Inflation, value investing, and coming up on the right side of the stock market with Bruce Greenwald

he wrote the book on value investing one of the best minds in finance today bruce greenwald has been described as a guru to wall street's gurus and over the last three decades he's passed on his deep knowledge of economics to generations of students along with the help of famous guest speakers like warren buffett and mario cabelli in this episode of influencers i'm joined by bruce greenwald professor emeritus of finance and asset management at columbia business school as we discuss the economy his philosophy around value investing and coming up on the right side of the stock market hello everyone and welcome to influencers i'm andy surwer and welcome to our guest bruce greenwald professor of finance and asset management at the columbia university graduate school of business and director of the heilbrunn center of for graham and don investing bruce nice to see you nice to see you randy so you are known as perhaps the most prominent value investing professor um in business schools today what is the difference between say being a professor of finance and being a professor of finance who specializes in value investing oh i i mean i think it's a world of difference i mean i think first of all being a professor of finance is increasingly a matter of technical mathematical work and models that are still rooted extraordinary to an extraordinary degree in efficient markets theory although there is increasingly this field of behavioral finance but what value investing i think is about is understanding that practitioners out in the world and this is how i was introduced to it have a much better handle on how to invest successfully in theory and in practice than the finance profession so it's really almost a renegade uh discipline at this point although in the last 20 years it has made an extraordinary advance in the academic community so i would say almost every leading business school now teaches a value investing course which is really quite uh significantly of variance with traditional finance well that's interesting so so these people would perhaps knock heads even at least academically well if you understand the pathologies of academic life they should knock kids but of course they completely ignore each other i don't know which one would be worse i'm ignoring each other because it leads no place right right okay um one thing p and people may not know this about you bruce but you are sort of a direct tie from graham and dodd to warren buffett and the columbia business school can you talk about that whole um sort of group of individuals and how it all sort of ties together including okay so so there has been an evolution of uh the value investing tradition intellectually uh it starts obviously with ben graham and david dodd they are really essentially gone by the mid-1960s and they were perfect in colombia right at columbia but it doesn't really exist anyplace else at all um so by the time i was teaching at harvard business school in the 1980s it was essentially a dead letter in academia and had been replaced by efficient markets a guy called roger murray kept it alive at columbia and i think he retired sometime around 82-83 and then strictly by accident um a family that had been investors with buffett decided to give a chair i mean the habrin family decided to give a chair in value investing and it was hard to fill so i had already just come to columbia and uh the dean said why don't you take this chair and i said sure not knowing at all what i was getting into and then a year later mario gabelli had decided to run a series of seminars at the television and radio museum uh with roger murray who at that point i think he's like 84 years old i was literally like an anthropologist recording a dead language and the dean came to me and he said look as a matter of courtesy you should go uh listen to at least one of these lectures so i went to listen to one of these lectures and it was clear it was just much more intelligent than anything we were teaching our students um and sort of talked roger into teaching of course with me first that warren buffett came to speak at and then developed into a book and then a sequence of courses and really metastasized to a lot of other schools including harvard business school which developed its own value course so really from those beginnings in the early 90s i think you've seen a change and i think danny to be honest there are very good reasons for that and it is simply this that even though there is overwhelming statistical evidence that markets are not efficient in the academic sense in the sense that nobody can forecast them because there are these well established patterns of momentum and the outperformance of value stocks the fact of the matter is that there is an inescapable sense in which markets are efficient and it is simply this the average return to all investors asset class by asset class and therefore all overall asset classes has to be the average return to all assets because everybody owns everything something is owned by you know nothing is an orphan asset and the derivatives the uncovered shorts so i'm net out there's a buyer and there's a seller so that the average return to the market is the average return to all investors and that means you have to ask yourself how are you going to be in the upper half of that distribution and that's not a question that traditional finance people have ever asked themselves and actually value investing has a sequence of good answers to that and can i interrupt it does that speak to the tension or the argument between the value investing camp and the efficient market people well i mean i think that it should again but the fact of the matter is that in the face of all this overwhelming statistical evidence against efficient markets in the face of all the developments in behavioral finance that provide psychological underpinnings for these violations of efficient market behavior most of the efficient market people just have not adapted and i think the value people have i mean it's basically the ideas that they have are look if we look intelligently for opportunities where investors like myself or like you are more likely than not to be on the right side of the trade we're going to do better than average and one way historically to do that is to take advantage of the irrational overpricing of lottery ticket stocks the growth stocks and the irrational under pricing of the ugly obscure uh despised stocks and that's for a long time what value investors did but why if if markets are efficient then why does buffett say that you should invest in an index fund oh but okay and i think that that's uh a good point to do well to be on the right side of the train you have to be a professional investor so i'll say something that ironically should absolutely dominate the investment world and doesn't which is if i'm going to be on the right side of the transaction more often than not i probably ought to be a specialist so you don't have internal medicine guys doing orthopedic surgery medicine law is highly specialized and if i've spent my whole life trading onshore you know south texas gulf coast oil leases and that's all i do and you fly in from germany and buy an oil who do you think made money in that transaction right right and the idea of specialization plays no role in academic finance adam smith notwithstanding but does this suggest that for ordinary investors then they should pretty much stick to um index funds maybe unless you're in a field like say you're a dentist and you see that this new product is going gangbusters and people don't seem to realize it then you buy that stock that is a very good way to put it the problem of course with that is once the dentist does that in dentistry he decides he's a market genius and he decides he can do it every place now you have to be incredibly disciplined about why you're the person who's going to be on the right side of the train and most part-time investors are not equipped to do that but if you just buy the index you can't be on the wrong side of the trade right right and it prevents you from over investing in the glamour stocks and that's the sense in which buffett is absolutely right so it's not just you know holding a sign up and saying i'm a value investor so therefore i'm going to be right you that that's that's sort of meaningless in other words you have to be you have you have to a have the strategy but b have to be able to execute the strategy those people can't do that yes and that's exactly right you have to be specialized you have to understand by industry and even by geography these days right you have to be because you're an industry specialist good at judging management's and knowing if you're going to intervene with management because activism is increasingly important where you're going to find a good alternative management if the management doesn't go along with it so you need a lot of detailed knowledge you need a superior evaluation methodology because you have to know what you're buying and a dcf methodology is almost worthless i mean if you think about it there are three things wrong with it that are so obviously it's incredible that its part in business schools so the first thing is and this is the most obvious if you think about what a dcf is is wait yeah what is a dcf i'm sorry it's a discounted cash flow valuation got it so i asked to make the cash flows into the future and i weight them and then i add up the values of the individual cash flows the problem is that the reliability of my estimates of those cash flows are very different so i don't have a very good idea of the five to 25 year out cash flows but i have a very good idea about the current cash flows but a classic discounted cash flow calculation doesn't make that distinction so what you wind up doing is you wind up taking very good information which is your estimates of the near cash flows and very bad information which is the distant cash flows and adding it together and as any engineer knows you add bad information good information the bad information completely dominance there are also no strategic uh ways to if there's no easy ways to integrate strategic insights into a complicated sort of dcf calculation and third and i guess this is important is that in the dcf calculations they're all forward-looking they're all estimates of the future you completely ignore the balance sheet and throwing away information that's as crucial as balance sheet information is not a good way to proceed and there are value investing approaches that are pioneered by graham buffett and roger murray and other people that really don't have those problems right and if you're not willing to make the investment to learn and practice those you shouldn't be in the business of pretending you're a good investor and and i wanted to follow up and ask you about warren buffett you mentioned that he came to your class uh that one time but is he has he come to your class more than that and what's that been like okay so the history of that was i think in the first uh four years eight years because he came every second year he came four times it may have been three the first six years then he invited the classes to come out to omaha and that happened for a number of years and that and that happened every year and then you know i think we still go out there but we go out there as part of a bigger uh meeting with him because he is more efficient with his time that that must make for a pretty um robust enrollment in your class do people just want to come in because they want to you know i'm here for bruce but they want to hear from warren well okay that i you would think they would be intelligent enough to do that but here's the problem if you look at the empirical data in the years where he didn't show up the enrollments were just as high as the years where he did show up so well that's very hard you being a draw as well bruce perhaps well i think it's the subject matter that's the draw i mean i think that understanding i mean understanding how to value growth stocks without sort of putting this extraordinary emphasis on the future cash flows that you can't measure understanding how to use the balance sheet understanding how to use the fact that in the automobile industry there are never going to be any competitive advantages or barriers to entry that are significant that takes you a long way and i think conventional investment courses don't teach people to do that okay quick tangent off that point when you say there's no barrier to entry in the auto industry would you include tesla in that oh absolutely so going forward absolutely now tesla will do a little better i mean there's an easy way to measure barriers to entry so the first element is what's the minimum market share you need to get to in order to be viable now if a market is small like the electric car market is today you probably need to get to twenty percent of that market to be viable in the mature automobile market that is global you can be viable at two percent well at twenty percent requirement tesla may be able to keep rivals out but at two percent nobody's gonna keep anybody down and guess where the electric car market is going it's going from seven hundred thousand a year to seven million a year and and so just to follow that point that that would not necessarily bode well to your thinking for tesla shareholders oh absolutely not i mean 20 years from now you really think that they're going to dominate the auto market not a chance and we know what a competitive auto market looks like because in that market most of the big companies have flirted with bankruptcy at one time or another but just to follow quickly like you know elon musk will say it's not just a car bruce greenwald it's an ecosystem with a computer connected to a database connected to solar panels yeah go ahead and you think other car makers don't have that they don't have computers they don't have databases they don't have solar panels right give me a break and if you're going to have charging stations you know apple always used to try this they do when they tried itunes they tried it only working with apple computers and you know the ipod didn't work at all right so when you have charging stations they're going to serve all the cars right right oh no elon musk is uh talking his book yes but when it happens is a tough question it will happen that go back to the market can stay irrational longer than you can stay solvent i think so especially in things like this right i would not try and uh short uh tesla people have gotten slaughtered doing that i've had my own terrible experiences with shorts and the thing about shorts is you have a shorter rise because it's uncapped on the upside right but i if i were gonna put the family fortune into tesla i would not be a comfortable dubi right one other besides buffett i know you've had a number of other high profile people uh come to teach your class as a guest what are some of the other people who come oh okay so the standard names are seth clarman uh glenn greenberg uh tom russo lee liu who manages charlie munger's money uh mario gabili michael price um and then you know just a number of uh younger people who we've promoted have done very well that's fantastic and so is there a high demand for your class i mean you have to do you have to i mean all right now i got to be thankful i retired two years ago yeah right and passed it on but we basically gave it all the time i was there in the biggest room at columbia business school and we filled it the thing about information is it's free if i'm going to talk i'll talk to as many people as possible so we tried to uncap the crass now for the speakers because they really come wanting to interact with the students we capped it at i think 60 people so i want to ask you a little bit bruce about um you know the market right now and your take on things and boy there's all these little substrata there's you know spax there's crypto there's gamestop i i bet you're a big fan of all those things huh i would stay away from all of it the thing about the market today is we are in the middle of an economic transformation that has for 20 years now and will continue to be extraordinarily favorable for stocks so we are in the process of a transition from a manufacturing economy with big global markets to a service economy with local markets and as we talked about local markets are the markets with barriers to entry so in local say caffeinated soft drink distribution you have to get 25 share and in service markets because there are continuous relationships between the customers and the companies you hit the demand tends to be really sticky so typically for example companies in these smaller markets and technology has driven markets to niches too have to get to like 15 to 25 of the market and maybe one percent to half a percent of the market changes hands every year so you're talking about maybe 30 to 50-year paths to viability so you've got to get to 25 of half a percent a year you know that's 50 years to get to viability so barriers to entry are going through the roof and behind those barriers to entry you've got sustainable monopolies and sustainable oligopolies and that means you've got pricing power and you have profits rising with that pricing power at the expense of wages and again this is data that you would think would be all over the place but in 1990 the profit share of u.s national income was about eight and a half percent today it's about 13 and it's going to continue going up so you are rising or riding a wave at which in these you know protective markets by moats you earn more than your cost of capital so investment returns are high organic growth doesn't just attract entry it benefits the incumbent first and cost cutting benefits the incumbent firm so i think as you've seen recently profits are going to do really well and the market is if you look at that in general are likely to do really well but what you need obviously is firms that understand dominating small niche markets and unlike tesla don't want to rule the world so you seem to be talking about certain companies are you talking about well let me talk about the one that again years ago i actually got in a fight with the rest of the value community over precisely on this issue of the transformation economy and that's john deere i don't know if you remember but um you know people like jim grant said oh it's the government that's sustaining all this demand for agricultural equipment it's going to go away and they're going to get trashed well what had happened was they went from being a manufacturing company and you can see this in terms of what the employees do to being a local service company and it consisted of ordinary service important parts and then with precision agriculture you know now all these machines are run off gps systems and every seed is individually placed with fertilizer and pesticide at exactly the right time in exactly the right place and the software that does that is of course local and that's done for deer machines second thirdly the machines don't wear out because they're plastic so your big second hand markets and those are local and finally because these machines do so much work i mean you have family farms now of 10 000 acres they cost a lot they can charge a lot because if you've got 90 deer machines in uh geography nobody's going to buy a kubota tractor because they can't offer those infrastructure services to the same extent and they're not going to buy an ad code truck so gear can charge a lot and that means they finance it well the knowledge of who's a good risk for financing is also very local local banks are much more profitable in global banks so they've understood this transition from being a globally competitive manufacturer to dominating in a disciplined way a succession of local markets so they have a very disciplined geographic strategy globally they don't go after wet agriculture in that group and you've seen what's happened their margins and a good year used to be eight percent and a bad year there is zero now in a good year they're like 18 to 20 and in a bad year they're 12 right look at that stock it's gone from 75 to well over 350. and so it sounds like there's another there's sort of a whole group of these kinds of oh absolutely and it sounds like you're actually fairly sanguine about the market and it's somewhat justified that the market's at elevated levels then i'm wondering if the fang stocks um amazon uh google those types of companies also um are fit this sort of description okay google is classically this kind of a company and it's in technology space not geography it does only search and that's a narrow function remember ibm used to do everything right and they absolutely dominate search and that makes a huge difference and whenever they try and do other crap they just lose money so that's a case where as long as they're continue as they do to set a first priority on dominating search they're gonna make a ton of money and what about microsoft what about amazon i was going to ask you amazon is really interesting i mean amazon has done really well in cloud computing where it's been very specialized and dominated the market although that's going to get to be a very big market and it's going to be harder to dominate but where they have been disciplined geographically they've done well where they haven't they've done bad so they pulled out of china india's not working particularly well if they would concentrate on dominating geographies in the united states and other markets one at a time i think they do a lot better because if you look at their retail operation it hasn't really made money except for amazon marketplace i want to go back and ask you we talked a little while ago about china but just to get you have a contrarian take on that i want to hear that again which is you don't think we really have to worry about china oh absolutely absolutely not i mean the world is moving to services and the thing about services is this but in addition to these small markets that are local is that service institutions are small and decentralized that means that you have to allow firms to exercise and managers to exercise local initiative that's a huge change from manufacturing which takes place in big institutions where you can concentrate a lot of resources a rigid system like china is not going to be good at decentralized operations that's the first thing second thing is that when you go to services individual performances are what matter it's individual doctors it's individual professors increasingly it's individual lawyers and so on if you think about that architects sales people and so on well the thing about that is it leads to an uneven distribution of income and smart people do really well smart people don't want to live in china anymore i mean we see that in the students who come to the united states so they're going to be lousy at services which is going to be 90 of the global economy just as agriculture disappeared manufacturing is going to disappear for the same reason that agriculture did productivity growth is going to be much higher demand growth and they're not going to have the people that do well in services and they're not going to have the structure to do well in services and you can see manufacturing dying already i mean in china the trade data is absolutely indicative i mean exports are growing at roughly two percent a year that suggests an economy that's growing a little more slowly than that so no they're going straight down the chains and it couldn't happen to a nicer bunch of guys wow okay uh let me ask you about um our economy and the federal reserve and fiscal and monetary policy which have been you know very accommodating and probably rightfully so given we had a global pandemic but too much are we too reliant on cheap money oh i don't i think the answer to that is no and it's for a rather peculiar reason which is that when we did all this extraordinary monetary expansion all the quantitative easing of buying bonds and so on it had no detectable effect on the macro economy so if you look at the fed's forecast they always think they're going to get to three percent growth two years out and meet their inflation targets two years out and the growth stayed at two war we were slightly below that and the inflation rate stayed right around one and a half percent so it had no effect uh in the long period since the financial crisis and it strikes me as very odd to think monetary policy at least is going to have any effect uh going forward which means that if inflation takes off we're going to have a tough time controlling it with monetary policy fiscal policy has never worked particularly well i mean to give you an idea of the historical weakness in fiscal policy admittedly this is going to date me because it goes back a long way in 1966 there was a very sharp contraction in the expansion of the money supply in 1967 was the year of the most rapid expansion of the vietnam war and wars are fiscal policy on steroids nominal gdp growth between 66 and 67 fell substantially [Music] and you know except for sort of tax cuts and giving money away it's very hard to detect because of the complexities of the timing of government expenditures the effect of fiscal policy quick follow-up question bruce so is inflation a threat now i think in the short run it's going to be brutal and again i come back to the fact that we are now an economy that is increasingly 70 oligopolies and local monopolies and there are also situations where these service firms who are dominant are always trading off present returns which is high present prices against future growth in attracting customers i think when the government scares these firms they're just not interested in investing in the future and i think the government has scared the crap out of them and they're going to protect themselves by using the pricing power that they have which is why you saw this extraordinary spike this year in even core inflation you know and i think the event was actually not monetary or fiscal policy i think it was the vacating of the vaccine uh patents and i think businesses are gonna look at that and say holy these guys are not my friends i gotta protect myself and the easiest way to do that is to raise your prices and when all the other local businesses raise their prices too you don't even lose that much business wow all right we're going to have to leave it at that a good dose of contrarian thinking i would say from bruce greenwald of the columbia university graduate school of business bruce thanks so much for your time thank you andy you've been watching influencers this is andy surwork we'll see you next time

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Id: wHwBtlR9h0k

Length: 31min 40sec (1900 seconds)

Published: Sat May 29 2021