Episode #352: James Rasteh, Coast Capital, “The World Is Running Out Of Gold”
Guest: James Rasteh is the founder of Coast Capital, a fund that takes a private equity approach to investing in public markets.
Date Recorded: 8/18/2021 | Run-Time: 1:10:16
Summary: In today’s episode, we talk about gold miners, European activism, and ESG. James starts by explaining why he’s so bullish on gold miners from both a macro and micro perspective that he created a fund dedicated to activist investing in that space. Then we talk about the opportunity set in Europe and why James believes the valuation difference between the U.S. and Europe isn’t justified. We even talk about the difference between being an activist investor in the U.S. and Europe.
As we wind down, James shares his frustration with the finance industry’s use of ESG as mainly a marketing exercise.
Sponsor: Today’s episode is sponsored by Hone Health. Did you know men’s testosterone levels can decrease by 1% – 2% per year after the age of 30? Addressing low testosterone and optimizing your hormones can improve your energy, increase your libido and muscle mass. Hone offers a safe and convenient solution to get hormone testing and meds from the comfort of home. Complete your at home biomarker testing, video chat with a doctor and get FDA approved medications that are delivered directly to your door. For a limited time only, listeners can get their at home assessment test and doctor consultation for only $45. Head over to honehealth.com/Meb to take advantage now.
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Links from the Episode:
- 0:40 – Sponsor: Hone Health – get 25% off your order today
- 1:22 – Intro
- 2:06 – Welcome to our guest, James Rasteh
- 3:03 – James’ investment philosophy
- 7:32 – What piqued his interest in gold miners
- 17:31 – Why the lack of interest in the gold mining sector?
- 22:49 – Factors and metrics to keep in mind when evaluating a gold mine
- 28:12 – Countries with the largest opportunities in the gold mining industry
- 43:45 – Portfolio diversification
- 47:00 – James’ thoughts on ESG and frustration with Wall Street’s use of ESG for marketing purposes
- 52:02 – Whether or not companies are receptive or skeptical of James’ involvement
- 54:00 – A funny story from James’ years of working in this sector over the years
- 1:00:11 – James’ most memorable investment
- 1:06:59 – Learn more about James; coastcapitalllc.com
Transcript of Episode 352:
Welcome Message: Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Sponsor Message: Did you know men’s testosterone levels can decrease by 1% to 2% per year after the age 30? Addressing low testosterone and optimizing your hormones can improve your energy, increase your libido and muscle mass. Hone Health offers a safe and convenient solution to get hormone testing and meds from the comfort of your home. Complete your at-home biomarker testing, video chat with a doctor, and get FDA-approved medications that are delivered directly to your door. For a limited time only, listeners can get their at-home assessment test and doctor consultation for only $45. Head over to honehealth.com/meb to take advantage now.
Meb: What’s up, everybody. Today we got a great show. Our guest is the founder of Coast Capital, a fund that takes a private equity approach to investing in public markets. In today’s show, we talk about gold miners, European activism, and ESG. Our guest starts by explaining that he’s so bullish on gold miners from both a macro and micro perspective that he created a fund dedicated to activist investing in that space. Then we talk about the opportunity set in Europe and why our guest believes the valuation difference between the U.S. and Europe is a big opportunity. And what are the differences between being an activist investor in the U.S. and Europe anyway? As we wind down, our guest shares his frustration with the finance industry’s use of ESG. Please enjoy this episode with Coast Capital, James Rasteh.
Meb: James, welcome to the show.
James: Thank you. Great to be here.
Meb: I hear we find you in Miami in a tie-dye t-shirt. Are you a Miami local? I think you’re Canadian-ish.
James: I’m a global reject of sorts. I was born in the Middle East and grew up in France. I have a Canadian passport and have spent the past quarter of a century in Manhattan. But I am indeed sending you greetings from beautiful, sunny, optimistic-looking Miami despite COVID and everything that’s happening in the world.
Meb: Are you just surrounded by an influx of California VCs wearing fleece vests? What’s the vibe there right now?
James: Not quite yet. I think people are still working from their homes and apartments mostly, but you can just smell that venture capital money, and anxiety, and anxiousness, and excitement in the air.
Meb: I love it. Miami is one of my favorite places. Hope to be back there in the next couple of months. Well, look, we’re going to talk about all sorts of topics today. You’ve been at this investing game for a while. Tell us a little bit about your philosophy or framework, how do you approach markets, and then we’ll get into a few topic sectors and ideas.
James: Philosophy and investment process has been really the same for 25 years. So I suppose that if I were to really think about my story is one of constancy, but yet, there’s been a lot of evolution and I really think improvement in the way we do things. But basically what we do is very simple. We look for and invest in companies that we think are really number one or number two, so market leaders in growing and profitable industries and with big barriers to entry. We cannot invest in companies that are being disintermediated, where the future looks very uncertain like we can’t touch retail you know, blah, blah. We like to see growth profitable industries, leading companies in those industries. And we like to buy them when their valuations are extraordinarily low, and when there are events to release value back to investors. So we look for a confluence of these three factors before affecting an investment.
And the biggest difference between what we do and what our peers do and what I used to do when I began my career because I’ve been pursuing the same investment philosophy really for 25 years, is we then work with the most impactful and inspired CEOs and operators from the industries that we invest in, to operationally due diligence on invested companies, and then to come up with value creation plans for the companies that we invest in. So we have an advisory board that if we invest in corporate services, we might work with sir Gerry Robinson, the founder of Compass Group, the largest corporate services company in the world, but also the CEO who has led the operational turnarounds of at least six different over 5 billion pound companies in the UK.
If we invest in retail, we might work with José María Castellano, the founding CEO of Inditex really created Zara and turned it from nothing into the most profitable and valuable apparel retailer in the world. If we invest in media, we might work with Leo Hindery, chairman of Liberty Media and founder of the Yes Network and blah, blah. And so these advisors who know our industries intimately well and who have spent their careers meeting some of the most well-managed, profitable, and valuable companies in these industries. A, they’re our anchor investors. B, they help us find our investment ideas, and C, they do our operational due diligence on our companies for us.
Meb: That’s interesting distributed model or augmented model I guess you’d consider it. As you talk about your philosophy and framework, how consistent are the industries and sectors over time? As we’ve seen in the markets, there’s always creative destruction with capitalism and free markets around the world shifting. And of course, it being not just the U.S. market, but a global one. Is it consistent where you’re saying these are certain industries we’re always interested in? Or is it opportunity-based where you say this year we see this opportunity developing? Is there any common threads?
James: That’s a really thoughtful question which I haven’t been asked before. We invest across industries. We only invest in industries where we feel we’re not subject to external forces that are beyond our control. So we don’t do much in financial services because I don’t know which way central banks are going to feel about putting interest rates a month or two from now. We don’t invest in insurance captive to similar to comparable forces. But over time, there’s really a great variety of industries that we look at whatever looks most compelling, given the state of the world currently. And we really do gravitate to companies and to sectors that other people have given up on allocating capital to.
So we have, for example, spent the past five years working on the gold mining sector, where we find easily the most neglected, undervalued, attractive industry I’ve ever invested in over the course of my career. And I would put investing in tech in the mid and early 90s in that same bucket. It’s absolutely incredible the opportunities we’re finding in that space. And guess what, nobody cares until they do. And we’ve been running our fund since the beginning of 2019. We just are making our first software investment, investment in a software company that happens to be the leader in a specific niche that’s growing 25 to 40% a year. And we’re buying our company at a 90% discount to its US-based peers. So we have capacity to analyze companies in a variety of sectors. Any company we look at, we usually end up spending at least six months working on anyway. So it’s always like reanalyzing the industry of the company in the context of that industry anyway.
Meb: Why don’t we start with, you mentioned the mining sector. We’ve done a fair amount of the natural resource podcast, most have been focused on farmland investing. However, we have done a few based on the energy/mining sector. Give us an overview. Why is this an attractive opportunity? And what got you started down that path? You’re part Canadian, so it’s in your DNA. Was it in your blood, or was this something more recent?
James: I think it must be in my blood. Actually, the first stock I ever bought was indeed that of a gold miner whose CEO I’m speaking with tomorrow, weirdly enough. That was like 30 years ago. So you’re absolutely correct about that, and particularly, Western Canada. Vancouver is the home city for…well, people don’t know this but 70% of the world’s gold miners are quoted in Canada. So it really is we have a hometown advantage there. But I grew up in this industry for the first 20 of my 25 years, maybe one investment in this sector. And it’s really over the past five years that we were on a very focused fund 12 positions, we mostly focused on deep value plus event opportunities. We’re finding a lot of those in Europe, which happens to be where we have allocated well over 50% of our capital. But the gold mining sector is pretty extraordinary from our perspective right now to allocate capital to.
First of all, we believe that we will continue to do well investing in the space whether the price of gold goes up or down. So we actually launched the funds focused on this industry in October of last year. Since launching our fund, I think the price of gold is down a few percentage points, and we’re up I think over 30%. So we are not doing this as a proxy for gold even though we would have every reason to be very or worth to be excited about the prospect for gold over the next five years. But here are, Meb, three observations about the gold mining sector that once we understood them, let us down the path we’re on.
One is the world is running out of gold. For every ounce of gold that we’re taking out of the ground, we’re only discovering 0.2 ounces.
Here’s another observation. Last year, we spent three times as much capital looking for gold as we have spent 20 years ago. And with three times as much capital, we found only 5% as much gold as we had found 20 years ago. A lot of the gold that we’re finding is very low quality and very expensive to produce, and it’s in geographies where planning permits are extraordinarily and ever more difficult to beget. So observation one, we are running out of gold to take out of the ground. That’s A. B, there is so little capital going towards gold miners by actively managed funds that most of the capital is going through ETFs. And when you invest in gold miners through an ETF, you’re basically buying the largest gold miners within the universe that the ETF captures. And so we live in a world where the premium at which the larger gold miners trade against their smaller peers is at all-time highs.
And then the interesting thing is the companies with the attractive reserves that aren’t yet fully in production, are really in the small and mid-cap of the industry. And so in a world where the largest gold miners, A, are running out of gold to produce, B, are not discovering any more gold. We’re looking, by the way, at an industry that 10 years from now will be producing 50% less gold than it does today. So gold production is declining because of our failure to make new discoveries. We basically found all the gold that is near enough to the surface to be discovered. And we don’t have the technology to make 10 or 20 kilometres below the surface in years, we just stopped. So the gold that we can produce for the foreseeable future, we already know where it is, how much of it we’re going to produce, and guess what, production is declining by 50% over the next 10 years. And people don’t seem to understand this.
So in a world where major gold miners A, are running out of reserves to produce, B, are seeing decreased production, and C, their valuation is based on their size. And the larger the company you are, the higher your multiples. Like a diamond, the bigger it is, the higher the price per carat. It would stand to reason that these majors are going to want to buy the smaller companies in that space. And so, we’ve actually created a fund that is actively engaged in investing in the sector. We’ve created the only fund that I know that has an advisory board that’s made up of some of the leading geologists and mine engineers and CEOs from the gold mining industry. And we are privileged in working with some of the best-in-class operators across these different competencies.
And I must admit that there’s a dearth of first-class operators in the sector.
And we’re finding great companies that are absolute takeout targets that…and some of which we’ll buy at two times cash flow with decades of cash flow ahead of them. And by the way, when I say two times cash flow, we’re assuming that they sell their gold at 1,500 an ounce. The price of gold currently is closer to 1,800. And going forward, we’re assuming that we only sell our gold for 1,450 an ounce. So we’re not counting on the price of gold going up, we’re not even counting on the price of gold remaining where it is. And we’re finding some of the greatest bargains I have found over the course of my career with unreasonably low expectations.
Meb: All right. So that’s a pretty good backdrop. So let’s dig into a few questions. I don’t know how much time you spend on the macro side of it. The question seems to be a head-scratcher for a lot of people with real interest rates where they are today with gold not ripping and roaring and somewhere in that 1,700, 1,800 range. Any thoughts on that in general? As you mentioned, the challenges of supply. Why do you think we are not seeing gold face ripper right now?
James: I love to make analogies and they go from bad to worse. So my first analogy is a one out of 10 in terms of effectiveness, and my analogies only get worse from there. So let me start with the first analogy of this discussion with you, Meb. In Florida is 31 degrees Celsius out today, which is pretty hot. It’s in the high 80s Fahrenheit. And it’s like saying if you’re out in this weather, your skin temperature should be really very elevated. And if it isn’t, then there’s something wrong. And how would you explain that? And maybe you would have just left a hyper air-conditioned store. And so in the gold mining sector, you would expect the price of gold to be ripping given the fact that indeed, you have an explosion in money supply around the world at an unprecedented pace. And you would expect that to lead to inflation, and you would expect that to lead to a dramatic increase in the price of gold. And you would think that because the price of gold isn’t ripping, it means that gold is no longer a barometer for money printing.
And actually, I think that it is but with some delay. And that delay weirdly enough is caused by COVID. And here’s why we’re seeing the delay. Over 50% of the gold that is produced in the world goes into the jewelry industry. And mostly women and men who wear jewelry, usually do it and usually wear jewelry when they go and socialize. If you have a particularly impressive piece of jewelry or whatever, you’re not going to wear it by yourself at home sitting around looking at yourself all day. I don’t really know maybe some people do, but that’s not how jewelry is put into use. You do it when you spend time with your friends, your relatives, or you’re outside, you’re at events and you want to make a certain impression and you want to convey a certain message about who you are, blah, blah. And look, most of the world is still not socially functioning the way it did pre-COVID. People are still not gathering, they’re not going to the opera, they’re not going to family gatherings, we don’t have great big weddings, by and large in most of the world. And so jewelry demand last year was down 40% year over year when COVID began and is still down quite a bit.
And so conversely, you could say that it’s amazing that the price of gold hasn’t declined precipitously because the biggest buyers of gold, which are jewelry makers have seen sales decline by double digits. When the world comes back into circulation and people again begin to socialize the way they have for millennia, demand for jewelry will remain at levels that it was previously. Maybe you will go notably higher because of where we are in terms of money supply and that surplus wealth that’s been created. And I think that the missing mechanism, the clog in the system that has correlated the price of gold to money printing, which has been taken out of the mechanism will be inserted back in. And I think that we’re likely to see the price of gold go up pretty dramatically.
But outside of that, I don’t have any observations to share with you and your sophisticated audience isn’t aware of. It’s just inevitably, I do think that this extraordinary exercise in money printing around the world, extraordinary and unprecedented, has to and will dramatically affect the price of commodities that are valued around the world and that are in limited supply. And gold is in limited and decreasing supply around the world. And people don’t understand the decreasing supply part of it certainly.
Meb: Does China play much of a role? They’re one of the biggest producers now it’s hard, of course, to get good data what they’re always up to. Is that something that plays into y’all’s thesis?
James: Unbeknownst to most, the Central Bank of China is funding local banks and it’s funding local Chinese-owned companies to go and buy gold mines abroad as much and as rapidly as they can. So you will see that China has attempted to acquire some of the largest new discoveries in Canada, for example. And in one of those cases, we inserted ourselves in the middle and felt that it was inappropriate for China to be able to buy that asset given Canadian companies aren’t allowed to control comparable assets in China. So the Chinese are I think playing as per usual a really thoughtful long-term game in the gold mining industry. And there’s no country whose government has greater exposure to and has as much of an expanding presence in the gold mining sector as China’s. Very, very smart, very thoughtful operating below the radar screen, just incredible.
Meb: So let’s dig into the gold miners. You said, in general, valuations are cheap, a couple of times cash flow on some of these. What’s the reason? Is it simply because it’s an asset that has gone nowhere for a number of years? As you mentioned, I think gold over a long period has gone up and the market cap-weighted gold miners haven’t done squat, depends on the timeframe, of course. Why the lack of interest and why the opportunity?
James: I think the opportunity is directly reflective of the lack of interest. And Meb, you’re actually beyond correct in your assessment of gold miners having gone nowhere. In fact, here’s what’s happened. So the index that tracks most of the companies that we invest in, though it’s not reflective of the average company that we invest in, is GDXJ. GDXJ was basically put together in 2009. Since its inception, the price of gold is up 100%. Guess what’s happened to the index? Don’t look it up.
Meb: I know it’s trailed, but I don’t know by how much.
James: Try by 50%. And keep in mind, these are companies that on paper are really operationally geared to the price of gold. So if the price of gold was up 100%, they could have gone up by 200%. So the valuations would have remained the same. Buying your gold miner right now is like buying prime real estate in Kabul on the 18th of August 2021. There is no demand. And so we love it. We actually don’t talk about… we try not to talk about the specific companies we’re investing in because some of them we’re hyper-excited about and we’re raising more capital to invest into.
But really a big part of the reason why direct investors like myself aren’t looking at the gold mining industry is twofold. One is it’s a really complicated sector to look at. And you better have a genuine geological understanding and historical understanding of the assets you’re buying into it. You need to know what that jurisdiction is like to operate in, you need to know what the political risks are, and you need to know how likely the mine life is to get extended, what the history of that mine is, how attractive the geology is in adjoining regions. And you need to have a really thoughtful and ultimately correct perspective of all that. You cannot get there just by looking at spreadsheets and speaking to companies and just chat, you need to have operated in the sector. Then you need to have a detailed understanding not of geology, but of geology in that particular region for that particular kind of formation. And we have that for the companies that we invest in. It’s taking us many, many, many years to get to a point where we have the advisors who help us operationally and geologically understand the assets that we’re buying into. And I think most people who don’t have it probably rightfully stay away from the sector. And I really would not necessarily recommend that people invest without having that capacity.
The second thing is, this sector has destroyed more capital unnecessarily than any other sector that I know of.
When we started looking at the sector about five years ago, the whole sector had a market cap of maybe about $350, $360 billion. With a fraction of Apple’s cash, you could buy every single gold miner in the world. And the top 20 companies in this sector alone, in the 10 years prior to when we started looking at the sector had destroyed, as in misallocated and written off $157 billion worth of capital. So the top 20 companies in 10 years had destroyed half of the entire industry’s market cap in the misallocation of capital. How did they do that? Well, here’s a problem that has plagued the industry consistently over its history. One is when the price of gold goes up, historically, it’s changed completely now, it’s a completely different operating mantra in the sector it’s taken over.
But historically, when the price of gold went up, the average CEO who had and continues to have de minimums exposure to the share price of his or her company and frankly, whose compensation was not based on how the share price did or return on capital or return on equity, but rather was based on how large the company was in terms of output. The price of gold goes up, the share prices go up, their cash flows go up. Banks throw capital at them, they go and buy the biggest asset they can, and they take on leverage to do so. Price of gold goes back down, their cash flows decline, they have debt to service, and they sell the assets they had bought for pennies on the dollar. And you instantly repeat this over a number of cycles and you supplement it by investing billions and billions and billions of dollars into exploration projects that yield zero return on capital because there’s no more gold to be found, you end up with a sector that has an abysmal track record of capital allocation.
And that’s why I think the few or last of the Mohicans who were allocating capital to this sector basically gave up and decided not to invest in gold miners anymore. And I think that if you focus on historical return on capital, that is the only sound conclusion that you can get to. But this misallocation of capital historically, which had destroyed so much value is really what drew me to this sector, to begin with. Our thought processes as active investors, we are particularly well-placed to discipline management teams that have lost that discipline or to ensure adherence to thoughtful allocation of capital, and therefore, prevent capital destruction, and therefore, create important value for investors going forward.
Meb: So if you were to look at the factors in the gold miner space, and I know it’s much more complicated than this, but are there any of the standouts? So I’m thinking market cap to proven reserves. Is it some sort of, hey, we’re looking at this exact comp or some sort of dividend and buyback shareholder yield for the more mature companies? What are the metrics you guys are particularly using as waypoints that you think are helpful to try to avoid these capital incinerators?
James: That question is difficult to answer because it really depends on the company we’re looking at and what stage of its lifecycle the company is. But most of our invested companies are in a similar enough stage in their life cycle. They’re productive companies, they have long mine lives, attractive production costs, very, very low valuations. But usually, the first thing we look at, and the first bar to clear is jurisdiction. We’re not going to be very comfortable buying an asset in, let me exaggerate, like North Korea or the DRC. And in places where the rule of law is tenuous and you need to put up with risk parameters that are extraordinary, we just don’t invest in. So we invest mostly in North America, in a few select countries in Latin America, and then Australia and New Zealand. These are geographies we look at.
Then we look at reserves, we like to have long mine lives and long term reserves. And then we look at the quality of the reserves, which ultimately results in a low production cost. So we like to have long mine lives with low production costs in safe jurisdictions. And then we look for the very lowest valuations based on these considerations. And knock on wood, we’re finding really attractive bargains in first-rate jurisdictions just now.
Meb: How much actual work can be done remotely quantitatively, and how much of this is a traditional value add fundamental digging? And I imagine it’s different for the really large $10 billion-plus companies that have been around forever, Newmont and Barrick. The smaller guys, the dozens and hundreds of companies that are sub $5, $10 billion market cap. Any advice? Any thoughts on how to go about it?
James: For us, we invest in a few companies at any point in time. We do a lot of due diligence on the companies we invest in. Everything we’re invested in, we are advised by people who…if it’s a recent enough discovery, maybe they discovered the asset. But for every single investment that we have, we know our advisors have visited the assets on the ground multiple times, have specific geological understanding of the asset, what it looks like, and what the ideal expiration path for the company should be, and what ideal life of mine plants should be, and what that means that the asset is worth now, what could it be worth if we were to operate the assets slightly differently, who are the likely buyers of the assets, what are key risks, what are key ways to improve operations.
So we have a really detailed understanding of every asset we’re buying into based on multiple site visits by ourselves, by my colleagues, by my partners, and by our advisors. And that’s just how we like to invest. And I really do think that that’s the best way to invest because then you really know your asset. And guess what, some days you wake up and the market says, “I think your asset is worth 20% of what you think it is.” You’re like, “Fine. You think what you want, but I’ll buy more.” And some days you wake up and the market is very enthusiastic and it’s paying top dollars for the asset, and you go ahead and you sell it. But I think that having that really detailed understanding of what you’re buying prevents you from being jolted by a market that I think certainly in the gold mining sector fundamentally doesn’t seem to understand these companies. Certainly doesn’t seem to appreciate on average their values and is as the market is in any given industry quite prone to manic-depressive behavior.
Meb: Yeah. If you were to look at one industry and say, “Meb, which industry is the most dangerous if you don’t know what you’re doing?” And I would say mining because I talk to my friends that are in y’all’s world. And you just go through this list of CEOs and he’s like, “Oh, this guy’s a habitual crook, you can never invest with him.” But if you didn’t know that, I don’t think a lot of people consistently get fooled into believing the dream, etc. And so that’s probably one area that there seems to be consistent value add from doing the work.
James: I forget the name of the author who said that the goldmine is a hole in the ground with a crook standing on top of it.
Meb: Sounds like Twain, everything gets attributed to Twain, I think. But I was reading one of your old letters and you had another great quote. I think it was the Edison, but it was talking about hard work. Do you know the quote I’m talking about?
James: Yeah, yeah. Opportunity. This is one of my favorite quotes of all time and it is so true. It says “People fail to recognize opportunity because it goes around dressed like hard work.” And time and again, the things that we invest in people say, ah, it’s a value trap, ah, people aren’t going to be interested, gold miner is too complicated. It’s just, thank you. Thank you the communal collective investment world that isn’t doing the work and that isn’t looking at the opportunity more for us to go. I sometimes feel like we’re at a buffet that’s been thrown for a whole bunch of impatient kids, and we’re at the caviar buffet and there ain’t nobody else in line. And we got to walk away with cows, probably, but happy to be where we are.
Meb: So before we leave the gold miners, is there any particular country or area that you think is particularly attractive where you’re like, look, man, it’s companies focused on New Zealand, or it’s all the micro caps at $100 million, or you can get by with just buying GDXJ? I know you don’t want to talk specific names, but what are the more opportunistic areas?
James: So two things. One is because the sector is so under-invested, you don’t need to take geographic risk to create returns. And so my advice would be stick with the best geographies. And I really do think that Canada and the U.S. are pretty unbeatable. Even in Mexico, there are states where we don’t want to be just given the state of affairs and the concerns over safety and security of staff and what have you. So we really are very partial to North America, Australia, and New Zealand. And look, maybe we’re slow, but it’s taken us five years to discover the things we’re finding. And I’m scratching my head and I want to give up everything I’m doing and frankly, just allocate every dollar of capital that I can to the companies we’re investing into. When you buy a company that is selling its product for $1,800 per unit, but you assume they only sell it for 1,500, you have every reason to expect the price per unit to go up meaningfully over time.
And meanwhile, you buy the company at two times cash flow, assuming 1,500 per unit. And in today’s world, in the context of SpaceX being valued at 600 times revenues or wherever that is, we’re really thrilled with the things that we’re finding. And I don’t think you need to give up safety from a jurisdiction perspective. This being said Meb, I don’t know you well enough, but there’s something slightly adventurous about you. Maybe it’s you having grown up in Colorado and I don’t know, but to the risk-taker in you who might be looking for more than average returns, I would point you to the, if I may, to the country of Colombia. Because weirdly enough, Colombia happens to be depending on the province you looked at, one of the safer jurisdictions you can invest in or one of the least. So you really need to know where you’re investing.
I think that a country like Mexico and Colombia which aside from Brazil are the only three geographies we’ve made massive allocations of capital to in Latin America. They’re like micro countries. You really need to look at these on a province by province or state by state basis. But Colombia probably is the only country in the world with really important gold reserves that aren’t currently in production, and some of which haven’t been discovered yet. But I think that industrial development in Colombia had been put on hold for many decades because of the FARC. And I think that as Colombia enters a new and there I hope much more safe chapter in its history. I hear there’s a lot of exploration work to be done in that country and a lot of exciting opportunities to look at.
Meb: I’ve been to Colombia a few times, and listeners who have heard this story, newer ones, I’ll tell it again. I’d given a couple of talks in Colombia maybe six years ago. I think the company that actually organized the talks is now out of business. I’ll have to look it up. Anyway, it was a big institutional investing conference. And this is when oil was rocking and rolling, and their stock market was one of the most expensive in the world at the time. And since then, and why it’s probably creating opportunity, their stock markets performed very poorly over the past six, seven years. I have to look up the exact date. So, I may have it wrong. But it’s now one of the cheapest countries in the world.
And I was really unpopular when I went there because I preached that message and said, “Look, I love you guys, great food, wonderful people, beautiful country, but your stock market is one of the most expensive.” And I want them to have me back now. But the problem is when you’re in long bear market, everyone knows the answer, now they know it’s cheap, but no one ever has any money. So we need some friendly activist investors like yourself to kickstart things a little bit. Let me know when you go I’ll join you down there. Do you do any macro derivative hedging for gold price in general as an input?
James: No. It’s the last thing I would do, especially now. But no, we don’t.
Meb: Easy answer. Okay. Now, let’s go across the pond. What’s the opportunity elsewhere?
James: Yeah. If I were to think of myself as a waiter at a restaurant, the main course we serve at Coast really is European event-driven investments. That’s what I’ve actually done for 25 years and that’s what most of our main fund is invested in. And there are few times over the past few decades…because that’s all I know, is the past 25 years. And I wish I could go way back beyond that. And if I try to tap that historical understanding, I usually go to my friend Jim Grant, who is a national treasure and who has that kind of perspective. But most days, you could wake up and say Europe is an attractive buy because it’s trading at a discount to the U.S. And many companies there face better growth prospects than their peers in North America traded discount, therefore, buy Europe. And you can see that most days. You couldn’t see that in the late 90s when Europe traded a premium to the U.S. And we can talk about the reasons why. However, you would say that I think that you would have to be loudest about it now.
In the past 25 years, valuation discounts in Europe compared with their peers in the United States have never been as large as they are today. They were larger at the beginning of this year, but the gap has narrowed by 5% not a whole lot more. So since the inception of the New York Stock Exchange which I think was in 1792, like never have American stock traded commanded such a premium compared with their European counterparts. And I think a lot of people say that well, James, that’s a worthless observation because the U.S. is much more geared towards tech, and therefore, it’s two apples comparison and therefore, there’s no value to that observation to which I would just share the remark that actually there is no industry that trades and invest in 20% discount to the valuations, its companies command on average in North America. So if you adjust for an industrially adjusted basis, the lowest valuation discount Europe trades at is 20%.
So valuations have never been as low. And at the end of the day, there are a lot of companies in Europe that like their North American counterparts have the same geographic footprint, have the same sales growth prospects, have the same margins, and have the same tax rate. But because the company trades in some extreme cases in London, it fetches one-fifth evaluation, it might get or one-third, or however much might get if it were trading in North America. And so, again, we are blessed to work with an advisory board that is made of some of the leading CEOs and operators from the industries that we invest in. And if you look at our advisors, you will see that almost 100% of them are based in Europe or look at gold miners. And the majority of them are based in Europe, but have specific European industrial backgrounds and expertise. So there’s a lot of good work for a fund that takes a really deep dive approach to operationally analyzing and understanding companies that invest in figuring out what these companies could and should be worth and under what circumstances they can actually achieve that value.
There are some very simple and extreme cases where a great company says for the country that it’s based in, the company could be based in Silicon Valley, but it trades in Ireland. And so private equity comes in, de-lists it and relist in the U.S. and gets a two, three-fold increase in valuation moves on. There’s a lot of that happening and there’s a lot more of that to go. And I think that the whole thing has been exacerbated by…perhaps it’s been partly explained by two factors. One is European investors and particularly, institutional investors are mostly interested in debt, and they’re interest-seeking investors, first and foremost. And so equity culture in Europe never was, never would be as developed as it is in North America. But the second and bigger problem is probably that the Europeans have shot their listed companies in the foot by insisting on MiFID regulation. Whereby…and this is just the stupidest thing that European regulators have done. There’s a pretty long list of mistakes. This is the most egregious.
But basically, European investment banks cannot subsidize the cost of research with investment banking revenues. Whatever trading income you generate from your research, from the research that you produce, is the money that you can spend on research. And so as a result of that, the average company in Europe has less than half the number of analysts covering it, and observing it, and writing up about it, and creating interest in it than the same company would in North America. So there’s been this shooting of already shy or reticent equity culture in Europe by the regulators in that part of the world, which makes for a really interesting set of opportunities, particularly in the small and mid-cap end of the range. Because at the large-cap end of the range, there are funds that everybody seems to be invested in because nobody gets fired for investing in IBM, and therefore, everybody invests in IBM. So the large funds go after the large companies and there the variation gaps with U.S. are much less interesting. And I think the returns profile is therefore much more attenuated over time, I would expect. But in the small and mid-cap end of the range is where some really interesting things keep popping up.
Meb: I agree with you. Listeners on the podcast will have heard me talk about this thesis recently. The big difference has been a lot of European countries are starting to break out to all-time highs. Some are not there yet, but it certainly has trailed the U.S. over the past decade extensively. The UK is my favorite example, even because it has the longest history that you can compare, and is arguably the biggest discount it’s ever been relative to the U.S. But I don’t like to just have guests that I agree with on because it makes for a boring conversation. So I’m going to try to play devil’s advocate with some of the questions I hear a lot. One being, “Well, Meb, the sector composition the U.S. has more tech firms, the U.S. has better firms that are just more disruptive and innovative, Europe is slowly sinking into the Mediterranean with calcified ideas.” How do you respond to these general critiques that these companies are cheap for a reason, and this is going to continue rather than revert?
James: If I’m culturally a part of any country in the world, then that country has to be the United States. I’ve lived here longer than anywhere else, my dearest friends, family in the U.S. And so I’ve very humbly and with much love and affection for this country, but with the kind of love and affection you can have for a country not having been born into it. And having come from maybe from your perspective, less compelling background being all the more eager to point out how great the country is, I would say that we could in America use a giant pill of humility. I grew up in Paris, France, beautiful suburb, great setup, wonderful schooling, very grateful for Paris and the school system, and how kind that country was to me and to my formation. I could never repay my debts to the country of France. But nobody enjoys living in Paris, by the way. It’s a great city to go to for a week, but it’s a miserable place to live from my perspective for anything.
But some of the best engineers in the world are formed in France. Electric engineers, some of the best programmers, some of the best civil engineers in the world are in France. Some of the most sophisticated financial work and analysis being done in the world is conducted in France. Some of the best engineering in the world is done in Germany. And guess what? Scandinavia, the largest producers of ball bearings, or trucks, or trucking engines, or aircraft parts, or aircraft, whatever come and will continue to come from Europe. I think that the much more pervasive culture of education, a much larger part of the European population has access to world-class education I think than in North America. And over time, that really does result in important innovation and very thoughtful evolution of these populations.
I’ve gotten old enough that nothing really shocks or surprises or really horrifies me anymore. But the best waste management companies and recycling companies, the ones that have the best technologies and protocols and processes are based in Europe. We’re currently investing in a waste management company in Europe that we’ll buy into it four times, I want to say normalized EBITDA. This company is way ahead of any of its peers in North America and turning any product that you give it into end recycled products that either go into making soil or go into making bricks, or make energy, piles of recycled aluminum or steel, or whatever. This company has the fastest and most effective way to produce recyclates. And pursues like processes and technologies that if we’re lucky and inspired, we will on average adopt in the United States 5 to 10 years from now.
And I’m buying this company at four times EBITDA. Meanwhile, the U.S. peers are valued 20 times. And guess what, the production of waste volume in this particular country is at least as rapid as it is in the United States on average. And I have better returns on capital, and I have much better revenue growth, much better EBIT growth, but I just pay one-fifth evaluation. And people who think that I want to continue to allocate capital just to the U.S. because I’m buying better management teams, better companies, I think the facts do not corroborate that thesis.
But we live in a world where I think a lot of investments are being made, not based on facts, but based on sentiments.
Look at Bitcoin, look at Virgin Galactic, look at the companies like Nikola. And in Europe, I find that the world makes incrementally much more sense than it does here in North America.
Meb: There’s a couple of stats, the simple takeaway is that people love to extrapolate recent history. And so certainly looking back at the last decade, U.S. has outperformed and the vast majority of that outperformance has simply come from multiple expansion. Now, if you look at the opportunity set today, there are two stats I love that I tell people. The first is, it’s simply a question of breath. You have a lot of stocks in the U.S., but simply looking at one country, you’re ignoring the vast majority of the world. And if you look at the top 50 or 100 performing stocks every year, going back forever, including the last decade, over three-quarters of the best-performing stocks are outside the U.S. and that’s just the way it should be and is obvious. But also, the value case can be extrapolated by saying how many dividend companies paying 3% and where they’re located. And it’s like 90% are outside the U.S because the U.S. dividend yield is creeping down close to the 2,000 low, it’s like 1.2% or something now. And you find these companies in developed and emerging markets that are 4%, 5%, 6% yield still.
James: And this is not something we focus on, but I would also think about where are those respective currencies headed in terms of the relative value against the US dollar over time. And if you formulate some thoughts around that, that reflect the pace at which money has been printed in the United States, I think that really is another dimension or another lens through which I would look at these factors, and I think would be very important. But I’m not a macro guy.
Meb: Are there any countries, in particular, that really stand out? Do you guys concentrate most of your firepower on one or two, or is it a pretty diversified bet?
James: As you can tell, I suffer from the fact that I really do like to engage in dialogue and speech. And so I speak a number of European languages. My favorite language by far is Italian.
Meb: You can talk to my wife, she speaks Italian.
James: Actually, that’s great. I remember in the late 90s, I don’t know if you were up but the mobile phone operators around the world if you looked at the Italian ones compared to everyone else, they had 50% higher margins. And people were like, “Why? How is it that these Italians are so much more profitable?” And it’s not like it was a less competitive market, in fact, the opposite. But the thing was in Italy, people talk a lot more than they did in places like Germany. And I totally believed that’s because the language is actually really fun. When you listen or speak Italian, it’s almost like singing and it’s kind of fun. Whereas no offense, but when you speak German or Swedish or Norwegian, it’s much more truncated and much less sonorously pleasant. And so, I usually say that I love to invest in Europe because who would not prefer to visit a company in Italy than in Idaho? And I think everybody could and should. But the truth is the fun countries are not necessarily where your capital is best looked after, particularly as an actively engaged investor. I find that Southern Europe which I grew up in. So I grew up in France, we used to spend our summers in Italy. Italian and French are like Spanish.
And so I feel like Spain feels like an extension of the territories that I grew up in. But those are the countries that we do less in. We do a lot in Germany, Scandinavia, Germany, UK, Switzerland, and the Benelux. Simply because as an active investor, the regulations are very consistent and much more predictable. And I will tell you, for active investors, people don’t understand this. In the UK, the rights that you are awarded as a minority investor in a company are greater on average than the rights you have as a minority investor in a company in the U.S. And so it’s just a much better place for an activist investor. Same in the Netherlands, people just assume that no place surpasses the U.S. From a regulatory perspective and looking after minority investor’s interest, I would say that’s entirely not true. The UK and the Netherlands and Canada weirdly enough, much more accommodating rules. We can talk about what those are specifically if you like, but there you are.
Meb: Yeah. Let’s hear it.
James: Well, here in the U.S., you can have poison pills and companies can devise their own corporate charter and can put in poison pills and staggered boards. And in Europe, that’s been outlawed in the countries that I mentioned, by and large. And in the UK or in Amsterdam, if you own 5% of a company, you can call an EGM. And you can say, “I want to fire the entire board.” And you can do that as many times as you want in a year within cool-off periods. But investors, I think hold a much heavier baton over the heads of their management teams, many of whom deserve to feel that baton with some frequency, I think. But here in North America, there is no consistent regulatory framework. And on average, investors are not as well looked after as they are surely in places like the UK or the Netherlands.
Meb: There’s a little more that I want to get into before we have to let you go. You talk a little bit about ESG. And this is a topic that as a fund issuer, we certainly see a lot of discussion about over the past decade, particularly in the media. It’s less driven by assets until recently and a lot of different views. So, let’s hear yours.
James: I wrote up about our views in a paper that we published in the “Globe and Mail,” and I ended up losing half of my ESG friends. And it’s not like I have many friends to start off with, but I really think a couple of things. First of all, investors in public companies have an extraordinarily powerful position vis-à-vis those companies and their operations and a lot of responsibility, therefore, to ensure that the company does well by the community where it operates by its employees and environmentally as well. And the fact that the overwhelming majority of investors relinquish this power, or worse yet seed it to an organization like ISS which does extraordinarily superfluous and worthless analysis before making recommendations to their investors, in my experience. I think that that has gotten us into quite a pickle. And I cannot help but feel aggrieved and deeply disappointed in these big institutional investors really not doing anything to police the companies that they’re invested in.
So then you have this birth of ESG movement and you have companies that say, “We’re here to make the world a better place and invest in companies that have low carbon footprints and are making the world a better place to live in.” And then, the most celebrated of these companies was Generation Investment, which Al Gore was a co-founder of. And in 2016, Generation Investment’s biggest investment was Facebook, which has had as much as anything outside of the Russian government played a, I think effective role in weakening the pillars of democracy in the Western world. And really Generation like Facebook is the best and biggest investment you could find as an ESG investment. So I think that the whole process that leads to this kind of decision-making is flawed and farcical, if I may be perfectly candid, I don’t judge people. But at the end of the day, there are people who want to make the world a better place and who have spent their lives doing volunteer work in their communities, and serving on the boards of charitable organizations, and donating important amounts of money to organizations that need it and can put it to good use and blah, blah. And then there are people who really are wired like that. And then there are people who are really not like that at all and who really don’t care about the world, and the impact that they have on it and what they do. And I have worked with many of these people and many of them are great friends.
But to see people who have never cared about the environment or the impact of their invested companies has or how the average employee in their invested company is treated and who, when they’ve had problems from this perspective brought to their attention made it very clear that this was not a topic of investment. When I see people like that start ESG focused funds, I cannot help but conclude that the whole thing is really mostly a marketing exercise at this point. At the end of the day, I think that it’s a fairly complicated topic. But what I would present as an idea, if I may and I could be wrong, and please feel free to disagree or disregard what I say or whatever. But I would say that investing in companies that you think have low carbon footprints, or investing in companies that you think already are doing a good job from that perspective, isn’t going to make the world a better place. But investing in companies who provide a product or a service that the world needs, but who in the process of providing that product or service make negative contributions to the environment, like the gold mining sector, like the iron ore industry. But working to make sure these companies adopt cleaner mining technologies and more thoughtfully, treat their employees, which doesn’t elevate the operating costs, and sometimes can do the opposite.
But engaging with these companies to improve their impact on their environment and their local community, I think that that is what people could and should do. And I think the only way to make the world a better place. And it’s hard work and you need to really personally be into seeing that improvement. Most people don’t want to work hard, most people don’t care. And so it’s much easier to pick up stocks off a spreadsheet that Bloomberg has printed for you and says this company ranks higher than its peers based on some arbitrary and inconsistently chosen and implemented comparisons that depict its ESG score and you put together a portfolio based on that and put it into your marketing machine and hope for the best. That’s uninspired and it’s a problem and it’s ridiculous and it’s worthless. So, there you have it. I really think that proactive and actively engaged investments in the sector are what we need. And I think that the world is moving that way.
Meb: How often do you have the companies receive you with open arms, welcoming like it’s a friendly activism, and how often are they fearful, reluctant, downright antagonistic?
James: So, Meb, when you say receive you, I never think of us as just Coast Capital, I think of us in the work that we do as accumulation of the work that is put together by some of the leading thinkers and operators in that industry. If I ever want to force my own personal untested opinion on a company, I’d be pleased to get a kick in the ass and I would not complain. But we do a great deal of work in consultation with leaders who usually have much better operating track records than the company that we’re investing in does. And we approach our management teams and boards with that perspective. And I find that most often we are well received. And in a number of minority of instances, we are not. And when we’re not, the boards are antagonistic. It is invariably because people don’t like to have their mistakes pointed out, people want to hang on to businesses that shouldn’t be put together.
There are people that have led in our leading companies we’re investing in that belong in jail. There are management teams that we know that have shared material nonpublic info selectively with certain investors just to keep their jobs.
And it’s incredible the kind of shenanigans that go on. And I find that the regulatory framework around the world is lax, too lax in dealing with these problems.
So boards and companies that have problems, you get a sense of it pretty quickly. And usually, it comes down to people who are a mix of incompetent and arrogant. I find that the two often go hand in hand. And I find that the most competent people end up being the most humble which, God, whoever devices our personalities must have a sense of humor. But in the vast majority, maybe even the overwhelming number of companies that we invest in, it’s a positive productive dialogue that moves the company and the discussion forward and that we’re really, really pleased and happy to participate in.
Meb: Any particular stories come to mind as you look back on the discussions you’ve had with management over the years that you think would be instructive or even humorous?
James: There are so many. And these things when you really, really get down into them and when you really get involved and affect important change, there really are a pretty heavy mix of comedy and tragedy. So kind of depends on your disposition. From a humorous perspective, I would say one that keeps going back to the Thomas Edison quote, “People miss opportunity because it goes around dressed like hard work.” We once invested in the largest contract catering company in the world which at the time was valued at less than 10 times earnings its peers, which had lower economies of scale were valued at 25% plus. And the company was making 3% operating margins, and the peers were at 10% plus. So it was trading at half the multiples of its peers on earnings that were one-third of what they could or should be, and nobody knew why the company was so much less profitable than its peers. And I spent six months doing the traditional analysis that you do as an analyst, and I couldn’t get anywhere. And then had a bit of a eureka moment where I called the company’s founder and I was like, “Hey, we’re big investors in this company, you founded it. Under your leadership, it was three times more profitable than it is today. We have no idea what’s going wrong. Can we work on this with you?”
So next thing I know, this guy flies to my city on his own dime and sits me down and says, “Look, this company which makes $10 billion of revenue, and half of which it spends on raw materials.” It’s contract catering company, so it makes blocks of cheese, rice, or whatever. He’s like, “They’re making 3% margins, so 10 billion in revenues, they’re making 300 million of EBIT a year, but here’s what you should know. The food that they’re buying, they’re not going through designated vendors, and they’re paying 20% more than they could or should.” And I’m like, “Why is that? This Is incredible. I’ve never even thought to look at their procurement policies.” And he’s like, “Look, the reason is because they don’t have a tough adherence policy and they don’t discipline people who don’t stick to procurement through designated suppliers. And when you buy through a wholesaler or a friend of yours instead, you pay 20% more. But at the end of the year, bada bing bada boom, they send you 12 bottles of champagne or whatever. And he goes on to say, ‘Multi-billion dollar company where the average management team is like running amok, paying a whole lot more for the food than they could just to get a kickback at the end of the year.” Then we write a three-sentence white paper on here’s how to increase your operating profits threefold in the space of three months.
And we fly to meet with the company in London, we have a meeting with the chairman and we sit down with him. And prior to meeting with him, we share our analysis with the two largest fellow investors that we have. And between the three of us, we’re at 33% of the company so the chairman had better take us seriously. And we go out and we meet with them we’re like, “Well, this is what we think you should do, and these are the reasons why.” He said, “Thank you very much. We’ll take this into account.” Which is usually what people say when they do nothing with what you’re telling them at all. But sure enough, within a week of us visiting them, they fired the CEO. And the CFO who was great, by the way, and who helped us come to the understanding that we had stayed in place, and the chairman became interim CEO. And they ended up hiring a CEO that we felt very strongly about. And the stock price basically went up tenfold over a few years during which the FTSE declined by I think 20%. And all they did was react to a very simple observation by the company’s founder. And I’m like “$10 billion worth of marketing cap and it never occurred to you to go back to the founder and say what are we doing wrong?”
By the way, they were paying £50 million a year to McKinsey to figure out what the problem was. That exercise really led us down the path that we’re on, never again work on a company without having a detailed operational understanding of it because for sure, I’ve never led a company, I’ve never led an organization with thousands of people. I’ve never put in place and policed procurement policies, I’ve never procured insurance and negotiated for automation software. But there are people who have and they’re very aware of the transformative effect that a simple thing like your procurement policy can have on your EBIT. And those are the people that you need to know because they will not tell you about these things unless they know you and trust you, and they have a reason to speak with you. And it’s taken us 20 years, basically to put together the advisory board that we have. But it just makes the job a whole lot more fun, if that makes sense.
Meb: Sometimes the answers are simple. And having people who are resources whether it’s prior founders or operators that are outside of the company, sometimes people just get entrenched and lazy and happy with their business. And that becomes the eventual story arc where you got a young hungry disrupter that comes in and challenges it. And that’s both the opportunity and the risk, of course.
James: Yeah. And Meb, I have to tell you I cannot help but think that in a world where you basically are paid really well for buying Amazon and hanging on to it, or buying Google and Apple and these tech winners and they’re spectacular disruptive winners. I find that we went through a period where you used to get really well paid to take these risks and to conduct this kind of analysis to do this kind of work. And we were up 58% last year and we didn’t have a single technique and we run our fund with zero leverage, really. But I find that maybe in today’s world, you don’t need to work that hard, you don’t need to do these things to create returns. And so I just wonder if there’s a fat crop of investment opportunities like this that’s shaping up. Maybe that’s wishful thinking, but we’re seeing it in Europe.
Meb: My thesis overlaps with yours and there’s a lot of opportunity currently in the world, and there’s a lot of danger. There are a lot of companies that are bananas, expensive too. So good time to be an active manager. How many names you typically hold in your book? You’ve got a couple of different funds, right?
James: We have two funds. We have basically our main fund, 12 names or less and then we have a gold mining-focused fund which is just about six names.
Meb: Wow. So that’s the real concentration. I love the Kahunas. That’s my favorite active managers. We always say, “Look, if you’re going to pay more than five basis points for the global market cap average to get an active manager, you want them to be weird and different.” And those are some concentrated portfolios. That’s awesome over your career. And there’s got to be hundreds of names. What’s been the most memorable investment?
James: Meb, just two thoughts. One is I promised myself after I graduated high school that I would outgrow my weird moniker. And I just realized that maybe I have not. So that’s a personal observation for me to take away. And I must, unfortunately, agree I think I have unusual wiring, which is maybe why I do what I do. The first company I invested in you can see that I picked when I was 21 and a half, which is when I made MD at the fund that I was working at, which went on to become the best performing European hedge fund in the world based on Sharpe ratio because of one stock that I picked. And it’s the best stock has picked over my career and I must now do better than that. But basically, in the mid-90s, I found this tech company that was the leading provider of setup boxes and software that goes into setup boxes and the dissemination of content, but digital content. And the world at the time was moving from analog to digital. And you could see that this company was going to see an explosive growth in revenues pretty well immediately.
Because I bought into it in ’97 in France and Germany and the UK and the Netherlands and Italy and everyone in Scandinavia all said, “We’ve got to move from analog to digital before the end of ’99.” And you’re not going to do it at the last minute. And as you move from analog to digital, you will need new setup boxes, and you would need these broadcasting companies and these pay-TV companies to basically buy new technology. And we were the only independent provider of that technology in the world. Bought into the company at five times depressed earnings. And by depressed earnings, I mean, not a single digital order or analog. And it was the end of those orders before the wave of digital came in. So that company ended up seeing a 20 fold increase in revenues within a three-year timeframe. And then the valuations applied to these companies went up tenfold. And so we bought into the stock at an average cost of 27, 28 pence so that would go up to 10 pounds within a year and a half. And we put a really big chunk of the portfolio in it because the company was cash flow generated, it had no debt on its balance sheet, it was the leading player in a profitable and growing industry. So it’s like what is the risk of buying a leading player in an industry that has explosive growth ahead of it, is already cash flow generative, has no debt on its balance sheet, and then you’re buying at five times earnings?
So we bought quite a bit and as much as we could and saw it go up like 40 fold in a year and a half. And it is my ambition to find another company like this. And 40 or 50 fold upside is tough to get. We have a few things that we think maybe could be like tenfold if we play them right or if we’re lucky. But anyway, that was probably the most fun I picked.
Meb: How do you think about holding a company, and this is a challenge for a lot of people as it grows to be a bigger part of your portfolio and you have the one bagger, the two-bagger, the five bagger? We did a Twitter poll, we said hey, asked our listeners have you ever had a 10 bagger? Have you ever had 100 bagger?” And most people haven’t. And part of the challenge is you have a stock or an investment and it doubles. It’s like hallelujah, confetti, you’re celebrating. It’s the best thing that ever happened because most people don’t really see the potential or the chance of a company actually going 50, 100x. It’s hard to fathom. And so how do you think about selling? And this applies to all your names, good times bad times. Is it just a fundamental story, an update? Is it some technical criteria where you don’t want it to be more than 20% of your portfolio? How do you think about it?
James: Really good question. And there’s a person who answered this question beautifully and I’ve met that person and I can tell you what they said, but I don’t know. But look, before I started our fund, and I used to work in JANA Partners and I left to start our fund then. I basically went and met with all the portfolio managers that I most respected in the world. A number of who ended up becoming really dear friends. Maybe top among them Mark Kingdom, who is one of the most thoughtful people I’ve met over the course of my career and who I must give a shout-out to. But another extraordinarily thoughtful person that I met with was really kind and super generous with his time was Julian Robertson. And he really I think, does a great job of explaining how important your question is, particularly for value-focused investors because you might invest in a company that’s deeply undervalued and as it moves from being deeply undervalued to perhaps being valued in line with peers, what you as a value investor can usually forget or usually do forget is the effect of the most powerful force in the world. And this is not what he said but something along the lines of Einstein said the most powerful force in the world is compounding.
So if you own a company that continues to grow really nicely and that continues to be well managed, and that continues to play an important, dominating role and growing and profitable industry, unless it’s overvalued, you will do well not to sell. Over 95% of my career and until the very recent past, I have always moved to sell when something has gone to a price target that we had affected when the company’s fortunes were much more dim than they are today. And we’re like, “Well, that the price target that we have and, therefore, we’re going to exit.” And then we see it go up another tenfold and we’re like, “Well, what have we done for selling this?” But on the other hand, we allocated capital to other things that we felt had greater upside. So I think there’s something to that merit, there’s a lot of things that we’re finding to allocate capital to.
But by and large, when you catch a company that is a growing leader in a profitable industry and where you believe that the best is still ahead of them, you don’t need to sell unless it gets into clearly overvalued territory.
Meb: The concept of a lockbox or Coffee Can portfolio I think it’s hard for a lot of people. And a lot of people also I think underestimate the time that it takes for these 100 baggers. If you look at some of the studies over history, a lot of these can take 10 years. But some of those charts my God, the most beautiful thing you’ll see is a stock doing 20% a year for a decade. It’s a gorgeous sight to behold.
James: Yeah…you find that a lot of the returns end up being jammed up in certain specific periods. And the timing element I think is the one that by definition we can never get right because we are not in control of time. It’s like a wild variable in our lives in general. I’m sure you know our investment lives. And I think that allowing for time to work and being patient enough to let time do its thing, I would say it’s invariably rewarding, again, if you’re invested in a company that is a leader in a profitable and growing industry but it has low valuations given its prospects.
Meb: James, this has been a blast. Where do people go? They want to follow your writing, inquire about the funds, all that sort of stuff. Are there some good places?
James: We have a terrible website, coastcapitalllc.com. I’m on Twitter and followed by no one, off note. I think we’re listed on Bloomberg and we have a website with contact info, and I’m on LinkedIn and we can meet people that way.
Meb: Awesome. Look, man, it’s been a blast thanks so much for joining us today.
James: Thanks, Meb.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.