trying to be in a more
entertaining way, rather than necessarily factual. So I’ll let you sort
the facts out later. So one of your
analysts wrote to us. They said that Bill
really likes and remembers the facts when you
present something to Bill. So they presented a
stock to you at $10. And about six years later, when
the stock had grown 20 times, you still remembered
the presentation, and you liked it even more. So you purchased
the stock at $200. BILL NYGREN: I did. Thanks for reminding me. SAURABH MADAAN: Is that correct? What is the message you’re
trying to send here? BILL NYGREN: Well,
things change over time. The stock that we’re
talking about is Netflix. And one of our
analysts presented it about seven years ago. And his story was
basically everybody’s focused on the
wrong numbers here. What you should look
at is the market thinks HBO subscribers are
worth whatever the number was. I don’t remember, $800 a sub. And Netflix subs are
worth a small fraction of that in the market. And it seems like that’s wrong. Netflix is growing so
rapidly, HBO isn’t. So the time, we
knew a lot of people in the media industry because
of investments that we had, and we talked to them. And they said, Netflix
is hugely risky. HBO spends about three
times as much on programming as Netflix does. They could basically squash
it any time they want to. By the way, look at look
at their churn statistics, especially in the
month of February, when they release House of Cards. This is a one-show company. Most of the media companies that
have sold programming to them regret the decision. They had no idea it would
be sold to so many people. So they’re going to see enormous
increases in programming costs. When House of Cards
goes up for rebid, they’ll easily be outbid by
one of the bigger studios. And we looked at it and
said, the stock’s cheap, but it’s really at a very
risky stage of its lifetime. And one of the things
we do at Oakmark is, if we think the risk–
the risk and reward have to have to be in balance to
make something interesting. You can’t go into a high risk
situation for a small reward. You’d only want to be
in a high risk situation if the reward is
very, very large. And as we looked at it, the
risks were just too high. So as I was saying
earlier, I don’t even think of this as a mistake. I think you learn a
lot about investors by what they look back on
and say were big mistakes. A lot of people would
say this stock went up 10-fold, 20-fold maybe, not
buying it was a big mistake. Well, it didn’t
meet our criteria. When we researched
it thoroughly, it didn’t have the
risk return profile that we were looking for. And fast forward to
just a few months ago, one of our young analyst
comes into a large room. There are about 20 of
us, the investment team, that sit around the table. He’d written a report on
why we should buy Netflix. And I’d gone through it. And of course, it’s hard
to get out of your mind that you missed buying
it at like 5% or 10% of the current price. And the report didn’t
really jump out at me. We go into the
room, and he starts by saying people
subscribe to HBO now and they pay $15 a month. They subscribe to Spotify,
they pay $15 a month. Sirius XM, more
like $20 a month. Those same people,
when they rate the services they
subscribe to say Netflix is more valuable to them. That if Netflix,
instead of charging $10 a month charged $15, it would
be selling at 13 times earnings. And it was like
the bell went off. It’s like that’s a way of
thinking about the business value that I had
never thought of. That the willingness of Netflix
to sacrifice current income by not charging as much as
they could for their product, to instead grow their
subscriber base 25% a year, get to the point today where
the moat has become almost so large that it’s impossible to
think of somebody displacing them, $8 billion a
year on programming, that’s almost now two
to three times what HBO spends on programming. And because the sub base
is growing so rapidly, the cost per subscriber is
going to be substantially less for any programming
that Netflix considers buying compared to HBO. Now clearly, that’s a stock
most value managers won’t touch. It sells at almost
200 times earnings. The market’s at
18 times earnings. It’s just a name they
don’t even think about. But I think, as value
investing has evolved, more of the interesting
opportunities today are coming
from these businesses that the P/E ratio does a really
poor job of assigning value. We’ve talked about companies
that have non earning assets. And I was asked not to talk
about this company, so I won’t. But there are
companies that have a lot of cash on
their balance sheet that earns almost nothing today. So the P/E investor really
is getting cash for free. There are companies
that are investing in unrelated businesses. It’s costing them
current income. And the accounting
doesn’t set up an asset to represent
the venture cap type investment that they’re making. There are companies
that are investing in largely unrelated
businesses, like a Netflix, sacrificing current
income to grow scale. And when you can find companies
with those characteristics, that happen to have
large P/E ratios, you get in kind of
this weird area, where most value investors
won’t buy it because the P/E ratio is too high. Sometimes growth investors
aren’t excited about them anymore because they aren’t
in that upper decile of growth rates. So I think of it as kind of an
overlapping area between growth and value, where
the growth rates are higher than value
investors are used to, the prices are cheaper than
growth investors are used to, and the names kind of fall
through the cracks there. And you find a lot of
our portfolio at Oakmark has large pieces of hidden value
in assets that aren’t currently earning anything. SAURABH MADAAN: So just to take
that part one step further, a lot of companies, and
I’m thinking Amazon, for example, which have
a large user network, are also in a position where
they can invest in content. And I’m not
necessarily posing this as a question of
Amazon versus Netflix, but I’m just wondering
about Netflix’s mode in general, independent
of their valuation, could there be danger to
Netflix from other people, who could come in and compete
with them on as big a scale as Netflix has? BILL NYGREN: Right, I
think that is a risk. But when you look at the scale
that would have to be today, it’s a pretty small
number of companies. And Amazon is probably
large enough to do that, maybe Facebook, maybe
Alphabet, maybe Apple. But to go in and say we’re
going to commit $10 billion to programming without
an obvious revenue source to offset that, there
aren’t many companies that can take that kind of risk. And then I would
also add, people are paying today
$100, $150 a month for their cable
TV subscriptions. This doesn’t have to be
a winner take all market. You can have a $15 Netflix
subscription, and maybe a Hulu subscription, and
an Amazon Prime, and there’s no reason
to think that it has to be one versus the other. I think there are a small
handful of companies that will be disruptors relative
to the current cable TV model that we have. And there’ll be more
than one winner. SAURABH MADAAN: All
right, and I know I paused you there while you
were continuing your story. So I just want to throw
the gauntlet back at you. BILL NYGREN: Oh, so we had
kind of this different style of investing. And when I got an opportunity to
interview at Harris Associates, all of the companies that
they were talking about were the same
companies that I had been doing research work on. And you could see kind of
a meeting of the minds. And I knew that was
a way that I would be able to maximize my
value as an analyst, is working in a shop where
other people were like minded. And I think that’s been
one of the biggest reasons that Harris and Oakmark has been
as successful as we’ve been, is our brand means something. Oakmark, anybody who hears
that knows its long term value investing. It doesn’t matter if it’s our
international fund, if it’s a domestic fund, or
funds that combine stocks and bonds to have
more of an income element, it’s all long term
value investing. And that helps in multiple
ways, a network effect where smart analysts know that
other value analysts are at Harris Associates. So they want to come there
to be in like company. Investors know that the
Oakmark Fund is a value fund, so maybe they should look
at Oakmark International, if that type of
investing works for them. And one of the big
advantages we’ve had is, because of that environment,
where everything we do is value investing, we
don’t lose a lot of people. So our top investment
decision makers, from the time I’ve
been there, have always worked with each other
for more than a decade. And when you work with
somebody that long, you get to know their
strengths and weaknesses, you know their biases. You know what you can learn
from them, bouncing ideas off of them. It makes our– it
effectively gives us a moat. Because you couldn’t
just take a similar group of talented people,
throw them in a room, and have something as successful
as Harris and Oakmark is. Because the group has
worked together and that’s a big asset. You think of most
mutual fund companies, and it’s almost like they’re
trying to fill the Morningstar style boxes. They’ll have a high
turnover growth fund. They’ll have a long
term growth fund. They’ll have a value fund. They have all the
different boxes filled. But when you do it
that way, your brand loses value, both in terms
of attracting customers and attracting employee talent. And I think that’s something
that’s really helped us. SAURABH MADAAN:
And do you see that this philosophical
evolution in value investing is going to a
different level now? People were talking
about this in 2000. So I think I ask this question
with a lot of humility in fact, and skepticism, because in
2000 when people were investing in technology companies,
there was a case to be made that value
investors were not– they were saying they were not
getting in on the internet. What you’re saying is that
there is a similar case today, but the situation has changed,
where these companies are big enough, they’re producing
cash and real earnings. Lay that out for us. Help us understand what
the reality is now. BILL NYGREN: Sure, to
that specific question, and I want to go broader
with that in a minute, but when I started in the
business in the early ’80s, most of the companies we
think of as tech leaders today were of a size that
the ability that they could be displaced by someone
else was a very real risk. They used to joke about two
high school kids in a garage coming up with an invention
that would eliminate one of the industry leaders. You think today
the market position that companies like Intel
have, or Texas Instruments, or Microsoft, two
kids in a garage aren’t going to displace
these companies. And one of the things,
as a value investor, you’re always thinking out
like five to seven years into the future. How is the company
likely to change? How will it market share change? How will cash flows change? How does the addressable
market change? The tech companies
back in the ’80s, your vision got
really cloudy fast, because the industries
were changing so much. And I think now
that companies are of a scale that can’t happen. But the evolution
of value investing, I’d like to take
back to more just the evolution of investing. If you think this asset
category called stocks that got me interested
in investing, because it had such a high
expected value, 50 years ago maybe, the only way
you could access that was your local stockbroker. And that was a pretty
high cost way to access. And then came
along mutual funds, which was a much lower cost way
to access this wonderful asset category. And just by being a mutual
fund, and passing along the cost savings you got, by
aggregating all the customers, was a tremendous advantage
for the customers, and gave mutual funds a big leg
up on the local stockbroker. Then you take that
to a farther extreme, and indexing came along. Just aggregating isn’t
enough to add value anymore. That’s not enough to charge
your active management fee. Because we can aggregate,
do it in a no-cost way, pass the savings on to
you, and we will be better than the average mutual fund. So then value investing says
well, we can one-up that. We’ll just buy the
lowest quartile of P/Es. And that probably still worked
in the ’80s domestically, maybe in the ’90s internationally. You just put a
portfolio together of all the low P/E
stocks, you be patient, you hold them until they’re
not low P/E anymore, and that was enough to work. Then the ETFs came
along and said, we don’t need to pay stock
pickers to get low P/E stocks. We can get a computer program
to pick low P/E stocks, we’ll give that to
you for almost free. So to earn an active
management fee, you’ve always had to stay one
step ahead of the computers. And I think one of
the frustrations you hear with a lot
of value managers today is, what I did 20 years
ago isn’t working anymore. I think that’s
always been the case. What worked 20 years ago very
rarely still works today. 20 years ago you could
just buy low P/E, low price to book value stocks. And that was enough
to be attractive. Now you can do that
for almost no fee. And the computers
have gotten smarter about combining low
P/E, low price to book with some positive
characteristics, book value growth, earnings growth. And so the simple,
obvious stocks that look cheap generally
deserve to be cheap. And when I started at
Harris 30 years ago, we were one of
the earliest firms to do computer
screening to find ideas. And once a month,
we would pay to have a universe of 1,500 stocks
rank ordered by P/E ratio. And as analysts, the
day that output came in, we would all be
crawling all over it to look at what the new
low P/E stocks were. Today, any of our
administrative assistants could put that screen together
in a couple of minutes. And because it’s
become so easy to get, it’s not valuable anymore. And I think it’s probably
not just investing. That’s through a
lot of industries, as information becomes
more easily accessible it loses its value. So today, the more interesting
ideas, to me, at least, are these ideas where
a P/E ratio misses it, or there’s a non-earning asset. We talked about cash. We talked about
unrelated investments. We talked about income
statement investing, where you’re offering the
customer an unusual bargain to grow scale and grow
the size of your moat. And that’s kind of evolved
into the technology area today, because these companies
have become big enough to think about what they might
look like five to seven years down the road. And think, it’s really
not much riskier to try and guess what Intel will
look like five years from now than it is to try and guess
what Procter and Gamble will look like five years from now. All industries are
undergoing rapid change. And the idea that technology
is outside of my sphere of competence because it
changes so fast, I think has become an outdated idea. So we own a lot of
technology names at Oakmark. And most of them follow the
idea that there is a way to look at the
assets kind of piece by piece that gets you
to a core that you’re not paying nearly as high a
multiple on as it appears on the surface. SAURABH MADAAN: I see
that in your portfolio, you not only have
technology companies, but you also have the
traditional value investing names. I’m thinking, for example,
Citigroup and AIG. Could you, maybe for the
purposes of our audience, in maybe your professor’s
hat or teacher’s hat, and walk us through
one of these thesis as to how do you analyze
it, in a way that maybe we can all learn from. BILL NYGREN: So we felt
that the financial sector became very attractively valued
after the financial crisis. Obviously, the stocks had
been horrible performers. And there’s always a
tendency of investors to look too much out the
rear view mirror instead of trying to guess what lies
ahead through the windshield. And financial stocks
had been a disaster. So a lot of people
didn’t want to own them. Even value investors, you’d
often hear something like, I really made a mistake owning
the financials in 2007 and ’08. I had no idea what
they were doing. They’re too opaque. We’re just never going
to buy them again. And that never really
resonated with us. To us, we didn’t see the
housing crisis coming. I wish we’d been
smarter on that. We weren’t. But if you think
about what banks do. I mean, they take in deposits. They generally lend mostly
against real estate. If you knew real
estate prices were going to fall by
20% or so, you’d know you don’t
want to own banks. And it didn’t matter what kind
of securitization happened. The main asset category that
they owned on a levered basis suffered an
unprecedented decline. So we said you don’t have
to be afraid of banks if you don’t think the
same circumstances are going to recur. And on a price to
book value basis, banks used to sell at two
times tangible equity, pretty consistently. They’d vary around that. They’d be cheap at 1-1/2, they’d
be expensive if they were much more than 2. And most of them were
selling in the market place at a large discount
to tangible book. So our interest was piqued,
because it was contrarian, and the pricing was out of line
with historical guidelines, and very much out of
line on the cheap side. And we started talking to
executives of those banks. And you could see a
dramatic change in behavior. That they realized
they’d made mistakes going into the housing crisis. They were lending without taking
into account the probability that the person they were
lending to would pay them back. It was more just
saying, this house is worth a million dollars,
we’ll lend 800,000, and if they don’t pay us
back, somebody else will, we don’t have to worry about it. But they’re getting back to
good old fashioned lending standards. One of the other
reasons banks had gotten riskier was
the dollars of assets that they had relative to the
dollars of equities, that ratio just kept growing and growing. And very quickly, the banks,
partly of their own accord, partly because of
regulation, dramatically increased the amount
of capital they had relative to the amount
of loans outstanding. So instead of 5% equity against
the loans, they were at 10%, so if you have twice
as much capital, there’s half as much risk. People were afraid that
with the regulation that the companies
weren’t ever going to be able to get capital
out to shareholders. One of the things we heard
a lot as we were trying to explore bear cases for
this industry was they’re going to get
regulated to the point that they basically trade
like electric utilities. And we looked at it and said,
the average bank’s at about half of book value, the average
electric utility is at about 1-1/2 two times book. It wouldn’t be so awful
if they started trading like electric utilities. So we started to not be too
concerned about regulation. And thought, we’re buying
at less than book value, absolute worst case,
if overregulation makes these companies not want
to be in these businesses, they can stop making new loans. Their loan book can run off. And in company after company,
as we started penciling out what that would
mean for cash flows, we said in this
downside scenario, we still come out
OK, given that we’re buying at such a discount. And on the upside,
if earnings get back to where the companies
can earn 15% on equity, and sell book and a
half or two times book, there’s very significant upside. So one of the things
that was important to us as we started interviewing
management teams and listening to presentations
that they’d made, was that we were invested
with management teams that were OK with growing
through shrinking. So taking capital and
reducing the equity base. Because it’s dangerous, if
you’re financial, to go out and just try and
grow your assets. When you really try and push
the accelerator down on growth, you often make mistakes
with who you lend to. But growth through
repurchasing your shares at half a book value,
that increases the book value of the
remaining shares, it decreases the risk
profile of the company. So we’re always
focused on trying to invest with managements
that want to maximize long term per share value. And in this case, we
thought that meant having a willingness
to repurchase shares. So we started investing
in the companies that were repurchasing shares. That became a more
popular way for the banks to reinvest their capital. So what started out as an
investment in JP Morgan quickly became JP Morgan, Bank
of America, Citigroup, Wells Fargo. And we didn’t own all of them. But we owned most of the major
banks with an entry price significantly under book value. And as this story progresses,
last year after the elections, regardless of what you
think of the politics, there was more confidence
in a growth outlook that is good for banks now. It means higher interest rates. It means higher
asset values, which helps the loans that are
on their books already. Probably means less
regulation in terms of being able to get capital
back to shareholders. And we’ve seen a tremendous
run in these names. But still, most of them are
selling at less than 150% of tangible book. Most of them will still
see earnings growth if interest rates normalize
to a 2% or 3% inflation level. And most of them still have
significant excess capital on the balance sheet
that either ought to be valued by investors
through requiring a lower discount rate, because these
are less risky businesses, or could potentially be returned
to investors, which then, it’s dollar for dollar
that you realize value for excess capital. SAURABH MADAAN: Some of them
also have deferred tax assets, right? BILL NYGREN: Right, the
deferred tax assets, another non earning asset. Along that theme, both deferred
tax assets and excess capital really aren’t generating much
today in the way of income. So you miss that, if
you’re just looking at the banks selling at a
12 or 13 times P/E multiple. Now there’s some risk
with the tax bill that the House passed
yesterday that would take corporate rates down to 20%. You might see write offs on some
of these deferred tax assets. The flip side of that is the
financial industry in the US is one of the highest taxpaying
industries, paying quite close to the statutory rate. And normally, it takes
a number of years before a competitive industry
returns a change in tax policy to the customers. So even though a large
holding for us like Citi would see several dollars
a share of book value go away if the tax laws
end up getting passed, like the one did
yesterday, we think that would be more than made
up by the increase in their after tax earnings, that
they would benefit from, until the banks start competing
that away from each other. SAURABH MADAAN: So
along those lines, we talked about
tech companies, we talked about financial
services companies, but you also have high quality
compounders in your portfolio. And I’m thinking companies
like MasterCard and Visa for example. Talk to us a little bit, bill,
about a company like Visa and MasterCard,
we know that most of the transactions in the
world are still based on cash, I think about 80-85%,
somewhere in that ballpark. So the market understands
the value and the growth that is possible. But these are not selling
at low multiples right now. So why do you continue
to hold these? And will there come a
multiple in terms of valuation where you will say that
yes, this is overvalued? BILL NYGREN: Sure, going back
to her our previous discussion about Netflix and can’t
there be competitors, even though card processing,
payment processing, is just as much a network
business as companies like Visa or MasterCard–
it’s a great example that they’re not
fighting each other, they’re both fighting cash. And there are two big winners. The way we look at trying
to assign values here is in any company,
we make a projection out two years, all of
the financial statements. And then for the
five years following that, we assign an
estimated growth rate in operating
earnings for the company, make an estimate of what
the cash needs or cash production of the company will
be if they meet our targets, and then get to a growth rate
in business value per share. And we say our crystal
ball gets too cloudy after about seven
years for any company to make much of a forecast
beyond that time period. So the assumption is that at the
end of that seven year period, companies sell at pretty
similar multiples to each other. We’ve made estimates, starting
with how much of world commerce is being done by
cards today and what an extrapolation of
those trends would likely produce for revenue growth
for MasterCard and Visa. What kind of incremental
margins these companies are capable of having, again,
if they aren’t investing in adjacent technologies. And based on that, and
just a mathematical model that we use, produce what kind
of premium to the normal P/E this company would be
deserving of selling at today. And despite MasterCard
and Visa selling at pretty strong
premiums to the market, they still haven’t
gotten to that level that we would call fully valued. Now I would say we got
a little bit lucky here, where the market gave
us a great opportunity to buy these companies back when
regulation called the Durbin Bill– SAURABH MADAAN: Credit Card Act. BILL NYGREN: –yeah, was going
to dramatically reduce what they could get on debit cards. And both MasterCard
and Visa fell to prices that they weren’t much of
a premium to the market at the time we bought them. So we’ve benefited from business
value growth and stock prices both growing at a
pretty similar slopes, with the stocks never
getting to a level that we would be
wanting to sell them. Most of this time, they
haven’t been cheap enough that we’d say, if new
money came to us today and we had to start a
portfolio from scratch would we buy this company. But they’ve kind of stayed
between buy and sell targets for an extended period of time. And as each year rolls
by, and our analysts then start to look at a new
year, the new year that’s seven years out, the confidence
hasn’t wavered at all that these two
companies are going to continue to dominate payment
processing as much as they do today. SAURABH MADAAN: So
let’s put some numbers, so that we get some ballpark
to what you just said. Let’s say their revenues keep
growing double digits for five years, and they keep
getting some operating leverage in the business. So earnings grow at say
15%, for five years, so that would mean the
earnings have doubled roughly in five years. If the multiple
goes from 30 to 20, because you say
after seven years you’re approaching
roughly market multiples, you get 100% upside and
then 50% contraction due to the multiple. That’s net 50% in five years. Does that cross the hurdle? How does one think about it? Where would you say that– and I’m just putting some
numbers to ask the question, where would one make the
call, I’m going to sit in cash and not stay invested. BILL NYGREN: So the
answer gets pretty complex and quantitative,
but if there’s ever a group that wants to
walk through it that way, it’s probably this group. We start with the idea that
if you want to invest capital at no risk for seven
years, the US government bonds for US investors
is the way to do that. And if you do that today,
you’re earning something around 2%, maybe a little
bit less than that. To take the risk
of a normal equity, you need to earn
a premium to that. So we start, we
say the 2% level– well, we actually make
an adjustment and say, a 2% seven-year doesn’t
really make sense in a 2% inflation environment. So we’re going to pretend
that those bonds are at 3%. We don’t want to be investing
based on an interest rate for that bond that we don’t
think is long term rational. So if we say the
bond would be at 3%, and we want about a 4% premium,
which is in line with history, for stocks, we’d
say we want a stock to earn 7% a year to
call it fairly valued. And we want to sell
a stock at about 90% of what we think
is fair and buy it at about two thirds of
what we think is fair. So when we go through
that math of saying, based on our seven year
forecast for MasterCard, that we think it makes
sense that it would sell at 20 times pre-tax
earnings two years from now, the math behind
that would say then you would still earn your
appropriate risk premium to the seven-year bond if
it today sold at that price. So on our math, something with
the growth characteristics of a MasterCard or
Visa is worth something on the order of
20 times pre-tax, even though the
rest of the market sells it somewhere around
12 or 13 times pre-tax. SAURABH MADAAN: Even five
years from now, you think. BILL NYGREN: Our
five-year from now guess for the market
would be based on a seven-year that’s
at 3%, and would still be at about that level. SAURABH MADAAN: I see. Because these are high
quality compounders. You BILL NYGREN: No, I’m
saying market would still be at about 12 times level. So if five years
from now we still thought we had seven years
of runway ahead of us for supernormal growth
at MasterCard and Visa, then we’d still have a very
high relative multiple on it. But the way our math
works today, we’re assuming that as each year that
goes by, that they’re growing 15% or 20%, the years, eight
years out, nine years out, those are normal growth years. And one of the reasons it’s
been such a good holding for us, and we’ve held it five years or
so, is as every year goes by, and we start that you’re
worried about disruption risk from alternative payment
processing systems, at the end of the
year, we end up saying the moat that MasterCard
and Visa have is just as strong as it
started at the year. So we don’t have to
lower our multiple. And if the company’s
growing 15% a year, and you aren’t
lowering your multiple, your business value
is growing 15% a year. You’re putting
yourself in a position to get lucky if you buy
these companies that have disruption risk, and then
that disruption doesn’t happen. SAURABH MADAAN: Yeah, I
see what you’re saying. Great, and thank you. I mean, this was
a great example, just to sort of walk through
as to where you bought, what was the motivation,
how you think about long term,
short term valuation, and what happens in the course
of holding an investment, how you make a decision. So moving on from there, a
couple of related questions. And then we’ll open
up to the audience. I wanted to ask you,
who are some investors that you personally
admire or look up to, or that have been
influential for you? BILL NYGREN: I would
start with what I jokingly refer to as the usual suspects. You talk to any value manager
and they’re going to tell you they were strongly influenced
by Warren Buffett, Benjamin Graham, John Templeton. Those are my heroes. I’ve read almost anything
that they’ve written. And they have had a very
dramatic impact on my way of thinking, on Harris
Associates, and Oakmark. I think value
managers especially tend not to go a lot
broader than that. And to me, that’s a mistake. After you’ve read a few
books about Warren Buffett, and you read the next
book, and maybe you learn what his breakfast
habits are, or what TV shows he likes, but you really
have the foundation for what’s made him a
successful investor already. And it’s like comfort food. You know it’s not
really good for you, but there’s something about
reading another Warren Buffett book that makes you feel
good as a value investor. And the investors who are
very different than us, I tend not to want to emulate
their style of investing. But I find I learn
more when I read books about some of the
great hedge fund managers, a Paul Tudor Jones,
and Michael Steinhardt, George Soros. And there’s not nearly the
overlap of the circles, like Berkshire Hathaway, and
the way we differ from them, I mean there are
differences at the edges, but it’s a very similar
thought process. The circle with
Michael Steinhardt still overlaps, but
it’s not nearly as much. And I’ve never read a book about
one of those great investors who weren’t value
investors that hasn’t made me think about some detail
of our investing process. For example, Mike Steinhardt
was famous for never wanting to make an investment until
he’d sat down with the person he thought was the smartest
bear on the stock and understood their case. We try to do that in our
process at Oakmark, by whenever somebody is presenting
a new idea to us, we assign the task to
someone of saying your job is to now come into
the room and explain why this person is wrong. And we want you to argue to the
best of your ability to prevent us from making this investment. And hearing the two sides
argue with each other is a much more
productive atmosphere for learning about an
investment than just hearing the bullish case. Paul Tudor Jones,
there’s a famous picture of him sitting at
his desk, and pinned on to the bulletin
board behind him is a sign that says
losers average losers. How many times have you
heard a value investor say the stock’s down 20% today, but
my estimate of business value is only down 10%. So it’s really cheaper
today than it was yesterday. One of the great things
about data analysis having become so cheap,
and us having the history that we have, it’s really easy
to analyze our own history now and be more data driven in
our own decision making. And we can look at and say, OK,
we’ve got 20 years of history here, about 130 stocks
on our approved list, what happened when this
fundamental started to deviate from what
the analysts suggested, were those good
opportunities to add. And we looked at
it and said, you know what, that was really
more of an indication that we were off
base in our analysis, and it was going to
get worse after that, before it got better. And adding some
guardrails to our process, of saying when things
start to go negative on the fundamental story– we don’t ever want to
be the investor that says if the stock falls
20% it’s an automatic sale. But if the fundamentals start
to deviate, and the story isn’t playing out the way
we thought it would, the fundamental story,
we want to increase the pressure on the
analysis, to make sure more people in the
firm are thinking about it, forcing more meetings
with the management team, forcing more of a devil’s
advocate thought process, with the idea that one of
the most productive ways we can add to our performance is to
get rid of our losers earlier. I get teased. We’re not momentum investors
by any way, shape, or form. But I do believe there is such
a thing as fundamental momentum, that companies that
are performing well are more likely to
continue performing well, and companies that
are performing poorly are more likely to
continue poorly. SAURABH MADAAN: Newton’s
first laws of motion. BILL NYGREN: Yes. So it’s not a new concept,
but at Oakmark, it’s applying something that’s
thousands of years old. So you can take these nuggets– George Soros, with his
theory of reflexivity, which was written up in
a book hundreds of pages long that I find very
difficult to follow. But way, way
oversimplified, says that what’s going on
emotionally in investors can actually influence
the real economy. And that psychology has a
real effect on the economy. And when direction changes,
a simple psychological change can be enough to bring about
a real change in the economy. When you go through tough
cycles like ’08 and ’09– and people are
always saying, sure, if things get back to normal,
then everything out there is really cheap, and
the names you own would be the right
basket of names to own. But what can ever change
to make things get better? Just thinking that things could
change to get back to normal can be an impetus to start
that process happening. In the same way
that if you’ve gone through an extended
recovery that’s created tremendous
excess in the economy, just people starting to worry
that things go back to normal could be enough to
slow the speculation, slow price increases and
bring things back to normal. Those are things
you don’t usually read in books about
great value investors that I think can really help
refine a value approach. And like I say, I think
I learn more reading about how great investors
who weren’t value investors invested than I do by reading
the 200th book about value investing. SAURABH MADAAN: That’s
a very good suggestion. So final question is
what does your day, what do your routines look like? What are some of
your reading habits? And any advice you have
for those of us here, and people who are going to be
watching you on YouTube, how they can be better investors. BILL NYGREN: So the alarm goes
off at 5:52 in the morning. That’s so that I
can watch the top 10 plays of the day on
SportsCenter before I get started on the
business part of the day. I read The Wall Street Journal,
New York Times business section, Chicago Tribune,
CNBC’s top stories of the day, Real Clear Markets top
stories of the day. Do most of that before
I go into the office. Do some of it while
I’m riding an exercise bicycle in the morning. Always trying to multitask. Try to get into the
market a good hour before the market opens,
which is 8:30 Central time. We’re in Chicago. So that I can see if
investors have given us new money to invest,
have taken money away. We have to figure out how
to manage cash flow changes. Want to make sure
I’ve had a chance to read the important first
call notes on the companies we’re invested in or
considering investing in. And then most of the day at
the office, you see movies and they show pictures of what
asset management firms look like, and you see
this trading room, and people are on two phones,
and they’re getting angry and throwing things. Our office is more
or less a library. SAURABH MADAAN:
[INAUDIBLE] screens. BILL NYGREN: Yeah, all the
screens all around them, everything electronic flashing. You walk into our
offices, and it’s mostly people sitting at
a desk reading, with a pile of papers
stacked on their desk. And most of the day is reading. And it’s reading about
companies we’re invested in. It’s reading about
companies that are trying to challenge
those companies, disruptors. It’s reading stuff
written by other investors that we admire of
companies that they own, that we don’t, trying to
see if we missed anything, if we can learn something
from what they wrote. It’s sitting around in a
room with other analysts, bouncing ideas off each other. Which again, is one of
the great advantages that we have at Oakmark,
is either direction outside of my door, I can walk all
the way around the office and find another
value investor who’s got a slightly different
perspective on things, who knows me well
enough, who knows Oakmark’s way of
investing well enough, that we can really learn
from each other bouncing ideas off each other. And you hear about
like the investment banking firms where
people are still at their desks at midnight,
one of the nice things about reading being a big part
of what our job is, is you can do that anywhere. So I have had the
good fortune of being able to have a lifestyle
that I’m home at dinner time almost every night. But I might be reading
an annual report before I’m falling asleep. There’s a tremendous blurring. It’s probably true
in any industry where people are really
passionate about what they do. Tremendous blurring between
business time and private time. Might be at the
office and having a personal conversation
with my dad or somebody else in the family. And you can say is that
really fair to your employer to be taking that time. But at home, I’m
watching a baseball game and reading annual
reports, or other reports by other investors
that whole time. I go shopping and I
can’t help but see what new products are out
and how they’re priced compared to old products. Or if you’re in an
off price store, that there’s suddenly a
tremendous amount of inventory from Nike, and
there wasn’t before. And does that mean something. It’s just, I think to be
a successful investor, it has to be something
you love so much that you can’t ever really
turn it off, and you don’t want to turn it off. You get enough
enjoyment from it. And it doesn’t create
stress in a way that you feel you need to
get away from it to relax. So those are my days. And then every once in
a while, it’s traveling. It’s going out to
meet managements. We like to sit across
the table from the CEOs and CFOs of the companies
that we’re invested in, and hear in their own words
what’s important to them, what their goals are. I was out in New
York the past couple of days meeting
with the managements of a lot of the cable TV
investments that we have. We own QVC, the TV and
internet shopping network. Charter Communications,
recently meeting with the management
and GE, which has been a breath of fresh
air, in terms of the change at the company, but not
entirely pleasant for us, because it’s been a position
we’ve owned for a while. But to us, there’s no
substitute for the sitting across the table and getting
a feel of what’s really important to these people. And again, along the lines of to
earn an active management fee, you’ve got to be
able to do something that a computer can’t do. After you’ve interviewed
100 investment– 100 corporate management
teams, you really start to have an ability to
say these guys are really above average,
these not so much. And you don’t have to
be perfect with it, but if you can be better than
50/50 at how you bucket them, as above average
and below average, it can be a tremendous
addition to what’s largely a quantitative
approach to investing. SAURABH MADAAN: I think
your love, and passion, and enthusiasm for
investing is very obvious, and it’s very contagious. Thank you so much for sharing
your thoughts with us. If you we have any last minute
questions in the audience, we’re open. I’ll just repeat the question. There was this talk about is
there a bubble in the market, everything seemed overvalued. Other people are making a
lot of money out of bitcoin. And what do we do right now? BILL NYGREN: So we’re
generally in the camp that if you can’t understand
how something is priced, it’s better not
to talk about it. But intellectually, I’m more
in the camp with Jamie Dimon, that I have a very hard
time understanding why Bitcoin is valued
at whatever price it ends up being valued at. And you’re not going to find
it in the Oakmark portfolios. I don’t think markets today
are in bubble territory. P/Es are only slightly
higher than they’ve averaged in the past 30 or 40 years. And I think with
interest rates as low as they are, inflation as low as
it is, it makes sense that P/Es would be somewhat elevated. Not to mention the things like
all the technology companies that are making so many
investments in areas tangential to their basic business,
that are depressing current earnings. And one of the statistics I put
in the last commentary we wrote was that if the four FANG
stocks weren’t in the S&P 500, the S&P multiple would be
about a point and a half lower. Which when you’re talking
about a multiple that’s maybe two or three points elevated
relative to history, a point and half is a big deal. And I don’t take
the stocks out just because they look
expensive on a P/E basis, but P/E is such a bad metric
for measuring the value of those four companies. So we don’t think the
market’s really elevated. You know, the recovery’s
nine years old. But the magnitude
of the recovery has been relatively trivial
compared to historic growth of the economy. Recessions come about to
correct excesses in the economy. It’s hard to see those
excesses being created. To me, the more fascinating
part of your question is how do you deal with
a bubble like 2000, where a strict
discipline valuation approach to investing just
says none of these names make sense to us. We can’t figure out the values. And how do you keep
people invested with you when you’re holding the line
that says these names just don’t make sense. The Oakmark fund assets
peaked at about $10 billion in 1997, ’98. And even though
our net asset value had been about flat for
the following two years, our assets were
down to $2 billion. Because we refused
to buy anything in the technology space, people
took 80% of the investments away from us. And that’s a tremendously
difficult time when you’re running a
business and you’ve got people to employ, that you want
to have continue with you, and you’re seeing your
revenues fall by 80%. I remember at a
conference call I was on. One of the advisors who was
in the process of selling out of the fund, was
pleading with me, saying won’t you please just
on one technology stock, because if you buy
one of them, then I can go back to my
investment committee and tell them that’s OK. And I remember saying
to her, I said, if we could find one that
fit our value criteria, we’d happily own
it, but we can’t. And because of that we won’t. I said, and I’ll bet
you something else. There is going to be
a time in the future that you’re going to say
it’s not that Oakmark’s incapable of buying technology,
but when technology is out of favor, we’re going to
own more than the market weighting in it. And I said, you’re
probably going to be just as upset with
us then as you are now. Because we’re investing
in something then that would be unpopular. And it’s tough. But if you don’t stick
to your discipline– there was a Chicago
firm that was known more for growth
investing that was still a pretty strong
fundamental value firm, but they applied it
to growth stocks. And about February of 2000, they
threw in the towel, and said, we’ve lost too many
of our investors, we’re going to start
buying these very high priced internet names,
even though they don’t work under the
way we used to invest. So they didn’t
ride the market up. They rode it all the way down. And it put their
firm out of business. You mentioned earlier, I was
named Morningstar Manager of the Year in 2001. It wasn’t that we did anything
different in 2001 than we did in 2000, or ’99, or ’99. It was the market suddenly
corrected valuation excesses. And the traditional
companies we’d owned through this whole
period went up in price significantly, while all the
tech names came crashing down. But it was the discipline
to say we’re going to keep doing the same thing. And we know if
we’re fundamentally right on the analysis, the stock
prices will eventually follow. And we’re not going
to try and placate investors who want to see us
invest in the current bubble. I remember being
on CNBC back then, talking about how high priced we
thought technology names were. And I hopped into a cab
on my way home from work. And I can see the cab driver
looking in his rear view mirror, and he’s like
I think I know you. And I’m like– I kind of got my head down, and
I’m like no, I don’t think so. He was like, yeah, yeah, I do. I’ve seen you on TV. And I’m like maybe. He’s like, you’re
that guy on CNBC. And my portfolio’s
kicking your butt. And I’m like, you know what,
it’s not that far to my house, why don’t you just
drop me off here, I’ll walk the rest of the way. But when things
get that popular, it’s very rare that they end
up being good investments. And as long term
value investors, we get a lot of comfort
from the history of seeing bubbles
grow and bubbles pop. And the people who
whether those bubbles well are the ones who had a
philosophy that grounded them and they didn’t change it to
reflect bubble level pricing. SAURABH MADAAN: Well,
thank you so much. Really appreciate all the
time that you took being here. BILL NYGREN: Great, thank you. Thank you all.