Value Investing Fundamentals & Current Market Conditions w/ John Huber (TIP634)

Big Tech companies like Microsoft, Facebook, and Alphabet have become significantly more capital-intensive, with Facebook/Alphabet/Microsoft combined capex increasing from $28 billion in 2017 to an estimated $152 billion in 2024 (over 5x increase), driven by cloud infrastructure and AI investments, creating uncertainty about future Returns on Capital that is obscured by accounting lags where depreciation trails capex.

“these businesses are getting more Capital intensive and so um I wrote a post about this where you know they're different businesses than they were and this is kind of sort of dub Tales into what we were just talking about with and and this isn't necessarily something to worry about if you're sh holder of these companies um I've owned a couple of these companies for for many years I think they're great companies I do think they're changing though the the makeup of the business and potentially the Returns on Capital are changing because of the fact they're getting so much more Capital intensive”

The largest stocks in the market (like Apple, Meta, Microsoft) regularly show 40-50% gaps between their 52-week highs and lows, yet their intrinsic business value does not fluctuate that much, indicating that market sentiment and short-term factors create persistent mispricing opportunities even in the most well-covered stocks.

“I've done some posts on where I show this chart of the top 10 largest stocks in the market and the gap between the 52 we High and the 52 we low is almost always on average 50% or more and my point is basically the intrinsic value of those businesses these are the biggest companies in the world the intrinsic value isn't fluctuating that much but the stock price does and so at times There's an opportunity there”

A company growing earnings at 7% per year with a constant PE multiple will deliver approximately 7% annual returns; however, paying too high a PE ratio creates valuation risk that can erase gains even if fundamental performance is strong, as exemplified by Coca-Cola trading at 50x earnings in 1998 despite delivering excellent earnings growth over the next decade.

“if you use an example of a stock that grows at say 6% or let's say 7% per year um you know that that stock is going to double that that that earnings of that company is going to double over the next decade so 7% per year over a decade is roughly at 2x um if you paid 10 times earnings for that stock and it goes to 20 times earnings that is another 7% growth on the PE multiple expansion”

The true goal of investing is to compound capital, not to adopt a style label ('value investor' or 'growth investor'), and investors should instead focus on identifying opportunities within their circle of competence that offer high probability of success, which may come from any category—compounders, unpopular large-caps, or bargains.

“the goal as as an investor is to not you're not trying to pigeon hole yourself into investing in a certain type of company your goal is to compound your Capital right it's to grow your Capital it's not to invest in Gross stocks it's to grow your Capital um you could do that by investing in grow stocks at a certain price you could also do that in value stocks right but it's not I don't think people should think of themselves as I'm a value investor or I'm a growth investor you should look for opportunities that make sense to to you that fit within your own circle of competence”

Individual investors have a time-arbitrage advantage over professional money managers because professionals are often incentivized to generate returns in the current year (due to performance fees and client requirements), while individual investors can afford to look 3-5 years ahead and be contrarian when sentiment is negative, which is the biggest edge available to retail investors today.

“it's hard to do that as a professional because you have clients and you have you know I've tried to structure my firm where I I don't worry about that I have my own money invested and so I don't worry about that um and I've tried to purposely structure it because that is a real risk is people people have to make money this year and so you're as an individual investor you don't have that same requirement or that constraint and and that institutional imperative so you can look past that and give yourself a real advantage and that's that's really the time Arbitrage which I think is the biggest Edge in marcet today it's not information it's not analytical it's more this behavioral mindset that that anyone with the proper uh behavior and proper mindset can can achieve”

Businesses have inherent trade-offs between stakeholder priorities: serving customers well (Costco), paying high wages (Google historically), or prioritizing shareholders creates different cultures and returns, and there is no perfect company that optimizes all constituencies simultaneously.

“I've learned that there are trade-offs there's no perfect company no perfect investment no perfect valuation I I I don't think it's realistic to to to try to have everything lined up perfectly because there's always trade-offs you know if you think about employees there's different constituents every company has there's employees there's customers there's shareholders there's management um there's vendors right uh Costco prioritizes its customers I think it does a great job with its vendors but there's always a little bit of give and take there um you know Google might historically at least was very good to their employees uh perhaps at the expense of shareholders in some way although it's hard to argue with Google's results there as well”

Buffett's famous quote 'if you're lucky in life, make sure a bunch of other people are lucky too' means sharing resources (financial and, more importantly, time) with those around you in family, community, and volunteering, because time is the ultimate finite resource and giving it creates fulfillment.

“to me it's it's if you're you know to me it's it's if you're blessed in life with with certain resources and certain assets and and these aren't necessarily Financial assets they could be they could be Financial assets of course but I think um you know making sure others around you are lucky as the quote says to me that's um you know sharing what you've been given with with those around you and in an attempt to try to try to benefit their life”

A 'base hit investing' philosophy is about making incremental progress daily through methodical processes and hard work; over a long time horizon, these compounding base hits result in significant production, applying to both investing and life more broadly.

“Bas in investing is is about that um to me it's more broad than just the investing side it's almost like a life philosophy where I'm trying to make incremental progress every day I'm trying to get better at what I'm doing and the way you do that is to um come in every day and follow a methodical process and and put in the work and over the long over the Long Haul those base hits can compile into a lot of production so to speak”

Retail investors should focus on studying company annual reports (10-Ks) and case studies rather than reading numerous investing books, because soaking in financial data and learning to spot margin profiles and capital requirements is more valuable than consuming investment theory.

“one piece of advice I'd have for new investors is um you don't really need to read the next investing book you should you should focus more on studying individual case studies or even just reading 10ks you know I think I think the more the sooner you get into studying company annual reports and learning about a business and looking at its past numbers it's like looking at baseball card statistics you know like the more numbers you soak in the more the more you start to understand the margin profile of different businesses and the Returns on Capital”

Apple in 2016 was trading at 10x earnings with a 10% free cash flow yield and was viewed as a mere hardware commodity despite having ecosystem advantages and recurring revenue dynamics more akin to consumer brands like Starbucks or Nike; this undervaluation created an attractive opportunity where even modest 5% growth plus the 10% yield would produce 15% returns before considering multiple expansion.

“in 2016 it was viewed as a consumer Hardware business um or or a hardware manufacturer electronics company that you know almost like Dell or uh you know like a computer manufacturer that didn't have a mo believe it or not I mean it's hard to imagine but eight years ago that there were worry there were numerous worries on Apple um I think people viewed it as certainly better than Dell but it was trading at 10 times earnings and so it was trading and and people said it deserved that because again it's a hardware manufacturer and um you know Hardware is is more or less a commodity is is how that company was viewed”

Stock price appreciation is determined by three factors: earnings growth, the change in the PE multiple, and the amount of cash returned to shareholders via buybacks or dividends, and understanding these three engines is critical for long-term returns.

“there's three things that determine a stock price it's earnings growth it's the change in the PE multiple and it's the amount of cash that you receive from the company via BuyBacks or dividends so Capital return so growth the change in the multiple and the capital return are the three engines”

Writing helps investors clarify thinking by forcing them to confront gaps in understanding and articulate their thesis succinctly, and maintaining a journal with dated investment notes allows reflection on prior analysis and updating of thinking as businesses evolve, creating a feedback loop for continuous improvement in judgment.

“I do think it's it's very valuable to write um you don't have to be good at it you know writing helps it's a forcing mechanism it clarifies your thinking it forces you to um uh it sort of forces you to look at um things that are not um well understood yet in your own mind and then it gives you um the ability to go and address those things that you're not sure about yet or not you don't fully understand and so it really is a helpful tool as an investor to sort of improve your understanding”

Buffett and Peter Lynch's investment in Fannie Mae was a highly successful 'compounder' through the 1990s that went up many-fold due to a strong market position (a quasi-duopoly), but Buffett sold in 2001 when he noticed management was making bets outside their core competence on securities underwriting, which was a precursor to what eventually led to the 2008 financial crisis, demonstrating the importance of monitoring how companies allocate capital.

“I Buffett invested in Fanny May and I mentioned Peter Lynch she did you know Fanny May was a great investment for both those guys Peter Lynch and Warren Buffett and throughout the 1990s it was a it was a compounder it was a stock that went up many many fold over that decade and it had had a lock on that portion of the market um the securitization Market it generally had like it's a duopoly basically”

Walter Schloss, one of the greatest investors of all time, achieved 20% annualized returns for 50+ years primarily through statistical analysis and Ben Graham net-net analysis rather than deep business understanding or management contact, proving that consistent application of simple value discipline can work at scale.

“Walter schoss made a career he's one of my favorite investors of all time and he did 20% a year for five decades um just a phenomenal track record and in terms of its returns at its longevity um and he very rarely from what I understand talk to management teams you would make bets make investments based on the numbers solely and uh sort of a classic Ben Graham uh numbers based approach and you know he achieved his um expected return he he achieved the values that he was expecting the expected values the returns he generated were done through like the law of large numbers”

Reading Buffett's annual letters and attending (or watching) Berkshire Hathaway shareholder meetings is a foundational investment education, as they cover competitive advantage, Returns on Capital, business pitfalls, and include case studies that teach both the positive and negative examples.

“I think the top of the list would still be uh Buffet's letters you know and and I think it's widely acknowledged that those are an invaluable resource for for business owners and for investors to study um but you know just because it's widely acknowledged doesn't diminish the value of those things so to me that's like the number one place to start if you were trying to learn about business um you're going to learn about all kinds of things relating to competitive Advantage the importance of Returns on Capital um the pitfalls that that businesses face the blind spots that that managers have and that investors might have the risks out there um along with and so you let cover all that and along with case studies”

A stock earning 20% per year by buying back shares at the same price can deliver 20% annualized returns even with zero reinvestment of earnings, demonstrating that capital returns (buybacks and dividends) are an independent engine of returns not synonymous with growth, and investors should not conflate the two.

“you can have one company that um has 20 % return on Capital they reinvest everything and if your multiple stays constant constant you're getting 20% returns over time and then you sort of flip that and say you have another company that has 0% reinvestment but they're trading at a multiple of five and they're buying back or or paying out dividends uh with with all of their earnings and that also leads to a 20% return so it's not all about just earnings growth or it's not all about uh just share rep purchases and dividends”

When analyzing investment opportunities, thinking about what the business needs to do fundamentally to achieve a 10% return can help calibrate expectations; for Costco to deliver 10% returns from current levels it would need to replicate past decade's growth and have the market value it at closer to 40x earnings in a decade, which is optimistic.

“another way you could look at it is what do you need Costco to do fundamentally to achieve a 10% return you know and and in my what you know know for me I'm looking for a significantly better return than that when I buy a stock but um even to get 10% returns it's it's challenging um you would need like I said the same fundamental growth as you got last decade and you would need the the PE multiple to be closer to 40 in a decade and it's possible that you could do that but that's to get a 10% return”

Low valuations act as an antidote to interest rate risk; stocks with high free cash flow yields (12%+) are less impacted by rising rates than stocks with low yields (3%), because the gap between yield and risk-free rate provides a buffer against valuation compression.

“if you have 1% interest rates and you have 3% earnings yield and rates go to two that Aid up half of your um you know so you could think of it like a margin of safety you know the gap between your 3% earnings yield and let's say a 1% risk-free rate you know but if you have a a 12% um free cash flow yielding you could think of like a bond like an equity Bond like a you know these are stocks we're talking about but if you have a 12% yield um and rates go from one to two the the impact on valuation is you know much less in the to the 12% than it would would be to the 3% Bond”

Accounting creates a timing mismatch: capex flows through cash flow statement immediately, but depreciation flows through income statement over 5-6 years (equipment life); therefore, earnings may appear elevated now (high capex, low depreciation catch-up) while true earning power is lower than reported.

“the nature of accounting is the cash flow um the the Investments they're making now in let's say a data center or a server uh flows through the cash bow statement today but it takes 5 years to flow through the income statement because it's depreciated over five or I think these servers are now six years let's say but they're am they're you know the expenses advertised over that period And so only a fifth of that expense you can look at the cash flow statement and see wow they're going to spend 50 billion this year they spent 40 billion last year”

Investors should think of themselves as owning 100% of a business (as Charlie Munger suggests) rather than as traders of securities, which changes how they evaluate stocks and encourages deeper understanding of the underlying business fundamentals.

“one of the best things you can do to become a better investor is to think of yourself as inheriting 100% of some sort of business so you think of yourself as an owner of it and then you really come to understand everything you can about that business um because you know it kind of puts it that most people just see stocks as something that can be easily traded so um you don't really think of yourself as an owner so you don't want to understand that business fully”

Huber categorizes investments into three types: Compounders (high-quality, durable businesses with excellent capital allocation and Returns on Capital, regardless of growth rate); Unpopular Large-Caps (the largest stocks in the market that become significantly mispriced at times, often when market sentiment is negative); and Bargains (stocks trading below intrinsic value with strong balance sheets, good cash flow, and margin of safety).

“I have three categories that I I tend to to uh my investments tend to fall in one of these three categories and it's uh Compounders again uh a term that I think has been overused as of late and I can tell you my definition of that but Compounders would be high quality companies that are um very well managed with capital allocation that I understand and so that does not necess not necessarily mean fast growth it it's high quality good Returns on Capital it could be fast growth or it could be moderate growth it could even be low growth but the goal is compounding your Capital that you invest in it”