Chris Bloomstran - Taking Principled Stances
This week Chris Bloomstran stops by The Business Brew to catch up. Part of this conversation are a bit scary. Parts you may disagree with. Regardless, it's very apparent that Chris thinks A LOT about what he is investing in.
Chris is the President and Chief Investment Officer of Semper Augustus Investments Group. He is best known for his annual letters; most of which have an incredibly detailed analysis of Berkshire Hathaway. See here.
We hope you enjoy the discussion.
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All right. Now, this episode features Chris Bloomstran. Chris is perhaps best known for his annual letter, although his Twitter threads are increasingly getting him more known. I met him at a Manual of Ideas event, and found him to be a very fun guy to hang out with. He may come across as quite serious when you hear him chat in an interview, but I can assure you that he's got a very non-serious side, and he's super thoughtful. I find him to be a deeply principled thinker. Some investors may think that value has had its day in the sun, and value investors in general are a thing of the past and destined to underperform. What I will tell you is, I think that Chris understands those arguments, has internalized those arguments, and disagrees with those arguments. You can think for yourself as to whether or not you agree or disagree with Chris.
But what I don't think that anybody can say is that, Chris hasn't thought deeply about his positions, why he thinks the way he thinks, and I admire the way that he tries to sound the alarm in areas that he sees some risk in. So, I hope that you all enjoy the episode. I have enjoyed getting to know Chris, I enjoyed recording this episode, I hope I left off where some of the great podcasts that he's done like Invest Like the Best and The FORT left off, I hope that I can add to this discussion. And as always, none of this is financial advice. All the information contained in this program is for entertainment purposes only. Please consult your financial advisor before making investment decisions and do your own due diligence. So, with that out of the way, Chris, how you doing? I wish that we were enjoying a nice glass of red wine together as we sometimes do, but soon enough, soon enough. So, Chris, how you doing today?
Chris: Bill, I'm well. I'm off a recent bout with the COVID which was unexpected and took a little more of a toll than I had hoped, but wound up doing Regeneron's monoclonal antibody therapy, which is badass stuff and knocked it out in a couple of three days, and kind of 99% back. I lost a little bit of my smell and taste, which you know talking about drinking wine. I'm knocking wood and hoping this thing reverts to 100%.
I'm one of those bona fide snobby guys that can stick his nose in a glass and come up with a decent idea of where it's from and even occasionally nail down whether it's new or old, sometimes the actual year, sometimes the actual vineyard to lose that ability, and lose the smell and the taste of good food. I mentioned in that message we traded that I'd have to think about Aubrey McClendon yet-
Bill: [laughs]
Chris: -if I didn't recover. Obviously, kidding on that front. Kids, don't--
Bill: I thought it was a funny thing to receive from you given how much, I know that you know about wine and I will say if anyone is fortunate enough to enjoy wine with you, one of the benefits of your almost encyclopedic knowledge of wine is, you know the best value wines on the menu as well. I have never been disappointed with the price or the wine that we've ordered together. It's a nice benefit, because I'm usually just at the sommeliers, whatever they recommend then I'm usually overpaying relative to what I think I should be paying.
Chris: Yeah, being a value guy, it definitely translates into consumption habits and so. I've learned over the years if you're at a big steakhouse, don't go to Napa, California. You tend to find bargains in Italy and in Spain. So, a nice real-- A lot of times, you can find wines are a little off the beaten path that are outstanding that wouldn't retail for a lot. The big California cabs tend to get marked way up at most places, because that's what most are familiar with, and so, if you're a little more familiar with some of the other worldly stuff, you can find some value. You know, if you look at my basement, I wouldn't call it a wine cellar, I've got a wine basement with too much wine. I do not drink at a high price point. I've got some special bottles. I set a few bottles down for each of my kids to give them. I thought originally when they were 21, the wines were from the year of harvest, but decided that they're going to get them when they're 30, and that was years ago. That was right when they were well, about three years after each of them were born, because it takes time to harvest, and then put in the bottle, and send out to distribution. But in self-reflection, I realized, Good Lord at 21, I wouldn't have known wine from--
Bill: [laughs]
Chris: Bartles & Jaymes, that's the old-fashioned, these seltzer water things, the spiked seltzers which are finally in decline, thank God.
Bill: [laughs]
Chris: So, at 30, they'll be a little initiated and my daughter is 20, and she'll have a glass of wine with us at dinner, and we'll sneak her a glass even at dinner, and break all kinds of laws. So, developing a palate, and I did with her. I took her back and said, "Look, why don't you drink California Chardonnays?" which I've way evolved from? I like whites, and she believes so anything. Burgundy or Chablis, the chardonnay grape, but where it's mineraly and kind of dry. Yeah, The big--
Bill: I like a good Chablis. It's a crisp white.
Chris: Yeah.
Bill: I enjoy every sip of one. I don't think I know it like you know it, but I know that I like it.
Chris: That's 99.99% of it if you drink what you like, and when I was young and getting into business dinners, I thought these big, fruity, full-bodied California shards were terrific, and they were, because that's what my palate was suited for coming off drinking largely Coors Light in college.
Bill: [laughs]
Chris: Your palate changes and evolves, and I find myself liking a little more of the old-world stuff. So, anyhow, I've got some California stuff, and I've got some old-world stuff for each of the kids when they're 30 which for those of you out there that are young and having kids, it's been a fun thing to look at those things in the wine refrigerators that I have. I got a ton of bottles just in racks and stored in bad conditions in the basement. But the special juice, I tend to try to keep at the right humidity and temperature, the ones for the kids are certainly in that bucket. Then when you come down to the house, that's when I tend to pull out some of the big gun juice. But day-to-day if we're drinking on Friday or Saturdays, which is typically when we do, I drink at a very low dollar price point. That goes back to that value mold.
Bill: I'm going to assume you buy your daily drinking wine at Costco, but that may not be a correct assumption.
Chris: I do buy at Costco. Costco is the largest wine buyer in the world. But to the discussion, it's very California centric, they do a little bit in Italy, they do a little bit in France, they'll occasionally get some unbelievable wines from the Old World. But after the financial crisis, they were getting a lot more. There were even some wineries that were private labeling juice that there was just a surplus of juice and not enough demand. So, you had some really great wines that were put in private label bottles, and even under the Kirkland banner that were great. But I used to buy a bunch of online, Bill, and I was strictly buying on price, and I knew what I was getting from a couple of good suppliers. I knew where provenance was. There were a couple guys that would do these gimmicky auctions in the wine of the day.
At a point, I'd bought enough from those guys, and again back to being able to stick my nose in a glass and know what it is, there were some sellers, disreputable in my opinion that I'm 99% highly confident. They were pulling the actual juice out of the bottle or they were using fake labels and so. I know I was not drinking what I was supposed to be drinking. So, I've dropped those. But now, I like to support one shop and particularly here in town, the retail markup is a little greater, but these guys are really knowledgeable, they're fun, they're fun to drink with, and I would rather pay despite being a value guy, nominally higher price point and support my local merchants on that front. They go really deep in France, and really deep in Italy, and really deep in Spain, really deep in Bourbon. They're just fun guys and love sporting the local guy, despite my affinity for Costco. So, it's a blend. I kind of get my wine all over the place.
Bill: If you come down to where I am ever, we'll head over to a friend of the pod, Jack [unintelligible [00:10:05] house and you guys can enjoy good wine together. I remember, he was telling me he did something, I believe similar to what you're describing, where he bought his-- He has five children. He bought them bottles of the vintage of their birth, and I think it was his middle daughter threw a rager once, and she opened a bunch of them, and he was like, "What? What is going on here?" So, she had no idea.
Chris: She wasn't 30 yet throwing a rager.
Bill: No, she wasn't. It was not approved, and she was too young to enjoy what she was drinking. But I think they all had a good time. Different times, man. Different times. Before we get into the investment stuff, I heard a rumor that you hold weightlifting records. Is this true?
Chris: [laughs] Yeah, there's a magazine that has floated around the internet that I hadn't seen forever. Being on Twitter, somebody found and it was up-- I'll say I was a first team High School All American football player, and made one of the All-American teams, and the write up took the top, I guess, 24 or whatever players, and they listed some of their academic awards and honors, and some guys had fewer academic awards, but they also lifted your lifts. So, I was a powerlifter in high school and they did some powerlifting meets in college.
So, I wound up with some pretty decent lifts for my size, and even at the time, I think I still hold several High School Colorado State records. At the Senior State Championship powerlifting meet, I broke the all-weight class squat record at 630. I wound up ultimately squatting 750 in college. I benched 400 In high school, which was far from a state record. Benched 475 In college, which was far from a record. I was at Colorado and there were a couple of guys at Oklahoma State benching over 500. So, the bench was not my big lift.
Bill: Dude, you were a monster.
Chris: Yeah, I had some good lifts. My clean was good. I wound up cleaning, my best was 375 in college, and actually I ran a 4-7-240 at almost 300 pounds.
Bill: Wow.
Chris: Right. But you know, I believe some guys out there probably worked as hard, but I doubt anybody worked harder. So, when I stopped playing football and that was kind of the end of that, and I migrated to the investing world. I think I've applied the same work ethic that I learned from growing up with sports and just the competitive drive you get from it. But I lived in the weight room. Again, nobody was going to outwork me, and I also think starting lifting at a very young age, we were kids. I was probably in fifth grade, and my father brought home a used universal weight machine set.
So, it had the leg press and it had the bench. So, we started lifting it with no routine, but you want to see how much you can lift for one rep and you're always kind of maxing out and you were doing three, four, or five reps, and you do it once a week, do it a couple of days. But I think building a base at a very young age, both my brother and I, my brother was never as big as I was, but he was a great lifter as well. We wound up with a lot of weightlifting records. But a lot of that just goes to the hard work on the time spent living in the gym and trying to make yourself a better football player and a better athlete.
Bill: Yeah, that's cool. Somebody had told me that I had to ask. I said I knew we played football, but I didn't know that you threw weight around quite like that. I guess, that was something I didn't realize, and that's what people get on The Business Brew. They get the insights.
Chris: Well, you know where you are now, the player of the year who wound up doing okay was on the cover of the magazine. I actually got my mug, probably, there were eight of us that got our picture in the article. But the guy that got his picture on the cover was a gentleman named Emmitt Smith, who some of you guys may have heard of.
Bill: Yeah. He had a decent career, if I recall correctly.
Chris: Yeah, Escambia High School. Played at University of Florida, obviously, and then pretty decent run in the NFL.
Bill: That was all the line though. No, I kid. I kid. He's a monster. But the line did help. I've always wished that I could have seen alternate realities. I would've loved to see Barry Sanders behind [unintelligible [00:14:16].
Chris: I played in college against Barry.
Bill: Did you really?
Chris: Yeah. He was at Oklahoma State. He was back up running back to Thurman Thomas.
Bill: Yeah, that's right. That's incredible.
Chris: He was coming and he had to sit on the bench for a couple years. But I've never played against a better athlete, better running back. I like to think at the level at which I finally played. You could play blindfolded, and I played defensive line. So, just from technique, you had a sense of where the ball was going to be as the blocking schemes were coming at you. So, you'd find your way to the hole, and you'd see a running back, and you'd see Barry Sanders on the hole, and there he was, and there he wasn't. He would disappear.
Bill: [laughs]
Chris: He had an unbelievable ability to just pivot and change direction on a dime, and that persisted. I tell you, 'Yeah, you're right. If you had given him a strong team of strong offensive line in the NFL, he would just got mercilessly beat up running for the Lions as many years as he did," and was such a good athlete and a great guy. He would play games, his games at Oklahoma State. He wouldn't go out and do what the rest of us idiots did and drink too much beer on Saturday night after the game. He'd go to the library. He was just a class act.
I wound up coaching my son's football team-- tackle football team from second grade through eighth grade, and that was a joy and a privilege to work with kids, and I'll go back and do that again. That's one of my life highlights was coaching. But I had these little kids, and I'd like to give them life lessons and gather them around for about 10 minutes and just tell them stories. So, I was talking about what class act Barry Sanders was, and how he scored a touchdown, and hand the ball to the official, and he was famous for that. These kids are shaking their head going, "Coach, you don't know what you're talking about."
Bill: [laughs]
Chris: I said, "We don't even know what I'm talking about. I played against the guy in college." He said, "No, no, no. I mean, Sanders would high step and run his mouth." I'm like, "Oh, you idiots are talking about the other Sanders-- Deion Sanders.
Bill: [laughs] Deion sanders.
Chris: "So, you all need to look up Barry Sanders and he ran at a different speed than Deion would have a run at."
Bill: Yeah, that's funny. That's funny that they knew Deion. Deion had a cool career, two sport athlete. That was pretty amazing. But yeah, I would take Barry to Deion all day long. Barry is one of my all-time favorites. I think I have his helmet somewhere around here, but the signature is rubbed off a little bit. Over 20 some odd years.
Chris: Yeah, that's pretty cool. You know, you're a Chicago guy. I think obviously Walter Payton, you can come up-
Bill: Yeah.
Chris: -you know, right at the top of the best. But I'd put Barry Sanders at the top of any of the running backs and it wouldn't be far behind.
Bill: Yeah, no doubt. Well, turning to investments, first of all, I think people to do their due diligence on you should check out your appearances on Patrick O'Shaughnessy's podcast, and you recently did one with Chris Powers on a podcast called The FORT. So, I don't want to make you rehash what you've spoken about recently. I do think if you don't mind going into a little bit about your philosophy for those that don't know who you are, and if you then don't mind talking a little bit about what these times remind you of things that you've seen in your career. Maybe, that's a good place to start the conversation. We'll see where it goes from there.
Chris: Yeah, you want to start with parallels? The obvious to me, parallel would be the late 90s, early 2000.
Bill: Yeah.
Chris: You know, you had a bubble in a large portion of the stock market. You had the bull market really began in 1982, the bond bull market began in 1981 with long-term rates at, I think, it was 15.78%, short rates were 20%. You brought interest rates down stocks in the early 80s, had really been sideways to down for 17 years. Now, you go back to 1966, and Warren Buffett stopped taking new money into his partnership by 1969. He was returning all of the capital to his partners suggesting he'd owned Berkshire, but if you wanted to own stocks, you can go hang out and give some money to my friend, Bill Ruane, but you really ought to own municipal bonds because the market's insanely overvalued, I don't know what I'm doing anymore, and he was right, and it was classic peak, stocks were just about as expensive in the late 60s than they were 1929.
Well, so after that late 60s peak, you had the high inflation of the 1970s energy crisis. your Dow which traded at thousand for the first time in 1966 was trading at 778, I believe in July of 1982. Maybe, it was August of 1982. In any event, so, you were down on the order of almost 25% peak to trough over 17 years when inflation averaged mid to high single digits. So, the investor had lost 75% of the purchasing power of capital during that bear market. Nobody wanted to own a stock, household ownership of stocks, institutional ownership of the stocks was very low, record lows, kind of back to depression era 1932 lows. But stocks were a dead giveaway. You could own the long bond, like I said, north of 15 and locked in great returns. But you could own stocks at seven times a 3% profit margin which gets you to 21% of sales.
So, just stock prices for interest rates and what have you and some argued that stocks were expensive, which was insane. But that launched the bull market trough to peak, then the S&P averaged almost 20% into March of 2000. So, that last four years of the 1990s was really when you started getting a bubble. Alan Greenspan and talked about irrational exuberance. The NASDAQ four years prior to the peak, five years prior to the peak was 1000, it wound up peaking at 5000, when the S&P peaked at 1520 in March of 2000, and then again, it took a while to roll over. But even in September, the S&P traded back to its high even though the breadth of the market was really breaking down, and you were genuinely in the bear market for six months prior to people actually realizing you were there. But that last four years was crazy.
What happened was, you had the peaking of the big blue chips, which you'd call the new iteration of the NIFTY 50, which the 50 blue chip stocks traded at 40 to 50 times earnings in 1972 way ahead of fundamentals and then went into a nasty bear market, the S&P, and the Dow dropped 50% from 1973 to 1974. It took years for a lot of those high fliers to get back to even. So, you get to the late 90s, and the blue chips peaked in 1998, and that would be GE, and AT&T, and the Baby Bell spin offs. Everything was really expensive. Then, the next year and a half, so those blue chips started rolling over, Walmart rolled over, Coca-Cola rolled over, the big blue chips started getting cheaper, and everybody was chasing tech. At the peak of the tech bubble, the NASDAQ traded at 242 times earnings. That's where I see a lot of parallels to today.
You had a bifurcation in the market, you were a 401(k) investor, profit sharing plan investor, individual, even institutions, and you were chasing performance. You get your quarterly statement, your monthly statement and say, "My God, these tech funds, the NASDAQ was up 84% in 1999." When we started our firm in 1998, our stocks did 20 something percent in our first year and kept pace with the S&P 500. Maybe even outperformed it a little bit, but everybody wondered why we didn't own any tech. And you had the real tech businesses that were making genuine high levels of profits, and he also had a lot of the internet new tech, new media fashionable businesses that were all being invested on the com. So, in the camp of the real businesses, Microsoft sat at the top of the heap, spent about six pages and a series of predictions in my January 1, 2000 client letter talking specifically about Microsoft as a proxy for the overall tech bubble. So, you can pick your name.
But Microsoft had been public for about 15 years, and the stock had compounded at north of 60%, sales had compounded at 40 something percent, they were doing a 38% after tax profit margin, and the stock traded at $620 billion on $20 billion in revenues. They were doing around seven and a half billion in profits. So, 80 plus times earnings. I simply argued, "You cannot repeat for the next 15 what you've done for the last 15, because the market cap would be in the quadrillions of dollars. They had been dilutive with enormous amounts of stock options given to the employees over that run over the last seven or eight years, dilution was 40% of the company.
But you know, I simply said this is a great business. There's no knock-on Microsoft. If you're a chief technology or Chief Information Officer, you're not going to replace the operating system, you're not going to replace the Word, Excel, PowerPoint suite, and this business will continue to grow. But it can't grow at the same rate at which it had and the stock certainly can't repeat. So, I argued that shareholders at that point would lose money for 15 years, which they did, including the dividends that they started paying, including the $3 special dividend they paid after a few years. When I was out buying the stock six, seven years later when it traded at 10 times earnings, I mean, think about that.
Bill: Yeah, that [crosstalk]
Chris: Stock traded down from over 80 times to 10 times, and at that point, it was a hated stock. But the big businesses like Oracle and Sun Microsystems and Cisco in the genuinely profitable companies traded at exorbitant prices that had pulled forward anywhere from a decade to 20 years' worth of future performance. Some of those companies like Lucent wound up not making it. There were a lot of new technologies that did not make it, but then you had this whole myriad group of internet type companies, and everybody was all about the internet. GE was all about the internet. Jack Welch talked incessantly about B2C and B2B, and everybody forgets that or they're not initiated to it. But you had this whole crop of companies that had recently gone public, didn't produce a dime of profit, and were being valued at 20, 30, 40 times revenues, and it was all bets on the com. There are a whole bunch of those kinds of companies today. Twitter, Shopify, you know some of these things may wind up being great businesses, but when you're paying 10 times, 20 times, 30 times revenues for companies that don't generate a profit, it's a tough road to hoe, because a lot of those companies will not get there.
You take a company like a Twitter and extrapolate 10 years of say sales growth at 15% a year and run a 20% or 30% profit margin, if you run it at a 20% profit margin, I would guess you would factor in dilution of maybe 4% a year, and somebody has got to convince me that they're not going to keep giving shares away when you consider the shares that are already outstanding and unvested comprising RSUs and options. There's an enormous amount of overhang. So, you assume maybe 40% or 50% dilution over the course of a decade, and stocks trading for 20 times or 25 times what they're going to earn in the most optimistic sense, a decade hence. You take any of these great businesses to your point, I mean, the ones that are just obvious great companies that you pay any price for. At the end of the day, price matters. When prices get to extremes, they really matter. I went a little bit after Ark, and I took great exception to Cathie Woods. Price target forecast report on Tesla back in March, where she suggested that the stock would trade at $3,000 a share by 2025, and you got into the assumptions behind that report. and there's just no mathematical, no realistic way to get there on a business fundamental case, when you objectively measure the revenues from each of the various subsidiaries and industries, they think they're going to disrupt.
The mathematics were impossible, and I think you know either delusional or intentionally puffed to promote inflows into the funds, but her portfolio for the better part of well, for the six, seven years prior to 2020 to take the aggregate of those companies as I do every year in my annual letter. when I look at our portfolio, I aggregate on a size weighted percentage in the portfolio weighted basis, each of my companies as though they're a single business and measure all the fundamentals, measure balance sheet characteristics, return on capital characteristics, and so, you do the same for what was Cathie's portfolio for the first six years and the thing traded for three to five times sales.
It's an-- in aggregate, the companies don't make any profit and so, you can't measure it on a P/E basis. You can extrapolate forward like I just did with Twitter, and my math on Twitter was probably wrong. That's, you know, off the top my head, but that's the exercise you have to go through. Well, you get her in 2020, and she made 150% in her main fund. So, the entire ETF was I think $1.9 billion at the end of 2019. It makes 150% which would take you to four and a half billion. How big do you think the fund was, how big do you think the ETF was at the end of 2020, starting at $1.9 billion?
Bill: Just based on flows and whatnot?
Chris: Just based on flows and returns. Returns would have gotten you to four and a half.
Bill: Yeah. Oh, man, I got to be north of 10, but that's not even close to high enough. I don't even know how to guess this number, because I'm going to end up low or just obscenely high?
Chris: No, you're exactly correct.
Bill: Yeah?
Chris: It is north of 10. $17.7 billion.
Bill: Yeah. I was going to go north of 20, just because I think when flows happen like that they can really get out of control. But 17 does not surprise me.
Chris: Well, no, extrapolate three months forward, the flows continued. So, you had somewhere on the order of 10 billion that flowed in, in the back half of 2020. The money didn't come in, in March and April in May. It came in after Tesla had its rally, after it had been added to the S&P 500, after it had done its stock split, and then in the first three months of the year, another $10 billion or so float in. So, you start off 2021 at $17.7 billion. It's down, I don't know, 6% or 7% for the year. So, it should be about a $15 billion fund, 15 and a half whatever. It's $25 billion at the end of June.
Bill: Yeah, that doesn't shock me.
Chris: So, the parallels there, and now, at the end of June, her portfolio was trading for 15 times revenues. Not the three to five times that it had traded for, for the entire history. So, you just take the price back down to three to five times revenues. That's a 65% to an 80% decline. Now, you've got redemptions coming out of the fund, and that reminds me almost to a T of Janus from the Janus Fund.
Bill: Yeah, this is what Toby talks about quite a bit, too. He's like this feels similar. I'm going to play devil's advocate in this conversation. Wouldn't it make sense, though, that now people have realized how great these companies are going to be? They didn't understand how great these companies were when they were trading at three to five times sales. And this is sort of the new rereading that like, why will those companies go back to three to five times sales, I guess, is the question? Because aren't they just fantastic companies that people have realized?
Chris: Well, they don't have to. You can grow into your valuation. So, you run a best case, say, the growth rate in revenues for the aggregate of her 55 companies or any portfolio of some of these more SPAC businesses that don't yet make money. I'm not just singling out Cathie and her portfolio, because there are plenty of folks running money, and there are plenty of stocks out there that resemble and represent these characteristics. I'm talking big multiples to sales with no profits yet. So, if you take a 10-year period of time that matches what the big five tech stocks that sit atop of the stock market, Apple, Microsoft, Google, Amazon, Facebook. You take those five, they had grown their market caps, total returns, some are issuing shares, some are buying back shares. So, they made about 20% for a decade. Revenues had grown at high teens, profits had grown at a higher clip, Amazon's been growing into its profitability, they were not making money for a long time.
Now, they're making a six and a half percent profit margin. The billion-dollar question there's, what does that margin structure look like at maturity? We can have that discussion. But if you take a portfolio of these 15 times sales companies, forget Cathie, let's just take the universe of the 15 times. Well, those were the best performing stocks in 2020. I did a thing in my annual letter this year and I took price to sales measured by year, perspective returns for one year, two year, three year, four year, and these rolling all the way back to 1999. And your last iteration when you traded at the same crazy multiples to sales was the end of 1999, early 2000 right at the peak, you had a really bad experience. You lost a bunch of money over the next 5, 10 years, 15 years. Some of those companies made it. Two or three made it, but most did not and most flamed out, you lost a bunch of money. You're sitting here at the same type valuation base. So, you don't have to go back to three to five times.
Bill: Yeah.
Chris: If you give them 20% sales growth, which is really hard to do. I mean, it's really hard to grow at 20% top line for a decade-
Bill: Okay.
Chris: If you allow them to grow into a 30% profit margin, which now gets you into the realm of those five tech stocks, some earn less, Amazon earns way less, Microsoft is back to earning 37% having dropped from its 38% margin back in 2000 all the way down to 22%. I had modeled a decline over all those years dropping to 20. Well, all of a sudden on the back of subscription software, and Azure, they're back to a 37% profit margin. The damn things back to where it was in 2000. But the stock has only done seven and a half percent-- seven and a half percent from the peak. So, you lost money for 15 years, and you've peak to peak done seven and a half, which matches the S&P, because the S&P was equally overvalued in March of 2000. So, you take these high-flying stocks and allow them to grow to a 30% margin, 20% topline growth, and capitalize them at 30 times earnings. That's best case topline, that's best-case margin wise, that's best-case valuation wise in aggregate. You make a single digit return.
Bill: Yeah.
Chris: If profit margin only gets to 20%, you make four or five. If you wind up getting diluted by a factor of 2%, or 3% or 4%, which is at a minimum what's coming out of those companies across the broad stock market, the S&P 500, the dilution factor on the front end is 2% of shares being given away, and that gets masked by companies spending more than 55% of their profits with 45% coming out as dividends. They're spending more than the balance of their profits augmenting with debt, three purchase of shares to buyback 3% of their market cap per year. So, you're net shrinking the share count by only 1%. So, you're masking that dilution that comes out. Well, these companies that don't make any money are famous for giving prodigious amounts of stock options and RSUs away. I mean, Tesla, after Elon was in control, years after he was in control was awarded in a series of two grants 20% of the company.
Bill: Yeah, I remember these grants.
Chris: So, you can grow into a best-case scenario. But if your Twitter and you use the math I just ran through, you've already priced the thing for where it best case could be 10 years from now. You don't you don't make any money. So, if you're going to make a mid-single digit return, you've got to get the whole portfolio, not just one or two companies. So, if you take 55 companies, or you take a couple of hundred companies, or however many 400, 500 companies traded through these ridiculous multiples of sales, figure out how many am I really going to make it. Most of them will not make it. The winners if they exhibit those characteristics of 20% top line growth margins of 30%, 30 multiple to terminal earnings, that's the best case. But you can't take and assume the best case for all those companies. So, the average investor in Janus came in late in the game and lost a bunch of money. The majority of Janus shareholders lost money.
The majority of Cathie's shareholders are now underwater, because so much money came in, in the back half of 2020 and the first three months of this year, they're sitting on losses. That's where the trigger mechanism comes into play. When you've come into this game late and you were not an early investor in some of these companies, and you've not enjoyed 6, 7, 8 years of spectacular compounding, and you come in looking at trailing gains, and you expect those gains to persist, and you don't get those returns at the point where you're underwater, you either get margin called out or you simply sell because you can't handle it. That's where I think in the world of retail investors, and common stocks, and even extended to a number of institutions, and professional investors, most investors lose money because they buy high and they sell low. You're prime today with a valuation extreme, especially, in that new IPO growthy techies fear, where things are priced very similar to what I saw in the late 90s.
Bill: Yeah.
Chris: There aren't enough investors that live that, breathe that, experience that. There are those that take some of the perspective from guys like me that lived through it and navigated it very well. By the way, I mean, we made 30-ish percent during a 50% decline in the S&P and an 80% decline in the NASDAQ, because under the surface, under all that tech stuff, there were some phenomenal smaller and mid cap businesses that were being given away, because the guy that got his 401(k) statement sold his small cap value fund, sold his mid cap value fund, because he wanted to chase tech. The same things happening today. There is a bifurcation in the market, it's not as extreme. But, Bill, I'm buying assets in the last six months and I'm buying them here in the last week, earlier this week at low single digit multiples to cash flow. Not earnings, cash flow. Businesses make a bunch of money. They exist.
Bill: Well, are these all cyclicals though, Chris? This is the natural question, right? How do we know that it's normalized cash flows, would be the natural question?
Chris: Yeah, that's the trick. I think that's where investing cyclically is very hard to do, and you've got to be a little initiated to being able to ferret out mid cycle valuations, and you've also got to believe that there's a bull case to the commodity if you will, underlying the business that you're not in a permanent state of decline. So, for that, I've got big concentration and energy today and there are a lot of investors that won't touch energy.
Bill: Yeah.
Chris: Either for ESG reasons or because they believe we're going to EV, we're going to solar, we're going to wind, and the carbon footprint companies are going to get crushed, and I happened to paint a completely different scenario based on what I think is the reality. But for that, you've got assets being given away for nothing that are producing a lot of cash, and your breakevens wind up not being very long when you're paying low single digit multiples to cash flow and in today's market-- so you don't even need the recovery in the commodity. In fact, you don't have to have peak levels on oil or Nat gas, or some of the other things that I own. You just got to get to the haze level of profitability and they're minting money, but they're assets that a lot of investors and a growing number of investors either will not own or cannot own.
Bill: I think, when it comes to those kinds of ideas, the question that I usually ask myself is, why are the cash flows going to come back to me? Because I always get worried that the cyclical will generate a ton of cash and then go out and spend on another oil project, or another sawmill, or whatever it is that they may end up spending on. But I do not disagree that there is such a large aversion to those ideas at least among the people that I interact with, and potentially that's because of who I spend my day interacting with. But it's very, very hard to get people to be remotely interested in a cyclical idea in a world of compounders and tech ideas. I think that's objectively true.
I wanted to ask you to give you the opportunity to discuss, because you do these threads on Twitter, whether or not it's Ark or whether or not it's Tesla, what's the purpose behind doing those? I think, one, it's a good way to get your message out, and two, I think you're ringing a bit of an alarm bell. But I do want to ask what's behind that because it does appear to take a lot of time when you put those out.
Chris: There was no forethought into pointing out various inconsistencies, and I think in a lot of cases, pointing out some abuses that are taking place today. Having seen the retail investor sucked in to the bubble in late 90s, having seen the retail investors sucked into the bubble in 2007, investors got sucked into real estate. Same thing happened in the 60s, the Manhattan fund. If Goldman Sachs wants to screw over a hedge fund or two, so be it. We're all big boys and big girls. But the abuses today are in many cases far beyond what we saw in the late 90s, and my letter when I wrote up Microsoft and said you're going to lose money for 15 years that wasn't self-serving. That went to my clients. I didn't have a distribution list where the broad public was reading that letter. I had pressure from our clients wanted to know why we didn't own tech, and why we didn't own Microsoft, which was 5% of the S&P 500. So, I needed to articulate to the best of my ability, why you would lose money for 15 years and why you can't chase recent trailing performance?
I should probably in being on Twitter, and I blame and think in the same breath O'Shaughnessy for on Twitter, we've done an early podcast, and he had asked me, even prior as I was getting to know him, we were having drinks so, and what have you. What I thought about Twitter, I don’t think about Twitter, and I don't do social media. I write an annual letter, and if you want to see what I have to say, read the letter. It takes 100 pages, and there are a lot of thoughts there.
Bill: There are.
Chris: Anyhow, they are recorded and released it, and I was with my daughter at Sea Island. She was taking some golf lessons, and we were playing a couple rounds of golf, and so, he released the thing that week, and on Friday or Saturday, he sent me an email saying, "Hey, we've had 28 billion listeners to the podcast in the last four days or whatever the number was. It was less than 28 billion, but a lot.
Bill: [laughs]
Chris: I thought, I was-- [crosstalk]
Bill: It'd be lower than that on this one. I assure you.
Chris: [laughs] Well, you never know-- you never know. We're doing the video and we're doing the audio.
Bill: That's true.
Chris: Anyhow, he said, "You ought to think about Twitter." and I replied, Man, I don't know. It's just didn't seem like my bag. I don't want to be out there daily." We've got compliance issues with talking publicly to the general public. Anyhow, he said, "Look, I'm going to give you the pros and the cons. The pros are, you're going to meet a lot of great people and you'll even develop some friendships from it." I kind of poopoo that. And he said, "You're also going to meet some allocators, and there are a lot of folks that are running institutional money, and family office money, and just really smart savvy people that tune into these podcasts, but spend a lot of time on Twitter, and there's some thoughtful people there." He said, "The downside is, if you really get into it, you're going to wind up consuming way more time than I know you want to spend with it," because your time is-- [crosstalk]
Bill: [laughs] That's a very honest assessment of what Twitter is.
Chris: He said, there are some hassles, and there are a few, and on all four points, the two pros to cons, check the box, and he was exactly right. But anyhow, when I was hemming and hawing, and Lucy and I were sitting there at dinner and he sent me an email saying, "Check your Twitter," because I did have a Twitter account. Lucy and my wife had set it up for me like a year prior. I had one follower, which was my daughter.
Bill: [laughs]
Chris: I never even looked at it. I wasn't initiated, how it worked. I wasn't following anybody. So, I had zero follow up, and I was following Warren Buffett, who had sent six tweets up to that point. So, I had one follower, one following. So, Patrick retweeted out the podcast interview and he introduced the notion that I was now on Twitter. I said to Lucy, "Oh, my God, what do I do now?"
Bill: Yeah, I think I remember this actually.
Chris: Well, I have no idea what to do. She says, "Well, you have to tweet something out."
Bill: [laughs]
Chris: I said, "How the hell do you do that?" So, we sat there at dinner and I craft a little message and copied the first of the Buffett tweets saying, I was now in the house or whatever, and maybe, I'll do this more than six times over the next six years, and the rest is history. I learned it's a valuable tool. There are some thoughtful people, but I would tweet about Berkshire, and fun stuff, and tweet about wine, and I said something about Tesla at a point, and it wasn't a big, long thread. I just made some innocuous comment, and the vitriol that I got back was pretty extraordinary. It's comical.
Bill: Oh, yeah, man. You and the Tesla crew, you guys like to clash. [laughs]
Chris: Well, I took that to the next level.
[laughter]
Chris: Did one of my, I don't know long 20, 30, 40. So, you know those 20, 30, 40 threads-
Bill: Oh, yeah. I'm aware of them, Chris.
Chris: -when I do the long ones, I'd write them out in Word, or in notes or whatever, you know it's a page, page and a quarter. I write a hundred and plus page client letter. It doesn't take me long to spend three or four paragraphs, and just randomly jot down thoughts what takes the time. So, it'll take me 10 to 15 minutes to write the thing.
Bill: Yeah.
Chris: It doesn't take a lot. I'm not doing a lot of deep research. I'm just talking about what I know. But then you got to take the damn thing, and fit it into each of those little boxes, which is insanity. Some have said, "Why don't you just do a blog?"
Bill: Yeah, you could sign up for a review or maybe, you could pay Twitter for Twitter Blue, get some of this optionality that's priced into the stock to start to generate some revenue like I am on Super Follows, though, not much. And then they can justify the share price. Then, wouldn't that be fun?
Chris: I did not fully answer your question about Twitter strategy, and what the hell I'm doing is, at the end of the day, when I realized the feedback I got from Twitter, and then went after simply the valuation and made the similar case to Tesla that I did to Microsoft. The year evolved, and SPACs became a thing, and having looked at SPACs in their early iteration, six, seven, 10 years ago even more, it's just a bad capital structure. Guys like Chamath come along and favorably compared himself to Warren Buffett, which was an insane comparison.
Bill: Yes, that was an offensive.
Chris: When I then ran his annual report-- It was offensive, I mean, just unfounded in reality, pushing the line on ethics, and perhaps even law. You're raising money in the capital markets from public investors. In my mind, fraudulently would be a heavy word, but you're misrepresenting returns, you're shedding them in the most favorable light, you're presenting gross and not net, you're running five funds and you're presenting your returns in aggregate, and not for each of the five. There was just a lot that was poor. But then, the selectivity of how he chose Berkshire Hathaway's returns was just off the charts, egregious. So, there are those things.
But the spirit bill of all of those various tweets and threads that I've sent are really, at the end of the day with an eye toward the retail investor being abused by larger pools of capital. And it's the same thing that happened in the late 90s. I had zero mouthpiece. Again, my client letter was a private document. It was read just by my clients and 20 or 30 friends. So, I've got a little more of a platform now, and given the degree of pushback that I've received, I realize, "Good Lord, there are a lot of guys out there that have totally been consuming the Kool-Aid, and they're going to get hurt."
If somebody with a little bit of experience in gray hair, who've seen some of these things, who's in my mind not over the hill, but pretty rational about how valuation works and how business works. If you can shed a little light on some of the abuses and some of the just blatant speculation instead of investing, I hope I'm doing a service and not just picking on other people, and I don't want to have reputation of being a bad guy. I mean, you've known me. I don’t think, I'm a bad guy.
Bill: Yeah, I don't think you have a reputation of being a bad guy. The only thing that I've asked myself is, "Is this Chris' highest and best use of time?" What I have come to a lot of the times when I've asked that is, "I do think fundamentally you have a view and you're expressing it, and as somebody who has seen your work, and I know how hard you work at doing things the right way, I think that it's very cool that we live in a world where you can get your message out and you're either going to be right or wrong in the fullness of time, but I don't think that, well, I know for a fact that you're not doing it in a schmucky way, which I see a lot of people doing things in schmucky ways, and I'm glad that their voice is like you pushing back on it."
I'm trying to navigate the landscape in the best way that I know how and I think that I'm not immune from some of the mistakes that some people are making. I hope that I'm not amplifying those mistakes with the podcast. But I'm trying to do my part to give back to in whatever way I'm capable of doing. So, at least the intent is good here. I can't attest to the mind and the ideas, but the intent I can. So, we'll see how that all turns out in the fullness of time too.
Chris: Well, I think you're doing a great job with it. I think the platforms that you've built and developed are just super. I think the messages that you're sharing and the light that you're shedding on various issues be it Robinhood, or what have you. I've just been of the noblest of character. At a lot of levels, I'm at the point in my life where I really want to give back and I spent a lot of time on college campuses talking to students, investing clubs. They were the groups that run their sleeves of the university endowments. I've taken my letter and I've done this for years. But I've always been so appreciative of Warren Buffett, and the give back of the time he spent, particularly, in the early years, , less so in the last five, six, seven, he's just not really in teaching mode anymore. But he spent the majority of his career and he's in teaching mode.
Bill: Yeah, it's tough, man. [crosstalk] there in age.
Chris: Yeah, he's done it. The 40-page letters, where he's teaching about various nuances of the capital markets, and morality, and ethics, and how they interweave, and he's just not going to do it anymore. I doubt that I'll be doing it. I know I won't be doing it in that fashion, and it in fact, I told him this year, my goal was to shrink my annual letter by 2.6 pages per year such that when I'm 90, I'll be writing the same-
Bill: [laughs]
Chris: -length letter that he is.
Bill: I like it. That's funny.
Chris: But a lot of my mindset has been molded by some of these greats-- investing greats that have given back that did not have to take their time to write and built a foundation on things that work and things that don't work. But I've learned a lot of lessons vicariously through some of the great investors and some of their teachings to the extent I can give back to the next generation of investors. So, my letter is read by a broad swathe, it's read by Mr. Buffett at one end, and it's read by some high school kids. But it's read pretty widely on college campuses by young investors, and I hope there's some teaching aspects and some things that I've learned over my 30 years as a professional investor that I'm able to pass on.
That's become more and more important to me as I've spent more and more time in what I think is this great profession. I look at my world as a profession or not as a business. For that, I've created this public persona in various aspects where those who read what I write or listen to you and I yammer on here, I hope there's some utility for some of the things we're talking about.
Bill: As do I. I got to tell you something that kind of pisses me off about where we're at is, I really don't like that people cite Berkshires share performance over the last 10 years as some sort of indictment on either Buffett's vision or capability to execute, and he's super underappreciated. I think it's amazing to be able to put up the numbers that he's put up for the amount of time and to still have people come at him. Even what he has done with Berkshire Hathaway Energy, it's as if people don't think he builds businesses. That business what it has turned into and what it does for the American economy and Burlington, Northern. It's shocking to me that people take shots at him.
Sometimes, I think maybe I'm a little bit overly of a fanboy, but at the same time it's odd to me how share price appears to be driving narrative at this stage when a lot of it can just be chalked up to the entity might be too big to generate outsized returns, maybe not. But I think Charlie would argue, it's probably not going to put up hugely outsized returns given the size. And two, there's a lot of internal capital allocation decisions that impact people's lives that they don't actually see every day, but because the stock doesn't rip people think that it's not going on I think. I don't know if my version of reality is true, but it feels that way at times.
Chris: No, I think it's spot on. Any performance record, anybody's performance record is (in point sensitive). You can take a three-month period of time, or four-year period of time, or a 10-year period of time, and at a point somebody will have outperformed somebody, somebody will have beaten index, somebody will have underperformed an index. I measured the next most recent iteration of Berkshire after they bought Gen Re Berkshire stock was extremely expensive trading at 2.9 times book. The common stock portfolio which was 115% of Berkshire's book value was equally expensive. Coca-Cola was 35 plus percent, almost 40% of the stock portfolio, and it was trading with those NIFTY 50s, the new iteration in 1998 at nosebleed prices, $200 billion market cap trading at 40 times earnings.
Berkshire needed to grow into its valuation, the common stock portfolio needed to grow in the valuation. The Gen Re transaction was seminal using the stock paying $22 billion when Berkshire shares were only worth half that in my mind with $11 billion, tripling the float, growing the assets of the firm by 75%, and only being diluted, only increasing the share count by between 20% and 25%, brilliant transaction. So, from that point though expensive stock, expensive portfolio, Berkshire's book value compounded at 10. The S&P 500 is compounded at 7.2 or 7.3, and I run, Bill as you know in my letter each year, both a forward and a backward compound annual growth series for Berkshire's change in book value per share, which was the original yardstick they used until about 15 years ago, and then they introduced the S&P 500 selectively Berkshire's stock and outperformed the book value. So, I think there was some-
Bill: [laughs]
Chris: -motivation for perhaps introducing the second metric, but then they always showed versus the S&P. But at the bottom of that table, they always showed you the compound annual from inception and that was it. You didn't get the one-year return, two year forward and backward. So, I started running the forward and the backward particularly when the book value per share was dropped as one of the utility measures in that table. So, I will always run it. So, I've got the compound series from the beginning of time which is 20%, and I've also got the backward compound series.
At the end of last year, Berkshire stock was only up 2.4%. Well, this year, it's up 17%, 18% for the better part of this year was it's been ahead of the S&P 500. I think it boils down to expectations and journalism sells and as Berkshire became a more known entity as you got into the 1980s, certainly the late 1980s and throughout the 1990s, you're going to be a lightning rod when you're that successful. Mr. Buffett's been a lightning rod for the passive crowd arguing that it's a fluke that nobody can beat the market over time, and there's some gimmick to this or it's just luck, and you run a number of coin flips in a row, and you're going to have that one in a billion that can do it.
Bill: Yeah, like Charlie says, "People just keep adding a sigma to their outcomes," right?
Chris: Yes. So, going in, you have to have a rational set of expectations for what the business can do. The aggregation of the utilities, which are brilliantly run in with brilliant capital allocation, the railroad, the manufacturing, service, retail, and now, finance businesses, the insurance operations, you have to have a rational set of expectations for what those individual businesses and all of the 80 plus subsidiaries can earn. I jump through a bunch of accounting hoops to get to a number that's now north of $45 billion is what I would call normalized profitability for Berkshire, and measured against their stated book value, you get to about a 10 ROE, okay? The stock is going to compound in line with the intrinsic value growth of the business. For the last 20, 22 years, the last 10 years, it's done exactly that.
I don't have an expectation that I'm going to earn much more than 10% on my Berkshire shares, and I can tell you that having bought it for the first time in February 2000, after the stock had been cut in half, after the Gen Re deal, I paid 105% of book value. Remember, it traded it 2.9 times book two years prior. I've bought it well over the years. So, my clients and my own Semper's Capital has had a slightly better experience than the average Berkshire shareholder experience, because we've bought the thing so well. But I don't expect to make much more than 10. And that's what it's done. So, you're going to have a period that excludes 2008's 40% decline in the stock market, you've had a rip roaring bull market much like you had from 1982 to 2000, and you're going to have a lot of people that when you pick those in point brackets, you can say, they're really stupid.
Bill: Yeah.
Chris: But you got to rationally look at what you actually ought to expect the business as measured by the underlying fundamentals of the business to do, and whether that translates into a stock price being high or low. If last year, the S&P was up high teens, and Berkshire stock price was up two-four, does that mean Warren Buffett's an idiot? He can't control the stock price in the short-term? But he can sure control the accretion of value and the allocation of capital toward Berkshire Hathaway Energy, which does not send a dividend ever up to the parent. Every dime of what's now $4 billion in profits is reinvested, appropriately levered at an equal mix of debt and equity, which is how utilities are operated. So, they're spending enormous amounts of growth Capex building out, serving public policy at a regulated return.
Building out wind and solar infrastructure. They're building up the grid, which does not exist to serve these disparate new supplies of power. Your solar when you drive through California, and Nevada, and Arizona as I've done with Lucy here, back and forth the last few years, the solar fields are unbelievable. They're enormous. The wind power, you see all over the country is enormous. Well, that's desperately, geographically located power. There's no grid that exists, and somebody's got to build it. Very complicated projects. Berkshire works with Kiewit, other contractors to get this stuff done the permitting process to make it all work. But I can tell you, nobody has the capital. Nobody has the capital that Berkshire has, other utilities are not run with a policy of not paying dividends, utilities are generally retail fashionably constructed entities that distribute the majority of their profits. So, if they're going to grow, they have to issue new capital, be it equity or debt capital.
Berkshire has the high-class problem of retaining every damn dime of profit that it makes, and they're getting regulated returns on high single digit call at 10% returns in a world of very low interest rates, they're driving their borrowing costs down, they're lengthening the duration of their debt structure, those businesses are appropriately levered, the vast majority of debt that exists in Berkshire, which is less than the aggregate cash in Berkshire resides in the utilities in the railroad. Railroads earning teens returns on capital, the utilities are earning 10-ish returns on capital, these are great investments. But in the aggregate of all of Berkshire, if I make 10, I think the rest of my portfolio will and should do better. But Berkshires my largest holding, because it's by far the most notable. Man, in a world of no interest rates, I can't own bonds.
Bill: Yeah, that's how I feel.
Chris: You know, retired individual, I look at Berkshire as a bond surrogate-
Bill: Yeah.
Chris: -Is a very predictable kind of a 10 ROE business. If I don't overpay for it, I can sit back and count on a very predictable return, because these are businesses that are not being disrupted, not being dislocated. There are some companies that no longer earn their cost of capital inside that MSR group, and they'll appropriately deal with those. But the capital allocation that's taking places as good as can be expected, it's brilliant, given the hand that you have, given $470 billion at June 30 in shareholders equity. Over $900 billion and firm assets, it's the largest business in the world by tangible capital, tangible assets. It can earn 10 In a world of no interest rates, and in a world where the overall stock market is now so expensive, you can pick these three-year, five-year, seven-year periods and say, "Mr. Buffett's an idiot," because he's underperformed the market.
Well, you're at the tail end of another bubble. Stock market's as expensive as it was in 2000. In the late 1960s, and 1929 so sure, an entity that only should earn 10% a year will look like it's failed, and the journalists will come out of the woodwork and the naysayers come out of the woodwork but to be critical, but not have an understanding set of what should be expected of a business is just folly. I enjoy watching the naysayers, and if enough of them jump on the bandwagon and keep the stock cheap, then Berkshire can buy back, you'll spend 100% of its operating income buying back shares as it's done for the last couple of years.
Bill: How do you think about, let's not necessarily talk about your portfolio. Let's just give a hypo. How do you think about opportunity cost of adding security when there's something like Berkshire that you feel like you can count on, because so, I've got myself in a shitstorm on Altice, at least from a price perspective, and I would argue from a business perspective too, it was probably a dumb bet. But here I got enticed by a low price, and I think I made a mistake. If it was a mistake, we'll see how it all turns out. But hard to argue that the bet was certainly, it wasn't timed well, if nothing else.
You had mentioned in an interview with Chris Powers that, when Nike went direct, you would avoid something like Foot Locker. I think I've found myself in a similar, but different position where I bet on a weaker business, because the odds offered out of the gate were more attractive to me. But the certainty of return is lower, and I am feeling the pain that a young Chris may have felt too, but an older Chris has trained himself to avoid. How do you think about opportunity cost to capital and when maybe going down business quality is worth your perception of increased return? Like you're talking about energy, right? That's a cyclical. We just talked about how confident you are in Berkshire. Why does energy belong in the portfolio and how do you think through those kinds of decisions?
Chris: It is, Bill. As I've gotten more experienced and with a better understanding of the nuances of how capital works, and how returns are generated and derived from investing in common stocks and businesses or investing in various other assets and asset classes. I got a pretty good understanding of how returns are generated over longer periods of time. We have no idea what's going to happen in the short term. So, it boils down to opportunity costs. The opportunity set that existed on March 23rd of 2020 is an entirely different opportunity set that exists today.
Bill: Yep.
Chris: I have learned to use Berkshire Hathaway as my initial opportunity cost benchmark.
Bill: Yeah, that makes sense to me.
Chris: I've got a very, very confident 10 to 15-year assessment of what my return ought to be from owning Berkshire. You can drill it down to a simple as, what's the business going to earn on its equity capital, book value may have more or more likely less utility over time as a proxy of value. But I can measure the earning power of Berkshire. I can do it through each of the subsidiaries on a sum of the parts basis. But I know what the business is going to earn on normalized basis. Year-to-year, there's tons of volatility you have to strip out, changes in marketable securities, you've got to strip out underwriting profitability, both of which I normalize. So, I can get to a very rational, very conservative, by the way measure of profitability. So, I start with 10.
Well, the opportunity said if my only option were to own passively the S&P 500, I'm going to make 4$ to 6%, best case over the next 10 years. You are priced at levels where margins are at record highs, and if we hit Wall Street's expectations for 2022, you'll be 150 basis points of net margin above the prior record. I don't think it'll happen. It could happen, but I don't think it'll happen. You've got very, very high multiples to earnings. You've got high multiples to earnings now for the five big tech stocks that now make up 25% of the S&P 500 for the majority of the last 10 years, 15 years, that group of five stocks to the extent they were publicly traded. Some were not public for the entire 10 or 15 years. They were not expensive. Apple traded at 12 times, strip the cash out of Google and it traded at teens multiple. Facebook recently was traded at teens multiple, but they're expensive today.
When I'm looking at anything new coming in the portfolio or I'm looking at adding to positions and most of my activity is trading around the positions that we own, it's trimming things that get dear, adding the things that get a little bit cheaper. On average, I'm only adding two to four names per year. Two and a half, maybe three would be the average per year of new names and I tend to offset that with a like number of sales. So, I've tended to keep the number of stocks in the portfolio at under 30, and I've tended to keep the concentration in the top 10 holdings at roughly three quarters of capital. And there's no method to why I do that just kind of the way the portfolio has evolved over time and how it's always been run. But any security that I have, whether I own it today, or whether I'm prospectively thinking about owning it, or I'm actively buying it, I'm not simply saying, this is a great business you can just buy it. Because that's as we've discussed, I think that's where speculation enters the mix and that's not investing. You have to kind of build out--
Bill: What about this idea of never sell, just don't sell good businesses?
Chris: That takes you down a whole another path. There's an entirely separate conversation to be had there. I have learned over the years that there are businesses that you ought not sell. I've made the mistake of selling some businesses regrettably, my largest mistake I wrote about in my letter two or three years ago was, a sale of raw stores. When the market was bifurcated and all those small caps and mid caps were really cheap. At the same time, the S&P traded it almost 40 times and the NASDAQ at 242 times, I bought Ross for 10 times, they had 350 stores, they'd really long runway to open new stores and the unit economics were terrific. But the stock had been crushed, not because the operations of the business were struggling but because it was a small cap value company. Small cap value fund manager was faced with redemptions on a daily basis and would have otherwise loved the portfolio, but had to sell to meet redemptions. That's what's happening in Cathie's world today. So, I paid 10 times for it and earnings were conservatively stated. I made two and a half times my money over the next couple of two and a half years.
Market dropped, S&P dropped 50%, I made two and a half times my money in Ross and now, it's trading north of 20 times, and I thought, because Chris was really smart that he would sell it and come back to it. Well, the idiot never came back to it, and it's been well above the 20 bagger from the moment that I sold it. Not from when I bought it, but from what I sold it. It's been one of the best performing stocks at the stock market for the last 15, 20 years. And I've got a number of those. So, what I've learned to do on that never sell front is, I'm in a world where I have to mesh institutional and non-taxable money, and I also have to run taxable money.
I run taxable money I think very well and I'm very price sensitive. But what I'll do now, Bill with a company like Nike is, I want to own Nike for the next 30 years or I want to own it as a coffee can investor would forever. But I don't want to own it 40 times or 45 times. So, I will trim that back and I'll try to optimize my selling in the non-taxable world. But I'll sell it down in a taxable account if the prices are far, far ahead of the fundamentals. So, my Nike holding today is one half of 1%, and I'm not going to sell anymore, because if I sell it, the likelihood that I repeat my experience with Ross and never come back to it, it is pretty high.
Bill: That's interesting.
Bill: I learned later just a few years ago, I read that Lou Simpson had ultimately done the same thing. He would keep his, what you'd call, today, fashionably compounders, but you could scale them down in size. So, I scale them down in size for price. Old Chris, before I started Semper, I managed money for a Bank Trust Company. I managed one of their mutual funds, worked with some big public pension money in the State of Missouri, had some super accounts. But I didn't know anything in my 20s, I was learning. I was on a very steep learning curve, but I was very wed to fundamental valuation. Price to earnings, price to sales, price to cash flow, price to book, dividend yield, and I didn't spend as much time thinking about business quality, because I didn't understand business quality. I just thought if something's trading at eight times, it's going to trade at 15 times eventually, because that's the median P/E for the stock market and everything on our trade at 15 times.
Bill: Yeah.
Chris: And there's some merit to that. I look at some of the garbage that I own when I worked at the bank and even in the first couple three years of running Semper, you scratch your head go, "Why would I have owned that?" I mean, not a great company. So, to your point about a Foot Locker, foot lockers wed to Nike, and Nike has gone direct to consumer. They're running a lot of business through the app, and that's one of the cases. I think it's much easier for the average investor to say the multiples too low, and I'm going to get multiple expansion. Well, we've thrived. We being the stock market has thrived on multiple expansion for the last 10 to 12 years. So, you're sitting here at nosebleed multiples because you've had multiple expansion, and well in advance of fundamental business growth, revenue growth, profit growth. You've had multiple expansion and you've had margin expansion in places. These five big tech stocks are more profitable today in aggregate than they've ever been, and I don't think there's a lot of room for upside.
But a Foot Locker because even though they're still wed to Nike and even though Nike is their biggest supplier, and the lifeblood of Foot Locker, Nike has to manage that balance, and they can't kill that distribution channel. They have to marry also the notion that, man, our sales through the apps are way more profitable and so, I was kind of early to baking in a doubling of Nikes net margin, which they're in the midst of, they're halfway there. And the world's now catching on to that. That's why Nike will trade it 40 to 50 times. It's really not trading it 40 to 50 times when you get to your normal, higher margin structure. That's hard to do. Finding the places where margins will durably grow that's really hard to do.
Amazon has been an evolution in that notion. They didn't make a bunch of money for a bunch of years, and they've got this core retail business that looks a lot like Costco. Over the years that I've owned Costco from 2004 to the present, which I have now shrunk back down in size, and I've not sold it for my low basis taxable accounts, but I've eliminated in my non-taxable accounts. So, Amazon has been clipping along, and they're now running about a six and a half percent after tax margin. I think it's more like 6.2%. You got to figure out where it's going to wind up. Costco over the years that I've owned it has increased their net margin from 1.8% to 2.4%. Some of that has been the lowering of the corporate tax rate from 35% to 21%. But it's also a business that has durably been able to increase its profitability, even though, they pass all of their cost savings that they're able to manufacture right through to price and to the customer, they'll operate at a 1% merchandise margin, which nets out membership fees, which get a little bit nuanced.
Amazon, as the world knows has created the second great business in AWS. A little bit more of a commodity business, take some capital, you got to figure out what the margin structure of AWS is. But Amazon's retail business, you've got the first party, then the third-party sales, you got to figure out what that margin is going to wind up looking like. Getting toward Nike's margin structure was going to double, kind of backing into what their online distribution margins look like was a fairly straightforward exercise. You had to tease out a lot of numbers to get there. I think in a best-case scenario, Amazon could get to a 10. I don't think you get any higher.
The core retail business inside Amazon shouldn't look a lot different than Costco. Costco finally has traded just about at 100% of sales. If you're going to do a 2% profit margin, capitalize things the way you would, you'd trade at a third of sales. If you're growing and you're earning very high returns on capital, you might trade it at a higher multiple. Costco can trade at half of sales or 60%. But it's trading at 100% of sales, which means it's trading at over 45 times earnings. Its earnings are no longer as understated as they were when I bought it in 2004. When you understand the structure of Costco, and it takes eight to 10 years-- eight years, let's call it for a new store to be mature, their typical store has 130,000 members, well in the first six months, you don't have 130,000 members.
It takes years to get there. It takes years to turn the inventory fully based on a full membership, building a new store in St. Louis, they have 330,000 members per store. You take the size of the metro area, they're going to cannibalize their other three stores for sure. But they have room on the brilliant real estate they select to go do that.
I would bake in same store square footage growth, if you grow the aggregate square footage of Costco's entire enterprise domestically and internationally 16, 17 years ago, it was growing at 7.5%. Now, it's going to grow at 2.5% to 3%-- 3.5%. They've only demonstrated an ability and their business model says, "We're going to open 20 to 25 stores per year." That was the cadence in 2004, that's the cadence today.
So, the square footage is not going to grow as fast. They will I think of all of the retailers maintain the ability to grow same store sales annually at at least double the inflation rate. So, you combine square footage growth with same store sales growth, and a durably increasing bottom line that can maybe grow 1% faster than the topline. They don't buy shares back because the shares have never been cheap. They pay special dividends to the shareholders. I paid 29 bucks for the stock initially, and in the interim, they started paying a dividend the first year I bought it and I thought, "Oh, no, does that mean they're not going to be able to grow as fast as I thought they would," no just the fact that they're disciplined on the real estate front, but they've also paid a series of four special dividends.
A couple of years after I bought the stock they paid $7, a couple of years later, they paid $5, then they paid $7, and going into last year, not knowing what the Biden tax plan would look like I said, "You watch, but they're going to pay a big special dividend." Cash continues to build, they paid 10 bucks a share. Ironically, if you add up those four special dividends, it's exactly my cost basis of 29. Well, the stock's trading at $450 today. They're going to earn 10 in change. It's as expensive as it's ever been, and it's not going to grow as fast. So, judiciously, you've got to measure the opportunity cost of what can Costco earn prospectively for me as a shareholder on an annualized basis for say, the next 10 years, and that company has robbed multiple years' worth of underlying growth. So, I can scale that back in the portfolio and move capital around now to the energy patch, where I'm buying assets at two, and three, and four times EBITDA.
You just saw the news that shell, which has been shedding assets at a rapid clip, it's selling nine and a half billion dollars of Permian assets to ConocoPhillips, three and a half times EBITDA. I own a couple of refiners for the first time in my career that I bought in October. They immediately doubled, they have come down now in the last four or five months to where I'm buying them again, but I'm paying prices that are more than 50% above what I paid in October. Why because my opportunity cost set is different today than it was in October.
Bill: Yeah, that makes sense.
Chris: I paid one and a half times normalized EBITDA for my refiners. They're trading a little higher multiple today. But I watched HollyFrontier earlier this year, maybe five, six months ago. Shell, they're European, they're going to decarbonize, they've got political pressure from the European Union, they've got political pressure inside the countries in which they're domiciled, they are shedding their carbon footprint. So, they sold a refinery to HollyFrontier for, I think, it was $300 million. One and a half times EBITDA. When you contemplate the fact that the internal trader inside of Shell is making his own P&L in book and has a motivation to earn his commissions and its profit in the hands of a non-major, nonintegrated, more independent operator like a Holly, they actually paid about one times EBITDA for that asset.
You don't have to generate that much profitability for that long, and I'll tell you on the front of public policy that says, we're going to go to a zero-carbon footprint by 2050 or 2060, even though, China is in the midst of doubling their use of coal by a factor of one United States of America use of coal over the next 15 years, which is extraordinary how that worked under Paris. But there's a scarcity of assets. Since 1981, the number of refineries in the United States in North America rather have been cut in half. We've increased the capacity of the refining capacity. So, we were actually able to refine more crude through what's half of the number of refineries. But nobody in Europe, nobody in the United States is ever going to build another refinery. It's not going to happen.
Bill: No.
Chris: There's a scarcity to some of these energy assets that are now dirty, that nobody wants to touch. But if you presume the population of the world of Europe, Europe's not going to grow. But if you assume the population of the world and of the United States, it is going to grow and it will, we have about one and a half percent penetration of solar and wind, and renewables of all power production to get to 100%. A is an impossibility. The wind doesn't blow 100% of the time, the sun does not shine 100% of the time, it shines its brightest on June 21 in the Northern Hemisphere. So, when it's down and you've closed natural gas fired production capacity as California has done, in fact, they just closed their last nuclear plant, Diablo Canyon, which is absolute insanity. And presume that you can buy power when needed because you're in a heat wave from outside the California grid. Well, guess what? Those outside of California are going to tell them to pound sand. You have to have interrupted supply of power. Meaning, if we're going to add solar and we're going to add wind, you have to add natural gas fired capacity underneath it.
Bill: Nuclear bulls would say, you could use nuclear, but that's got problems.
Chris: Well, we need to build way more nuclear. You can't get from A to B, and do it with solar, wind, and geothermal. You have to have nuclear, if we're going to decarbonize our energy production. But you take unrefined crude, and you think about all of the refined product that comes out of a barrel of crude. Kerosene, propane, gasoline, diesel, jet fuel, all the way down to asphalt, at the thickest at the bottom, and you think about all of the things that we use that require those various refined products, I want to have my knee replaced. Guess what? You got to have the plastics?
Bill: Yeah.
Chris: Where do you get the plastics?
Bill: Enterprise products, one time I checked. Maybe, I'm wrong.
Chris: Refined [crosstalk] we are for a lot of merit and good reason trying to reduce the production of carbon for the environment, and I think that's noble and makes a ton of sense. But you've got to be realistic about the timetable and how you get there. The fact you will not entirely get away, you want to have solar panels. The only way to create a solar panel, which is effectively a microchip is at very high temperatures. The only way to get that high temperature is burning coal. So, you can't go to zero coal. You're going to have to have various of these dirty assets, and as the shells of the world are shedding them, you're creating a scarcity. You're creating an imbalance. Public policy is driving the energy market to a tightness. Unlike we've ever seen him and I'm capable of running those assets.
Chris: Have you seen cold Twitter? They're going to love this, Chris. They're going to be super happy. I happen to agree with you. When I say I happen to agree with you, I think what is a more precise statement is, I've seen a lot of smart people interested in commodities on capital cycle theory and scarcity. I find it interesting, one that these are not people that have not been around the block. Like these are investors. They understand what's going on. Two, when you're talking about rolling out or reducing a position in Costco and getting interested in energy, it is so counter to the narrative and everything--
Forget about narrative. I mean, price and multiples are showing you what narrative is. I think those drive narrative as much as the other way around. It's so contrarian that I just don't know how many people have it in them to do it, because it's like, if you had to go to your clients and say, "This is how we underperform." You've got to have a lot of confidence, and you've got to have your clients trust you a lot in order to make that move, and it's a very uncomfortable move to make. So, when I think of one of the Max Payne trades in the market, what you're describing is one of the Max Payne trades that I can think of, and those types of high-level thoughts get me interested in things. I've been digging into different industries, I've got a couple interviews coming out. One is a shipping interview, one is a lumber interview. Mostly to educate people on how these things actually work, I'm glad I didn't do lumber, when it was mooning and I can't be accused of pumping now that it's like crashed. But it hasn't actually crashed. If you look at where it settled in, it's quite a bit higher than it used to be, and the question becomes, "Well, is this a new normal?" I think, they're very interesting conversations to have. In a world where I think that most of the conversations that I'm privy to and maybe it's just a selection bias, but I feel like a lot of them are going on. Just own Costco and never sell it. They're very smart people, very thoughtful people that own it. I accept that there's good reasons. But I also wonder whether or not a good idea has been taken too far would probably be the best way that I would say it.
Chris: We have to never sell. You're either going to never sell an outstanding business that generates very high returns on capital or you're never going to sell something that you're betting on the comp. Those are two different animals.
Bill: Yeah.
Chris: Nike, Costco, and Starbucks are totally different animals. Then, Twitter and Shopify.
Bill: You can keep taking shots at Twitter. I got love for Twitter, Chris. But I do not disagree with your comments. The one thing that I that I will ask you about to give you an opportunity to respond, because there's going to be someone listening to this that says, "You keep saying that they're not making any money. There's a lot of growth spend in the P&L." How do you think about normalizing some of these hypergrowth businesses? When you are thinking about what terminal economics are 10 years out, there's some, and I'm not saying Twitter necessarily. I think that there's a different issue there.
But some of these hypergrowth growing 80%, the way the accounting works is they're not allowed to capitalize some of the sales and marketing expenses, they're not allowed to capitalize some of the R&D. The organization is scaled too large in the expense base relative to its sales base today, but the sales base should scale over time. How do you think about that and what would you encourage younger people to get a model or look at historical examples, or how would you encourage younger people to think through it or not younger people, me, because I need help with this stuff? I'm confused more often than not when I look at a lot of these businesses.
Chris: Well, there's a lot there.
Bill: Yeah, there is. Sorry. [laughs] If you could give me a minute answer, that's precise. That'd be great.
Chris: On the expensing of R&D, I mean, that's a very great point. I think, it's not as black and white as some now think it is. You can take a non-capital-intensive business like four of the five big tech companies, that exclude Amazon from the other four. R&D to me equates to maintenance Capex. So, a business that's capital intensive can overspend or it can under spend on replacement of its capital and when your average CEO was on the job for four and a half years, and your motivation is to drive the stock price up. There are places where you have material underspending on capital assets. I'll go back to the energy patch. I've done energy three times, Bill and it's hard. It's very hard to invest in cyclicals. You have to be able to weather the storm. So, you're only going to get into your cyclicals when things look bleak.
Bill: Yeah.
Chris: In doing so. So, back way-- way back when we were starting Semper. I spent a week or two in Houston. About a week and a half and I was very interested in the deepwater drillers. They just been crushed. Oil was less than $10 a barrel on its way to $5.
The Economist had magazine cover with a straw stuck in the earth and it was as simple as pulling oil out of the ground as it was drinking a milkshake. These guys were in trouble. These new rigs that Transocean or a Diamond Offshore would have built for $300 million, then they weren't in use somewhere on five-year contracts, but a rig came off contract, they were being cold stacked. They were stacking up in the Port of Houston. So, I met with the management teams, everybody. I was young, but those guys wanted to take meetings because their stocks were in the tank and they were just happy to talk to somebody interested in the long side of the case.
Bill: [laughs]
Chris: It became quickly obvious that the lesser well capitalized of the participants in the industry companies like Rowan were going to fail within a few weeks or a few months, if the downturn in energy persisted in the utilization of their assets remained subpar. So, I wound up owning the better capitalized, the very well capitalized of the two.
Bill: Yeah, the survivors.
Chris: Kind of a very chicken way to play cyclicals, but I didn't want to get taken out on the stretcher. So, I wound up owning in retrospect, way too little Diamond and way too little Transocean, both of which tripled, but they tripled with an insignificant amount of my capital. But I didn't know it was going to turn, when it turned and I thought, three, four, or five months, I can add to these positions, and I never got a chance to add to them because they ran up, and I didn't understand as much about opportunity cost. Even though, something has doubled in price, but it's going to triple or more from where you bought it, you can still buy it. I think about the conservatism of accounting. So, I wound up going to lunch with a brand-new CFO at Diamond Offshore which is largely owned by the Tisch family and Loews. I asked this guy, "Why did you guys just extend the depreciable life of your rigs by five years?" That's a red flag.
Bill: Yeah.
Chris: When you're taking a fixed capital asset and you're extending depreciable life, usually that's funny business. So, his answer, and this was a very conservative guy. He was driving a Oldsmobile 88, there was a car, I mean, Oldsmobile is now gone.
Bill: Yeah.
Chris: Right. He was driving an Olds 88 that had like 388,000 miles on it. And it was work car. He lived way out on a farm, and he had a long drive every day, and so he drove his work car and he had some whatever sports car, he swore that he had some nicer car. But he was conservative guy and he said, "Look, two things. One, the decision to extend those lives were not mine. They were the prior CFOs." He said, "But Chris," and I forget whether they were extending from 20 to 25 years or 25 to 30. But he explained that they believed that these rigs actually had a 40-year life. So. you would build a $300 million piece of equipment.
Today, that same new piece of equipment with modern technology would be at least double that. So, $600 million, but then it was $300 million. We're going to do a five-year contract with Petrobras. We're going to operate the rig, and at the day rates that we can lock up on a five-year contract, we will have paid for the rig or breakeven five years.
Now, we're going to run it for a factor of 40 years. So, it'll come in, and we'll refurbish it, and we'll modernize it, and we'll send it out for another five-year contract. So, these are great assets. Well, guess what, here we are, the energy patch gorged on exploration, in 2011, and 2012, 2013, 2014, Exxon was spending $40 billion a year. The majors were spending like drunken sailors on projects that made no sense. The independence, a lot of whom have failed were likewise spending, and there was just a massive amount of overproduction. We drove oil down from 100 down to-- well, we're in the 70s today, but we traded last year in the 20s, and for a moment the front end of the spot curve was negative. That's technicality on a futures role. But you think about those assets that have now been in a six-year bear market.
Utilization of the modern fleet of deep-water rigs is way down. There's a lot of cold stacking that's gone on. When I had lunch with Christian [unintelligible [01:37:13], who runs an engineering construction firm in Norway, they have a fleet of vessels that will take a topside gathering platform that would be owned by a Petrobras, or by an Exxon Mobil, or by an Equinor, which is the old stat oil and connect everything that happens on the top side all the way down to the wellhead. So, all of your risers, and flowlines, and pipelines, they have pipe-laying vessels, very well-capitalized company, net cash on the balance sheet. Anyhow, Mr. [unintelligible 01:37:39] pointed out, "Look, when you get to about two to three years of stacking an asset, it ain't coming back."
Bill: Hmm.
Chris: "The cost of bringing it back and putting it back into production are gone. So, the fleet that you're counting is idled is a fraction of what the world is telling you that it is."
So, for that the older equipment, and again, when I was visiting Transocean and Diamond back in the day that was the late 90s. That was 1998. 1999-- it was 1999, let's say. That brand new shiny piece of equipment with modern tech and global positioning, very high-tech equipment is done, did not get to 25 years, did not get to 30 years, it certainly didn't get to 40 years, it's done. So, in the world of capital intensity, which the world has gone away from, you better be able to live through the cycle. And so, I tend to gravitate toward very, very pristine balance sheets, and managements that are better capital allocators than others, because you got to live to fight another day. But you've also got to be right on the cycle. Half the world, majority of the world things say, we're decarbonizing, so you can't own a refinery, because we're not going to have gasoline-fired cars. We're going to have all EV. There's going to be no use. We are going to 100% wind, solar, geothermal, and maybe some nuclear, but we're not going to have natural gas fired plants. We're not going to have any coal fired plants. We're not going to have fuel oil plants in the northeast. So, you got to make your bet as to a rational timeline as to when you get from here to there and also presume, again, with a growing population that you cannot eliminate some of these dirty fuel sources. And so that that's the bet that I've made. But even inside that bet, I'm trying to find very high quality, lightly or unlevered assets [crosstalk] you kind of make non-ESG. You go ahead, Bill.
Bill: No, that makes sense. I was thinking about some of these high-flying tech companies. It's interesting to hear you talk about, I mean, obviously, it's a capital asset, right? But it's interesting to hear you talk about this high-tech piece of equipment that was supposed to last for 40 years and is now gone after 20. I wonder what parallels exist out there among some of the-- I think some of the valuations and the underlying assumption is, these are installed bases, and they're just going to last forever, and we can cut costs eventually, and the margin structure is going to be 30% net, and it's going to be, I mean, some of these businesses are growing at 80% maybe off small basis. But if they can do it, just run the numbers on 10 years out, apply a 30% net margin, and then back your way back to what today's value would be. I think that's how people are doing things in the market. But it's interesting to think about which installed bases are going to stick and which ones may not. That's ultimately where people make money, right?
Chris: Yeah, exactly. You know continuing to unpack, I think your prior question, when you ask how I would value these things and how I do it. It's exactly what we talked about earlier, I'm going to presume a very best case long-term topline growth, I'm going to presume the most favorable margin structure, and I'm going to capitalize it at the most favorable price. Against that, you've got to measure what your return is in a best case scenario. If it's a mediocre number, you can't touch it.
Bill: Yeah, you don't even need to do anymore.
Chris: You have to back it off.
Bill: Yeah.
Chris: Bill, I would be a terrible, terrible, terrible venture cap investor. Horrible. It's not the way I'm wired. I'm looking for predictability or I'm looking for mispriced asset in a cycle. But where I've got a fairly knowable, predictable earning power, stream of earning power that I can capitalize that number that makes sense to me. There are nuances to owning non-levered or lightly levered businesses where I've got an enormous advantage or companies have the ability to reinvest capital. I take my broad portfolio, and you take as I do, aggregate all of my holdings as other a single business, and I only get 20% of profits coming back to me as a dividend. So, 80% of the profitability of the companies that I own, and you asked earlier about the knowability of a cyclical, and trying to get your money out of it, whether you're ever going to get it out. I've got 80% being reinvested.
Bill: Yeah.
Chris: And so, the advantage I have is one, my stocks trade at 13 times earnings. I'm trading at half the multiple to book, I'm trading at less than half the multiple to sales. I've actually got a higher dividend yield than the S&P 500 which has a 45% payout rate, which is pretty extraordinary. But I've got 80% of my job, one of my largest jobs.
The most important aspect of my job is measuring how well the CEOs and management teams of the companies that we own, how well they reinvest capital. I take what's an average kind of 14 and a half percent return on equity, the portfolio, you back out Berkshire, which has large holding and it earns 10 on equity, that tells you that everything else is earning more than 14.5% by a point or two, but I can go through the list of companies that I own.
These guys have durable places to reinvest. Starbucks can open new stores. They are reinvesting at mid-teens returns on capital. You think about the difference of what the broad market is doing, what the S&P 500 components are doing. They're paying you 45% to get you a 1.7% dividend yield and the dividend yield was 90 basis points in March 2000, which tells you how crazy expensive everything was then. We're sitting here with a 45% payout, and that's only getting you 1.7-ish percent, which tells you how expensive stocks are today. With the balance of your 45%, the residual 55% that you're not getting as dividends, that 55% that gets retained, guess what it's being reinvested in? It's not opening new stores. It's not reinvesting in R&D, and growing the R&D footprint. It's not growing the growth capex footprint. It's buying back shares. Those share repurchases are being augmented with debt and you're paying high 20s to low 30s multiples to earnings. You've been paying north of 20 times for the last decade, which takes you below a 5% earnings yield.
There's a capital destruction taking place, which is merely trying to offset the dilution that comes from giving 2% of your company away every year to insiders and trying to still at same time shrink the share count, because who wants to see 2% of your market cap being bought each year and have a flat share count? Why are we buying back all the stock if the numbers don't go down? So, they drive it down by about 90 basis points, not even 1% a year. But they're buying 3% of the time company. As prices have gone up, the utility of those larger and larger purchases are buying back smaller and smaller percentages of those companies, to maintain that share purchase cadence is requiring debt. So, the capital structure of the companies that comprise the stock market today have never been more levered. Leverage relative to equity, leverage relative to assets has never been higher.
Bill: It's so cheap, though.
Chris: Not 1929, not the 1960s, not at any time. It's never been higher in corporate America. I think that's a distinct advantage for somebody like us.
Bill: Something I think is interesting is, you would think that would be a rational outcome given where rates are. The thing that I've enjoyed to hear you riff on in the past is, we've arguably hit a point where debt is going to aggregate debt will impede growth. So, if you play that forward in many instances, you've got companies buying in shares at high multiples with arguably slower growth ahead. It could be a recipe for disaster. I don't really know. I'm one of these people that I've seen valuations go higher and higher and higher, and I've been wrong the whole time. So, I just kind of no longer hold strong opinions. I'm getting a little bit better at saying, "You know what, I just don't get it," rather than making a call. But it's definitely an interesting time, Chris. The next 10 years will be interesting.
Chris: They will and I can tell you they're not going to look like the last 10.
Bill: Yeah.
Chris: Even the big five techs can't repeat what they've done. If you go back to my letter two years ago, I wrote up a little thing on the impossibility of repeating 10-year performance, and those five tech stocks had a market cap of more than five. Collect five and a half trillion dollars. They've gotten up to just over 20% of the S&P 500. That group of five stocks is up, it got to be something like 60% to 70%. Since, I wrote that letter a year and a half ago, February of 2000 just before COVID, market cap at the top five stocks today is almost $10 trillion.
Bill: [crosstalk] To be fair, they generate a lot of cash, a lot of cash.
Chris: Yeah, they're 25% of the S&P 500. They are more than twice as profitable as the residual 495 companies in the S&P 500. Their profit margins are in aggregate probably 25%. Unlike the multiples of which they traded conservatively for the prior 10, 15 years, they're as a group trading at 30 times, they're very expensive, and the growth curves are slowing. They're universally slowing for all five of the businesses. Apple's mid-single digit growth if you linearly run it over the last three, four, or five years, they're coming down, and I don't know what it will take to shake and break the multiples, be it regulation, be it competition, but a lot of large numbers take hold. If you take nine and a half trillion, let's call it in market cap, which is probably what the number is, and you run it at 15%, and you run the S&P 500 at 4% sales growth, and assume we're at record profit margins, and so, we're not going to expand the profit margin.
So, net income per share and sales will compound at the same rate of four, which is about a point, but a half a point less than the rate at which the S&P has compounded for the last 10 years sales growth. Net income growth per share has been closer to nine and a half, and that's the margin expansion that we've seen. But if you run a 15%, total return on those five companies that are now 25% of the market, you're going to get to almost 100% of the market cap. If the S&P compounds at 4%, at 10%, you're going to get to 50%, 55%. I mean it breaks. At a point it breaks, I don't know what breaks it. But when that breaks, you can't tell me that every one of these new SAS software stocks are all going to get to the finish line, and that they're all going to grow into their valuation. You can't tell me that of all of these recent IPOs that don't make any money yet. Everybody says, "Well, it's Amazon, Amazon. You got to give these guys a runway to grow and make money." Some of these things will never make money.
I don't know if Uber's ever going to make money. Some of these are bad business models, but then some of them are unknowable, and some will face their own. Some of these disruptors will be disrupted. I just think when you start paying giant multiples to sales, and everything's on the comp, you're standing at the roulette table. You are not doing what I do, and trying to find noble predictable earning power, and buy it at a reasonable price. That's a totally different game and some can do it, some are good at it. I think the tale when we talk about debt in systemic debt, total credit market debt, government household corporate put it all together, we're beyond 400% total credit market debt to GDP. I thought we were at nutzo levels in 2000, when GDP was 10, and total credit market debt was 25 trillion. We were 250%. That we'd never been higher. Not in World War II where we higher in aggregate. Government debt was higher. But household debt, corporate debt was nonexistent coming out of the depression. Nobody was making any money.
Bill: Yeah.
Chris: We got to 2007 and GDP had grown by 4 trillion from 10 to 14 debt had doubled 25 trillion to 50 trillion. It took over $6 in debt during that seven-year period of the government maintaining low interest rates to grow GDP by $4 trillion. Here we sit today at a 22, let's call it 22 and a half trillion dollar economy. We got $88 plus trillion in total credit market debt and households are in better shape, because they were given a mountain of money by the government over the last year and a half. So, if you take the extreme of how do you deal with excessive leverage, and you look at what's happened throughout history, eventually, you get hyperinflation, which is a crazy thought and something I never thought we'd have to deal with. But if you get hyperinflation, then some of the best assets to own are your long duration companies be they private or public. Maybe the markets getting that right, and maybe Nike should be trading at 40 plus times.
Bill: Yeah.
Chris: Maybe Apple should be trading at 32 or 33 times, because those are good stores of value, those are companies that will sell to you in any economic climate, and they will durably persist. The best performing stock market in the last couple years has been the Venezuelan stock market. Well, they're in the middle of a hyperinflation, and that's priced in local currency terms. If we have hyperinflation, it's not going to be the United States alone, it will be the entire industrialized world resetting its debt. Terrifying thought. I think there's a 10% chance it's underway, and if that's the case, you better own companies as a store value or you better own some real estate, you better own some productive farmland, you better own some cattle. I don't know. I wouldn't do it with the crypto, but I don't understand the crypto and how there's a permanent store value there when governments are in trouble and run their monetary policy through the fractional lending system. I don't think there's room for crypto in that world. Maybe not all crypto and there's a lot of fraud in crypto, tethers of fraud. There are some clear frauds and how much of that are bitcoin and Ethereum caught up in that. Who knows, man? I don't know that. But that's a whole another-- that's a conversation I shouldn't have, because I'm not-- [crosstalk]
Bill: Well, I can understand the idea of digital gold but it is an idea. I think the interesting thing about bitcoin specifically is, I'm crypto curious. So, I'm not one of these people that says like, "Oh, I'm not. I think, it's stupid." But I do think it's funny that they don't like Fiat, but they don't mind putting their faith in a math equation. It's sort of a Fiat of type, but it's a belief in math and whatever. If it works, it works. But it is fundamentally a belief. I can understand why it's in the too hard pile, I'm with you. I would rather own companies. I can get my head around that, and I can stick with that, and that's what really matters.
Chris: Yeah. If we get to where preservation of capital and purchasing power is what matters, and then that really is all that matters at the end of the day. Then, if you're going to have extremes of monetary policy, which we've been having and we're going to fix the debt bubble that we have, the Feds disarmed itself from the ability to help the economy, because its government debt is now 140% of GDP.
You've passed the point at which incremental government debt can be stimulative to the economy, it can certainly be stimulative to asset prices, which we've seen in the last year. But we're going to go into this taper, and we're going to reduce the cadence of buying $120 billion worth of securities per month. Somebody's got to explain to me, why the hell they've been buying $40 billion worth of mortgages in the midst of one of the strongest housing markets this country has ever seen. That's about as misguided nutzo policy as you can have.
But if we're going to taper this thing, forget about raising rates. I don't think they can raise rates durably and I don't think they can permanently taper either. We saw that from 2013 to 2018, it doesn't work. You've got an eight and a half trillion-dollar Fed balance sheet versus what was $750 billion or $850 billion before the financial crisis in 2007. So, tapering does not imply that the Fed is going to be selling treasuries and mortgages, but when their current holdings mature, they simply don't roll and replace.
So, if our government is going to run a $3 trillion deficit this year, 15% of GDP having run 3.1 trillion last year 16% of GDP, if we're going to run these gargantuan deficits from here to eternity, which is MMT. Then, who's going to buy the paper? Because the treasury is not now running a balance book. They're borrowing a net $3 trillion a year, whatever it's going to be for 2022, $1.5 trillion, $2 trillion. It should be lower. Hopefully, it's still a big number, it's still going to be way north of more prudent three or 4% of GDP. Who's going to buy the paper if it's not the Fed? The public markets, the private sector has to buy that paper. What does that do to financial asset prices in the meantime for somebody to fill that stop gap? I don't know there's a lot going on.
At 400% credit market debt to GDP, we can't have a normal, what you and I would think of the normal term structure of interest rates. You can't get back to 5% on the short end of the curve, and 7% on the long end of the curve. Not going to go there because you've got too much debt. The system can't service the debt.
Bill: Yeah.
Chris: Somehow these wizards have to reset it and figure out what we're going to do and I know elected officials and appointed central bankers here and abroad are not going to go down the path of belt tightening and austerity.
Bill: Well, it's not in their self-interest.
Chris: Pardon.
Bill: It's not in their self-interest, right?
Chris: No.
Bill: That requires telling hard truths, and last I checked, politicians don't love that.
Chris: No. They've got constituents, they've got to get themselves reelected, and so they just spent. But we've spent ourselves into oblivion and it's a mess. 400%, it's unfathomable to think we can have almost $90 trillion in on balance sheet liabilities on the front end of the boomers theoretically retiring.
Bill: Yeah.
Chris: We have unfunded liabilities for Social Security Medicare Medicaid, which depending on how you do the math or another $40 to $80 trillion. On top of the unbalanced sheet leverage that we have of $88 trillion, it's a broken system that all of this federal spending is not going to be accretive to GDP. GDP peaked, growth peaked in real, population adjusted terms in 2000 when we got to 250%. We've grown nominal GDP at 3% a year since then. Real GDP per capita, which had grown between one 1.5 to 2% for the prior 70, 80 years, is clipping along at less than 1% now, and has done so for the last 20 years.
Now, we just layered on another turn of debt to the system, and that can only be deleterious to topline economic growth, which is functionally translative to topline revenue growth for the S&P 500. So, the markets got a lot of this right. Places where you have durable growth, it's priced it accordingly, and these businesses are appropriately trading at very high multiples, especially, in a world of low interest rates. But bear in mind that low interest rates are low because we don't have any growth. Because we have too much debt. Those are both gargantuan problems that we're going to have to deal with at some point. Now, unfortunately, at 52 years old, we're going to deal with it in my lifetime.
Bill: Mine too. This is terrifying, Chris. I'm regretting having this conversation right now. [laughs]
Chris: I tend to have that effect.
Bill: I look forward to having more of the conversations with you. I got one last question for you before I let you get out of here because I got to go to Berkshire's float. I think you and I agree that it's not as overstated as people like to cite. I have advocated the idea of some sort of a venture-y type bet on long duration assets. I don't know pay up for quality businesses maybe is a better way to say it and recycle the capital on a more ongoing basis. The reason that I've said that is, I thought that March 2020 would be Buffett's shot to go elephant hunting and I'm not sure that the government's going to let him do it anymore. So, now, more of like either by an index fund or just dollar cost averaging to great businesses, is what I have thought of. What do you think of that idea and why is it dumb?
Chris: Well, when you say float, I think what you're really just talking about is the cash that sits on the left side of the-- [crosstalk]
Bill: The excess cash that accumulates is what I'm actually referring to.
Chris: Yeah. Float is effectively the insurance net liability.
Bill: That's right. I apologize.
Chris: Some people equate it to cash, but Berkshire's got $135 or $140 billion in cash on the balance sheet. I've presumed for the last four or five years that maybe only half of that is effectively spendable. The other call it $65 or $70 billion resides in the subsidiaries, and it resides is kind of permanent, fixed income surrogate in the insurance operations. So, between the energy and the rails, they've got about $5, no, $4 billion let's say. I think the MSR businesses have close to 20. As I go through my year end reconciliation, and it's taken me a lot of work to get there. There's some cash in the holding company. Right now, you've got $80 billion in cash. In the insurance operations, you've got another $19 billion of fixed income, and that's where you start to think about the fixed income and the cash somewhat equating to the float of the business. But Berkshire's insurance operations are massively overcapitalized. I think I talked it about it on podcast with-- [crosstalk]
Bill: Yeah, on Chris' podcast.
Chris: I won't get into it here, again, but you've got total insurance statutory capital of $230 billion, $240 billion. They only need a fraction of that to write what they write, the $60 billion in annual premiums that are being written between GEICO and the primary businesses, the new specialty business, the home state businesses, the med mal stuff, and then obviously the reinsurance operations between national indemnity and Gen Re massive over capitalization, which allows Berkshire to own $300 billion at common stocks. So, you're talking about the cash.
Bill: Yeah.
Chris: You strip out the cash that's going to be held on hand, and Mr. Buffett acknowledged that in this year's annual meeting. I think it's probably 70 and he said-- I think he said $60 or $70 billion is probably more like the permanent number he had written for years. $10 billion was the permanent threshold below which we would never take the cash balance. They just doubled that in the very last 10Q to $20 billion. But I think it's structurally across the operation more like 70. So, half the cash. $70 billion, let's say is available for purchase. Putting that in context, Berkshire's total assets, as I mentioned earlier over $900 billion.
Bill: Yeah, it's not huge.
Chris: For the last 20 years, the cash as a percentage of firm assets has averaged 12% or 13%. So, it's on the order of 16% today, it's not that much aberrantly higher.
Bill: Okay.
Chris: Operating income, if you ignore the retained earnings of apple and all of the common stock holdings, the $300 billion in common stock holdings, there's about $10 or $11 billion, call it $11 billion today that's being retained that Berkshire does not book as cash through the cash flow statement, but its profit nonetheless. So, Berkshire's operating profit $25, $27 billion.
Last year, they bought back almost $25 billion worth of common. First two quarters of this year, they've bought back 12, 13 something like that. They're spending 100% of what they're making in terms of the spendable cash.
Bill: Yeah, I don't mind them buying their shares. That makes sense to me. I just don't know how much more you need to let accumulate. That's the question that I have.
Chris: Well, it's not growing.
Bill: Yeah.
Chris: In the last couple of years, the cash balance really relative to assets has not grown. I think the amount of money being spent in the utility operation as we discussed is brilliant. It's a very large sum of money. Because, again that's not profit that gets distributed to Omaha, but it's retained. That utility operation which is worth something like $60 billion, maybe $70 billion today, its $4 billion as I do the gap adjustments to my profit, it's going to be a way bigger business 10 to 15 years out. If they continue to build the grid, continue to spend on renewables, continue to appropriately shrink the coal footprint, the utility operation is going to be big, really big.
Mr. Buffett talked about Apple and the railroad being roughly kind of worth each other. The Union Pacific was valued at $170 billion in the market. It's down to like $130 billion today. Bill, I think if the disposable spendable cash is 70. you are correct. There are no elephants to be had. There's too much competition from private equity. All of these SPAC morons are going to have to find something to buy next year.
Bill: [laughs] You're coming into year two. There's going to be a lot of bids, Chris. [laughs]
Chris: There'll be a lot of deals done. They are going to be a lot of happy sellers.
Bill: Yeah.
Chris: That's for sure. I'm not sure about the current shareholders who don't really understand the game they're playing. So, you're right. No elephants.
Bill: There might be one. I'm just saying, I don't know that you can count on it. That's the tough part.
Chris: Kind of net-net, the overall stock markets expensive. You look at some of the recent buys, I think all that's taking place is buying what Omaha believes to be durable, predictable earning power at low prices. That's what they did with Apple.
Bill: Yeah.
Chris: They buy something like Verizon, that's what they're doing. I think the bet on Chevron, which has been trimmed back, I think, it was an earning power bet.
You just buying the drugs is a basket of companies that are trading at teens multiple. Mr. Buffett buys earnings yield, earning power. But there's not a lot more to be had. So, I'd love to see the stock cheap. I'd love it when people talk about Mr. Buffett's grandson, or grandnephew, or whoever the journalistic world figured out is outperforming Mr. Buffett. I haven't read the article yet, but I love those headlines, because they're losing it. I'm the weird investor that when I look at my portfolio, and everything's green, and has gone up in price, I'm just miserable. Because I know I've got cash to invest, I've got dividends to invest, I've got new clients and deposits coming in all the time, and I'd rather have low prices than high. Berkshire's the same way. I'd rather have a low price.
At some point, they'll get a chance to spend a bunch of that $70 billion. So, patience, grasshopper. It'll happen. It's not a big number. It's not harming us by sitting in cash. I assume they'll earn 7 on that cash. I really think they're going to earn 10, but I don't assume they're going to earn it right away. There's some time value of money to that netted against what they're actually making in T-bills, which today is zero. A couple of years ago, it was 2.5%. So, you run that differential. You're talking about what I think can be a potential of $5 billion earning power added to the system. But I already account for that in my 45 plus billion dollars in profitability. So, whether they do a deal or not, it doesn't change my appraisal of the company, at the moment they do a deal if that makes sense.
Bill: Yeah, it does.
Chris: But you want them to spend the money.
Bill: Yeah.
Chris: So fortunately, the stocks have been cheap. Last year's, almost $25 billion in repos were done at 105% of book value. That's the cheapest I've ever bought the stock back in 2000, again last year. That's a [unintelligible 02:07:36].
Bill: Yeah.
Chris: There's not a lot that's going on the capital allocation front that I think can be done better. I think they're doing a great job and I do not lose sleep over that half of the $140 billion in cash, that's really spendable has not been immediately spent. I think patience is a virtue and we all measure performance in quarters and years. I think of all the places where capital gets allocated, I think the lens of the value of time has always been appropriately measured at Berkshire. There's just no sense of urgency to do something because when you do something for the sake of doing something, you're going to do something stupid, and they don't tend to do a lot that stupid. You could point to a Precision Castparts and say, "Well, that was stupid. Well, Donegan had rolled up that industry." But I don't think you would have known--Well, you knew that the energy business was already in trouble. So, their turbine business was already flat on its back. But you wouldn't have seen the impact on the airline industry and aircraft manufacturing to the extent we did. But it clearly, there was an overpay. We own precision prior to Berkshire's acquisition of it.
I would not have paid the price that they paid and it's clear that the business is worth less now than it was at the time of acquisition which was already overpaid for, but those [unintelligible [02:09:02] are few and far between inside Berkshire. You know, they bought some mediocre businesses and some have been disrupted and evolved into mediocre businesses, the newspaper businesses, the World Book, stuff like that. There are companies within Marmon that I think they're not very happy with. All in all, given the resources, given the cash that exists today, and the money coming in from profit, I think they're doing a great job, and I just think it's all very conservatively done, and that that lends to the ability for me to own a whole bunch of it, and believe that I can make at least 10% a year out of it.
Bill: It makes sense to me, sir. I thank you for sharing your wisdom, and I hope that I add some value back to your life, and I look forward to seeing you soon, and drinking some wine together.
Chris: We're going to be together in three weeks, I believe, and I'm in charge of the wine list.
Bill: Well, I look forward to that. I will outsource that to you any day.
Chris: What I'll say is, my smell and tastes are back to somewhere above 90%. But I do not at the moment possess the ability to stick my nose on a glass and figure out what I'm drinking. I can promise you and the guys, we're going to have a couple of dinners with it. I will not skimp on quality.
Bill: I assure you that you had 90% better than me at 100%, and probably in more than just wine. So, [crosstalk] we'll leave it at that. [laughs]
Chris: I had one glass of wine on Saturday night. Mary and I went out to dinner and stuck my nose in the glass, and had a taste, and poor server goes, "Oh, my God, is it bad?" I said, "No, I just had cold, man."
Bill: [laughs]
Chris: I have no idea what I'm drinking here, but it doesn't taste like wine.
Bill: Well, I hope you get your taste back, and thank you for stopping by the pod, man. I look forward to seeing you soon.
Chris: Yeah, Bill, it was great to be on with you. I love what you've done. I think your pod's outstanding. I love the new cover art. It's almost Rat Pack-ish.
Bill: Indeed.
Chris: I almost feel like I needed to wear a Tuxedo to talk to you today.
Bill: Yeah, the people that watch it on YouTube realize that the album art is, it's just a persona. But I've wanted to do something like that for a long time. So, I finally got a shot, so I took it.
Chris: Oh, it's a great picture.
Bill: Well, thank you.
Chris: It's a great thought.
Bill: Thank you.
