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You're listening to IP on this week's episode of the Investors podcast, we have our mastermind discussion for the third quarter of twenty twenty. For anyone not familiar with the format, each person brings one stock picker to the table in the rest of the group tries to provide valuable feedback and risks associated with the pick. The intent of these episodes is to provide the listener various ways to assess the strengths and weaknesses of trade ideas, while also showing you some insights into the key metrics we look at when finding and selecting various trade ideas.
So without further delay, let's go ahead and dive into this episode.
You are listening to the Investor's Podcast, where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone, welcome to the Investors podcast, I'm your host, pressed and patient, as always, I'm accompanied by my co-host, Stig Protozoan. And like we said in the intro, we're here with our two great friends in finance, Toby Carlyle, Hari Ramachandra. Guys, welcome back to the show.
Thanks so much for having me. I love doing this, the highlight of the quarter. How are you? Welcome back, buddy. Thank you, Preston, A.J.. All right, so, Stig, I'm going to throw it over to you for your pick, because I find this to be very brave, smart, and I'm concerned all at the same time. Go ahead. I want to hear this one. I'm happy to say that Presson is I am repitch Alphabeat, most people probably know it as as Google, but the parent company that is Alphabeat, which is primarily Google, but they're also a bunch of other businesses.
I completely get where you're coming from here, Preston, because, you know, with the valuations we see right now with the fang stocks not looking to be able to be any more expensive and still, you know, you can be surprised. Why am I pitching Alphabeat? I pitched this back first November twenty eighteen for the Q3 Marchmont meeting. And since then it has outperformed the the market is returned twenty six percent compared to the S&P 500 to 12 percent.
And I think it's a very different type of pick than Spotify that it did last week. It is a tech company, but it's a very different tech company. And going back to what president said before, I would like to argue here that has a different downside protection than something like Spotify, but you probably won't see the same 50 percent saw as you saw with the last pick here since the last quarter. And one of the reasons why I really wanted to repitch the stock is that you're being a value investor.
We tend to learn to become contrarian and to think that we can be right even if the market is wrong.
And I guess what I've experienced in my own investment career is that I've sometimes taking it too literally, too often thinking and for too long that if I had a different opinion, then the market must be because I'm so much smarter and it just takes such a long time for the market to wise up. That approach is very expensive and opportunity cost because you could invest in something different, the better business. And I also come to realize that often I just have to acknowledge I was wrong and have to move on with my life and sell that stock.
So I sort of like wanted to to use that going into Alphabeat, because whenever I do see a stock that has outperformed the market like it's the case here, I really want to see if this is a chance to double down and see if my investment thesis has not been fully appreciated by the market and especially what we've seen here recently with a lot of great investors, definitely not including me, but a lot of great investors building stakes. I think the most famous stake here recently, Seth Klarman, just building a five percent stake in Google.
This episode will come out August 15, which is the new time for the search. And they're filing. So let's see what the so-called super investors are doing. I want to talk about another reason why I really wanted to repitch Google or Alphabet. So sorry if I use that interchangeably is that over the past two years, Google have been breaking out a lot more detailed information for the business unit, including YouTube Cloud and many other of the units specifically on the bat.
So there are a lot more information available that we didn't have the last time where I see that we can unlock a lot more value. But that was probably the longest introduction I've had. So let's get into the actual pitch. So if we look at how Google makes money, Google products are still the main source of revenue for Alphabeat. The revenue competitions have gradually changed over the past few years, and Google search is now only fifty eight percent of the revenue.
And part of that is that alphabet has simply just changed. The accounting has broken out more separate units from that. So that is part of the explanation. But whenever you think how Google makes money, you think about AdWords, think about sense. Today, YouTube is 10 percent of revenue. This is a segment that has grown thirty three percent year year in Q1. It's only up six percent year year if you look at Q2. But that also includes a lot of covid-19.
And then you have Google cloud, you know, seven percent of total revenue, but it's growing like forty three percent growth year year. And then they have a bunch of smaller units typically categorized in other Google revenue, which includes YouTube, not advertising revenue and play, which is up twenty six percent. Then they have all the bets. Now I usually give a more detailed explanation of the industry whenever a pitch a stock which for Google still is online advertising primarily through search.
However, I did that last time in Q3 twenty eighteen and I'll make sure to link to that in the show notes. And in that space, not a lot has changed. And I'll get back to that because I actually think it's a good thing. But Facebook and Google still heavily dominates the space. Amazon has caught up a little, but there's still way behind the two giants. Let's talk about Google's moat that comes in many different shapes and forms, typically talking specifically about search.
The still dominate the market with more than a 90 percent market share. And some of that moat simply comes from the brand recognition and people just going on Google search by default. But interestingly, the mode of the most public service that Google has is really not doing a much better job than most of the competitors. However, where they really have a moat and why so many people use the service is also that 15 to 20 percent of the searches are so-called unique.
And there's a huge difference there because Google has such. A data advantage, so they get so much better search results on those trees. And speaking of data, I would like to emphasize that for a company like Google, it's not really only the vast amount of data, which in itself is a moat. Whenever it comes to the amount of data, there is a saturation point. So rather, I would say that it comes from the breadth of data of all the different platforms we have and how they're able to process that in a central spot.
Because data is not just your input data, it's training data, it's feedback data. And you'll need all of that to maximize the value. And because of that, in many BUTLIN not only feels Google really has a moat compared to most other companies, including some of the big tech companies, I think it was last time Hari introduced the term China proved and Corran approve. So it was kind of interesting the way he looked at that. So I wanted to include that here in my pitch.
And starting with China, there's a clear distinction between competing in the West and competing in the East. And if we do look at the Chinese giants like Tencent and Alibaba, and you can even say Baidu to some extent, talking specifically about search, even though the Tencent Alibaba is sort of gearing up to make Baidu services less relevant because of what they're doing with their ecosystem, they would just have a such a hard time competing with Google in the West, just as we result will have major issues in China.
By the way, one practical example is that for something like Klout, they're just not competing about the same type of customers like you just have some customers going to something like Amazon Cloud, Google Cloud, Microsoft products, and then a completely different segment going after cloud in China and in the East. In terms of being Korona proofed advertising, it is expected to decline. They'll we are looking at around five percent in 2020, but still 30 percent, up from twenty nineteen to twenty twenty two.
And I remember going back to twenty eighteen that I was so concerned about what would happen with the next crisis. And I don't think we could have almost a more severe crisis that what we're facing right now. And given that advertising is probably the first thing that's being caught in a time of crisis, we've really seen advertisers feel the pain has been in conventional offline marketing and not in the online. I think it's quite astonishing to see the impact of the lack of impact for a company like Google.
And from the perspective of a business owner, despite where you are in the media cycle, if you can track a hundred dollars in revenue from a ninety nine dollars expense is still an easy decision to push through. And I kind of feel that's very important to understand. Whenever you look at something like whose revenue and this is an ability for advertising, but before go to the to the valuation, I actually wanted to talk a bit more about some catalysts and sending that some of that over to Tahari, because if you look at Google, you know, one of the big things that Dick did back in twenty seventeen is that launched the first strategy.
Know I'll be the first one to say that you don't hear anyone talking about that. They have a strategy never to use. I so I do understand that it's a buzzword for many companies more than actual strategy. I wanted to see how that translates into into alphabet. Sundar Pichai said that we want our products to work harder for you in the context of your job, your home and your life. And that was sort of like the framework we sold the new strategy around.
We saw Google, a system with just one of many products that we saw around that time coming out. This strategy in itself doesn't really I want to say it doesn't clear the no test. Sorry, throwing that over to Harry. I'm curious to hear some of your thoughts about where you see some of Alphabet's revenue coming from in the future and what your more qualitative analysis say about Google and the disruption we're going to see from EHI. This is a great conversation and an ultimate introduction cover all aspects of Google, and I do agree with you that for the next three to five years at least, Google is well positioned in terms of quality to aspects of the business.
I think they have really strong boards in terms of their search engine for now at least. And of course, YouTube, they're also making great progress in Google Cloud, which is not talked about it, the third most popular cloud platform. I think they're making some good progress with Thomas Corian. However, there are some issues or concerns that I have with Google, and they are more for the longer term. Number one is the optionality factor that Google used to have and like how they came up with new businesses.
Looks like all the pieces are now kind of big then, except for the self-driving technology, which people don't really understand how to value, how it will change Google's future revenue and their position. But there are some concerns in terms of what has happened in the past few years. I would say in the core business search, one of the developments that concerns me is Amazon stealing their lunch for the most lucrative such works, because today if I want to buy a product, I just go to Amazon directly, not Google it.
Those were the ads that Google had the most most expensive, which so that's number one. And number two, in terms of their a dancefloor was like one of the best the way they launched it. But there are other open source and other platforms that have taken the lead now. It reminds me of how Sun used to be back in the day when they were the one to come up with the best technologies, like if you see today's operating system, especially anything that is UNIX and Linux based operating system, a lot of the underlying technologies were actually pioneered by Sun, including Java, which they open sourced, but they were never able to capitalize on it.
And there were other people who ate their lunch. And when I look at Android, when I look at some of the progress that Google has made in terms of open sourcing with denser flow, I don't say that Google is sun, but it's kind of very similar. And finally, with Larry Page and Sergey Brin not at the home, I miss them. There is a difference between a founder led company and executive hired hand leading the company. There is definitely a difference in terms of the vigor and vibrancy.
But having said that, this is all for next year. The concerns are high, but I would rather have Google in my portfolio than cash. That's how I would say. Yeah, I agree with you on the Google versus Cash comment. I got two questions for you based on some of the stuff you were saying there. So the Tenzer flow piece, which is the algorithm or the the code, the open source code that Google has for artificial intelligence, isn't the business model more to push them into Google cloud for processing?
So I'm kind of curious because your comment made it sound like other competitors are pushing developers into a different A.I. algorithm over tensor flow. Is that because Google Cloud is too expensive relative to maybe using Amazon's artificial intelligence software and in their cloud computing? That's a great question. I think it's not about whether the flow is good, in fact, it's really great and sophisticated. And you're right where Google wants to capitalize on their denser flow platform is to expose it to their Google cloud.
What I see the problem with Google and some of that is being drafted is in general their focus on coming up with the best and most sophisticated technology, rather than focusing on the use case for 90 percent of the customers enterprises, they don't need all the bells and whistles that tons of law offers. Folks like Amazon Web Services and other companies are just good at identifying what the customer needs and offering those features to their cloud or platforms. And Google has been struggling in that.
So that's the difference. The other question I had for you, Harry, was in the the driverless car technology, the software, because I really don't know anything about where Google stands in that race. Would you say they're competitive? Who's the front runner? I'm kind of curious to hear your thoughts on some of that. Good question, and I my knowledge here is also murky, I wouldn't say no. Who's the leader there? But there has been a divergent approaches that companies have taken, for example, to slow the approach of trial by error.
I would say in a less sophisticated way, in the sense that they went from there are five levels in self driving technology, like if you are level five and that's what Google is trying to Yemen, then your power is completely self driven in all conditions. You don't even need a steering wheel. But there are what Google decided to do is go for a level fight from the beginning, and that's the reason they have been taking a long time. So this might pay dividends in the future, but companies like Tesla and other startups with the approach of gradually progressing to the levels and then they're making good progress because in a more about data, then the algorithms nowadays, the models can be really sophisticated, but less sophisticated models can be more sophisticated models with a lot of data.
And rightfully in his book, Super Powers, kind of goes into details of why that is the case. And that's what is happening in self-driving. So that's number one. Number two is they did have it early, more at one stage. But every year that goes by, they're losing it bit by bit because there are many other companies getting into it. So one argument or one option was that once they have the self-driving technology, they can come up with Wilbur Lift or they can partner with live, for example, because they want some steak and lift and then capitalize on that.
And that's how they can basically get the platform. However, with other companies also making sufficient progress, I don't know whether it will be Google will be a clear winner. So it's really hard to say at this point. Yeah, I just don't know how they could catch up with, if you're saying in my understanding of how A.I. works, is it is all about the data this training sets and pushing as much data through the model as possible. And you look at what Tesla is doing and how much data they're capturing on all these different cars that are out there.
I don't know how Google is going to possibly be able to replicate that with all the hours of nine hours of driving that Pessl is able to capture. But my issue with this one, A, it's a great company. Obviously, everyone everyone knows it's a great company. When you look at the margins, they're fat. Top line, the bottom line, you're twenty one percent. The top line keeps exploding higher. The macro environment, they're adding more fiat into the system.
I mean, we just pump five to six trillion dollars into the system. It seems like all that printing goes straight into these fang companies. My only concern is when I look at the chart, I mean, it's it's straight parabolic.
So I'm looking at Tobi, who's totally relaxed and on vacation, and we appreciate him being here with us, even though he's on vacation. But he's laying there and he's smiling. And I'm looking at Tobi. Tobi, what do you think of the valuation on this parabolic chart? Google is my favorite business, and so I was really happy to hear Harry's criticisms of it because I've kind of fallen in love with Google a little bit because I think it's such a spectacular business.
It's like this automatic money machine with these gigantic fat margins. Any time you go to use the Internet, you're basically using Google. You go in through the Google search bar to find something. Google gives you it's picture of the Internet directly where to go. If you're listening to music through YouTube or something like that, you're on Google. If you're using Gmail, you're on Google. All of these things just kept so much of your life. I've got a pixel phone, so I use a Google phone.
There's no question that it's one of the best, if not the best business in the world. And I think the others are favorites. You know, I don't like fan mag. I like Facebook, Amazon, Alphabet, Apple. These are Microsoft and MasterCard. I think they're the best businesses in the world. Everybody else thinks they're the best businesses in the world. I think they're expensive. They're sort of the cheapest ones, probably Apple. And it's on like twenty seven times of free cash flow and then Google.
Similarly, I think the two challenges with them, I don't think with these businesses, they're the kind of businesses it doesn't matter if you pay up. The worst that happens to you is sort of dead money for a decade. You don't go anywhere while the market goes somewhere, but you're not going to lose much money in them. The other thing is that Google is really controlled by three people that Sergey Brin, Larry Page and Eric Schmidt, all of the other shares basically non-voting.
So you're at the whim of those three guys. So the two challenges, I think, for Google are there's no question it's one of the best businesses in the world. The two issues for right now, I think, are the valuation. And I agree. It's like when you say you prefer to cash, I interpret that is, you know, I wouldn't say so if I did, I wouldn't sell it here, but I wouldn't necessarily buy it here.
I just so I start a position to track it or just watch where it goes to. So if it pulls back, I can buy more. And the other challenges, corporate governance. I mean, if you're worried about the way that it's governed, are you worried about the ROI that it's run? There's really nothing that you can do. You sort of along for the ride with those three guys. So I want to piggyback on what Toby just said.
I completely agree with your comment. I don't know that I'm buying it here, but I'm watching it to buy it if I get an opportunity at a better price point. The one thing that I'm looking at from a momentum standpoint is the Makdisi. I'm looking at the daily in the weekly makdisi for all of Fang. And it appears right now at the start of August, twenty twenty, that a lot of the fang companies are all starting to really kind of their momentum is starting to fizzle out.
I'm curious whether in the third quarter we're going to have another whiplash like we saw in March, April time frame, where there's some type of currency liquidity event that drops everything. We get a really violent correction and you get an opportunity to buy a company like this. That's where I'm looking at it today is amazing company. I think that you might have an opportunity to get it at a better price here in the coming quarter. I hope you can, and I guess I'm looking for that opportunity, so.
Great comments, if I'm worried about anything, I like to get back to the valuation piece here a little, I'm definitely worried about Amazon and Harry, I think you kick this off by talking about you just go to Amazon now. You don't even stop with Google. And, you know, Google have been doing the Google shopping for quite some time now after they included that into the search piece of it. It works a little better. It doesn't work as good as Amazon, but they have started to generate money from that.
I guess the functionality of going into the Google shopping universe is just not as interesting as as doing Emison was.
Really, for me, it might be that the ship has sailed. The other thing is, is also that I'm thinking Google, knowing so much about us, is there a way that they can do it indirectly, serve those ads to us or sell those products to us one way or the other? I think that's sort of like the important key, not thinking about the next three or five years, but more that like the ten year considerations that you talked about before.
To me, it was very interesting whenever the CEO, Supachai, said that Google needs to be better, like in the context of job, home and life. And I think that statement is very inflation proofed. Now, I'm not one of those people who are thinking that we're going into something like hyper inflation or anything like that. Or that being said, I do see a lot of money being put into the system and I am not completely sure what's going to happen.
It's actually a very Warren Buffett way of looking at it. Whenever you talk about inflation, where's that coming from? And if you can do that to me, that in itself is an extremely value inflation proofed system, whatever you want to call that or and whatever the macro environment says. I guess for me, going to the piece about valuation, I don't really see a product or service that will replace advertising as the main source of revenue. But I do see multiple minor streams that might combined make a huge difference.
And most prominent of these are probably something like YouTube and Cloud. And you might even say that YouTube to some extent is advertising based, but you have so many other products and so many other projects that's burning cash right now. And a few of them will turn into highly profitable businesses. And I just see a lot of asymmetric bets there. So if you look at the owner's earnings for the companies, just far from the free cash flow, because the growth capex is just so high for a company like Google and of course, for a company of one hundred and sixty six billion revenue, it does take a lot to move the needle.
So whenever I refer to a few units to be highly profitable, I'm not talking about a speech recognition service that costs 20 bucks a month for 30 million users, but something bigger than that, which at least historically we've seen that the Google has been able to pull off last time of Google in twenty eighteen, I used 50 percent as my projection for growth rates over the next five year period. And since then we've seen growth in excess of 20 percent annually.
It is tricky to come up with growth projections, as it always is. I guess with my assumptions, I'm probably looking at I can see press on this smirking there, because I'm just about to say that if I use like a Tuesday's growth model, say call it 20 percent for the next five years and then a perpetual growth of three percent, I do a rival double digit return. That is not how it's going to play out. I'm not saying they're going to grow 20 percent, but I'm also not saying that's only going to grow three percent after five years.
So it's probably going to be somewhere there in the middle. Having known Stig for many years, at this point, he's not one to ever brag, but that was Stig very delicately bragging that at a 15 percent growth rate, he was underneath of something that actually went 20 percent. And he called this for many years ago. So I give him a thumbs up and kudos to you deserve it. Well, thank you, President. I just have to say the humble break came much earlier than was whenever I said the last pick actually went up 50 percent in three months.
That was actually Mahabharat. And I got no credit for that, guys.
Anyways, throwing it back over to you guys before we move on the next picture, I don't want to, like, take all the time here for us today. I actually wanted to throw it to Toby because I can hear myself saying weird things like 50 percent growth rates and 20 percent growth rate.
I hear myself. It's the weirdest stocks that I would never do. You know, I typically would do all the machinery type of low growth kind of thing. And I find myself pitching other things. And we do see more traditional value investors buying into big tech, not just this time and like you mentioned before, but we do see a lot of that. So, Toby, for you being a developer guy and I do immediately recognize the difference between deep value and value, I know it's it's two different things, but is it because that you have other investors who are now keeping up with the times, let's just call it that?
Or is it a question of value, investors having lost their way because they are just under so much pressure to outperform the market, at least not trail the market like many have because they haven't been in these stocks? So how do you see that? I don't like facing the definition because I don't like Netflix because it's negative free cash flow, Tesla's got some problems from a valuation perspective, but I think that there are a group of companies that are very big, very well-established, very good.
Moat's excellent returns on invested capital, excellent management. And that's that I caught fire from the list of companies that I gave before. In order to value those companies, you have to come up with some reasonably aggressive assumptions. And that's been the challenge certainly for guys like me. What I tend to do is look back at historical Credit Suisse, I think with Michael Mobius and has produced this document that shows you the rates at which companies have been able to sustain very high growth rates.
I want to say. Right, it's can a company sustain a 15 or 20 percent growth rate? What are the chances they can do it for a decade, for two decades, for three decades? And you come down to these vanishingly small numbers. So you're making these very low probability bets and you're paying a reasonably high multiple for it. Having said that, if you look at these companies individually, it's probably hard not to see how some of them are not going to do that over a period of time.
So the challenge has just been for value guys to sort of be a little bit more aggressive. And those who've done it have done quite well. And those like me who haven't been as aggressive, tend to be more conservative, haven't done as well. So I think these probably are going to do very well, the underlying businesses. The question is going to be and this is the question that I always have. Just can the valuation sustain? Can the multiple sustain, even though the business is going very well?
If you think back to that first dotcom, there were lots of really good companies. And I'm not even talking about the famous dot com blowups. I'm talking about Disney. Lots of big companies came into that peak and they still very, very good companies. But they were punished because their valuations were too high and it took them a decade to grow back into those valuations. And I think that there's a little bit of that going on now. And I think that it's driven by interest rates being too low.
That's all it is. Squash interest rates to zero. Then a three percent free cash flow yield becomes very attractive, a growing three percent free cash flow. You you can't get that anywhere else. So Google is a better option than cash. You've got two challenges. If the interest rates go up, then you've paid too much. I have tended to be conservative and that's hurt me. Thank you for your response to that. I really need to think a lot about this thing around seven percent of my portfolio, I tend to be quite concentrated investor.
And Google is actually not my biggest stock picker stock because that's much more than seven percent, which I don't know if it's good or bad, but you really, really happy thing about doubling down on something like Alphabet at this price level. So thanks, guys, for the for the feedback. I really appreciate it. Let's take a quick break and hear from today's sponsor.
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This is our exclusive link Express VPN Dotcom's less type and you get an extra three months free on a one year package. That's XP, our SS DPN Dotcom's last tip Express VPN Dotcom's less to learn more. All right. Back to the show. Stig is just a final comment, I would look at your correlation, too, so if it's a large percentage of your portfolio, I know on our tippy finance, we're now doing that where we're showing compared to all your other stock picks, what's the correlation look like in indexes or whatever?
How correlated is that to everything else? And it just is another consideration to try to keep it is uncorrelated to the rest of your portfolio, if possible. I'm going to go ahead and pitch mine real fast here. Might as E-Trade. The ticker for this is ETF F.C.. I think anybody who listens to this show knows what ETrade is and pretty much understands their business model. The thing that attracted me to this one is two things. There's a lot of volatility in the market, which typically means that there's a lot more trading taking place.
And the numbers on this for me were really good. When I look at the numbers, the top line more recently or in the last three years hasn't really kind of exploded. It's gone up. It's been good. When I look at the free cash flows on the business, it's doing really quite well. When I go in and I do an intrinsic value on this, I do an IRR on the free cash flows of the business and I do it in a conservative way.
Moving forward, I'm coming up with a valuation that should pump out something in excess of 15 percent annually. Then when I look at everything else that's on the market, I'm not finding too many things other than the finance sector that's kind of pumping out our hours at this level. And I really like that. ETrade is more focused in the trading realm than they are in like the J.P. Morgan type side of finance. So, General, I mean, you look at the revenue to their bottom line, that's thirty three percent margin.
They're very healthy company, good balance sheet in general. I really like it. I think when I look at the momentum, the momentum is in a positive trend. That's all I got. It's pretty simple. I like the numbers. I like the sector that it's in and I like the conditions, the environmental conditions. As far as volatility, I expect there to be a lot of volatility in the coming year. So I think this is going to do well.
I think it's a very interesting pick, Preston, and if you look at how they make money, they basically do that three different ways. So they have interest income, they have commissions and then fees and service charges. And whenever I look at something like the interest income, we have to talk about the low interest rate. I can't help but think that at the rates we are now can only go up, which would be good for a company like E-Trade.
But I've been saying that for five years. I guess most people have thought that we can't go any lower and still seems like we can do that. And I guess at this point in time, as much as I see the low interest rates, I also don't really see them going up. Obviously, there will be some sort of mean reversion eventually, but I don't see that happening anytime soon, especially not what's happening right now with the crisis. So that's probably not where the money is going to come from here anytime soon.
If you look at something like commissions, we've seen a lot of disruptions in commissions here lately.
That is probably also not a place where you see more money coming in. I'm not saying that it would just be completely gone, but with the new players you've seen in everyone has been Robin Hood. I think that's a term that I've heard a few times. And it's a bit painful even for some of the discount brokers who, like each race, will come in and undercut like the big banks, like they're getting disrupted to the same way that they went into the industry.
Then if you look at something like fees and charges, I think that's an interesting one, too. I guess for me, I like to look at it in a very Jeff Bezos type of way. You know, he says that he doesn't want to talk about what's going to change. That's too difficult for him. He's more focused on what will stay the same for a very, very long time. And he uses the example of faster and faster delivery and low prices.
So that's a very Emison way of thinking. If we look at it from a company like this, lower fees, that's one thing.
And commodities, financial service, that's another thing.
So I guess that's some of the red flags that I see right now for a company like E-Trade hoariest. So we have had a point there. Great point, Steve, but I just don't like your comment about Robin Hood is quite prescient. I think that's definitely a risk and especially now every other company is driving down their admission fee. So how will they explain their margins and their revenue? But one thing I wanted to point out of E-Trade is one of the strengths which is not well known is that they are the preferred vendor or brokerage for most of the companies to offer their employee stock option plans or Oracle's restricted stock units.
And that's very sticky. And also the volumes are huge there because of all these companies grinding their employees to eat food. And I work for multiple companies in the Valley and invariably it has been E-Trade. I have not seen any other company. I don't know how they managed it, but somehow there seems to have some stickiness there. I also wanted to listen. There is a lot of rumor about a merger between E-Trade and Morgan Stanley. Is that any factor while you're looking into it?
And would that be kind of an arbitrage that you are looking for in the short term? I think any time you see the numbers where these numbers are at as far as how much margin and profit a buyer could capture. Yeah, absolutely. So I mean, they're a prime candidate to be purchased. I mean, just think of all the data that they've got that would benefit this far as a merger for a company like Morgan Stanley. So, yeah, I think that that's definitely something that's in the cards.
When you look at the size of this company, it's really kind of on the lower side for a large cap. I think their top line was, what, two billion or something like that? Two point eight billion. It's small relative to a lot of other things, which makes it another great candidate for a buyout. So when I'm looking at the IRR and the numbers are literally double, triple, quadruple, what you find for other companies, IRR, and it's that size, I think it's a prime candidate for a buyout.
Just to address Stig's comment real fast, when we look at Robin Hood, they're selling their order book to high frequency traders. So is E-Trade exempt from that activity? I don't know. I mean, that could be doing the same thing. I don't know necessarily their corporate culture or whether they would entertain something like that. I'm sure if things got competitive enough where they really started seeing a hit on their revenue, that that could be another avenue that they could maybe step in and really kind of give Robin Hood a run for their money.
I don't know. But I think you have a lot of people that are not day traders that have accounts with ETrade, the conduct a trade once a month. And for the fee, it's like, so what? It's not a big deal. The hassle of them changing all of their information in their data over to another platform is way more friction than they want to deal with for the few trades that they can conduct on an annual basis. I think you bring up a good point.
It's definitely too sticky, something like what can we broker? I mean, you don't want to switch broker if you can avoid doing it. I definitely agree with that. I think what you see right now with brokers is sort of what you've seen the asset management field is that, no, you're probably not going to to switch from one variable to the next to save 10 basis points, but you just see an overall pressure on profitability and it's just all becoming more and more commodities.
I do think that's the effect that's going to hit something like E-Trade more than anything else. I quite like E-Trade. That's a position that I've held in the fund, and I like it for all the reasons that you like at stake, I think it's beaten up along with all of the other financials. It's still a really, really good business, generating lots of money, really solid balance sheet. And it's in a good place, I think, in terms of being fairly low cost compared to its competitors.
The reason that we sold it was because it had this bid from Morgan Stanley. When they set the bid, it was at fifty eight point seventy four. It's one point zero for three to Morgan Stanley shares. At the time that we rolled out of it, we just had better opportunities. I see it's trading around fifty dollars. So it's an interesting I just can't do the calculation right now, but it would be worth working out where the bid is right now, what the bid is worth and sink, because it's one of those things where if the bid goes through, you do very well because you'll get a good little return from here.
And if A doesn't go through, it's still really undervalued. I completely agree with you, Toby, I'm seeing it the same way. All right, let's go ahead and go over to Toby for a year pick. I picked is Berkshire Hathaway. I think it's a popular pick on this podcast. I think everybody knows that Berkshire has underperformed the market for the last sort of could be 15 years. Basically, it needs no introduction. But Warren Buffett, one of the biggest companies.
It's like a four hundred and seventy five dollars billion market cap right now. There's a little bit of flood liability there. So it ends up being a five hundred and forty billion dollar enterprise value on a valuation front. It's very, very cheap questions are is there something lurking in the portfolio that from an insurance perspective and that's why everybody's being cautious about it. The other question is, has Warren Buffett lost it at 90 years old? Is he too old?
So the only thing that I would say to the question of Warren Buffett, has he lost it? I think that the greatest pride ever is Warren Buffett buying Apple. And I'll tell you why. I think it's the greatest trade ever. Apple was a completely known quantity at the time that he put the money in and he invested, I think it was thirty six billion dollars, which might be one of the biggest acquisitions, probably one of the biggest acquisitions for Berkshire Hathaway, maybe one of the biggest investments ever made in the market.
And the stock is up almost three times since he put that position on it now accounts for almost half of Berkshire Hathaway book. So I don't think there's any question that he's still the best investor in the market. The company is built by him to be resilient and to perform very well. I don't see how you can lose in Berkshire Hathaway at this price. They're really the only question is, is there something in the book that we don't know about?
And I think that you have to trust management. That's really the only thing you can do in insurance. And I don't think there's any management more trustworthy in America, probably, but certainly in insurance, even though that they are quite old. I think that the company is constructed in such a way that it should continue to do very well into the future. And the fact that Buffett has absolutely nailed this apple tree recently just is proof that he's still fully in command.
And so I'm sort of astonished that purchase, cheap as it is, I think that it's one of the easier positions to put on in this whole market. Whatever happens next, if it's a big draw down or if it's a big draw up, I think the purchase from a valuation perspective, from a management perspective and from a quality of business perspective, I think it's one of the easiest decisions I've ever had to make. I know when I look at the numbers, Toby, they look very good, I'm not accounting for the look through earnings and I'm coming up with a nine or 10 percent at the current price in terms of forward return.
Yeah, and in terms of the IRR that I'm doing on the company, I'm looking at the free cash flows and I'm making an estimate into the future and then basically taking the current price and solving for the percent that I think you'll get without the look through earnings. I'm already getting nine to 10 percent. So I think when you add those in there, especially if Apple's taking up as much as the balance sheet as we're saying they are, I think that you've got a lot there.
I think there is risk in the insurance area, especially if this global economy plays out in the very negative direction. I think it's going to go in the coming year. I think you're going to have massive insurance claims and I think there's a lot of risk there. With that said, of all the insurance companies that are out there, I would put Geico at the top of the list just because I know how conservative they look at this and how they're not chasing market share.
They're chasing protection for their shareholders at Berkshire and the operational subsidiary of Geico. So I think that all the insurance companies in the whole U.S. have that same risk as Geico. And moving forward, I think that as things continue to play out, they're going to continue to adjust their policies and try to manage those risks as they pop up. I don't see any one particular risk being able to blow up all the assets under Geico. So we know the one that Warren always talks about at the shareholders meeting.
But I don't think that that's something that's very realistic in the grand scheme of things. Whenever I look at the way I think I mentioned during the last meeting that I just added yet again to my position, so I'm probably not going to come with a huge bear scenario. But I do think that there are a few different important things to note. If you look at both the performance and a buffet gets a lot of things thrown at him right now because of the lack of performance.
And if you look at the lows since 2009, the S&P, five hundred and Berkshire, they're more or less the same. Like we're looking at something like a what I looked up here was one hundred eighty eight percent return to the top five hundred, one hundred and eighty one for Berkshire Hathaway. And it's only here very recently that the S&P five hundred caught up. I do know that. And if you're looking at Buffett's track record, if that is what you're comparing it to, clearly you might be disappointed.
But as we talked about multiple times, there are a bunch of reasons why he can keep up with that track record. I kind of feel that Buffett is not getting enough credit. You mentioned the Apple deal before here. So and I think it's important to understand diversification here. Buffett is famous for saying that diversification is a protection against ignorance and that is the case and makes little sense if you know what you're doing. And a lot of people are saying, well, you know, Apple is like half of your equity portfolios feel it's the wrong way of looking at it.
I mean, he's having sitting on so much cash, everyone wants him to put that question to use. He's doing that. He's outperforming everyone with that position. Then people don't like it. I mean, I kind of feel it is sort of like difficult to satisfy anyone. And Buffett has been asked specifically about the diversification part. And now what he's just saying is that this is just the third major company aside from insurance and his real interests. And I guess you can put in something like Berkshire Hathaway energy, too.
I mean, it's just another great business that he is running. One deal that he's been doing for the recent quarter really like what he did with Dominion, employing close to ten billion dollars. And we're looking at something around the one billion dollar EBITA and know we have these reservations about that. But that was what was reported, especially with natural gas prices at historic lows, buying something at a 10 percent multiple. I think it's it's not screaming cheap, but it looks like it's a good value and a very, very Warren Buffett type of way owning the infrastructure of natural gas.
I think he he had to start from eight to 18 percent of the transmission on that. I guess my question, sending it back to you, Chobe, is how much can this be a part of an investor's portfolio, something like Berkshire Hathaway, just to chipin some color around that I mentioned before, that Google was seven percent of my portfolio and it's by far not the largest position to have. That would be something like of the way. But what would it be for you to be like?
Where would you feel that a retail investor should feel comfortable? Who really understands? Berkshire Hathaway wants it to be a huge part of the portfolio. But how big should and can it get? That's a difficult question to answer, because it's always going to depend on the individual and the other opportunities that they have. It's hard luck in the fund. I run 30 positions long and I just equal with them, rebalance them on a quarterly basis. If I was to run a more discretionary portfolio, I would probably run as many positions and I'd have more concentration in some.
The thing about Berkshire is that I think that it's a reasonably steady certain 13 to 17 percent IRR minds a little bit further north because I include the the earnings. You get one hundred billion dollars in cash. You got one hundred billion dollars in Apple, five hundred billion dollar market cap. So you got the rest of the company is just the rest of the businesses that I think are already worth more than where the market cap is. I think it's a pretty easy decision on a valuation, but it's just the downside is very, very limited and it's run by great managers.
It's one of the safer positions that you can put into the portfolio. The question is whether it's going to give you the rip-roaring upside that some people are looking for. If I was to run a discretionary, I'd put it somewhere between 10 and 15 percent probably in my portfolio. But then I like five other companies that are listed a few times. If they're hard to own on a valuation basis, I'd be inclined to have much smaller positions in them just so I could track them.
I might have a one percent position in lots of those. So I'm already getting looked through into Apple. But I think Berkshire, I get a big chunk of apple and I get it at a discount. I get Buffett managing it. I get all these other things started for I think Berkshire is unlikely to blow up, to say the least. So I think it's a reasonably safe position. If you're going to source one up, this is the one to size.
So let's take a quick break and hear from today's sponsor. You know how it feels when you find extra cash in your pocket. Now, imagine you found five times that surprise money. That's the feeling with Capital One, where a new savings account earns five times the national average savings rate.
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That's imu t you al m.o.b. i l e dots l. I think Sless Billion has to get started with your free consultation today. All right, back to the show. All right, Hari, talk to us about your pick here. Brookfield Property. I cringe when I proposed this as my pick this big, but the reason I'm pitching this is sometimes you gotta go where nobody wants to go. And Brookfield Property kind of is right in the middle of it.
It's basically one of the largest operators of a globally diversified polity that they include office and retail. And the problem is retail, because they have forty one percent of their assets in retail. They have their own eighty five billion under management assets, under management. They have been growing their assets under management quite handily, healthily. In 2015, there were 20 billion assets under management and today it's around eighty five billion. Obviously, I think Toby would be probably looking into it too, because it has deep value written all over it.
It will be correct me if I'm wrong.
I do have some concerns with with Brookfield, mostly in relation to corporate governance. I do see that they're trading at a deep discount to. However, I think the main concern is they do have good financial liquidity position that they say they have run six billion in cash and undrawn credit lines. They feel they can withstand this one year or more of downturn. Their terms in office space are doing okay. That average there. There are nine years and 90 percent of them have a long term lease in office space and most of their tenants are doing OK there.
But I think their retail is hurting. Their FFO obviously has declined compared to last year at one point ninety one dollars thirty nine cents this year compared to one dollar forty eight cents. This is not including there you see a lot of that investment. So they had a couple of unique things about Brookfield Property Partners is that unlike most rej, they engage in one developing their property into what they call as township. So they have just malls. They were build townships around them and then basically develop it and then sometimes even resell some of their properties they already have.
So there is a constant flow of funds from the sale of their assets as well. So that's one thing that I found be interesting.
I think for me, the number one concern would be their leverage, high leverage. That's like thirteen point eight X that do better and it has been increasing. Their payout ratio is quite high. If I include the realized gains from the sale of assets at around ninety five percent or close to a hundred percent. But if I exclude it, it's way more than one hundred percent. There is also a component of fee that their parent, Brookfield Asset Management charges like their base fees, point five percent of assets under management.
Then there is an equity enhancement fee, which is one point to five percent, and then there is incentive distribution fee. So there's a lot of fee that one has to go through and that kind of eats up into the returns that one makes and conflict of interest because Brookfield Asset Management owns it and the fee is such that it's kind of tilted towards growth. They get more share of the growth and hence they might be incentivized to take more risk. So that's some of the concerns I had.
I think in conclusion, I wanted to bring it up here more to get an opinion from you guys. Is it worth looking at this price point? It's more than 50 percent down. It used to be like close to twenty dollars beginning of the year, and it's now around eleven dollars. It was eight dollars something few months back. So obviously it has to come up. And the Brookfield has also offered to buy back year at twelve dollars, and then they recently sent our tender to all the existing shareholders.
So obviously they are seeing value and but they're confident to buy it back. Well, I was thinking the same about IBM when they were buying back their shares.
So a disclaimer, Brookfield is one of those ones that is heavily discussed in the Valley community because it's cheap. It's run by guys who operate a compound of type investors. So the long side is always that. There's a sum of the parts and a fee valuation that you can come up with that makes it look very cheap. And the criticism of that is that you base that a lot on what Brookfield tells it. Yes, it's worth. And they tend to be maybe a little bit aggressive with their valuations.
And it's very rare that you see Brookfield Trade NIV. I don't think it's traded at a premium to NIV because they are a little bit more bullish in their in their assessment of those numbers. The fact that they buy it back means it's probably undervalued. But the big risks, I think it's got a lot of leverage. You kind of bidding that interest rates stay very low. And the other one is that the corporate structure that they have, it's just mind bending.
Every time I try to go through it, it just puts me to sleep. I can't figure it out. And I've seen even reading somebody else's assessment of it's this interlocking web of multiple companies that make it very. Difficult to work out who owns what and why it's structured that way. It's one of those things where I see that sort of complexity and it just makes the hairs on the back of my neck, gets my hackles up a little bit, makes me a little bit nervous.
I mean, why is it that complicated? Why have you built it that way? It's possible. Their answer is just ad hoc. And as things have come up, we've had the money where we've bought it and that's what's created this structure. Not saying that there's anything going on. It's just whenever you find something going on in these companies where there's some sort of fraud or self dealing or something like that, they also have very complicated corporate structures because it's a way of hiding what's going on.
I don't know. In relation to Brookfield, it's just hard to get a bead on where it is so that the complexity of the structure and the leverage and some of the questions about the valuation of their own assets make it too hard basket for me. I just can't see the valuation on the free cash flow side, so you were talking the net asset values, which is just your assets, minus your liabilities divided by the shares. And so what it really comes down to is, are those values that are being listed on the balance sheet, really the valuations that we're going to see moving forward into the future.
And when I think about those valuations of those properties, so much of the valuation is is dependent on the free cash flows that those properties are able to kick off. I know from looking at our screen our tipi finance, when I'm looking at the small cap companies, the momentum status on all of these small cap companies are bad, really bad. When we look at the indexes going up, we're really talking about a couple of companies that are driving these indexes and all of this this five to six trillion dollars worth of printing that's taken place.
It's all nesting itself into these these tech companies. And when you look at the smaller businesses that make up the lease holders and the people that are fulfilling or sitting in these buildings, all those small businesses, they're getting crushed. My expectation moving forward into the coming year is that that's going to continue to persist. And if you have a lot of vacancies and you don't have them filling these buildings, my opinion is that there's impairment on the valuation of those buildings.
And so, like, that's my real concern. On a fundamental level of the underlying assets on this company is that I think they're overstated. When I look at the valuations on this, it really doesn't excite me all that much. I see that there has been a little bounce from the March low. It has had a little bit of a bounce. So there might be something that I'm missing. And like Tobey said, the complexity of the corporate governance and what's actually sitting on the balance sheet is the part that's really hard for me to understand when I'm looking at what I'm doing.
A quick glance, and I obviously haven't spent a ton of time researching this, but just from a very high level standpoint, those are my concerns. Generally, Horie, whenever everyone is running away screaming for something, I'm always curious, I guess that's something that's just comes with the territory whenever you have value investor. What I've also come to realize, especially over the last few years, is that there's often reason why people are running away screaming. And the kind of arguments that we had famiglia on here last week from crossbreeds.
He talks about how spacious the new luxury and they're both with something like the malls that I think I have 122 now and they have one hundred and thirty four office properties. And I see that argument. And anyone should definitely listen to a lot more what he's saying that than what I'm saying. But I think what goes into this is that, yes, space might be the new luxury, but you also have to account for not just the impairment. The press was talking about the redevelopment costs because so many of those buildings, they can't be used the same way.
So if space is in luxury, it would have to bring a lot of cash before you see cash coming back again. All right, guys. Well, I think that concludes all of our remarks. I want to give Toby and Harry a chance to tell people where they can learn more about you guys and check out some of your stuff. My fund is called the Acquirer's Fund Ticker's S.A.G., and I've also started managing another call, the Deep Valley Fund, the Ticker's DGP.
That's going to be a small and micro-cap Deep Valley Fund. Deep valleys, very out of favor at the moment. Sir, if you're a mean reversion contrarian type investor, then take a look at deep value. It's really beaten up at the moment. I also have a website, Acquirer's multiple dot com and I'm on Twitter at Grainne Backed GRB and basically. Thanks, Christian Toby and State, for your feedback. Yes, I knew that this is something that I was on the fence and that's the reason I brought it up here to kind of put it on the dissection table.
You're right. There is a reason why everybody is running away from this. My reason for looking into it is I said any time when everybody is running away, it's time to just give a closer look at the positives I see as most of the bad news is out. But at the same time, we don't know how long this will last. And Christine, you brought up net asset values might go down as you are talking about how much capital they have to put to redevelop those properties in case things change.
So there is risk. So I wouldn't I wouldn't bet my farm on this, but thank you. This is good conversation and feedback. All right, Harry, tell folks where they can learn more about you. As usual, people can find me on big business, on my blog and my Twitter handle. How are you? I'm happy to engage in constructive conversations. All right, guys, as we're learning, Chobe in a hurry go, we're now transitioning into playing a question from the audience and this question comes from Scrumming.
Here we go. Hi, Preston.
Hi, Steve. My name is Mike and I'm calling you from United Kingdom. First of all, big thank you for your podcast. I've been with it since the beginning. I love to see your journey as investors. It's fantastic. I've got a question about stock dilution. So when I invest and I do fundamental analysis, one thing I don't understand why sometimes companies like Tesla issue more shares. So essentially they dilute my shareholding and the shares actually go up the next day and then continue to go up.
So how to factor this into fundamental analysis, the risk that the company will be diluting your equity by issuing more shares to investors? And is that something that's captured in some of the fundamental models of investing? Thank you so much for your podcast. Appreciate it. By. I think it's a great observation you make now, Tesla in itself is a tricky example, and we often talked about here on the show how Tesla sort of goes against everything we learned about value investing.
For instance, Tesla took over the position from Toyota here recently as the world's most valuable car maker. And that was not by having any earnings actually haven't had since it was founded in any fiscal year, but it's been through issuing stocks and taking on billions of dollars in debt. So I'm not sure if that is the best case study to understand what is fundamentally happening when a company issues stock.
But what does happen whenever a company's stock is that the individual stock price doesn't have to go down in price by default, because what it means is that the company raises capital and they will also have more owners to share the ownership of that company. But again, it's from a higher base. So the effect can both be positive and negative on the individual share. And you can, of course, bring up the argument that it's better if the company can generate cash flow and it doesn't have to finance it through issue of more equity.
But keep in mind that companies are very different stages. You might have a growing company who needs it to turn profitable very soon, or you might have a situation like with airlines who are a mature industry and used to be very profitable, but now due to covid-19 is not. And we all knew that they needed capital. And then the terms that got actually what that bats and the market reacted positively to that. So you had to divide it up and say that in the first place?
No, it was not great, that new capital. But at the time that they made the announcement, the stock was already punished hard. Everyone expected it. So everything else equal. It was actually a not as bad as it could be scenario which the market liked. And it's also important to understand that if we use the case study of airlines, the fundamental value of airline stocks is lower than 20 19, but not because of the dilution of the shares, but because the missing revenue and the bleak outlook.
You can even make the argument that if airlines didn't issue shares, they couldn't get loans and then they would go bankrupt. So dilution of stock, as mentioned, is not really a good or a bad thing per say, but it really depends on the specific circumstances for that deal.
And it could even be so, though this happens more often priority than publicly, that you have companies seeking capital not just for the sake of capital, but as an adult also to get new investors in with how but really issue a question about is the dilution of shares accounted for in valuation models?
Most valuation models use a per share basis. And so it's a great point to ask what happens if you now have more shares? But as I mentioned before, the answer is a little more complex because it does depend on which value the company would have after the issue of more shares and whatever happens with them with that equity has been utilised.
So that's why if the market deems that in a positive light, you can see that you actually had the individual share price even after the announcement would go up in price. Chemeq, I'll be honest with you, I don't really have too much to add beyond what Stig said, because he really kind of covered all the bases for people that might be looking at this with a fresh set of eyes and have no experience with it. I would just tell you, at a very general and basic level, when a company's going through this, they're taking newly issued equity and they're just turning it into a currency.
They're turning it into cash in order to subsidize their inability to earn free cash flows. That's really kind of the essence of what it's at. So whether they can raise capital through the issuance of debt or they're going to do it through the issuance of more stock, that's pretty much what they're getting at. And so when you're thinking about the valuation on the on that playing out or you're concerned about a company doing that in the future, the main thing you've got to really look at is, are they do they have free cash flows?
And if they don't, well, then they're going to have to probably go down one of those two paths in the future. So that's probably a good indicator as to whether it is or isn't going to happen with respect to Tesla specifically. Man, there is no way Steg or I can provide you any type of advice as to why you might be seeing some of the things you're seeing on Tesla, because this is a this is a case study of case studies as to how this stock keeps moving and all the intangible things that the market seems to value on this one that I have continued to be surprised with.
So I can't really add much value in in critical thinking and some ideas on that one. So I'll leave it at that. But Trimark, outstanding question. I really enjoy questions like this and for asking such a great question, we're going to give you a free subscription to Tip Finance where it will help you do intrinsic value calculations. It'll assist you in many different areas for momentum investing and helping you filter and find good value picks. We're really excited to be able to give you that subscription for free and for anybody else out there.
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All right, guys. Preston, I really hope you enjoyed this episode of the Investors podcast. We will see each other again next week. Thank you for listening to TI IP to access our show notes, courses or forums, go to the Investors podcast Dotcom. This show is for entertainment purposes only before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network written permission must be granted before syndication or forecasting.