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  • Chris Mayer

Three Questions to Think About Now

Updated: Apr 17

I held an online call with my investors yesterday in lieu of our planned annual meeting in Ireland. (The actual Woodlock House, from which my firm gets it name, is in Portlaw, Ireland. We were going to hold it there, but the virus had other ideas).

I enjoyed the call. I have great partners. And we had a good discussion. They asked thoughtful questions. I thought I’d share a few of these questions. Maybe you will find them interesting and helpful to think through for your own portfolio.

First up: “Would the stock we hold be your first choice in its industry given the values on offer now?”

I like this question because of the wrinkle “in this industry,” which narrows the consideration a bit. It makes you think about commitments you have in hotels or oil or whatever and ask: If I started from scratch today and had to pick one hotel or oil stock would the one I own be the one I’d pick?

In the oil patch, for example, I have one stock – Texas Pacific Land Trust, which has a dominant position in a prolific basin. (They also have a water business and easements business). If I had to pick one oily stock today, I’d pick that one.

I like Texas Pacific because it has a great balance sheet with lots of cash and no debt. I like the royalty structure – capital light, cash generative – which has proven it can generate superior returns even when oil declines.

This chart from Horizon Kinetics presentation brings home that last point particularly well:


Show me another oily stock with these characteristics and perhaps I’ll reconsider. But there isn’t one that I know of.

Of course, production will get hit. There seems to be an awful lot of oil around. I don’t know when oil will recover. But I think it will recover. I’m not saying I’d put all my money in Texas Pacific, but I sized it appropriately and I’ll wait it out. It could be a multi-bagger from here over the next, say, five years.

Anyway, I think this is a good question to mull over as you go through your portfolio. You might decide to stay in the same industry but switch players. Even if you don’t, asking the question might deepen your understanding of your own position.

By the way, I disagree with the advice that you should sell or lighten up on stocks that have held up well and go after the stocks that have fallen the most. I have heard even professionals say this.

Price action alone should not dictate what you do. The stocks that have fallen the most might have done so because they are garbage. Maybe they don’t come back. Or maybe they do, but only after you’ve turned into a skeleton waiting.

Don’t assume that stocks that have fallen the most are the ones to come back the most. You have to look at it on a case-by-case basis. In fact, you might find it is better to do the opposite. Get rid of the big losers and add to those stocks that are relative winners. Again, it’s a case-by-case situation.

Second question: “What about inflation? Do you think we’ll have a resurgence of inflation and how are we positioned if so?”

There is a lot of stimulus coming. I think it’s natural to wonder about potential inflationary consequences.

First, I would say let’s not make the same mistake people made in 2008. We had QE then and lots of “money printing.” And yet, no aggressive inflation as many expected. If the money just winds up plugging holes in balance sheets – both personal and corporate – I don’t think you’ll see meaningfully more inflation.

But I could be wrong. To that end, I have several positions I think will do relatively well in an inflationary environment. (I’m not sure anyone really gains from rapid inflation. It is more a matter of who loses the least).

Most people when they think of inflation hedges think they want to own businesses with tangible assets. Actually, you want the opposite. You want businesses that are capital light.

On our call, I mentioned Warren Buffett’s 1983 shareholder letter. Buffett goes through an exercise showing why the above is true. I recommend it – you’ll find the argument in the appendix:


https://www.berkshirehathaway.com/letters/1983.html

Here is his conclusion:

“Any unleveraged business that requires some net tangible assets to operate (and almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets simply are hurt the least.

“And that fact, of course, has been hard for many people to grasp. For years the traditional wisdom – long on tradition, short on wisdom – held that inflation protection was best provided by businesses laden with natural resources, plants and machinery, or other tangible assets ("In Goods We Trust"). It doesn’t work that way.

“Asset-heavy businesses generally earn low rates of return – rates that often barely provide enough capital to fund the inflationary needs of the existing business, with nothing left over for real growth, for distribution to owners, or for acquisition of new businesses.

“In contrast, a disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets. In such cases earnings have bounded upward in nominal dollars, and these dollars have been largely available for the acquisition of additional businesses.”

I have been repeating this argument for years, which is why I had the 1983 Buffett reference easily retrievable in my brain. I worked in the newsletter business for 15 years. There are a lot of gold bugs and doomsters in that world. And their knee-jerk reaction to inflation is always to “own stuff.” Not the best call, in my view, for the reasons Buffett states. (I'm talking about investing in public equities here, not about owning, say, gold itself).

Businesses that can change their prices quickly would seem to be good choices if you are worried about inflation. I think Texas Pacific should be a good one longer-term, assuming oil prices react to inflationary pressure (they might not). Obviously, a rise in oil prices increases their sales via royalties.


The best would be businesses that have pricing power – like Buffett’s See’s Candies.

Of course, it’s not like inflation happens in a vacuum. There are lots of other things going on at the same time. So, for example, hotels price their rooms daily and in theory could react to inflation. But if travel is down 50% or whatever, it won’t matter much.

As I say, I wouldn’t automatically assume we’re going to have runaway inflation. Just remember 2008. But if we do have it, or if you want to prepare for it just in case, the above thoughts are a good starting point for how to think about it.

One more question: “What’s our cash percentage and how are you thinking about that?”

We’re at about 15%. On March 1, we were about 25%. I’m trying to be patient about deploying it. Big bear markets like this one don’t just end in a month. There is usually a zigzag pattern for a while. Not that I’m trying to time the market, but I want to have some cash when those Q1 numbers roll in and companies start giving bad guidance or no guidance… I suspect there will be outstanding opportunities yet.

Of course, I have my list of stocks I want to buy. Everybody has a list of stocks they’d like to buy if they hit their price. But then March happens and everything is on sale. Suddenly, you start and hemming and hawing and getting especially picky…

I was trying to think of an analogy. It’s like if you were shopping for a certain kind of car last year and had a really, really hard time finding it… When you did find one, you bought it. You looked past some faults. “Okay,” you say to yourself, “so it’s not perfect. It’s not the right color. It has a funny smell. And it is a little more than I wanted to pay…. I’ll take it!” That was last year.

But now, it’s like you’re shopping for that certain kind of car and you’re finding them all over the place. Well, now you get picky. “Meh,” you say to yourself. “This one is yellow, I’ll pass. This one doesn’t have leather seats. Next.” Now all of the sudden you’re passing on cars you would’ve bought last year.

I bet that’s kind of what’s happening with a lot of people. It’s interesting when you think about it… and very human.

My preference for that cash is to buy more of what we already own. But as I say, I have a list. And if the market gives me a chance, I have cash ready. I expect we’ll be fully invested over the next few months. We’ll see.

Thank you for reading and I look forward to writing you again soon.

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Published April 9, 2020

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