My Interview With USA Investments

Mike Jefferson puts out a free investment pamphlet every month from his firm USA Investments that is aimed to increase investor literacy. These pamphlets appear in the Dallas area at business locations—auto-repair stores, dentist offices, law firms, coffee shops, and the like. Normally one of my articles is syndicated in each edition. For the November 1, 2016 edition, however, I get interviewed.

I include the transcript below:

1. Tim, how do you view the stock market right now?

The past two years or so has been the first instance in my adult life in which I thought that buying an S&P 500 index fund wasn’t a great deal. When you have a P/E ratio that will take away two percentage points a year from P/E compression, earnings per share growth around six percentage points, and dividends around two percentage points, you are really setting yourself up for six percent annual returns. I think 6% annually is going to be the center of gravity for indexers during the 2016-2026 stretch.

I sense most readers, and this includes myself, are not satisfied unless they believe they have probabilities favoring a range of 8-12% annual returns. I’d rather focus on specific businesses that fit into this range, and then add them up.

For instance, an individual business like Hershey at $96 has an extremely high probability of outperforming the S&P 500 over the next ten years because it is an individual business with the characteristics of a strong investment.

2. What make something a strong long-term investment?

Oh, there are so many ways to be successful. Broadly, you can be like Wal-Mart where you only make 3% on everything you do but the volume is outrageously high, you can be like a mattress company that sells something for $600 that costs $40 so your margins are obscene, or you can have a strong brand like Nike where people see the brand encompassing their aspirations a little bit so you have that added pricing power that fuels semi-regular purchasing.

Personally, I look at cash compared to debt on the balance sheet; I look to long-term positive changes in profits; I look to a business model that is successful with the status quo and doesn’t require a lot of reinvention; I look to the ability to give cash to shareholders as dividends without losing competitive position; I look to total returns on capital; I look to management history regarding new product launches and prudence with share repurchases.

My two favorite things are strong brands that get entrenched over the decades and industrial niches that have excellent distribution networks (economies of scale) and fully-formed sticky relationships that are unlikely to uproot.

3. What’s the best investment idea that you’ve ever had?

FedEx (FDX). I thought it was absolutely being given away during the recession and its aftermath. It was earning over a billion in profits even while its stock price was cratering. It was one of my first birds-eye view lessons on the irrationality of the stock market. I don’t know how anyone could view FedEx stock the way that I viewed it and then turn around and prattle about the merits of the strong-form efficient market hypothesis.

It made me incredibly annoying to be around for a short while. While my fraternity brothers were talking about getting drunk and laid, I was going on about FedEx trading at 5x its future five-year earnings estimates. Instead of partying, I’d go out and drive a bus called “Traveler” from 10 PM to 2 AM so I could have the capital to get my hands on the stock.

Many of my friends were wealthy, so they bought the stock anyway without having to make the labor sacrifice that I did.

4. As someone with an audience that features many multi-millionaires, do you get jealous sharing ideas with people who will get a disproportionate result from them compared to you?

No, because I recognize that everything in life is a series of advantages and disadvantages. I can’t overweigh a relative disadvantage without acknowledging the advantages that I have. For instance, if I were a billionaire, I’d probably walk around and talk to my dad. Well, that’s what I’ve been doing for the past two decades. I’m lucky in that many of the things that give me satisfaction don’t cost money. Not everyone has that wiring.

And plus, the greatest determinant of where you will end up in life is based on the IQ, parents, country of origin, physical health, and class standing that you bring with you into the universe at birth. I won that lottery so thoroughly that any envy would be like a $200 million powerball winner complaining that he didn’t win on the day the payout was $400 million. Sometimes, you just have to shut up and praise the Lord.

5. Speaking of which, how do you regard the intersection of faith and investing?

I have four thoughts on that.

First, I’m highly informed by Jesus’ Parable of the Talents in Matthew rather than the Root of Evil in Timothy. Creating and owning useful things that wouldn’t have existed but for your labor and intelligence is an act that reduces the squandering of your potential. And that is what long-term investing is—the gradual acquisition of an ownership interest in the production of useful things.

Second, I do think it is hazardous that the discussion of Jesus has been relegated to one hour on Sunday and an indulgence when grandma gets to say her Christmas prayer. At a minimum, you are missing out on information that has immense secular value independent of its religious meaning (for instance, incorporating Jesus’ instruction to aver away from vengeance has a positive earthly effect that lets you move on to greater things rather than spending your life looking backwards to settle old scores.) At a maximum, you are a participant in moving the civilization to the Sodom & Gomorrah side of the spectrum and setting yourself up to reap the consequences of that. Thomas Jefferson said that, at the end of human civilization, Jesus will be regarded analogous to Zeus. I mull over the implications of that observation a few times per year.

Third, faith helps to develop your sense of humor which makes it easier to weather and survive the vulnerable points associated with adversity. I’ve only made one investment—Valeant–that resulted in a significant loss of money. When the Prefect of Rome was burning St. Lawrence at the stake, he reportedly said: “Turn me over! I’m done on this side.” If you wake up with that attitude, and respond to adversity in that spirit, how can you not get the best out of life?

Fourth, I think about it a lot in the context of the primacy of shareholder wealth as a business imperative. The ties between communities and large businesses have been weakening as factories consolidate and tech improvements allow firms to use 1,000 people to do the work that required 25,000 people half a century ago. The opportunity to lead a dignified life if you are a hard-working honest man but got short-changed a bit in the IQ department has been compromised, and the faith part is that you need more corporate executives to act compassionately when it is wise to hold back from chasing that last nickel per share in earnings.

6. Does that mean you consider most American business leaders today to be immoral?

It means that I have a problem with short-term incentives that modify behavior accordingly. People will try to do more of what is praised, and less of what is condemned.

The predecessor to Pfizer used to give executives bonuses for hiring more people. If you increased the size of the work force by 10% in 1955, you got a nice bonus. Could you imagine something like that today? Heck, the typical modern response of the investor community to layoffs is a 2-6% immediate uptick in the price of the stock.

I’d prefer 7% earnings growth to 10% earnings growth if it meant you got to keep more of the people around who could afford the stuff the economy sells.

Projecting out over centuries, I think of the Karl Marx quote: “The last capitalist we hang shall be the one who sold us the rope.” The management expert Peter Drucker talked about how the efficiency of the knowledge worker would lead to a point where you will have owners of the production and a few technicians monitoring and maintaining it as the end-point of advanced economies.

It’s not quite tragedy of the commons, it’s not quite the paradox of thrift, and I’m not sure what you call it—but the disregard for considerations other than net profits means that each individual business contributes to the benefit of owners at the detriment of the workers, and the cumulative consequence is enormously harmful even if you can’t point to an individual actor as having a causal effect on the consequential harm.

How do you go against a norm when the shareholders or board will fire you for making a profit tradeoff that benefits the stakeholders in the community? As William F. Buckley said: “The problem with socialism is socialism. The problem with capitalism is capitalists.”

7. Do you think corporate executives are aware that they are doing this?

In the song “Shades of Grey”, Billy Joel includes the lines: “Fight ‘til the other man falls / kill him before he kills you.” I don’t think they regard it as an act of immorality but rather necessary survival within a system that will spit them out if they don’t perform on profits. You know, Bill Gross acts a bit unusual, and doesn’t outperform for a few quarters, and the investors pile out. Your ability to provide for yourself and family gets compromised if you don’t accept the premise of the economy.

Although I do find it noteworthy when certain corporate executives that spend their lives engineering layoffs turn around later in life to make large charitable contributions. They’re giving away what will soon no longer be theirs, or if it is in a will, what is already no longer theirs to atone for past conduct. It seems like Lady MacBeth trying to wash the blood off her hands when the deed’s been done, no?

8. What is your advice to people affected by these forces?

Well, keep in mind that highly talented workers are still sought after. So do what is in your power to become highly talented. If you can solve problems that few other people can solve, you can still do well for yourself.

Also, thinking about your best economic likelihoods means it is okay to ignore college. Plumbers, electricians, and other trade works are in high demand because no one knows how to use their hands anymore. If you narrow your ambitions from the abstract “I want to be a successful businessman” to “I want to be the best plumber in the county”, your best efforts sustained over time can probably make the latter a reality.

And savings plays an enormous role. If the knowledge economy means that it takes fewer people to make a large output, being an owner of the production is the best thing you can do for your life economically. Kraft-Heinz shareholders are going to have a better twenty-year stretch than the employees, so why not put yourself on the side of the fence of the former? Use the surplus from your labor to align yourself with the wealth tailwinds of the decades to come.