A "Free Lunch" with Money Manager Bill Smead

(upbeat music) - Hello everyone and welcome to Barron's Live, our weekly live call and podcast. I'm Josh Schaefer, Barron's investor circle newsletter editor and I'm in for Lauren Rublin. Thanks for joining me today's call to learn more about the state of markets, value investing and a dig into the latest financial results from Berkshire Hathaway. I'm joined today by Barron's associate editor, Andrew Berry, and Bill Smeade, founder and chief investment officer of Smeade Capital Management. Bill and Andrew, thanks for joining me and call it a thanks for having us. - Good to be here. - Bill, I want to start with just your general outlook. We were chatting before this started about it. It feels like crazy times again. There's plenty going on in markets every day and your value fund is having a great year to start the year. Your up over 20% are ready outperforming major bank marks like the S&P 500. - Yeah. - What's your outlook on the market right now and what do you think's been working for the fund? - Yeah. We believe that we're in a secular bull market in commodities and our good results come on the back of being a big player in the oil and gas business. And that's true in both our US and our international fund. And then secondly, we're incredibly nervous about what breaking this mania in technology stocks is going to mean for a common stock investors. And that's why I brought up the subject of diversification so much in that the most investors don't realize it. But they've lost a lot of their diversification as the S&P 500 index has been so spectacularly successful and become concentrated in a relatively small number of stocks. - In terms of diversification and that unwinding of the AI trade, how do you think you're fond and the stocks that you have in the value fund are positioned well for when the AI trade does unwind? - That's a great question and one of my favorite ones. So when I'm not talking to our existing investors and potential investors, I always ask them the question is why did Willie Sutton rob banks? And of course, Andrew, be happy to tell you that because that's where the money is. So the key to mortgage rates is right now, money, massive money is being borrowed to do the whole AI thing. And without knowing whether there is going to be profit at the end of that rainbow. And when that mania breaks, two things are going to happen. First of all, the S&P 500 index results will be damaged severely for an extended period of time. And the fear that that will put in investors will drive them to the bond market to earning interest and taking less risk. Because that's where the money is. That's where the money is. So it's important to understand that when I came into the business in 1981, the 10 year transition is 14% interest and virtually no one wanted to own common stocks. They would much rather own a couple of rental homes and the building their business was operated out of rather than own stocks. We're at the absolute complete and total opposite end of that spectrum right now. - Yeah, me back then, Bill Adal was trading around a thousand and now it's 54,000 that tells you what's happened. - The ender's an optimist. It was brought him down at 7.35 in 1982. And so again, there's not too many great things about having been in the business for 46 years. But one of the great things about being the business for 46 years is you understand the extremes. You've seen him a number of times. And this is an extreme. And that's why most investors should stop now and just take a look and say, "Gee, do I want to wait until the clock strikes 12 and Cinderella's chariot turns to pumpkins and mice or do I want to be proactive and say, "Okay, I've probably made enough money from this wonderful stretch the last 15 years. How about if I diversified by going into things like oil and gas stocks or home builders that have been deeply out of favor, but would benefit greatly when the market turns sour?" - Bill, can you explain the bull case for oil and gas in terms of, I think this year a lot of investors have obviously seen Brent Crude Oil, WTI Crude Oil Spike because of the war, people are looking at energy, which is actually the leading sector in the S&P 500, at least the last time I checked up about 30% this year and thinking, "Okay, it's just because of the Iran war. That's what's driving energy stocks. I would think you probably believe there's more than just the war in terms of that case. Why is oil and gas set to continue to outperform?" - Yeah, well, the first thing is how off, well, first of all, it's an addictive legal drug, right? The product keeps getting used and getting used and getting used. Secondly, how much of it that's in the ground is limited, right? So there's a limited supply. And then thirdly, after the stupidity of the brick trade and the oil boom in the early 2010s, the industry got wise and started thinking about running the business to cause the best owner earnings. So owner earnings are critical to the idea behind what we're doing with the oil and gas stocks. These companies sell an addictive legal drug or generating very good returns on invested capital and they trade at price earnings ratios at microscopic in relation to the average stock. And it's funny, the most popular thing the last 12 months were semi-conductor stocks. And semi-conductor stocks are the most cyclical business in the entire S&P over my career, right? Like they are outhouse to penthouse, penthouse to outhouse, outhouse to penthouse. And so they're worried about the oil and gas stocks being cyclical but they don't care what's aware about the semi-conductor stocks being cyclical. - So I mean, Bill, I think you don't own X on, and I'm not sure if you own Chevron and you own some of the Canadian oil energy companies as well as a patch. Can you just briefly talk about kind of what you own and why in the energy patch? - Yeah, and our international fund, we're loaded with outstanding Canadian oil and gas stocks, Sonovus, Strathcona and others. So what happened was Cole was talking about Sonovus and Cole's meet as my co-manager in the US fund and the lead manager in the international fund. And I said, Cole, does it trade on the New York? And it does under the symbol CVE. And I said, well, the old rule was, if it's got three, no letter symbol, I can buy it. And of course they do a lot of business in the United States because the refineries feed into, you know, the Northern part of the United States of America. And so again, what's happened is these companies have really good assets. The Canadian companies have better dinosaurs than we do in the United States. Now what do we mean by that? Well, in the United States of Permian basin wells last 10 years and most of the oil comes out in the first three or four years. That's how fast Billy Bob Thornton gets the oil out of the ground. And then in Canada, they have 25 year life wells. The tar sands, it's heavy oil and the wells last 25 years. So here we are, we're short oil, there's not enough oil. Everybody's deluding themselves into thinking that opening the straight of hormones is gonna fill the void of draining the strategic reserve and every tank that's out there that had the oil in it has been drained to try to keep up with what's going on. And so here are the Canadians, it's like, okay, we're happy to help you out. We've got oil, we've got 25 year life. So it's a, a patchy's got great resources that they've organized themselves, they added to their resources. And that brings up a second thing. We're gonna go through what we went through in the '70s. You know, we ended up with about five gigantic oil companies and we're gonna start that process somewhere here 'cause you can drill for oil cheaper on the New York Stock Exchange than you can by drilling, which was Boone Pick and famous line. Bill, can you talk a bit about the International Value Fund? I know that's also been an out performer this year. What sticks out to you as far as other international opportunities? Indeed, international versus US continues. You wanted to be diversified outside of US stocks at this point. Yeah, our track record in the US fund was kind of built on the back of coming out of the financial crisis and Occupy Wall Street and the disfavor of the banks. And what's happening is in Europe, the banking industry is finally the regulators are starting to loosen up and we own Baweg and Unicredit and they're just like in a position to swallow and create efficiencies and across multiple countries and so we're at early stages of a wonderful era in the banking business in Europe and that would be something we're taking great advantage of. But in general, I mean, let's face it, we travel for our work to Asia, to Europe all over the place, right? Because we have a usage version of our two funds and so what we know is it doesn't make any difference whether you're a multi-billionaire family office in Dubai or whether you're in Hong Kong, whether you're in Hong Kong, you are sitting with a large pile of the S&P 500 index in the middle of your portfolio, 30, 40, 50 percent. In fact, most advisors tell us that if they sell part of their S&P 500 position, the client will fire them. Well, the S&P has three points, something percent in the entire energy sector. In 1981, the energy sector was 28 percent of the S&P and six of the eight largest companies in the world in 1980 were oil and gas companies. So we're at the complete opposite end of the spectrum when it comes to that and then secondarily at the opposite end of the spectrum of liking international investments. People got really excited about international investments when the Berlin Wall fell, right? And John Templeton was a famous person and helped people understand and gain a benefit from that. But the US has been the only game in town for 15 years, right? It's just been the only place to be and when they rob that bank, right? When they go to the bank of the S&P 500 and start robbing it, that money is going to get sprinkled on other things and that's what we're seeing happening on an international basis and this year with the value fund. I can't help but point out it's a Monday after Berkshire, Atthaway, Erning's Day. You are our reporter that's always covering Berkshire, everything, Buffett, etc. What stuck out to you about the most recent quarter for Berkshire? Well, I mean, Berkshire's stock is having a very good day today. It's up about two to three percent. It's nearing its record high. Investors like what they saw in the Erning's report. A couple highlights, operating earnings, excluding some currency gains, we're up about six percent which beat the consensus. Industrial businesses like precision cast parts, Lou Brazol were strong. Insurance was a little bit weaker. Another big positive was buybacks about four and a half billion in the second quarter. They did about three billion as well during the month of July. After the quarter ended, you got about eight billion total over that whole period. That's when the strongest buyback activity in some time. Then you've had capital being deployed by Greg Able, the CEO. Investors have wanted to see Berkshire bring down their almost four hundred billion dollars in cash. Invest that they bought about 20 billion plus in stocks in the second quarter, including about 10 billion of alphabet. They also bought a home builder Taylor Morrison and Mid-Size home builder for about eight and a half billion. Investors are happy about basically three things. The earnings were pretty were good. Stock buybacks are accelerating and capital being redeployed. The stocks have been a big lagger this year. It was only up about two or three percent coming into today. It was behind the S&P's 14 percent gain. Getting some catch up there. There could be some more legs to the to the Berkshire trade. That was what I was going to ask you. Do you think shares look attractive here? I think there's a reason to be attracted about one and a half times book value. Maybe add or around intrinsic value. It's also lagging comparable companies like out in which it operates like Union Pacific and railroads or Chubb in insurance. I think there could be more legs to the Berkshire trade. We'll see how things play out later this year. I think you followed Berkshire. You had some thoughts on Berkshire. Maybe some of the home builders. I think we owned Berkshire for a long time in the fun. What I really like to think about is they bought Taylor Morrison. I think four of the top 15 publicly traded home builders have been bought out in the last three or four months. Let's just think about that for a minute. Why is smart money like Berkshire Hathaway buying entire home builders? Well, the first thing is that they're being priced for a permanent, terrible life. The best time to buy home builders is when home builders sentiment is low and it is trolling along the lowest it ever gets. Secondly, the industry has changed completely. The scale is we own Horton and Lennar. They do 40% of the revenue in the entire industry, throw in NVR and we're approaching 50% of the revenue in the entire industry. Now, the number of homes being built divided by population is at the far low end of the last 60 years. The difference is now the average first time home buyer is 40 years old. That would normally be really bad news. But the good news is the next 10 years there's more 40 year olds than any time in the US every so if you're just a patient long-term investor, the home building business looks very attractive. And again, mortgage rates probably won't come down until the S&P 500 has a serious damaged period. The next bear market whenever that does come, then will he set and will rob the bank? I mean, you know, Lennar, which we've written about in Barron's favorably has been a big laggard in the group trading around bookfowl. Do you have a, have any brief thoughts on Lennar? Yeah, I, we added to that last quarter. What stands out about Lennar in terms of the different home builders to you? This speaks to one of our eight criteria for a commas stock selection, which by the way are the backbone of both the US and the international fund. Strong insider ownership preferably with recent purchases. So Stuart Miller owns 7% of the entire Lennar Corporation. A Wharton family owns 7% of DR Horton. That that we're side by side with those kind of people and that's true in both our US and our international fund. Straff Kona has a huge Adam Waters owner and and or Chelle as a huge unit credit guy. I mean, we love to get side by side. So think about it. What I read, we love that Berkshire Hathaway is buying heavily in an area that we're invested in. And then I want to get to some of the live questions to you that we're getting from the audience here. One of them that came in Bill was just when you get asked about underperformance staying the course in a technology driven market. The market has really been as you mentioned, all tech forward, all max seven for a few years now. How do you talk to clients about staying the course and finding value opportunities? Well, the first thing is Charlie Munger said, Envy's allows he sin because it's the only sin that's never any fun. So, so I we don't spend any time being envious. It congratulations to the people that catch that stuff and make a lot of money from it. But, but that's okay. I mean, we're very comfortable just sticking to what we do well. I wrote a piece recently about circle of competence that you have to stay in your circle of competence and we make all the money that you can make within that circle. And don't we really don't envy the others because I've been around long enough. I know that the people that catch that hot money, those hot money gains every day that goes by is one step closer to them getting smashed if they don't get out. You have to make two great decisions when you're buying aggressive stocks. You got to make a great buy decision and you got to make a great sell decision. If you examine, if you go back to the start of our our US fund in early '08 and you can go to Morningstar and you can see when our initiation date of each common stock we've owned right now was. And there's like six that have O8 arm. Why? Because the reason the S&P has been such a great vehicle until it got so under diversified now is they held their winners to a fault and our competitive advantage as a value manager over the last 15 years has been we hold our winners to a fault and and and that is a difference from us and because a lot of value managers are great they're great stockpickers they buy a $50 it goes up to 85 cents they sell it they go try to find a new 50 cent dollar well the problem is we've been in a bulk market off an on for 15 years with relatively short interruptions so it's not like there's loads and loads and loads of 50 cent dollars out there laying around right now I mean Bill we got a question about real estate and I think you own a some of your biggest holdings and your concentrated meat value fund are real estate can you talk briefly about them yeah it this is kind of a John Templeton kind of thing it's 2020 right and everything was shut down in the COVID right so everything's shut down so we were lucky enough we live in Arizona our company's based in Arizona now and and so the end of the 60 day quarantine was May 15th so we were only shut down for 60 days and and so we're shut down for 60 days at the end of the 60 days I said to my wife I said honey I want to take you shopping now you have to understand that I'm not a shopper my wife is a brilliant shopper I mean she's one of the best shoppers of all time she has you know 15 grandkids to shop for so I said honey I'm gonna take you shopping so after I got the smelling salts out and and she woke back up from feigning we went to the tanger outlet near Glendale Stadium and they're at 10 o'clock in the morning there were 50 people lined up in front of the the Nike outlet at at Tanger to go in two people at a time for 15 minutes at a time and I turned to my wife and I said this idea that people are not gonna shop is is just not right so so we bought more mace rich at $6 we bought Simon properties at $60 a year now three or four years ago I spoke at the London Value Conference and they asked us the pitchestock and I pitched Simon at 102 and and and a pan about a seven percentivity so what's happened is this idea people don't want to shop was wrong and then secondarily on top of that for people that stay single way into their thirties the the mall area for teenagers up through 20 somethings is just a place to go to do things and I know this sounds terrible you know take pictures so they can put up on social media of what they were doing or what they just bought or or you know being influencer or god knows why interesting so you think playing the strong consumer rather than buying retail stocks like you mentioned a Nike there which I think some people would argue maybe is getting to an area that it's interesting rather than buying Nike or retail stock you'd rather own the real estate where the retail is happening yeah I'd rather own the bar then buy the drugs fair enough Bill and I can't let you off the hook here because we are getting some subscriber questions about some of your picks as well that are starting to come in Jeff had asked about Subaru which you had picked a couple weeks ago why do you like Subaru here? Well Subaru is the Japanese automaker but it actually sells on about 60 percent plus if it's cars in the United States it's got a cheap stock it's trading around $8 a share a ton of cash on the balance sheet well over half of the market cap is in cash and I think the outlook for the companies pretty good they got a very dedicated a group of car buyers here in this country and it's also potentially a takeover play for Toyota which owns 21 percent of it and it basically could it could buy could potentially buy in Subaru if it wants to do that I mean Bill I believe that Subaru's in your international fund and I think Cole us meet your who heads at fund is a fan of the stock yeah it it it's exactly the kind of thing that wonderful company always have been identified as making a fine car energy efficient etc and its popularity kind of comes and goes but yeah I mean I've been aware of that company for 20 or 30 years good balance sheet makes a great car it's everything you want Bill another question we get a quite a few questions on gold as we always do and I'm curious do you think gold has a place in a portfolio right now how much would it have a what sort of percentage would it have in a portfolio and maybe gold stocks is there opportunity and gold miners or any of the stocks sort of related to the precious metals well it's a good question no we don't and I know we're we're into productive assets and and so when it came time to participate heavily in commodities we wanted to repeat customer business now by the way something I didn't mention originally when we talked about the oil and gas stocks how many industries had a political and religious campaign against them exist from 2017 to 2021 right two two men that tried to become president of the United States formed the biggest campaign against an industry I I've seen in my 46 years it was called ESG right so so four years investors put $450 billion into ESG ETFs and funds and they put nothing in those four years into the oil and gas business and you know what that putting nothing into the oil and gas business has continued even though they've done well this last year so so we love we love the fact that that you know does it make sense to be conscious of the environment of course it does but if people need energy to flourish Andrew we had gotten another question about another one of your picks here you have plenty of picks that do great for us here at Barons but one of the ones that you had at the start of the year was Flutter which has not done great I'm curious as you think about that company now and how the stories played out do you still feel like there's opportunity in Flutter at this point I mean Flutter is depressed it's done about 50% since we talked about it or what about it favorably the end of last year it's been hurt by it Flutter is the leading online sports gambling site in the world they own fandall here in this country which is number one two draft kings the problem has been that the prediction markets have really been eating they're eating into that market at the Calci and Polly market they're trying to adapt and it's been a problem I mean the stocks valuation has come way down and the interesting to see how they deal with it they just reported results which weren't great we're going to continue to monitor it but clearly it's been a disappointment it's the worst of the 10 stocks by far that we picked coming into this year could I comment on that yeah you know I know a lot of young people because you know we have five kids and think think think about from just a societal standpoint think of the numbs goal things young men between 22 and 35 do when they're not married okay they like to incinerate money that's what they're really good at so they incinerated on sports betting gambling they incinerated on on Calci and Polly market and option trading short dated option trading etc etc I mean if you're looking for any symptom in our society that needs to get purged that's what that's what the next bear market will help purge is that we'll create another generation of young men that figure out hey this is not a good idea Bill we got a question to asking about real estate specifically and asking about interest rates there's a lot of feeling that interest rates are not going to be coming well or anytime soon they might even go higher at this point how does interest rates how do interest rates impact your outlook for home builders and for real estate right so so go back to the what I said before the home builders are a classic John Templeton purchase they are deeply out of favor the variable that everyone's the most conscious of it has is working against them right the mortgage rates have been going up and the builders themselves are the most depressed they've been for a long time right so I mean every every variable that you would look at that needs to improve is terrible and that's when you're going to get the best price right you're not going to get the best price when things move for the better you're going to get the best price when it looks kind of semi hopeless and that's why that John Templeton video with Charlie Rose is interview is fantastic because Templeton just reminds everybody that he got mega-tronically wealthy. I can remember like 1940 bought every $1 stock on the New York Stock Exchange because it looked like we're going to go to war. Bill, another one for you just in terms of maybe value opportunities that we didn't get to. We had quite a few folks just asked for where you think people aren't talking enough about in the value space. When you think about finding value in this market, where do you think people are missing the value opportunity the most? Well, actually the biggest opportunity is in value for us is to stay out of the way of the next major bear market which is going to be centered in technology and in all, you know, just literally the faith being put in these exciting people running companies and incredible pricing, right? I mean, what connection is there between a SpaceX and fundamental analysis? I mean, these are just pure bets on human beings. And so again, it might be just like Tesla. It all works out and and and and Baron will be the richest guy in the world. You know what I mean? It's fun. But the bottom line is that it's the antithesis of being a value investor. And again, we're fortunate that the market has had such a disdain for value that even our wonderful companies that have done great for us over the course of, well, say 10 years, they're just priced very reasonably because they have nothing to do with the most maniacal parts of the market. That's going to do it for us today. That's we are at time. But Bill, I appreciate you joining us and Andrew, appreciate you joining the conversation as well. Thank you very much for having us. Thank you. You can catch us next week on Baron's live associate editor, Rashma Capito. We'll be hosting and her guests will be subiters to Romanian from Bank of America. Thank you all for listening.