Rule #1 Finance Blog

With Investor Phil Town

InvestED Ep. 160 – Intrinsic Value: Let’s Talk About Tesla

We are back and better than ever coming to you to discuss different types of trading, finishing up our discussion on intrinsic value, and a little about what’s happening in the market including Tesla.

In Episode 160 You’ll Learn:

  • What is a long trade?
    • A long trade is initiated by buying with the expectation to sell at a higher price in the future and realize a profit. It falls in line with Rule #1 Investing.
  • What is a short trade?
    • A short trade is initiated by selling, before buying, with the intent to buy the stock back at a lower price and realize a profit, often known as short selling.
    • Not a good idea because it’s really unpredictable and even if you’re right about the information you can still get crushed by something unexpected.
    • Most companies that get short sold are fads, failures, or frauds (they don’t qualify for Rule #1 Investing).
    • Warren and Charlie don’t short companies.
  • Special Announcement: Book Signing & Live Podcast Alert!
  • What is Intrinsic Value?
    • The intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value.
    • Does the price of the stock in the current market matter as much as the price that you find? It does, but it matters the least as opposed to the other factors.

Show Notes:


Episode 160 Full Episode Transcript

Phil Town: Hey everybody! This is Phil Town.

Danielle Town: And this is Danielle Town.

Phil Town: Welcome to the InvestED Podcast, where we’re talking about how to invest like the best investors in the world, Warren Buffett, Charlie Munger, deep value investing-

Danielle Town: And my dad! We can add that now, dad, since it’s the title of our book: “Invested.”

Phil Town: That’s right. Except for this podcast where we’re not talking about how they do it. We’re talking about one little tweak, maybe a little tweak; because as we were saying last time that we have a certain advantage of being small and nimble, that Warren and Charlie have long ago given up.

 But they used to use that advantage substantially, by doing lots of different kinds of options, trades, and lots of merger acquisition kinds of trades; much, much different than their historical track record would indicate. This is not to say that Warren and Charlie are traitors per se, but that they didn’t just do long value investing. There’s another element back in the day.

Danielle Town: Okay, wait a second now. You might have mentioned this before but I’m feeling like it’s new information for some reason. It would make sense that they wouldn’t do only long trades because people who are really smart and who get real into this stuff tend to do other kinds of investing, other kinds of … you would call it trading, not investing, right?

Phil Town: We’re speculating to a degree.

Danielle Town: What long trades, the term means is that it’s what I think of is just buying a company; you’re just straight up buy the stock of a company, the end, and you hope it goes up eventually.

Phil Town: You’re on with Warren and Charlie right there.

Danielle Town: And then the opposite of a long trade … just to be clear here for everybody who doesn’t know … is a short trade, which means that you sell stock that you don’t own, which makes no sense to me. But you’re betting that it will go down, and then you buy it back at this lower price.

Phil Town: Just to clarify, yes.

Danielle Town: Please clarify, cause I don’t get option selling at all. I’m sorry, short selling at all.

Phil Town: Short selling-

Danielle Town: Or option selling.

Phil Town: Let’s say that I borrow my friend’s car. Wonderful car, beautiful 100 thousand dollars Mercedes car. Now, I’m gonna borrow this car because my cousin works in Berlin or wherever, Mercedes headquarters … wherever that is, Dusseldorf or something … and he’s fed me a little secret, like on the movie Billions at showtime. I’ve got inside info that I have to be very sneaky about so I don’t get taken down by the SEC.

Danielle Town: ‘Cause that’s super illegal.

Phil Town: Super illegal. I get this inside that, that model of Mercedes that my friend owns … let’s say it’s yours, just to identify things. I’m borrowing your Mercedes, okay Danielle? That model of Mercedes, they just found out at headquarters, when you rear end it, it explodes in a fireball. That information has not come out yet to the public; they’re still trying to decide how to best handle that. But I know it’s very soon that it’s gonna come out. You with me?

Danielle Town: Yeah.

Phil Town: Now, what will be the value of that Mercedes if that information comes out?

Danielle Town: Now, I own the car and I don’t know that, right?

Phil Town: You do not know that.

Danielle Town: But you are borrowing the car, and you found this out from a third party.

Phil Town: Right, before I borrowed the car. I’m borrowing the car because I found this out from a third party.

Danielle Town: Understood. You’re borrowing a car that will explode because you found it out?

Phil Town: Yes, right. Remember, we gotta think about the value of the car. Value of the car right now the way it sits is 100 thousand dollars. I should be able to get 100 grand for it, or you should if you sell it. But once they announce that it explodes, maybe not so much worth 100 thousand any more. You with me?

Danielle Town: Yeah.

Phil Town: I don’t know how far down it’s going, but it ain’t gonna be a hundred any more.

Danielle Town: Correct, agreed.

Phil Town: Now, here’s where I get sneaky: I borrow your car. Now, I drive it to a dealer, and I sell it to him for 100 thousand dollars. And then I come back to your house in a cab in an Uber. You go, ‘Where’s my car?’ And I say, ‘Well, I sold it.’ And you go, ‘you what?’ I say, ‘Yeah, but here, hold this 100 thousand dollars as collateral for your car, and I will get you your car back in the next few weeks.’ Okay so far?

Danielle Town: Mm-hmm (affirmative)-

Phil Town: Ignore that this would not happen in your world … ignore that for a second. It does happen in the brokerage world. Now I wait. Sure enough, two weeks later here comes this horrible announcement about this car. I wait another week, and by the time that next week is over, everything has been confirmed and now I go back to the original dealer that I sold it to. I say, ‘I’d like to buy that car back.’ And they go, ‘Fine. We would love to sell it back to you.’

Danielle Town: They’re like, ‘Nobody’s come in here for two weeks.’

Phil Town: Nobody wants to buy this car. I said, ‘I’ll give you 20 thousand for it.’ They go, ‘Give us 40.’ And I go, ‘Okay, I’ll give you 30,’ and we do a deal. I now buy your car for 30 thousand dollars. Now, that’s the first money I’ve put out so far. I bought your car from the dealer for $30 thousand. Now I owe you a car … I don’t owe you money … I owe you a car. So, I gotta drive your car back and I give you back your car, and you give me the 100 thousand dollars.

Danielle Town: So you made 70.

Phil Town: I made 70 grand by shorting your car.

Danielle Town: That was a really cool explanation, dad!

Phil Town: I’ve done that one before. Because in class, I go through that explanation, and then I tell people why we don’t do that.

Danielle Town: Why don’t we do that? Cause it’s super-duper risky in case the information doesn’t come out in the next few weeks?

Phil Town: You’re lawyer-gene just kicked in big time there. Yes, that’s exactly why. Because, there’s so many things that can happen even if I’m right about the information. For example, Volkswagen could buy Mercedes to get them out of the trouble. So, sometimes even when you’re right, you get crushed.

 For example, one of my favorite investors is a guy named David Einhorn. Phenomenal investor who shorted Green Mountain Coffee Roasters, because he thought there was some fraud going on in their accounting. He shorted it; it did go way down. I’m sure he made a lot of money. But then Coca Cola came in and bought the whole company, just on the rumor … Coke either bought them or entered a deal. I think they entered a deal with them. Just on the rumor that Coke was gonna do that, the stock went through the roof.

 So Einhorn’s shorting these guys at around 90 bucks a share. They go clear down to 25 a share, and I hope he covered. By covering, that means you go in and you buy the stock in the market for 25 and hand it back to the broker, and he gives you your 90 dollars a share. But if he didn’t, the stock went clear back up to about 110, or 120 as Coke got involved.

Danielle Town: I would not be able to handle being right about something and still losing. I would not be able to handle that.

Phil Town: It’s horrible. Ask me how I know.

Danielle Town: Oh, the pain of that! It’s one thing to be wrong and go, okay, we talk about this all the time. Our checklist of expensive errors that investors have made that’s in our book, Invested. We talk about stuff we screwed up on, stuff we’ve missed. That stuff I can handle, that’s my error, that’s user error. That’s something I can work on in the future. But to be right and not have screwed up and not have missed something, and to still get totally crushed like that? Oh, Lord.

Phil Town: It’s not fun. That is one of the main reasons that Warren and Charlie don’t short companies, even though they have lots of information that the company’s not good. The second reason is that early in Warren’s career, he acquired a company near Omaha that was in a small town in Nebraska. He basically bought the company because the value of the company was substantially more broken up into pieces and sold off in pieces, than it was selling for in the market.

 Other words, like buying a Porsche car for such a cheap price that you could take the engine out and sell the engine and get your money back. And then you’ve got the wheels, you’ve got the tires, you got the seats. You can disassemble the car for a profit. Warren did that in this small town at early, early, stage in his career. Of course, when he disassembled the pieces, a lot of people lost their jobs in that town. And the town-

Danielle Town: I thought you were gonna say something like that. I don’t see him being the kind of person who can just break up a company and feel okay about it.

Phil Town: I think he was horrified, actually. He made money on the backs of working people. Even if the company deserved to be broken up, even if it was the right economic thing to do, the harsh reality is that a lot of people, his state neighbors lost their jobs. It was a lesson, I think he never forgot.

 I read that in one of his biographies. It’s such an important story for Warren and Charlie why they don’t short companies. Because short sellers are hated by management. The people who are running the company, the people who work there. Remember, we’re talking about investing in companies, and every dollar you put into this company is a vote for that company to be around in the future. Well, every dollar you short a company is a vote for it to fail in the future.

 How do you think the employees think about you if you’re a big short seller? They hate you, and the management hates you. This is just not Buffett’s [oove 00:11:00] at all. He would prefer, like most of us to be loved rather than hated. There are short sellers who do very, very well.

 But for that reason I’m encouraging our students to really focus on the positive. Let’s encourage companies, let’s not discourage them. The third reason that shorting is maybe not taught by me is that the companies that you short, you should restrict to those companies which your fads, failures, and frauds.

Danielle Town: Fads, failures, and frauds. Fads, like trends.

Phil Town: Something that’s just, the hula hoop or the pet rock. Just a faddish, not gonna be around long term company. That’s a decent thing to focus on a short. A fraud, of course, if you can identify a fraud; like Einhorn thought he identified accounting fraud at Green Mountain. If you’re at that level of forensic accounting that you can find that when the SEC isn’t finding it and the shareholders aren’t finding it, that might be a level I can’t play at.

Danielle Town: I’m thinking, you’re describing me to a “T” dad. I totally understand forensic accounting.

Phil Town: I’m not there. There’s just too many clever ways that accountants who are handling corporate books can mess with the accounting in ways that are not illegal; they’re not fraudulent. It’s just very confusing, so I’m not going there. And finally, that the company’s just a failure, that the products have failed completely.

Danielle Town: It’s going down. You can see it a mile away.

Phil Town: One of the favorite shorts out there right now for a lot of people is Tesla.

Danielle Town: Really, people are shorting Tesla?

Phil Town: They are.

Danielle Town: Because the price is so insane?

Phil Town: Because the stock price will require the company to perform some day, and deliver a lot of vehicles into the market place. They’re having production trouble with their lower-price sedan. This is where shorts come in. They come in and they look at this and they say, ‘Well, Elon Musk is this visionary, but he’s a visionary for going to space, he’s a vision for solar, he’s a visionary for cars. What else does he want to be a visionary on?’ Is he focused enough?

 There’s a recent article I think, that was really to the point, and that is that you’ve got this guy named Durant who basically built GM. He was a visionary back in 1900’s. He built this fabulous company, but he was looking to be the next visionary of the next thing and the next thing.

 Alfred Sloan was brought in by the board to try to get this company under control. Sloan is the guy who made GM super successful in the 1920’s, and 30’s and 40’s. The company wouldn’t probably have made it under Durant. It made it big under Sloan. I wouldn’t be surprised if there was that guy floating around Musk’s organization waiting to actually be the guy who makes production work.

 Here’s what the short’s position is: he’s not gonna get there soon enough, that guy. Because GM, Mercedes, they’ve been watching Tesla for years now and they’re under way in their own slow behemoth, ‘turn the ship’ way. The question is whether Tesla’s gonna get there soon enough. Not whether they’ll get there; they’ll get there, but whether they get there soon enough to fight off the established mainstream companies.

Danielle Town: I would guess that the other reason is that the actual stock price of Tesla is so high compared to how much money they actually make and how many cars they actually make. It’s something like the size of GM or something like that. I’m getting it wrong, but it’s insanely-

Phil Town: No, no. You’re not wrong. It’s right up there.

Danielle Town: It’s insane for what they actually produce, which is hardly anything compared to what GM produces. And so, I can see shorting it just thinking, ‘This is not sustainable, this price.’ It reflects nothing that’s in reality, that’s happening at the company. It’s all just optimism about Elon Musk, which I completely get.

 I completely get it. We all think what he’s doing is fantastic. He has created a sea change in car manufacturing that has made the electric car be a viable option. That’s incredible and world changing for us. I really respect all the work that he does, but that doesn’t mean that the stock price of his company has to be the same as-

Phil Town: And that’s the toughest thing. You are thinking like an investor now, who needs certainty about the future in order that this is not a speculation. When Tesla by any definition of speculation is a speculative investment; it’s a trade. It isn’t an investment in our definition of investment. You were thinking like an investor, honey.

Danielle Town: That was a really good compliment. I appreciate that.

Phil Town: You’re definitely thinking like an investor. The hard thing about being a good investor is you have to let go of a lot of things you yearn to own. You have to put those in that risky biz category and keep the amount of money you’re exposing to a minimum because it’s at risk. You don’t know where it’s gonna come out. It’s a lot of fun to buy Tesla and to be feeling like, ‘Hey man, I own the future here. This is a great company.’ But you wouldn’t want to bet your retirement on that.

 You go back to Warren Buffett’s great statement, that Bill Gates early on told him: “Buy Microsoft.” They’re buddies. “You need a computer, Warren. And when you get one, you’re gonna see how important Windows and Excel are, Microsoft products.” And Buffett said: “What do I need a computer for?” Gates goes: “Well, you need it to do your taxes.” Buffett goes: “I don’t pay taxes.”

Danielle Town: What?

Phil Town: No, Gates said: “You need it to keep track of your stocks,” and Buffett says: “I only have one stock. I only own Berkshire.”

Danielle Town: Hey, speaking of Berkshire, great segway, dad. We are gonna be at the Berkshire Hathaway meeting … I’m just gonna throw this in there quickly … as I mentioned last time, we’re scheduling as we go here. We’ve got our live podcast scheduled on Sunday at 1:00 p.m. at The Bookworm. Please come early, and there’s gonna be limited seating. 1:00 p.m. at The Bookworm in downtown Omaha, and we’re gonna have special guest Laura Rittenhouse or L.J. Rittenhouse, who is an incredible Buffett expert. We’re gonna talk all about Mr. Buffett, Mr. Munger, our experience at the meeting, and maybe have some other special guests and bold-faced names dropping in a well.

Phil Town: Don’t miss it. Are we going live if we can? Are we gonna be like-

Danielle Town: We’re going live if we can. We’re working out all those details, so we’ll probably be on Facebook and Instagram at least. And then maybe live otherwise also.

Phil Town: We’ll try to be live at 1 o’clock.

Danielle Town: That’s 1 o’clock central on Sunday, May 3rd?

Phil Town: What’s Laura’s book’s name that it’s just so phenomenal that-

Danielle Town: Sunday, May 6th. Sorry. Sunday, May 6th.

Phil Town: Sunday, May 6th, 1:00 p.m.

Danielle Town: Central. What is the name of one of her books? Is that what you said?

Phil Town: The main book that I think is just so great about-

Danielle Town: It’s called, Investing Between the Lines. I put this in my first actually newsletter that I send out now with what I’m looking at, what I’m reading, what I’m thinking about as far as companies. I featured her book because I thought it was such genius. And then I got to talk to her; we both got to meet her and convinced her to be on the podcast with us.

Phil Town: She is off the charts, super smart, and she’s a friend of Warren Buffett’s. He praised her for putting this book out. He said: “You’re on the side of the angels in this battle against the corporate reality time warp that they do.” They write letters that many of these corporate officers just have written by their PR people. It’s just full of soft mushy goo, and reflects nothing about the things we need to know as an investor. Laura ranks these guys’ letters, and shows you how to do it too. Shows us how to do it.

Danielle Town: What she does is fascinating. She uses words to determine actually what the numbers mean. As you all know if you’ve listened to this podcast at all, I love it. I just love it so much, ’cause words I can understand. Numbers, more difficult. What I’m also excited about, dad, is I don’t think we’ll get into her book on that podcast ’cause I wanna hear about her impression of the shareholder meeting on the weekend. All the people she’s met, ’cause she knows everybody.

Phil Town: Go read the book.

Danielle Town: What I’m going to do is we’re gonna have her on the podcast for a proper conversation about her book in the future. And what we’re gonna do guys, is launch our Invested Book Club, finally. You’re right, dad. Take this as the first sign and we’ll mention it again coming up once we have everything scheduled. But go get her book, Investing Between the Lines, so you know what we’re talking about when we speak with her.

Phil Town: It’s pretty cool ’cause-

Danielle Town: We’ll announce it so that you know when you should have read it by.

Phil Town: ‘Cause you know how important I think letters are from the CEOs, and how important Buffett thinks a letter is and what an incredible letter he writes to give people everything they need to know in order to figure out the value of the business once a year. How are we doing? What’s the value of this business? And that’s what investors need to know, and that’s of course what many CEOs don’t bother to give us, because they don’t want you to look at them too closely. We want to look very closely, and Laura really helps us out with that, so get the book.

Danielle Town: That’s exciting, and let’s get back to the short selling, and what we’ve been talking about … this is why this came up … and just so you guys know, I haven’t forgotten the big picture of what we’re talking about here. What we’re talking-

Phil Town: Good, ’cause I’ve completely forgotten the big picture. I don’t know where we’re at. What are we talking about?

Danielle Town: I’m here to say, we’re talking about the market. We’re talking about what is happening in this market which is going up and down, lately down. How we … as you put it wonderfully, long trade and long term oriented investors should think about this market and interpret it. And what you had been telling us a few episodes ago is about these technical indicators which blew my head off. We’re gonna get to them, cause we didn’t end up finishing, because we got off talking about intrinsic value of companies and [crosstalk 00:22:23] prices.

Phil Town: I’m seeing something historic right now on my screen.

Danielle Town: Oh, yeah?

Phil Town: Real-time. These arrows, these indicators … I call them arrows cause they’re green if they’re indicating ‘get in,’ and they’re red if they’re indicating ‘get out.’ One of those arrows is flickering red, and then it disappears real-time. When it hasn’t flickered red for two years.

Danielle Town: Which arrow is that?

Phil Town: The MACD.

Danielle Town: Oh! You told us about the MACD. That was the first one you told us about.

Phil Town: It just went red, just now. As I’m speaking it went red, and it had gone red a couple minutes ago. It’s gone again. It’s no longer red. In other words, we’re on the cusp here of a significant shift if this thing goes red in the next few days. Significant shift in the direction of the market. Not significant enough to pull the trigger to get out, but we’re getting there. This is-

Danielle Town: Hey guys, I’m not gonna tell you exactly when we’re recording this, because this is for education and entertainment only.

Phil Town: This is entertainment portion of the podcast.

Danielle Town: Exactly. We’re recording it some time around when this is actually coming out, but we’re not seven months in advance, and take it as entertainment education. Just because some little arrow on my dad’s screen showed up doesn’t actually mean anything.

 As you’ve been telling us so strongly, dad, that these indicators actually are to be taken very much at your own risk. So when you see an arrow … guys, give me a minute here, because I know we’re supposed to talk about what happens if the story has changed based on price; that’s where we left it last time. But I wanna ask you right now, dad, you’re looking at this flickering arrow. What does that tell you, and how much of a grain of salt do you take with it?

Phil Town: I take it with quite a big grain of salt.

Danielle Town: You sounded pretty excited just now. You didn’t sound very salty.

Phil Town: No. It’s a grain of salt; however, there’s this huge bucket of salt hanging over the table, and it just dribbled … the salt of Damocles is hanging over the table and it just dribbled a little on the table right there. There’s already one that’s been triggered. If this one is now dribbled a little on the table, the next one will be the bucket.

Danielle Town: Why are you saying that? Why the next one? Cause you had told me before that there were three indicators. We talked about the MACD. Wait, did we talk about the MACD, or did we talk … oh, sorry we didn’t talk about the MACD. We talked about the moving average. The ones we didn’t talk about were the MACD and the Stochastic. So when you say, ‘I’m looking at one, and now I need one other one,’ that’s two, not three.

Phil Town: I’m looking at three, but one is firmly red over it. Firmly red already as of the end of March. That had not been red since early 2015, so this is a three-year switch here that’s come along. The moving average actually hasn’t been red since late 2015. It’s still green, and therefore the salt of … what is it?

Danielle Town: The sword of Damocles.

Phil Town: Damocles. The salt of Damocles is hanging over the table still. But the one that’s moving right now and bouncing back and forth between red and green really, is the MACD. We’ll get into all this, you guys. We take this with a grain of salt unless a lot of other things are in place, and a lot of other things are in place right now that have been a long time coming for this market, this shift and move the other direction.

 There’s a lot of head fakes in this market, and a lot the federal government can do to prevent the market from continuing in the direction it wants to go, which is down. And those things it will do as much as it possibly can. There’s not a politician in America that wants to be serving in his capacity as a politician in the republican party right now, who wants this market to go down. The democrats would love to see it go down, of course, ’cause they’ll be swept into the next election.

Danielle Town: Now, tell me dad, should we talk about what the MACD is since you just mentioned it? Or do you want to go ahead and talk about-

Phil Town: I wanna talk about price, because price is the bigger picture here. All of these indicators are driven by price over time. Price is over time. Moving average is over time. Let’s just talk about price for a second, and then we’ll come back next time, we’ll talk about the actual use of price over time in this computer tools that drive trading across the market. Price over time. The big question was, do we make a decision based on changes in price? Is that what you’re driving at?

Danielle Town: That’s exactly right. My question was, we were talking about going on about the story of the company. The story of the company is the same as it has been. Everything’s just chilling, moving along, except that, let’s say the price of the company has made some big enough change that I, a lazy investor who pays no attention has even noticed it. Does that implicate the story, or does it not? Is it only price, and my story is the same? How do I think about it?

Phil Town: You think about price as part of the story. Price is a component of the story, and the reason price is a component of the story is because ultimately the story is about understanding the business well enough to determine the value of the business at a price we’d like to pay for it. Price is baked into the story; almost a conclusion of the story is price we’d like to pay for it. Part-

Danielle Town: It’s almost like actually, instead of price being part of the story … cause I actually purposely don’t look at the real-life price of a company when I’m writing a story, cause I don’t care what the market thinks. What I care about is what I think the value of the company is.

Phil Town: Well, yes and no. We do one version of valuing a business. We call the margin of safety analysis. We talk about this at length in the book.

Danielle Town: We went through it a lot last week.

Phil Town: That does get us to what we call intrinsic value, or the value of the business, or what it’s worth. But the other forms of valuing the business or putting a price … they’re not really forms of valuing it; they’re forms of pricing.

Danielle Town: You’re exactly right, that’s true. That’s true, we have two kinds of pricing and one kind of valuation.

Phil Town: ‘Scuse me? ‘Scuse me? ‘Scuse me?

Danielle Town: Oh.

Phil Town: What did you just say?

Danielle Town: Phil Town, you are correct.

Phil Town: I am so killing it.

Danielle Town: I stand corrected by you in this moment.

Phil Town: I would just like to point out that this is so historical, and I just want to thank you, my friends. I wanna thank my family. Thank all of you who are here today.

Danielle Town: I have a comment. Are you ready for this?

Phil Town: Yeah.

Danielle Town: I have your own words in our book. Page 235, everybody. Dad, I’m gonna read: ‘Remember,’ dad admonished me, ‘price is actually least important because time will fix errors on a wonderful business. If you buy a great company but pay too high a price, if it stays wonderful it will eventually be worth more than you paid for it. You’ll just have to wait longer.’ This is in the context of our expensive errors list, which is a fantastic checklist of errors that my dad has made, that other investors have made, which is great to check things against.

 I find this conversation really interesting about whether the actual price in the market is part of the story or affects the story at all. What you’re saying is, the price that I find, that’s part of the story and it’s incredibly important part of the story to understanding the company, to making sure you know what you think is gonna happen with that company, to understanding the event that’s happening to that company. You’re dying laughing over here.

Phil Town: You’re doing that lawyer thing, which I love so much. But here’s what I was driving at in that price quote from the book, and that is that it’s least important, but it’s not unimportant. It’s part-

Danielle Town: Exactly. I wasn’t trying to invalidate my, ‘you are correct.’ I was adding color.

Phil Town: We need to understand the business, and then we need to figure out what we’re willing to pay for it. We’d like to be able to think that involves figuring out what the value is. But I think, as Warren has pointed out more than once, we don’t necessarily understand for sure that we’ve got the growth rate right, that we got the PE right, that we know 10 years from now what this will be worth. That’s obviously quite difficult for most companies to know what it’ll be worth.

 We might have a range that we feel we’re comfortable with. The reason I’m bringing that up, that idea that we probably are gonna have an idea about value, is because when Warren was really getting rolling in the 1950’s, his standard modus operandi was to sell at that value price.

Danielle Town: Say that one more time. Sell at the-

Phil Town: At the value.

Danielle Town: At the value.

Phil Town: Yes. Therefore, he knew what he thought the value was, obviously. In other words, he’s gonna buy it at a good price. He does understand the value and the range well enough to say, ‘Hey, we might not know exactly, but we know we’re in the ballpark, and we’re gonna sell here. And we’re gonna take our profits.’ On the basis of that, he was killing it. He was making 30, 50% a year, 100% some years by liquidating these companies as they got toward their intrinsic value. When you think about that, that’s really smart because at intrinsic value, a company stops having a super high rate of return for you that you have because you bought it on sale.

 For example, if we buy a stock at half of its real value, which is what our target is … wanna buy it at half of real value or intrinsic value, and it goes back to real value, we’ve doubled our money. Now, our compounded rate of return is just a question of, we’ve doubled our money, and how long? If we’ve doubled it in five years, our compounded return is 15%. If we doubled it in three years, our compounded return is 26% per year.

 Let’s assume that this company is a slow growing chewing gum company like Wrigley’s or something. We love the business and it’s super on sale, so we go buy it. And son of a gun, we were right about buying it at that price, and within three years it goes back to its real value that we believed it was worth. That means we’ve doubled our money in three years. You’re writing things on the page.

Danielle Town: Yeah.

Phil Town: Every time I start to talk numbers, did you just zone out on me?

Danielle Town: No, are you kidding me? I’m really struggling between this idea of, all of a sudden you’re telling me Warren Buffett has been selling for years and years at the … I suppose the intrinsic value-

Phil Town: Intrinsic value. Let’s be clear, he only did that years and years ago. When he got big, he couldn’t do that anymore.

Danielle Town: Well, right. But the advice that you told me and that we have enshrined in our book is, you don’t sell unless the story has changed. And Warren Buffett says you never sell, and you only have 20 companies to buy in your entire lifetime. It’s okay if you’re changing your mind on that, but let’s acknowledge that this is a change.

Phil Town: I’m not changing my mind on this. It’s not a change. No, this is actually to the point of owning 20 companies in your whole life and getting very wealthy from it. Follow this: that as this company goes back up to its real value, we’ve just doubled our money and let’s say it took three years for this chewing gum company to do that. And we’re making 26% per year. That’s a stunning, huge gigantic rate of return. We’re killing it.

 But now this chewing gum company is no longer … it doesn’t grow at 26% a year. We only got 26% a year because we bought it massively on sale. So the actual growth of our money from the time it returns to its real value in the market goes down to whatever its growth rate is of earnings. Which, let’s just stay in this case, stipulate in this case, it’s 4%. Earnings growth is 4% a year. We got 26%, 26%, 26%, and now we own it forever; and we get 4%, 4%, 4%, 4%, 4%, 4%. You see what I’m saying?

Danielle Town: I do.

Phil Town: When Buffett was small and nimble, he thought it was a better idea to unload that thing at that price of intrinsic value, and then go buy something else that’s on sale. Now, let me take us to the 20 companies. This chewing gum company being one of our 20 companies. We sell it as it’s reaching its intrinsic value about the time the market has recovered from the last recession. Following me?

Danielle Town: Mm-hmm (affirmative)-

Phil Town: We sell it there at that high value, it’s full value, and now it’s on our watch list and we wait for the next recession. Sure enough, here it comes two or three years later. Next recession chops the price in half again, and we step in and buy our chewing gum company back. And then the recession’s over, it goes back up, we double our money, and we wait some time in there. We sell it, and we wait for the next recession, and we buy it back.

 This is Buffett’s modus operandi for many years. Let’s take the case of Coca Cola. If he could have been nimble enough, he would have sold Coke at $75 bucks a share. We know that because he told us the reason he didn’t sell it was because he wasn’t nimble anymore. He said, ‘If you don’t think the size of your investment portfolio is a weight on your returns, you don’t know how hard a weight that is.’

 Let’s say he was nimble and sold it at 75, and Coke came down to 40; he’d be a buyer again. And buy Coke … wait, goes back up. Sell it again. You can do the same companies over and over again if you’re nimble enough. Does that make sense, honey?

Danielle Town: It makes sense. I think the answer is that one way … tell me what you think about this: the answer is that one way the story can change … let me back up. The answer is, the story has changed. The way the story has changed is the event has resolved itself, and therefore the price has gone up to its intrinsic value.

Phil Town: Exactly.

Danielle Town: And therefore, the price does affect the story, or the story does affect the price; they affect each other, and that’s the answer. Yes, the story has changed. That doesn’t mean that you’re not still following that company and loving it and being obsessed with it in everyway.

Phil Town: If you happen to own a company that’s not a chewing gum company, you may not want to sell it at its intrinsic value because wonderful companies … this is what Charlie brought to the game … wonderful companies have a way of growing quite fast. Even though you had this explosive growth in your returns because you bought it so cheap, it doesn’t mean that it’s not gonna be something you wanna hang on to.

 If you’d done that, let’s say with Walmart … a company I’ve criticized here, but let me use it as an example of a company that did grow at 20% a year for many, many years. You could have bought and sold that company, or you could have just hung on to it and made 20% a year. Just hanging on to it, because the growth rate of the company itself was 20% a year.

 We don’t want to sell those companies. We don’t wanna sell companies perhaps, that are making a return on our capital of 20% a year; maybe they’re giving a lot of that money back to us every year. What the heck! I don’t want to sell that. See’s Candy, for example-

Danielle Town: I was just gonna say See’s Candy! I wrote down See’s Candy!

Phil Town: $65 million a year in cashflow on a company Buffett paid $25 million for. You don’t want to sell that company. That’s a golden goose. It’s just flowing cash into you. It’s really just about what’s the return on your capital, that you’ll make that decision on.

 Ideally, we never want to sell those companies. Ideally, because they continue to grow, continue to grow, continue to grow. We don’t have to do anything; they compound our money at a great rate of return. Leave it alone, leave it there. We’re not smart enough to beat that companies rate of return. Let’s just let them have it, rock and roll.

Danielle Town: What we’re getting at here overall, and this is our entire theme right now, I think, is, do we as investors sell what we own right now to prepare our washtub when it’s raining gold, or do we not? Do we hold on? Cause we don’t have unlimited funds in the back account.

Phil Town: The answer is, if the company is raining gold itself, because it was rate of growth internally, you’ve already got it on sale. You would buy more at this price or near this price. Hang on to that one. If it is a company that’s gotten you intrinsic value and it’s way overpriced, at a big recession it’s gonna crash. You’re gonna be able to buy it back.

Danielle Town: Let’s talk technical indicators next time.

Phil Town: Next time! That was fun. Okay, we gotta go play.

Danielle Town: Alright, thanks everybody! Bye!

Phil Town: Just wanna remind you all, that I was right. I was right.

Danielle Town: Bye!

Phil Town: Time to go play.

Danielle Town: Bye!

Phil Town: Hey, thanks for listening to InvestED. We hope you enjoyed this episode. Head over to Investedpodcast.com for our show notes and a special offer on how the podcast listeners can attend my three day, transformational investing workshop for free, where we just teach the heck out of you for three straight days. We don’t sell anything, and we get you a scholarship to come do it for free. So come on over there and take a look at that.

 And by the way, as our lawyers want me to say, everything discussed on this podcast is either my opinion or Danielle’s opinion … and my opinion’s right … is not to be taken as investing advice because I am not your investment advisor, nor have I considered your personal situation as your fiduciary. So, this podcast is just for your entertainment and education only, and I hope you enjoy it. Until next time, time to go play.

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On the InvestED podcast, Phil and his daughter Danielle shine a light on the successful investing strategies that gurus like Warren Buffett have used for 80 years. Listen in for a great stock market education on basics, learn how to invest on your own, and follow along with real-time examples and investing tips from week to week.