Steve Forbes does a great job in this far reaching intervie with a great investor..Video can be found here:
Value Investing
Steve Forbes: Jean-Marie, thank you very much for joining us.
Jean-Marie Eveillard: My pleasure, Steve.
Forbes: You have been called a value investor. Can you define what you mean by value investing?
Eveillard: Well, value investing, it, as you know, it’s Ben Graham, who in the ’30s, found the value school, founded the value school. And it’s the idea that you look at businesses, you try to figure out what they’re worth. Not in terms of the next quarterly earnings, but what, if you have the cash, what kind of price you’d be willing to pay for it today, for the entire business.
And then, later on, Buffet, who had worked with Graham, made successful and extensive adjustments to the teachings of Ben Graham, where, while Ben Graham had been mostly quantitative, sort of static, mostly balance sheet-derived, Buffet introduced the idea that there was a qualitative side, that you try to figure out the major strengths and weaknesses of a business and that what you were trying to identify was the extremely limited number of businesses where, after doing a lot of homework, you came to the conclusion what the odds were good, no certainty of course, that the business would continue to create value, not just over the next quarter, but over the next five or 10 years.
And if you could buy that business, at a discount although theoretically at no discount, then most of the money you would make would be made through the business continuing to create value in the future. So the value school encompasses a large number of ideas in between Ben Graham and Buffet.
Forbes: And it means you don’t go in for short selling?
Eveillard: No, because short selling is difficult. Short selling, you cannot sell short without taking into account market psychology. And value investing, if you’re a value investor, you’re a long-term investor, not a short-term trader.
Ben Graham said short-term the stock market is a voting machine; long-term, it’s a weighing machine, weighs the realities of a business. Short term you have the market psychology. If you’re long and you’re short-term, you’re in the hands of market psychology. If you sell short, you’re also in the hands of market psychology. I’ve never sold short.
Forbes: What are some of the specific characteristics you look for in value investing? Do you try to size up a management? Do you look at cash flows? What kind of metrics do you use that you find particularly helpful? EBIT I don’t think is one of them.
Eveillard: No, it is not one of them. Although we are partial in terms of valuations to enterprise value to EBIT, because enterprise value introduces a balance sheet, which price earnings ratio does not. And EBIT admittedly, earnings before interest and taxes, interest and taxes have to be paid, but to the extent that not always, but most of the time, we buy the stocks of companies that are financially safe, as Marty Whitman puts is, and where there is very little or no debt, then there is no interest expense. And as far as taxes go, I’ve always been somewhat suspicious, well, except in countries such as Hong Kong, where the corporate rate, your official corporate rate is very low. Otherwise, I’d be somewhat suspicious of companies where the tax rate is lowered. I figure that either they’re cheating the tax authorities and maybe the authorities would catch up with them, or they’re overstating their profits.
Forbes: That’s a very interesting point and you’ve made that, that if there’s a statutory rate of 35, put aside whether it should be that high, it is. And if it’s much lower, red flags should go up. Is that why, for example, you wouldn’t have gone into a company like GE?
Eveillard: That would be one reason. The other reason would have been, we didn’t go into GE, the other reason being that as somebody once put it, I wish I had come up with the formula. It’s a combination metal bander and hedge fund.
Forbes: Cash. Are you advising funds now to stay heavily in cash in an environment like this?
Eveillard: Well, cash is more like a reserve indicating, you know, possibly a lack of investment opportunities, which happens sometimes. Sometimes it’s unfortunately only a function of my not looking at the right places. And particularly cash today, where it yields nothing practically everywhere, almost everywhere throughout the world, and since the, you know, as you know the currency tends to be debased a little bit. If you’re not being paid to hold cash, cash truly has to be looked at as a reserve, as something which will be reduced as soon as you see investment opportunities.
Forbes: So you see a lot of investment opportunities these days?
Eveillard: Well, as a value investor, there are fewer investment opportunities today.
Forbes: Since the spring?
Eveillard: That’s right. Exactly. Because stock markets throughout the world, not just in the U.S., are up 40, 50, 60% from the March lows. Incidentally, I think the March lows, I think investors or traders who were selling at the beginning of a year where there was some forced selling, but there was also, I think, some investors who thought that the deleveraging, the ultimate outcome of the deleveraging would be a return to the Great Depression.
And if indeed that we were looking at a return to the Great Depression, you don’t want to own, that’s a killer for common stocks. But I never thought that there would be a return to the Great Depression because in a pure paper money system, there are no constraints. Well, except the possibility later on, but in the immediate sense, there are no constraints to the monetary authorities.
Forbes: Perpetual ATM machine.
Eveillard: That’s right. And I’m not a great fan of Mr. Bernanke, but I think he was right when years ago, he said, “Hey, in a pure paper money system, you can always increase nominal spending.” In fact, he took, because he’s not very original, he took an idea from Milton Freidman.
Forbes: The helicopter?
Eveillard: Exactly.
Insure With Gold
Forbes: You still believe in gold as the ultimate calamity insurances?
Eveillard: Yes. As the late Peter Bernstein used to say it’s insurance against extreme outcomes. And it seems to me that if you look at the various, you have the gold standard before World War I, you had the gold exchange standard after World War I, you had the Bretton Woods system beginning in 1945. And, you know, it became softer as time went by. And then, in 1971, then President Nixon closed the gold window, and it was a pure paper money system. And it has gone on for almost 40 years. And I think it’s fraying at the edges.
Forbes: Playing that, are you surprised how long it lasted, going on a pure paper system?
Eveillard: To some extent. Because, and there we get into the, if I may, we get into the Austrian school. The Austrian school, as you know, in the ’30s, they said, “Hey, it’s not enough to have overall prosperity and low inflation,” which is exactly what happened in the ’20s, Roaring Twenties. You have to be careful not to let a credit boom go on too long and be too strong, because you’ll get a credit bust after a credit boom, just like night follows day.
And that’s exactly what happened in the ’30s. But the credit boom in the ’20s, it was powerful, but it went on only for, I think, seven or eight years. In the U.S., the credit boom, you could argue the credit boom began in the early ’80s, and with some interruptions, went on for 25 years. And towards the end, you know, I think sort of accelerated. And then in 2007, we got the credit bust.
Creating Bubbles
Forbes: You’re not a fan of either Mr. Bernanke or Mr. Greenspan?
Eveillard: No.
Forbes: The point being that whatever you might think of Wall Street or bankers or whatever, we could never have had the bubble of the size we did if the Fed hadn’t printed the money.
Eveillard: That’s right. And I think to some extent, Mr. Greenspan and Mr. Bernanke are victims of the idea that markets are fully efficient. If markets are completely efficient, then there cannot be a bubble from their standpoint. And indeed, the reluctance of Mr. Greenspan as a result, the reluctance of Mr. Greenspan to try and identify bubbles. He said, “I can’t.” So I mop up after the bubble bursts.
Forbes: But of course, in terms of markets, the markets were distorted by what the Fed did.
Eveillard: Yes, considerably in the beginning. Of course, you know, as you pointed out with Mr. Greenspan, where after the dot com bubble burst, he kept short-term interest rates too low, too long, thereby, I mean, money was not only available widely, it was cheap. And so, that’s when the credit boom truly degenerated.
Banks Are Hedge Funds
Forbes: You said in the spring of 2007, to your credit, you said the tail end of the global credit boom is at hand. And you were manifestly right. You never fell into the trap of saying, “Well, the banks look cheap because their stocks have taken a hit.” Please explain your observation that you said, “Banks are disguised hedge funds,” became disguised hedge funds.
Eveillard: Steve, I’m old enough to remember when banking was a fairly simple, almost utility-type business, where the bank took deposits and made loans to the local businessman, to individuals, et cetera.
And it was not a highly profitable business, and bank stocks sold cheaply, at book or slightly above or below book. They were looked at, I think, by most investors, a little bit like electric utility stocks, whereby you got a decent yield, there was not much growth, and the profitability was not great, but they were looked at as safe investments for widows and orphans. And then, as time went by, and I think beginning with a gentleman who used to run Citibank in 1970, when he said, “We’re gonna grow our earnings per share 15% a year forever.” Banks became something different in the past 10 years or more. They became disguised hedge funds because of the importance of proprietary trading, and for other reasons as well.
Forbes: If you were reviving, or revising, I should say, the regulatory system, what new basic principles would you put in place, that if you want to engage in proprietary trading, you have to have a separate entity that could be allowed to fail? What kind of reforms?
Eveillard: I think that’s probably a good idea, that banking would be two separate businesses: One, traditional banking, and the other, your proprietary trading and et cetera, where a higher amount of capital would be required, and where the bank, the operation will be allowed to fail if necessary. An operation that would not be taking deposits from the public.
Forbes: And everyone would understand the rules at the beginning?
Eveillard: That’s right.
Adding More Debt
Forbes: Given your understanding of what they call fiat money, paper money, and given what a severity of this financial crisis, what kind of, do you think, first, will the recovery be of the post-World War II pattern, or is this going to be entirely different? We’re in a new field?
Eveillard: Yes. Steve, I think that’s one of the key questions. I don’t pretend to have an answer to it. I think there is a possibility that the authorities manage to lever up the system once more, in which case, you might have a traditional post-World War II economic recovery. It would go on. It would be sustained for three to five years.
Or we’re in a new economic and financial landscape after the worst financial crisis since the end of World War II. And then, there is a possibility that the recovery, I think there is enough stimulus in place today, monetary and fiscal, to stabilize, at least temporarily, the economy, and maybe to let it recover a bit.
But the key question will be, will that recovery be sustained next year, or will it at some point next year peter out? You know, the Austrians, what worries me a little bit is that the Austrians may be wrong in that respect. But they tend to say that.
Forbes: Or perhaps we get into psychology. People have learned too much or have been burned too much to take the drug again.
Eveillard: That’s right.
Forbes: Even if it’s available.
Eveillard: That’s right. That’s one side to it. And there are also the idea that adding debt if too much debt was the problem, adding debt on debt, how can that be the cure, and how can that truly work, except, you know, very briefly?
So incidentally, in Peru of all places, I ran across a professor at the University of Lima who is of the Austrian school.
Cautious In Japan
Forbes: It’s nice to know there’s some good thinking around the world. So in addition to gold, are you still bullish on Japanese stocks? Or are you becoming more cautious on them?
Eveillard: I’m more cautious in the sense that they have moved up, too, since March. And incidentally, I mean, I was reading, it’s not a book that’s particularly attractive, except that there are plenty of anecdotes, some of which I found sort of illuminating. What one of the French writers called a “petit fais vrai”, the small item that reveals the truth.
And there are world-class, industrial businesses in Japan where I think the stocks are undervalued simply because nobody, either the locals or the foreigners, is really interested in Japan. And not simply because there are demographic problems, not simply because the Japanese economy has been stagnating like forever. But also because if you talk with a Japanese individual and you tell him or her equities are the long-term asset of choice, since the Tokyo stock market today is about 70 or 75% below where it was 20 years ago, I mean, a bear market goes on for, with a few brief interruptions, it goes on for 20 years. Investors get discouraged. So I think there is some kind of, investors barely want to look at Japan.
Forbes: Is that why you think the Tokyo market is, as you’ve put it in the past, inefficient?
Eveillard: It’s one reason. There are other reasons that have to do with the fact that, as you know, there are no acquisitions that can be truly hostile.
Forbes: Right. Too many understandings.
Eveillard: Yeah. That’s what I was talking, at an average below what the business is truly worth, because investors know that nobody will make a pass at the company, because acquisitions cannot be hostile.
Forbes: Do you still find, though, Japanese equities attractive, because companies, certainly the large ones, do have a tendency to have globs of cash. Casualty insurance companies have even more cash.
Eveillard: Well, that’s an interesting point. Because for a long period of time, investors said to companies, “Well, you have to optimize your balance sheet.” Which of course, is code for taking on debt, buying back your stock, and et cetera. But you know, in the midst or after a major financial crisis, companies that are sitting on cash, and that includes Japanese companies, they are in a position where they will emerge for whenever that comes from the current rut a lot stronger than their competitors who are burdened with debt. And there are some industrial companies in Japan where I think currently, they are getting even stronger than they were vis-a-vis the European or American competitors.
Forbes: What companies come to mind?
Eveillard: Fanuc, which is best known for its robots, but actually, what’s more important is numerical controls for machine tools, which is in essence software, and where they truly dominate the field. And they are sitting on a ton of cash. And I think they are getting stronger in the process. And SMC, which is less dominant, would is involved in, don’t ask me to define it, in pneumatic equipment, which is gaining market share vis-a-vis hydraulic equipment. It’s machinery basically. And an American competitor is Parker Hannifin, and where I think SMC is gaining market share at the expense of Parker Hannifin, not so much because Parker Hannifin has a lot of debt, which they don’t, but because Parker Hannifin is, like many American companies, a little bit of a slave of Wall Street. And Wall Street tells them you have to increase your earnings per share as much as you can in the short term, which sometimes works to the detriment of the best long-term interests of the business.
Looking To The Future
Forbes: Now, some say Japanese companies have the luxury of being long term. How do you distinguish between those who truly think long term and those who say, “Well, we don’t have the pressure of quarterly earnings. Therefore, we can sit on our hands and just stagnate”?
Eveillard: Some do. And some, you know, management is lazy or lackadaisical because they know the company will not be the victim of a hostile takeover. They know that they’re sitting on so much cash that they truly would have to lose money for a great number of years before the company will go bankrupt. And they’re just sitting there not doing much. There is, you know, that side as well.
Forbes: You once made the observation about South Korea that South Korean companies you find are more adaptable than Japanese companies. Could you explain that?
Eveillard: Yes. You know, at the time of the Asian crisis, Korea, not just Korea, but other Asian countries as well, they went to the IMF for help. And the IMF said, “Tough beans. You have to take your medicine.” The IMF, which, as you know, is dominated by the U.S. government. “Tough beans. You have to take your medicine. It’s going to be harsh. But if you don’t, then we will not lend any money to you.” And they didn’t. In a sense, what the IMF, probably without thinking so, was saying, “Hey, this is the Austrian solution.” You have to correct at least most of the major excesses that sort of pervaded during the credit boom.
And that’s what happened to Korea. And that’s what never happened, of course, to the U.S., never happened to Japan. And the Koreans willy-nilly had to make, and the Indonesians as well, they had to make the adjustments. And they proved to be so adaptable that the adjustment did not take forever. I mean, there were two or three years that were very painful and then the South Korean economy recovered.
Forbes: What South Korean companies do you like today or have they become overvalued?
Eveillard: I mean, shortly after the Asian crisis, most South Korean stocks were selling for a song. That’s no longer true.
I think Samsung Electronics, I think is truly a very powerful company from a technological standpoint. And it’s a company that’s quite cyclical. But it’s a stock that never really got the aura of many other technological companies.
Forbes: China. You still staying away from China?
Eveillard: Well, we don’t really stay, well, we restrict ourselves to the stocks, Chinese stocks that are listed in Hong Kong.
Forbes: In Hong Kong.
Eveillard: Because from an accounting standpoint, we’re better protected in Hong Kong. Looking out five to 10 years or more, there is very little doubt in my mind that the east is rising and the west is declining. That does not mean that there will not be investment opportunities in companies in the U.S., in Europe or in Japan. Would it be only because many of those companies are global in scope, and many American companies, for instance, do already a lot of business with or within mainland China. But China, India and the smaller countries in Asia, if you look strictly from the standpoint of consumer spending, I think the American consumer, the British consumer are tapped out, which means for the next three to five years, the outlook for consumer spending is not good.
But at the other extreme, you have the Asian consumer, who is not leveraged. Indeed, corporations are not heavily leveraged in Asia, either, and the governments neither. And also, you have governments in Asia who understand that the export-based model is dead.
Forbes: Right.
Eveillard: Or half dead. And that they have to move, it will happen very progressively. They have to move towards a business model that’s much more rooted towards domestic consumption.
Forbes: Sort of what the U.S. did in the 19th century.
Eveillard: That’s right. And so the outlook for consumer spending, there will be bumps around the world, in Asia, also Japan. Probably Asian stocks are overvalued today. But looking from a very long term standpoint, we who never did much historically in emerging markets, I think my successor and I, we understand that over the next five to 10 years, we’ll have at least to do a lot more work than we used to in Asia outside Japan.
Japan’s New Govt
Forbes: One quick question on Japan. What impact do you think the new government will have? Is that going to upset the apple cart?
Eveillard: I think at worst, neutral. Nothing much changes because so far change has taken place at a glacial pace in Japan. Or something will change. I mean, the democratic party of Japan has already indicated that they wanted to place more emphasis on domestic consumption. Whether they can do so, in particular in view of the constraints associated with the very heavy indebtedness of the state, I don’t know. But I think it’s at worst neutral, and at best, better than neutral.
Forbes: What other areas do you find attractive for investment right now?
Eveillard: Well, as I said from a very long-term standpoint, Asia outside Japan, which I think although there will be, of course, investment opportunities in Brazil, maybe possibly even in Russia someday, and in central Europe, in the rest of South America, I’m more inclined towards Asia outside Japan.
In a more immediate sense, I think it’s more a, as I said before, I mean, all stock markets have moved up very sharply since March. It will more be a function of specific securities from the bottom up as value investors like to do, from the bottom up here and there.
Forbes: You once observed about newspapers in this country, that you found them utterly boring. You find them bargains now, or do you think they’re going to continue to shrink?
Eveillard: Look, that’s an interesting question. Because some of the newspaper stocks have come down, you know, 80, 85, 90%. I think if a, and also, newspapers companies make adjustments in terms of costs under pressure. They’ve reduced their break-even point. But if newspaper companies were able to charge for their content online, I think that would make a hell of a difference. Now, whether they will be, Mr. Murdock pretends that he’s going to do it, whether they will be able to do it or not, I don’t know. But still, as long as the newspaper companies don’t reduce their staff of journalists to the point where, you know, the content is not what it used to be, that content is worth something.
Look Down
Forbes: Finally, as a former portfolio manager, what would you tell portfolio managers today? What’s the one hard rock lesson you would try to impart to them?
Eveillard: I would tell my friends among value investors who, I think value investors, they’re bottom-up investors. Most value investors pay no attention, or very little attention to the top- down: interest rates, the economy, et cetera. Currencies. And it served them well for decades, until in 2008, it didn’t.
And I would tell them, you know, continue to be bottom-up as much as you can, but keep an eye on the top-down, because there is a possibility, I’m not saying there’s a probability, and it’s not, obviously, a certainty. The future is unknowable. But I mean, Ben Graham used to say “The future is uncertain,” which is a statement that sounds obvious. But there is no lack of people on Wall Street who pretend to know what will happen. And so, I would say to my friends, value investors, keep an eye on the top-down because there’s a possibility that the economic and financial landscape has changed.
Forbes: So in other words, study Von Mises?
Eveillard: Yes. I mean, the two economists who have dominated the post-World War II period, as you know Steve, are Keynes, and then, in the late ’60s, the Keynesians, beginning of the ’70s, the Keynesians or post-Keynesians or pseudo-Keynesians were discredited because of the inflationary ’70s. And Milton Friedman surfaced. And so, Keynes and Friedman have dominated the scene in the post-World War II period. And both of them are extremely, you know, important economists, there is no doubt about it. But nobody, you know, paid much attention to the Austrian school. And neither Keynes nor Friedman paid much attention either, to the phenomenon of, you know, credit boom and credit busts. And I think the Austrian school today is more interesting, to at least have some understanding of it, than it ever was.
Forbes: So look at Von Mises, Hayek Schumpeter?
Eveillard: That’s right.
Forbes: And they’ll do okay?
Eveillard: That’s right.
Forbes: Jean-Marie, thank you very much.
Eveillard: It was my pleasure, Steve. It was an honor to be here.
Forbes: An honor to have you. Thank you.