248- Robert Shiller & The PE Ratio

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BILLTOWN and Danielle town. Welcome to the PODCAST. Cast where we are learning how to invest not speculate but invest in spite of the fact that the market is not cooperating at all that may be my new favorite mature word spoken. Oh Gosh it is so funny like we were talking about last time you know the the ratio between the Wilshire. GDP and and the stock market pricing is is historically so skewed. Now it's over double where it needs to be to be a good deal. Yeah interesting point interesting point. 'cause you said it was at one hundred and seventy something and to be a good deal Etienne below. Yeah yeah so right more than more than double. What a good deal? So he really right now. If you were trying to find really good companies you might find yourself stretching to to make it work in your head to make Saddam yes projecting the magical thinking gene of. Please let this company be something I can buy out of the entire smorgasbord of companies. Out there that you look at and steadily get more and more depressed about how great it is and that you can't own it. It's like this degree Combo of like shod and Freud Freud for yourself or your like kind of enjoying that you can't that you found something you love but you feel sad you can't buy what is shot and Freud. Yeah well okay so shrodnr fresh or whatever commonly used term in the English speaking world as well what shot in Freud means and I use the edited. Take a Brad Pitt. Movie Inglorious Bastards Situation Pastor shot and Freud. I used it very very badly. What it means is to take pleasure in the misfortune of others? It's like when somebody else has some you know a flat tire and you don't like that person in your lake. Have a little bit of luck with joy about it that shot in Freud walk. That's seems very not nice. It's not nice now. Freud means taking pleasure in the suffering of others. It's like it's not. It's not a mean thing. It's like a small pleasure in the small small misfortune of others so it's not command. Cheese taking azure in torturing their prison not. Count a shot in Freud at on it would be something small. It's like it's that small little thing of like the example I just gave like it's it's it's a very German feeling of you know. Just a tiny bit of prick of joy and it just a certain moment when you see something they know what's happening. I have a feeling we all do this. But don't want to admit it. Well that's why it's a commonly used term in the English speaking world because we don't have word for that in English but it's a Greek word. It's a great word. So what I was referring to is like I used it very badly. A Self Referential Schadenfreude in a way of flight kind of being happy in your own misery. Oh man that is so deep and complex. It's way over my head. I don't think it's I think thank you. I think you've got it so when when you get that feeling of the now being able to find some or you find something but then you can't buy it. It's a bad feeling it sucks. It's depressing it is sort of although just finding something you really understand. Stick it on your watchlist. It's good knowing what price you pay for. It I find is just the the most wonderful thing it's just like. Yes because I know from doing this for a long time that will go on sale and that is just one one less thing I gotta think about. Maybe that's the method that you're about to tell us do this for a long time and you have our respective. You'll have perspective. I was actually actually thinking that when you find a company that is on sale in this market you should be very careful careful because when the market is priced more than double where historically Torque Li. It's been for something to be on sale in the market. Now this is a gross generalization because in all markets there are in fact great companies go on sale. There are in no matter how overpriced the market gets the market. Mr Market moves money around and it goes from one industry where it's likely to go up like crazy. And when that goes up like crazy than people sell out of it and sometimes it will go down much farther than it should or or individual companies are having a problem. They could have a problem and everybody bails out and runs away and that company goes on sale. But it's it's much more difficult and you should know it's much more difficult in a market like this one. Where in general things are double what they would be at a market where we think things are on sale? So things are really fully priced and then some okay well in that market when you see something on sale how you you should be careful because there are lots of people looking for sale companies right now and if you found one and the stock market hasn't founded the people at Goldman Sachs haven't founded Morgan Stanley hasn't founded and J. P. Morgan has invited. But you found it. You're the special official person that found it. That's really amazing. I just I've heard people say that a lot lately and I'm just not sure I totally buy it because it goes back to what we've talked about so many times about our own time horizon compared to other people's time horizon meaning that we have a very long term one and other people have a more shorter term one and I just I don't really buy in this market yes overall. It's harder to find stuff. I do agree with that. But Ed being able to find companies that are having events that are having things happen that are making. The price goes down for a short period of time. That's a situation that happens. Happens in any kind of market happens at bad Margaret Evans in a good market. I haven't been media market and those things usually are happening without being connected to the overall market. So if it's one thing to say like oh I found a company in the prices down own from where it was like. It's down from this very high market and that case it's probably still incredibly high and wouldn't be a good bye but but if it's if it's meeting the criteria of your own pricing methodology on its own independently Bentley not related to like. Oh it used to be high and now it's down then. I think that's something that you found and the reason other people are buying it. It's probably the same reasons that would be going on in any other kind of market. Now everything you say is totally true. That's exactly right. Went exactly how to think about it. Okay Okay what what I'm saying in terms of being very cautious is to make sure you understand why these people are getting out of that business. It's really important that you you selling to you. Who's yourself interesting point? I mean these are eighty five percent professionals who are unloading to you. uh-huh and they've got very good reasons why they are doing that. I guarantee you they have great good reasons. Sharon your point very well taken. Is that those reasons may have more more to do with a short term timeframe under which they're judged rather than the long-term final judgment on the company itself itself and if that's the case then more power to us the little guy that has this long term horizon and we can handle two or three years where it goes nowhere are no big deal right or it goes down even more so why. Be More cautious now. Because you gotTa make sure you really are not into something you're not about to buy is something that has a terminal problem in this market in other words there you just have to be doubly sure I. Maybe I'm wrong. Maybe maybe there's no big difference. You always have to be sure now. I can see what you're saying. You're saying because if we're if we're in a situation where the whole market has dropped there's been something that's gone on and the markets have been dropping. Let's say for six months and it's really been going down and companies are hurting gene and you're seeing which companies are surviving right like some companies are going to go away really quickly right. Somebody's going to be the pets.com. That's DOT com of this market and other ones are going to be the coke and be really well priced at the end of the day and are going to last for the next twenty years or the longer so you can see that happening to your point in a market that's dropping whereas in this market companies aren't being tested at all. They're getting getting easy money all the time. So right okay. You've done a great job of making my point. So that's what I'm here for. You see clear and then express it very well and so that's why we when when we're in a market that's it's really up there and everything is going good and people are buying anything for more than they should pay when they're selling it And they're not stupid. We just gotTa make sure that we know why. So you know the right now. Boeing for example is is a company. That's under a lot of pressure from a problem that they've got and they're trying to work their way through it they just fired their CEO. You know that's that's a big deal. It's a big deal. And I look at Boeing. I go man I would jump all over this at two hundred and fifty to eighty share. It's IT's selling for three thirty down from four fifty okay. So it's dropped a lot but hasn't dropped so much that is so good deal. I could just this jump all over it. I'm getting a ten count price. Just isn't there right. Because that's what Sony people look at. Its dropped forty percent or whatever that adds up it's dropped eighty percent from its high like that's what people say and seemed to care about and that doesn't actually mean anything on the is relative to what it was it's lower but when you see that just think you know the price of gold necklaces at a beachfront gold store. Eighty percent of we buy gold. Jeez yeah then. That's price just doesn't price just doesn't mean anything. It means what somebody somebody paid. That's all it doesn't mean value. It doesn't mean what it's worth it doesn't have a damn thing to do with it except in the long run eventually eventually the markets will price things where they should be. And that's what we trust will happen. And that's why we don't want to buy things that are expensive because the market's going to eventually price them where they should should be and even if they're gone they've gone up in ten years. which good company might you know if you buy it and pay too much you still gonNA come out okay? You're just not going to have a great great rate of return. You're just not going to get rich and what we WANNA do. Is We want to do an investment style that gives us financial freedom. We want to have enough money coming out of this thing with high rates of return and the ability to do that consistently that we don't have to worry about what's our job right where we WANNA go. Yeah so be careful. In this market because things companies tend to have their prices be inflated inflated and that can lead to not so great companies being propped up and it can also lead to good companies I'm being so overprice that maybe your own metrics get a little bit skewed inside your head. Which is the scary part? But we're GONNA talk about a method another method. Is this the method that you wanted to talk about. No this this is just sort of leading to that okay. So the second. We've talked about actually quite a bit here. There was was developed by Robert Schiller at Yale. WHO's the second did the Schiller? Pe Ratio. I have to say if anybody wants more information about this you can pick up our book. Invested which goes into excellent detail plug about pursue erase show. But you can listen to it here for free go ahead and what what show did it was so bryant was to find a method that shows that the market can be irrational from time to time and when it's irrational and you're buying into it and it's irrationally high your long-term rate of return by owning the whole market which is typically what people do in their 401k. They diversify across the whole market. You ready to return it in. The whole market is going to be very very low is going to approach zero for the next twenty years when it's too high long-term and when you have the market that's very cheaply priced your long term rates. Return even if you buy the whole market will be quite good. They'll be over ten percent and so this this chart that he's created is available by Googling Schiller S. H. I l. l. e. r. p. ratio. And it'll show you this chart. It goes all the way back to eighteen seventy and you can see very quickly that the average through all of the you know the last one hundred in twenty years up to the nineteen nineties has been about a fifteen sixteen. Pe ratio this is an adjusted pe ratio for inflation oughta skip cyclically adjusted pe Ratio Cape Cape ratio. So he got the Nouvelle Prize for this because he he and I am going to make this up a little bit. I haven't read the book although it's on my coffee table right now but I'll open at some point. He he came up with this method head of developing that particular. Pe Ratio Right. Yeah okay after researching every year versus the S. and P.. Five hundred in trying to understand. Say Sorry to interrupt you. P is price to earnings ratio. Just take the price of the stock divided by US earnings and you get a number but he tell me again what the Schiller ratio is with a Schiller takes into account a ten a year average. Yep and it's in other words it spreading the shorter term ups and downs in the market spreading spreading out over a number of years which softens the curve and it gives you a ultimately a better number to know. Where's the market dangerous in whereas it super good ed right and so this you can see that the market is typically averaging out around a fifteen or sixteen Schiller and? It's a really good time to buy stocks when it's at below ten fabulous because historically you've just killed it right so in other words when in nineteen in twenty one. If you've bought a bunch of stocks the Schiller was at five and you would have made a fortune in the next eight years and then if you're really smart art and he had the shoulder. Pe ratio which you didn't you didn't see that in nine hundred twenty nine Internet to quickly bring it on the Internet you would see that in nineteen twenty nine the Schiller pe ratio had gotten all the up to thirty. And you would notice that. That's a long way north of fifteen and you would have been very nervous and you would have gotten out of the market right and then you would have been able to buy back just a couple of years later again at a five. Pe ratio and you would have made another huge fortune. So the market's it gets very very up and down like this and what we've learned over one hundred and forty years. Is that when it gets up above you know twenty four twenty five. It's getting getting into dangerous territory and it's only been up there in all those years previous in one thousand nine hundred ninety eight twenty nine it got up there at thirty okay and then nine in ninety nine it got up there got clear to forty. Yeah and then again. In two two thousand eight it got all the way up to twenty eight and then collapsed and now it's thirty one so there's only only been three times in history of this ratio. Going clear. Back to eighteen. Seventy one was the great depression the second echo the collapse of two thousand the Big Tech Stock Crash and the third time is now so yeah I remember looking at the chart it could I remember looking at. I don't have it in front of me right now. I remember looking at it. And it's like the sort of zigzagging chart and then all of a sudden there's this like insane gene skyscraper from above everything else and that's ninety nine and then it's sort of zigzags a little bit for two thousand eight and nine. It's us and it's just like steadily steadily moving up to the right and by the way that one thousand nine hundred eighty nine hundred. Ninety nine skyrocket skyscraper was exactly the time when several investors who are world class superstars of this kind of investing that. We're talking about just quit it. I mean they their own investors. Were hounding them to get into this market when they were sitting in cash. Buffet is one of the he didn't and quit because he doesn't have fun. He has Berkshire hathaway and he could control it. But Oh man you know the. He didn't have any place to put the money and he was actively looking to buy back Berkshire stock during that Time Period Julian Robertson. Who has the second best track record I've ever heard of was actively bailing out of the market? He was all in cash and he finally quit his fund and I remember really clearly watching him on TV. Say and I just don't understand in this market anymore. It's nothing like I've ever seen so we're sort of back in that. Nothing like I've ever seen sort of market could be continuing to go crazy for another little while but looking at one hundred forty years of history we can see that a little while is really just a little while it may be a year or two but inevitably gravity catches up with a market. That's price like this. So that's the Schiller. Pe and some people argue that the Schiller pe isn't right anymore that things have changed and that the true facts of the Schiller. That's averaging in a lot of really high market. Pe's aren't shouldn't be counted because they were off. So I thought I'd just look up just the regular. Pe Ratio Right. Okay wait. The Schiller shouldn't be counted as a regular. PC's because it's a little off what well because the argument would be that in the last ten years. Let's let's say four or five years years ago they would say in the last ten years it's including some really high p e ratios therefore it's higher than it actually looks like the looks fire than it actually is but they can't say that anymore today. The Schiller P. is at thirty one and the actual pe ratio. The five hundred is at twenty four point two which is incredible guys. That's incredibly ably hi. It's incredibly high. There's only been the year two thousand and the year two thousand eight in excuse me and eighteen ninety five that have been that high. That's it even nine hundred twenty nine. Wasn't that high. Okay so we are are in a sky scraping crazy priced market right now and we've already talked about why right. The interest rates being extremely low not having alternatives is out there but it starts to build on itself and you start to get a bubble and just by saying you know you sort of have to be in the market. Everybody feels that way. There's nothing else you can do. Develop this market bubble mentality so we're trying not to do that. Market bubble mentality. We're trying to look at this soberly. uh-huh recognize it. It's we me and the mouse in my pocket okay. I didn't know if you meant like royal. We didn't know if you meant like We the American government or something like that. It's just we royally okay you I'm looking at this and and try I just trying to stay pretty sober about the whole thing right the night we know that this thing can't sustain because it never has but that's inductive logic gets the same logic that a chicken house when you know the farm door slams at six in the morning it gets fed every day for two straight months and then I think the door slams that you think he's going to get you know so we don't know for sure because we don't we can't read the future but we know that that historically this way of investing this way of thinking about investing of waiting patiently until the market greed goes away and market fear begins is the safest way to manage our money in the long run and I think so. That's how we do it. And I think it's pegged to actual prophets that companies make and as we talked about last time at some point these stock prices have to start reflecting the actual profits that companies make and the question. Make it a really good point There are some things that intrude in that reflection. Actually that are very important and right now. Two of them are manipulations by the companies themselves. Right so the probably the major one of those is that they're going to buy back their own stock Dr Stock Buybacks result in the stock price finding finding a bottom because the companies stepping in and buying it and making the price go up it can and and so that puts an artificial price on it. Ah they've got a lot of extra money and do they have a lot of extra money. Yes new and do they WANNA take a risk and by a different company at these high high prices or you know. Open a new branch when nobody's quite sure what's happening while they might want to do that. Because of interest rates but yeah. They're they're not. They're not taking a lot of risks with all their extra money risk and so it religiously and right now when we look at companies that are taking risks what we would expect expect to see. Is that capital expenditures. Go up that they're investing not just in stuff for how this year's going to go But in long-term investment they're putting railroad tracks or put it in airports. They're they're putting in warehouses and they're buying equipment. That's going to last this them several years. Those are capital expenditures. And we don't see that it's one of the real conundrums for president trump. Is that that the idea of cutting taxes for American businesses was to help them be more competitive to their bottom line but with the expectation that they would invest the money in more jobs by building warehouses and more capital expenditures. And they just haven't done that it said they bought back their own stock which is an artificial boost to the per share. Stock Price does nothing for the value of the company whatsoever. Yeah it's frustrating and it's happening so much that there are if you you want to take a minute and just google stock buybacks. There are some really interesting articles that have been written about how this works. And it's a fun like our of your life just read about the stock buybacks and how many companies are using them to help their stock price and to just just use some of this extra money what it's doing to the market and it's one of the ways we actually look to see if management is a good allocate or. I'm just thinking out allowed here. I really need to get that. That into the tool set the allocation of capital needs to be a judgment call. We look look at companies in our tool set of having good management if they're keeping their debt very very low two zero and if their return on equity return on invested capital sustain high and moving up then. We were like the way they're allocating capital but there's another allocation of capital very valuable and that is to look to see life if they're doing stock buybacks at a reasonable price totally so if they're if they're companies massively overpriced and they don't know that that's a a bad sign for allocation of capital if they're companies massive we overprice. They do know it in. They're buying back stock. That's a terrible allocation of capital. Because they're spending my dollar and they're buying fifty cents worth value for it. Yeah and that idea. And they're taking my money as a shareholder and using it in a way that's not optimal it's just. It's wasting the money that we have that they could be giving to me the and dividend which I would much prefer. You've talked a lot. We've talked a lot about how companies can use this extra cash. They can invested in Capital expenditures they can invested in buying other companies Through Manet they can give it as dividends to the shareholders and they can use it as has to buy back their own shares. And those. We've talked a lot about how those things are all kind of in theory equal. It's just a matter of toys on the on the part of the management And actually I think you've said a bunch like you would prefer that they not do the dividend option if the other options can be used well but prefer they grow it for me. Yeah but they have to use it well and instead what these guys are doing with five acts the stock prices so high is just wasting it and it's incredibly frustrating to see because it's giving buybacks a bad name to the point where now there's like politicians talking about legislation about it. Warren is out there with the platform that out to stop these foreign. I thought you meant Warren Buffet and you know to stop these sort of heinous buybacks and while I don't cheer on her method of doing it from the top down because there's all these unintended costs. Yeah Cheer on the Com motion about the content is like like. Yeah these morons I mean. IBM has been buying back. Its stock for the last ten years and you can may really make a good good case that they have been just wasting shareholder money. They might as well take those billions out in the parking lot and burn them all good in with his billions and billions liens and billions and billions of dollars. They spent on stock buybacks at one hundred eighty I share and hundred and sixty eight hundred fifty share and their stock one hundred and thirty. It's just for years so this is I mean go go read about. IBM's by and you'll see what I mean and just add up the billions billions and that money's Gone Gio any gone if this company doesn't get its act together so all it's done is support. The stock option prices prices for share for the management team. And that's just a heinous use of the money so the and then of course the the second way these guys prop everything up up is to borrow money and buy other companies so this is just one of the other ways you can do it you by another company and your company revenue goes up and you start to look like you're a bigger company and then the stock ideally goes up with that right so you get you get management teams that are bad alligators of capital making very bad judgments when it comes to acquiring other companies and again not to beat up on IBM too much but they've done a lot of buying a lot oughta stuff and it hasn't improved their position in the market while Microsoft came out of nowhere get handed. IBM It's hockey event. A success success story. That's been amazing to watch. I did not predict that. I don't know I don't know who did somebody started. But it wasn't wasn't anybody I know it wasn't the guys running Microsoft. They didn't know that was going to be this thing. Nobody knew somebody. He was going for sure. What's his name Such as something is the CEO. And I can't remember his name either right now but fabulous job Bob guys done is. IBM with more resources. By far and nothing is just struggling along with a very small percentage into that market so mergers and acquisitions I mean you can see companies do it man. But y'all stores the point that they borrow to purchase companies borrowed a purchase which is a threat then Tiki your money and purchasing companies which is different than purchasing companies using your stock. Those are three different ways. Three different ways and again you wanna see that the guys who are running their that women are running. The company are allocating capital sensibly. So if they're using their own stock to buy companies you really want him to be using stock. That's way overpriced. I want you to buy companies with stock priced at two dollars a share. When it's only worth a dollar by all the companies you can? I don't with stock price at fifty six dollar. Don't be spending it at fifty cents. So Oh and and the bad allocators do that all the time and so they instead of using our money then they'll go borrow money but you know uh-huh and that sounds okay except that especially when you're paying three percent interest except you guys when they borrow money at a corporate level they don't get it like you get it on your house for thirty years. They don't get a thirty year loan. They get a three year loan which means they are at risk for refinancing that money if they can't pay it off in three years and and you know they just mostly can't and dollar tree buys family dollar in a bidding war with dollar general and dollar tree wins the bidding war pain rain for more than it should have for. Family dollar borrows the money and it's it's trying to bury them now years later it's they're still L. struggling under the debt load. That's burying them. You're saying oh the deaths horrible and it's so hard for them to get out from under it and they've got all these stores that they paid too much for aren't doing well right so you've got to have people running. The business are really good at allocating capital. And then you see them spending money mergers acquisitions borrowing money increasing the debt. Buy Back stock at a high price. Those are bad allocators and we want to stay away from those guys especially in this kind of a market. We did a really fun interview with Jacob Taylor all about capital allocation and I would suggest going back to listen to that one and he wrote a great book that Charlie Monger himself recommended and So look up. Jacob Taylor's book on Amazon and check out our interview with him. I think that Kinda gives us today all right so we got at the Schiller. Pe and the Wilshire GDP ratio which are two methodologies. That we've talked about before but to point them out again and I think is really cool. I'm really glad that you brought them up again. It's a good way to start the year kind of know where we're at. Yeah give some context have have a little tether to what's gone before and then it allows me and this is ultimately personal right investing is very personal process and it allows me to feel more comfortable like okay. Maybe you know. Maybe I'm just not beating the bushes hard enough. Maybe I should be working harder. Maybe I I should be studying more. Maybe she'd be reading more. That's probably always true. Well that's true of course but then you just find you know that there's a frustration and you start to realize. Oh yeah okay well. The market is massively priced historically above its values historically and that gives me some comfort that I probably should be having trouble right now. Finding good stuff. Okay I got that now. Then what's three. What's what's the result of that is to remind myself to be patient Continue building the watch list. Like you said You'd find this wonderful company. It's frustrating because you can't buy it well there's another side of that coin and that is wow. I got another one. That's four my list that I can buy down the road another gym here. That's going to go on sale. And Yeah that makes me feel good when I can put one up there. I agree love adding to the wish list. All right thanks seventy guys. Thanks for listening to invested. If you enjoyed this episode you want more information including show notes outs. And more episodes visit us at invested. PODCASTS DOT COM. There's a special offer waiting for podcast listeners to attend my three day investing workshop absolutely free so just head to invested podcasts dot com everything discussed on his podcast. Either my opinion or Danielle's opinion and is not to be taken as investing advice. Because I am not your investment advisor nor have I considered your personal situation as has your fight do -ciary this past is for your entertainment and education only and I hope you enjoy it.

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