CW 391: Warren Buffet & Berkshire Hathaway's Success with Vitaliy Katsenelson of Investment Management Associates

Welcome to Creating wealth with Jason Hartman. During this program, Jason is going to tell you some really exciting things that you probably haven't thought of before. And a new slant on investing fresh, new approaches to America's best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self made multimillionaire who not only talks the talk, but walks the walk. He's been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason's footsteps on the road to financial freedom. You really can do it. And now here's your host, Jason Hartman with the complete solution for real estate investors.

Welcome to the Creating wealth show. This is your host, Jason Hartman. And this is episode number 391. 391. Can you believe that? I can hardly believe it. And I can't wait till we get to episode 1000. But yeah, episode 400 is not too far away and we've got it all planned out already through episode 402. And today I recorded two great guests that we'll have way up at number 403 and 405 or 404 probably. So lot of good stuff coming up for you. I've got Sarah here with me. Hi, Sarah, how you doing?

Hey, great. How are you?

Good, good. It's good to have you on the show. And you know, folks, I just have to tell you backstory. I always have to twist Sarah's arm to get her to come on the show.

I've been dodging this for like three weeks now, right?

I think it's been longer than three weeks. I've been bugging you to be on the show. But most people would want their 15 minutes of fame. But you, Sarah, you shun it.

I do.

You're just not into it, huh? You know what's interesting? A couple of news items here before we get to our guest today because our guest is going to tie right into two of the things I want to talk to you about as dive into it. Sarah, did you know that in New York, very expensive New York. And this is of course New York City they're talking about. I'm sure my grandparents are from upstate New York and that's where my mom grew up, on a farm on a dirt road in near poverty. They're not talking about that. They're talking about New York City. But did you know that 1 in 25 people that live in New York City is a millionaire?

I do now. Yeah. That's pretty amazing. I don't know what value that holds though these days.

Well, you know, it's just like I talk about on the show and at the Creating wealth boot camps, which by the way, we've got one of those coming up in Little Rock, Arkansas on September 27th combined with a property tour so you can get both of those at once. I talk about nominal dollars versus real dollars. And when you live in an expensive place like New York or like where I'm from, Orange county, you know, Irvine, Newport beach area, very expensive also. It's really like meas. What do you really get out of being a millionaire in one of these places? It's really no big deal because the price of housing is so expensive. I interviewed and I talked about this on a prior episode. I interviewed a high powered real estate broker in New York City on one of my other shows. It was for another topic. It's not really that fitting for the Creating wealth show, but maybe I should run it on the Creating wealth show too because I kind of keep referring to it because it amazed me so much. What she said is she said her average sales price about 3 million bucks. And what is $3 million buy you in New York? It buys you a 1400 square foot condo that's maybe built in 2004 and that's all you get for 3 million bucks. And I said, well, how much will that rent for, knowing the answer in advance. And she said it'll rent for about $11,000 a month, 0.3 RV ratio. I would much rather see anyone listening buy 30 $100,000 properties in diverse markets from us that rent for 1,000amonth each, getting them 30 for their 3 million. But then again, this is the thing. So being a millionaire in New York is no big deal. In fact, I would venture to guess and you know, there are indices for this and websites and people do stats on this. So I'm going to see if I can find one and talk about that on a future episode. But I would venture to guess having a net worth of a million bucks in New York City is equivalent to having a net worth of maybe $150,000 or maybe 200,000 in say Houston or Austin. Even Austin.

Austin, yeah. You know, it's funny you say that because I have a couple new east coast clients from New Jersey that I've recently been working with and it's just been great working with them because they're so excited about these markets and they can't get anything close to what we can offer them where they're from. So, you know, they really get it and really, really liking the markets that we offer.

Well, that's a good thing. And you know, one of the things I'm sure they're probably going to be listening to this episode, to those clients and all clients who live in expensive areas, first of all, I want you to consider this phrase. It's one of my new buzz phrases so it's worth remembering. Okay. And it is cash in to cash flow and what I mean by that. And I saw this happen in Mass in 2003-2004-2005-2006, even in California where people were taking and they were, they were either selling their home in California or they were selling investment properties in California and doing 1031 tax deferred exchanges and moving that money into cash flow markets. And alternatively they were doing refinances of properties in the expensive markets and moving that dead home equity that's not working for them, that's not doing anything because there's really no such thing as return on equity and they were moving that into cash flow markets. So when you live in a real estate bubble market and you've ridden that appreciation wave, hey, good for you. Congratulations. I've done it myself a few times in California over the years in those cycles. But I was just lucky. I wasn't good. I'm not going to take credit for knowing that happened. I just was in the right place in the right time. Which, hey, you know, I think it was Woody Allen who said 80% of success is just showing up. Maybe it wasn't Woody Allen, but it was somebody. And so you're there. You got lucky. Congratulations. So cash in. Use that wealth that you've created in the high priced market that doesn't make any sense to now become a sensible long term value investor. Which is a perfect segue to tell you about who our guest is today. It is Vitaly Katzenelson and he is an expert on Warren Buffett. And you know, Warren Buffett I kind of have a love hate sort of relationship with because I like Warren Buffett's value investor philosophy. And that is exactly the philosophy that Sarah and I believe in when it comes to real estate investing. But Warren Buffett has been pretty hypocritical about a lot of things too. So I don't like that part. But his value investing strategy is awesome. Just looking at this article about the wealthy New Yorkers for a second before we move on, this is researchers at Spears magazine say that 4.63% of the city's population have assets of $1 million or more, excluding their primary residences. And that means there are 389,000 millionaires in New York City. I guess if you're a single guy in New York and you're trying to pick up a girl and get a date, telling her that you're a millionaire, she's going to say, tell me something I don't know. That's no big deal. Okay. If you're trying to impress her that way. Right. When you look around the world, it's pretty interesting too, because around the world, New York has the fourth highest millionaire population in terms of residents. But there's a big drop off after the first because you can barely move around Monaco without tripping over a millionaire. Who are 29% of the population in Monaco, by the way. I love Monaco. Been there three times and it's a pretty awesome place if you can handle the haughty French attitude. But it's quite beautiful, that principality. And then Zurich, Switzerland, I was just there last summer. 27% of the population are millionaires, and in Geneva, 18%. It's interesting to look at Tokyo and London. It says by numbers of millionaires instead of by proportion. Okay? So here they're not taking a percentage percentage of the population. They're just looking at overall numbers. It says that Tokyo came out on top and London was third. Only two other American cities made the top 20 based on population of millionaires, and those were, interestingly, by the way, Houston. Amazing Houston. We have an opportunity. Not a problem, as the saying goes. And then San Francisco, that doesn't surprise me a bit. But Houston actually kind of surprises me. That's pretty interesting, isn't it?

Yeah. Well, you know how I feel about Houston. It's been one of our top markets for many, many years, and we do our best to source good properties there, but it's been tough to keep our hands on anything there. I mean, they're just going like crazy.

So inventory has been a huge problem for us for almost a year now. I'd say. We've been really struggling with inventory and we are on the verge of trying to solve that problem because we are hiring a couple of people to just be assigned with the exclusive job of chasing down good inventory for our clients. As you know, it's scarce. Good inventory is pretty scarce, but we're working on it. And so just remember the moral of that story, though, about the New Yorkers or about any. You know, if you live in any city where you've been fortunate enough to create a lot of that wealth You've ridden the wave. Good for you. Congratulations. Cash in. In other words, use that wealth to turn it into cash flow, because cash flow is what creates real long term wealth. Very, very important. Hey, Sarah. We didn't get a chance to debrief on the event we had a little over three weeks ago, and I wanted to just do that real quickly. Everybody's always kind of critical of themselves. I think I was a little rusty. I haven't done enough Creating wealth seminars lately, so I got to do those more often. I certainly love doing them, but we really focused our efforts more on the podcast and that kind of stuff and less on event. So I'm excited that we've got our event in Little Rock coming up. Give me a chance to practice some more. And I love doing that seminar. It's our core event, the Creating Wealth Boot Camp. But, you know, what did you think? What were some reactions or thoughts other than the room being too hot in the afternoon?

We had just under 100 attendees and we got some surprise registrations the night before. But it was a great group and luckily we were able to get a bigger room at the last minute. But definitely get your seats for the Little Rock tour and Bootcamp because once we lock in a room, it's really tough to open it up for new attendees. But yeah, the Creating Wealth Bootcamp, I mean, I always enjoy it. Maybe you weren't quite yourself. You've been doing a lot of traveling, but I think the clients really enjoyed it. I think you're definitely too critical of yourself. I know my good friend Christine came to help us out and she just loved the content. So always good content. I've sat through that seminar many, many times, and I've always said, you know, I pick up something new each time. So it's really important that if you've attended in the past or you've attended another bootcamp, that you come back and get a refresher course every once in a while.

And we used to say to people when we used to do those all the time, when we were really like doing a lot of live events, we used to say to people, and you might remember this, Sarah, come every six months. That's sort of your core thing. And just come back and see that every six months so that you're always refreshed. And I'll tell you why I think that you listeners need that, because it's sort of funny. And I think this is true of all people. I'm not being critical here. It's just part of human nature. I Can tell by the questions some of you ask us that you've been to the Creating wealth seminar a couple of times and we covered that, you know, and it sort of, it sort of surprises me sometimes. Why are you asking me that question? You know this, right? But there's, it really goes to show you, we need to reinforce. We constantly need to be refreshed and reinforced and be exercising those muscles.

Don't forget, when you come to an event for the first time, you're at a certain place within your investment time horizon. And you know, you may be new or you may have a few properties already, you may be very seasoned. We definitely gear that seminar towards a wide range of investors. But two years goes by and you're in a completely different place. You're taking everything you learned over that two years and now you're applying it differently. So as you grow as an investor, you gotta refresh your memory and your brain and there's just new content all the time. Real estate is very, very fragmented and gotta always be piecing the puzzle together.

Here's another thing, and I have mentioned this, but not for a long time on the show. And I remember learning this from the late great Earl Nightingale. Totally awesome, by the way. But he, you know, he's an old style self development speaker and he was definitely one of the greats. He's the one that helped us all discover what he calls the strangest secret. And that is that we become what we think about. So I know I'm probably going to turn into Taylor Swift, but how? So I think about her.

Oh, I get it.

I do think about her. So anyway, someday my unrequited love for Taylor Swift will be, you know, I'll get it my date and then my song written about me. Right.

I gotta find you a new country girl, Jason.

Yeah, okay. All right. Anyway, we're over that. Earl Nightingale taught us that we become what we think about. And you know, he was the first one to really take the concept of personal development and success and turn it into audio programs. And he was the founder of the company Nightingale Conant, which in the days before Audible was really big. They were huge audio content from Nightingale Conan. I used to be addicted to it when I was 17, 18 years old into my 20s, and I would just constantly be buying tapes, yes, tapes, cassette tapes from them and listening to them over and over again. And I just love that stuff. And what he explained to me, I thought was really quite interesting. And think of another old fashioned metaphor here. Sarah, do you know what a record.

Player Is, Yes, I do.

You do, or you're old enough to know what a. You know, you know what a record album is like it was black and made of vinyl. Oh, come on.

Okay, all right.

Okay. So you're not that young. But anyway, when a record is spinning on a turntable and you've got the tone arm where the needle is, that picks up the grooves and the sound to make the sound, and if you pick up the needle, our mind works the same way. So if you're sitting at the creating wealth in today's economy boot camp and you're listening to Jason Hartman talk about something, and then one of those ideas is particularly interesting to you. You sort of turn off your ears in a way and you start processing the idea and you listen to it. Then everything I say after that, you don't hear. And then as soon as you're kind of done processing the idea, you turn your ears back on and you listen to it. And then when you hear another interesting nugget, you start processing that and then you turn your ears off. And that's why, like you say, and it's very appropriate, Sarah, that every time you come to seminar, you learn something new. And I would totally notice that about myself when I would listen to Nightingale Conan audio tapes over and over again. It's like, did they say this on the tape before? I mean, it's the same tape, right? I definitely did not hear that. And the reason I didn't hear it is because I was thinking about something else that they said. It's like lifting the tone arm off of that record and the record's still spinning. And then you put the tone arm down and you're in a whole different place. You miss part of it. So.

Yeah, good point.

Interesting stuff. So I hope you all join us in Little Rock, and I hope. And by the way, I hope you didn't consider it too tacky, folks, but that Bill Clinton impersonator, I got quite a bit of feedback on it. That that was. You thought that was pretty hilarious. So glad you enjoyed that one. But, Sarah, let's look at a property in Little Rock real quick and give them an example. And then before we get to our guest, I've got one more sort of topic I want to talk about.

Okay, so the property I have here in Little Rock was built in 1970 and has been completely renovated. And if you want photos of this property, just email me sarahasonhartman.com and I will send you photos. It's gorgeous. I mean, I would live here.

Yeah, it Looks really nice. I'm looking at it now.

Very nice. So we'll break down the numbers. So it's a 1500 square foot property for 102,900. That's 102 9.

That's $67 per square foot. Right. Right around or maybe a little bit below the cost of construction. Good.

The nice thing about this property is that it's already leased. So it's leased for $10.75 a month. That's really ideally going to take away any vacancy you're going to have. Hopefully as long as they pay, you're going to have zero vacancy in that first year, maybe two years if they stay. So we have them on a one year lease, $10.75 a month. And with these assumptions we have it showing 25% down as your down payment. Some of you may even qualify for 20, 20% down. And so your monthly cash flow about 260amonth. After all your expenses, taxes, insurance, we've even got a vacancy loss in here, even though you might not feel it right at first.

Right, right, right, yeah. So there's a vacancy loss of 8% annually, which is one month per year. But Sarah, you know, $260 a month, positive cash flow according to the Performa here. So that's $3,125 per year. And again everything is in here. The management fees, maintenance costs, vacancy rate put in here. And by the way, the maintenance percentage on this, what we do is our local market specialists, we require them based on the age of the property to increase the maintenance percentage cost. So here the pro forma is 8%. 8% of the income is going in your slush fund essentially for maintenance expense. So that's $86 per month for maintenance, really a high projection, $1,000 a year. It's very unlikely you're going to have that much mainten on a fully rehabbed property like this.

If you get through your first year without that maintenance expense and that vacancy loss, you've got an extra $150 a month in cash flow. Great looking property, great market. It's kind of an, I would say it's not an oversaturated market. You know, not a lot of hype about Little Rock. Just one of those linear markets.

Yeah, not a lot of investors. You know, I really doubt there's been much if any imprint in Little Rock by the institutional investors, by the hedge funds and the private equity people. They probably, probably haven't been there much. You know, in this market this is Just a nice stable little deal. And so here the projected cash on cash return is 11% annually. And like Sarah mentioned, if you don't have any vacancy and you don't have those repairs in the first year, you know your returns probably, I bet that would bump it up to probably 13%. I don't have a calculator to do it in front of me, but that'd be an extra $2,000 or so that you would have in net income, bringing your net income that year up to about $5100 and your overall return on investment. Now this is the multi dimensional return with everything in it except one thing that the Performa does not consider. My listeners know what that is. It's the inflation induced debt destruction not included. So that makes, that makes everything even better. As long as you're not buying with cash. If you're buying with cash, you don't get the inflation induced debt destruction that comes with cash. And if you don't know what I mean by that, if you're a new listener, we've talked about it on the last 390 episodes, so just go back and listen to them. And 35% annually, I mean, wow, that's pretty awesome, huh?

And so just to clarify, you know, we'll be in Little Rock. Day one is, you know, classroom style bootcamp with Jason. And day two is property tour with the market specialists and Jason and great opportunity to see these properties in person, learn a little bit more about the market and identify some good income properties.

Yeah, absolutely. And you know, we're going to share a bunch of meals together. You'll get some good networking benefit out of it with other investors. Basically the schedule looks something like this. We will see you formally the first time on Saturday morning at 8:30am for coffee and continental breakfast. And then we'll start the seminar at about 9 o' clock and then we'll have lunch together right around noon, of course. And then we will conclude the seminar at about 6pm on Saturday. That's the 22nd 7th of September. Then we will all meet for dinner at about 7:30 Saturday evening and we'll go to a nice restaurant and have a great dinner and all of that is on us. So you know, don't pull out your wallet or anything. We've, we've got that covered. And then Sunday morning we'll meet and we'll talk a little bit and talk a little bit about the day, have breakfast and, and then we'll get on the bus and we'll tour the properties. We'll stop for lunch. We'll do a nice themed area restaurant for lunch and then we'll probably conclude the tour. So you can plan flights out on Sunday anywhere after about 4 4:30pm usually it'll just be a great time. So we look forward to seeing you in Little Rock. And it's the first time we've done a property tour there. I think you'll be very impressed. It's a very nice, clean city and again, kind of below the headlines, below the radar, not a lot of hype about it, which we consider to be a benefit. The gamblers and the speculators would not consider that to be a benefit. But we're the contrarians in that respect. We like the safe, conservative stuff, the simple stuff. So that's the tour. So join us. Go to jasonhartman.com, click on the events section. And there's super early bird pricing right now. So it's really inexpensive and that price will escalate as more people register and we get closer in time to the event. Now, Sarah, before we get to our guest today, because we're talking about value investing and I think this is kind of interesting. You know, I've always talked about how income, property is a multidimensional asset class. And when you look at the value of property and if there's appreciation happening versus the rent on the property. So two of the dimensions are price, you know, price versus rent. Those are two dimensions that are very important to consider. One of the things that, that a lot of people don't realize when they're talking to someone just casually about real estate and when things aren't going well, people will refer to it as a down market. When prices are going up, they'll refer to that as an up market or a good market. But that's really very misleading because it only looks at one dimension and that is price. But what they don't realize is that in most cases appreciation is a non correlating indicator to rental income. Well, I mean, it correlates in a way, but in the opposite way most people would think it does. When properties are appreciating, usually rents are softening because renters are tempted to buy. When they see prices going up, it usually is a result of low interest rates, high housing affordability and ease of qualifying for financing. So in this market right now, we've only got two of those three things happening. It's kind of an oddity that we've got right now because right now what we have is we have low interest rates and we have high housing affordability, very good affordability. But we don't have ease of qualifying, do we? It's pretty hard to get a loan. So for someone to move from the renter pool to the owner pool, that's fairly difficult, isn't it, Sarah?

Yeah, it surely is.

Yeah. So. Well, that's a big comment.

Hey, I think I'm a little rusty on my podcasting.

No, you know what I think you're doing? I think you're multitasking while I'm talking to people. No, no, see, I'll just ramble on and on. Sarah will make a casual comment here and there. Okay, this is the problem with not being in the same place. I can't see what you're doing. Okay, so what's interesting here is I found a little infographic from 2010, and here's what it said. This is from the Multifamily Executive magazine. And what that is is that is a magazine for apartment owners and investors, usually the institutional type, not our type, but larger institutional investors that would buy, you know, typical apartment properties above four or five million dollars and way up from there could be tens of millions of dollars for larger projects. So what this shows is one part of the infographic is a family moving into a house. So they got boxes and the kids obviously moving into a new home. And here's what it says. It says 2.6% is the percentage the cost of owning the average priced home has decreased this year. That is a combination of price or value and financing. So in 2010, the housing affordability index became better and it became cheaper to own a home. And that's what it's saying. But then in the other image on this infographic, you've got a picture of a woman who does not look very happy leaning against a wall. And it says 5.9%. That is the percentage rents have increased this year. So you see, that tells my story about the multidimensional nature of income property. Most people think in one dimension. They think, oh, the prices are up, the prices are down. It's a good market, it's a bad market. That's all they think of. But what they don't realize is usually when prices soften, rents increase and they strengthen. And usually when prices are going up like crazy, rents will start to soften because people are moving out of the renter pool into the owner pool and vice versa. And so that's what I love about income property. You get to be in the position where you can always adjust your strategy based on whatever is going on out there. And that is a great thing. And Sarah, if you're not multitasking, what do you think?

I mean, it's, it's. And I'm not multitasking.

Okay.

No, it's definitely true. Sometimes your rents are going up and your cash flow increases, and that's, that's a great thing if, if that's your strategy is to get the cash flow. But other times, maybe, you know, you're seeing a little bit more vacancy, maybe you're a little discouraged because your property took, you know, 60 days to lease and not 30 days. But meanwhile, you're taking a gain on the appreciation side. So you've got to always step back and look at your entire portfolio and see what it's doing and be involved in the markets that you're investing in and really watch what's going on.

Absolutely right. Many, many investors have made huge mistakes because they don't know how to do the math and they don't know how to properly keep score. Many of them feel like they're losing when they're winning. Okay. And many of them, the speculators and the gamblers in New York City and California feel like they're winning when they're actually losing. So it's very important to understand how this works. And, hey, we're going to talk about that on upcoming episodes of the podcast. And we're of course going to talk about that for eight hours in Little Rock.

Talk about making a full circle, right? I mean, this is why you got to plug into the events is, you know, sometimes you forget to look at the big picture. And if there's anybody that does the best job of pointing out the big picture, it's you. I mean, you really get the clients engaged, make sure they're keeping track of their investments and seeing all the different dimensions.

Well, just knowing how to do the math and knowing how to properly keep score so you'll know if you're really winning or losing is the great thing to do. So thank you for that, Sarah, and thank you for joining me. And let's go to our guest and let's talk about value investing, because all of this stuff that we're going to hear from our guests here, it really applies to real estate, which is the most historically proven asset class in America, if not the entire world. And just take these lessons and use them as a metaphor for your real estate investing. They're very good. So, Sarah, thanks for joining us. We'll be back with our guest in just a moment. It's my pleasure to welcome Vitaly Katzen Nelson to the show. He is chief investment officer at Investment Management Associates. And we are going to talk today about investing the broader economy as a whole and talk about some of the recent articles on his website. Contrarianedge.com Vitaly, welcome. How are you?

Oh, it's my pleasure.

Thank you.

I'm glad to be on the show.

And it's good to have you. You're to us from Denver, Colorado today, right?

That's right.

Fantastic. Just give us, if you would, kind of your broad view of things right now, the investment markets and the economy, if you would, and maybe we'll drill down from there. And I want to talk about Warren Buffett a bit.

As a value investor looking for stocks, it has been increasingly difficult to find values. You would think it would be difficult when the market had a five or six year run. From that perspective, I think the market is probably fully valued at least and most likely overvalued. But that doesn't mean anything because markets could become even more overvalued. So that's not a money. I'm not trying to time the market because in all honesty, it's very difficult to put market timing into process. But what we try to do is kind of value individual stocks. So we just look for stocks to buy and we have a hard time finding them. And so therefore we have a lot more cash in the accounts. And that's okay.

It's good that you say that's okay because a lot of investment advisors, especially at the big firms, I find they're just always pushing their clients into the market when sometimes it's just better to be in cash. Cash sitting on the sidelines. Right.

What's kind of interesting, especially mutual funds. Mutual funds have a directive that they have to be fully invested all the time. To some degree it makes sense. I understand why it happens because person takes some of his money and says I want to be invested in a large cap growth fund, therefore 10% of the person net worth should be allocated large cap growth. So as a mutual fund manager basically has to go out and buy large cap growth stocks, but if he can't find good stocks to buy, he has to buy the least bad large cap growth stocks.

Sounds like the typical American election. The least bad candidate is about the best choice we ever get.

So what you find is that basically in case mutual funds, they offer product, not a service. Right. And what we try to do is actually clients come to us say here's all our money invested for us. So we can't have this kind of view. I can't own the least bad stock in my clients accounts in part because also for selfish reasons, my kids own the same stocks. So I wouldn't want my kids to own this less bad stocks. If you look at Wall Street, a lot of times what it does, it sells products, not a service. And therefore you see rarely mutual funds hold cash even if they don't see good opportunities to put the money to work.

And I just want to drill down. You do define yourself then as a value investor. So let's talk about the most successful value investor of all time and that is Mr. Warren Buffett himself. Give us a glimpse into your thoughts on what has made Buffett and Berkshire Hathaway so successful.

I think Buffett's success came from two sources. I think he's an incredibly smart guy and he has been a very good investor. But also in all fairness, his success has been amplified by leverage. And that leverage came from the insurance company because Berkshire Hathaway is an insurance company. So when you buy stocks, an insurance company, they're financed by flow, which has zero, you know, we basically has almost zero cost.

Before you move on, let's explain that to the listeners and drill down on that a little bit more. The insurance business is really the only business in the world that has a negative cost of capital because they collect the premiums before doing anything. Like they provide the service later in paying claims. It's really reverse of every other business, isn't it?

That's right. Insurance. If you can underwrite where the sum of premiums will be more than you're going to pay out over time, you have basically, you're right, you would have a negative cost of borrowing. Right, because people are basically paying you to invest their money for them to invest the premiums. Therefore, Warren Buffett runs Berkshire Hathaway, which has an enormous float. And therefore whenever Warren Buffett buys a company or stock or American Express or whatever, Coca Cola, he does it with borrowed money where the cost of capital could be negative. And if American Express goes up 10% a year and Berkshire Hathaway has leverage of 30 to 50%, therefore the return would be 13, 50%, 15%.

It's interesting that Buffett would appear to, I think, and maybe I don't speak for everybody here, of course, but my impression at least is that he is a conservative investor. But really he likes leverage, doesn't he?

Well, the right kind of leverage, yeah.

Right.

The very important part, and this has to be emphasized, the leverage that insurance company has is a permanent capital. So in other words, when the market declines, it can't be pulled away from you. It's a capital that stays with you for a long, long time. And therefore, you're right. If you mix a very conservative strategy with the leverage of an insurance company, which is a very different leverage than you, borrowing money gets your home equity loan against your house, then it amplifies your returns. And it's okay for insurance company to have that kind of leverage. But I don't think for most people. I just want to stress this. I don't think most people should be borrowing money against the home to buy stocks. I mean, just, I want to make sure I'm not advocating the wrong lesson here.

So the leverage is one thing. Now, where did he get the leverage? I mean, take us back. You know, I don't remember my Buffett history. I hope I'm not putting you on the spot. I'm not asking you to be a Buffett historian here, but in his early days, what did he acquire first? What were some of his earliest acquisitions? Were they court furniture? He has Coca Cola, he has Geico, he has a bunch of stuff. What were some of his big early.

Deals, by the way? I don't want to take anything away from Buffett because he was a very successful investor before he started to benefit from leverage. So let's be clear about this. So if I remember right, he ran a partnership. At some point, that partnership bought Berkshire Hathaway, which was a textile company, which ironically, actually probably Buffett's worst investment it has been that Berkshire Hathaway, believe it or not.

And it's funny that that still carries the company name. That's right. Right.

And then at some point, I think they bought a National Indemnity that was, I think, the first insurance company that could be wrong. And then at some point, they bought Geico, and they probably bought some other insurance companies along the way. And if I Remember right, in 1998 or 1999, they bought General Re, which was a huge acquisition for Berkshire Hathaway. A lot of this later success of Berkshire Hathaway came from you actually made a very good point by buying very conservative stocks within an insurance company. So if you think about Cokes, Gillettes, later, Procter and Gambles, American Express, very conservative stocks. So at least if you look in the spectrum of the stock market, he was not taking a lot of risk. As long as those companies were around 10, 15 years from now when they had to pay for the premiums he received, the Berkshire Hathaway would do fine. And that's absolutely great because of that, because investing in conservative stocks that stuck around for a long time and produced decent returns. And he was able to amplify these returns because of the floor from the insurance company.

How much amplification did he get? How much leverage from the insurance company? Or is that really impossible to calculate?

Well, you know, I'll be very honest. I look at some other companies in that space, and for them, leverage was about 30 to 50%. I'm not sure what's the Berkshire Hathaway's leverage. So I'm guesstimating, I don't know, somewhere between 30, 50%.

Okay, so say it's 50%. That means you double, you get double. The way you're saying 50%. I just want to be clear, like the way a real estate investor would see it as a loan to value ratio. So you'd get an 80% loan to value ratio, for example, or 50%.

What I'm saying is that for somebody cents they put in, they get of equity, you get 30 cents of bloat, and that's how you get to a dollar. I guess that's what I'm saying. If that's to you would be 30%. That's what I'm saying.

He's changed quite a bit over his career. He's really kind of like three different people. Especially lately when the financial crisis happened, he was, was, I don't know, I wasn't as pleased with some of his more recent ideas and things in the last several years, recommending that people buy certain stocks and so forth. When he's on the inside of the trade and things like that, I don't know. That just kind of bugged me a little bit. But how, in your eyes, has Buffett changed over the years?

I'm not, to be honest, I'm not sure I know what you're referring to when you say that. But my biggest disappointment with Buffett was when Cocoa management put forward the compensation plan, which would be very dilutive to shareholders. Buffett looked at the plan, he went public and said he was public on CNBC saying that it was excessive. But instead of voting no for the plan, he abstained and didn't want to.

Lose any friendships on the board. Right?

Well, I think that's the reason for that and the reason I'm disappointed because over time, Buffett became this kind of moral compass for corporate America where people would look at him as a person who would do the right thing thing. But when the time came to do the right thing, he didn't at least in my mind because I think abstaining was a very weak message. Noah would have sent a message that yes, when the management of other companies want to vote, dilute shareholders excessively, as Buffett put in, you should say no. That was an important opportunity that Buffett missed.

Let's talk just maybe more generally for a moment about the different philosophies when it comes to investing. You're a value investor. Some people are charging artists and technical analysis people, fundamental analysis. You know, there's all these different schools of thought. Why did you become a value investor and what does that mean maybe in comparison to some of the other schools?

And I'll be honest, whenever I say I'm a value investor, I'm a little bit perplexed about this because it's a kind of redundant term. Either investor or you're not.

Right? Hopefully every investor seeks value, right?

Well, yes, I mean it's a basically value investor. And good thing about being a value investor, I guess you come from a very deep heritage of Benjamin Graham and Warren Buffett where everything I'm about to tell you has been said by somebody else. But basically a value investor looks to buy dower for a lot less. And when an investor does that, he basically seeks for margin of safety. So in other words, if you're looking to buy a dower for 50 cents, you have a 50% margin of safety. And also a value investor would conduct himself not as a trader but as a business, like analyzing stocks. You would be analyzing a company as a business like person as if you were buying not 0.25% of the company but buying the whole company. So that puts you in a very different, it's almost different mentality of analysis. But in reality value investing is really just common sense investing. To me, when you talk about technical analysis and charges, etc. To me I use very little of that because it really focuses on a stock and pays very little attention to the company. And it's almost like technical analysis is almost like religion. You either believe in it or you don't. And if you believe in it, then what other technical analysts tell you makes sense. And if you don't to view it just like a voodoo science.

I agree with you that it's common sense investing. I can't remember which books about Buffett I've read, but a couple of them. And it just seems like a good common sense, conservative, long term approach to investing versus this kind of get rich quick mentality that you see in every asset class. Profit pretty much. And it Just doesn't work. It's like one or two stories of someone who got lucky and then a whole school of thought comes in behind them. Everybody else loses their shirt. It seems like, well, I think you.

Get rich quick or the result and get poor quick kind of stories more often than not. Bull investing requires a lot of discipline, a lot of patience. And you mentioned the word long term. That's how you look at it because. Because when we analyze a company, we try to forecast their cash flows going forward and try to figure out what are these cash flows worth today. So we're looking 10, 15 years out a lot of times to arrive to value the same way you would look at cash flows from a real estate transaction. When you look forward so far out, you kind of lock in yourself to some degree to become a long term investor. Because that value, it may take a long time to realize that value. But at the same time, and this is some of the concepts I talk about in my book, a long term investor doesn't mean that you bought a stock and you hold it forever. If you bought a stock and the value has been realized in six months or a year, then you should become a seller. So it doesn't mean that you buy and hold. You buy and you sell. When the stock becomes fully valued, you don't hold forever. And this is, I guess probably the biggest difference would be between me and Buffett, our philosophy, the philosophical difference.

One of the things you started off saying is you said that you felt that the stock market market was fully valued if not overvalued. How do you get that impression? Is it the PE ratio? Where are you deriving that from?

I come to this from two different sides. One is from the trenches. It's just me, literally us looking for stocks to buy and we can't find good stocks. Right. And that's based on discounted cash flow analysis that based on valuing stocks on many different metrics. Different company will be valued differently depending on what kind of business it is. Just from practical perspective, it's difficult for us to find enough stocks to buy. So that's one perspective. Another perspective is just basically looking at the valuation of the market. If you look at the stock market valuation, and this is very important, and, and you adjust stock market's earnings for very high profit margins. Or in other words, if you look at the stock market valuation based on a 10 year trail in earnings, what you find that the stock market today's valuation is extremely high. Actually, in fact, in the past, the sideways market started at today's valuation from the trenches. When we look for individual stocks, you find that stocks overvalued. And when we look just from the macro perspective of evolution of average company, you find the stock market, it's fully valid or actually overvalued as well.

I would agree with you, but with the caveat, like you said, that it can always become more overvalued before there's a crash.

Markets can stay irrational much longer than if they remain so.

I love that saying. That's an excellent quote. The market can remain irrational a lot longer than you can stay solvent. So very, very good points. What's your general outlook on. Just before you go, I want to ask you inflation or deflation? I think you're on the inflation side like me, right?

My answer would be yes. In other words, it's either we can have both. I have a slight bias towards inflation, but I can see it's maybe 60, 40, but there is no clear sign that we're going to have one or two. Another it's almost a towing cost with a slight, slight tilt towards inflation.

That's interesting. Why do you say that? Because, you know, most people would just say look at the massive amount of debt, look at all the unfunded mandates and entitlements coming our way that the government somehow has to pay for. Look at the deficit every year. How can we not have inflation if. I mean, if you're a pure, you know, monetarist from the monetary side of.

The equation, look what happened in Japan, right? You know, the. Let me try to change my answer a little bit.

I want to ask you something about Japan too. Don't let me forget. I want to ask if you think they'll default.

It's almost to me a question of this. It's most likely that in the long run we're going to have a significant inflation. Will it happen first or will it have deflation first? If you look what happened in Japan, they had a tremendous real estate bubble and after that they had a deflation for almost 20 years. I would argue that it's going to at some point, point is going to lead to substantial inflation. But if, you know. But first they had deflation.

But the thing about Japan though, that you have to realize, at least for the real estate is that, I mean that market was in complete absurdity in 1989. It was so massively overvalued that no one could have really considered that valuation real. I remember hearing this thing on television way back then about how if you put a stack of hundred dollar bills a foot high on the ground in Tokyo, the land below them would still be worth more than that stack of just $100 bills. Just a footprint of the dollar bill, which is, what is it, maybe two and a half inches high and I don't know, five inches long? I don't know, I haven't measured a dollar lately, but something like that. And stack them up a foot high. I mean, how many, how many hundred dollar bills can you get in a foot? That's a lot.

But if you think about just what happened in Japan, and you're right, it.

Was a tremendous bubble and mind you, those are $1989.

But if you think about what happened in Japan, basically you had a corporate debt that declined over the years, but at the same time the government debt has ballooned. Japan is one of the most indebted developed nations. My point is that they had a real estate bubble that deflated. Corporate debt has declined, banks has declined since, and government debt has increased. If you look about what happened to, in our case, it's kind of the same thing, right? The corporate debt has declined, consumer debt has declined, but government debt has ballooned. So there are a lot of similarities. And I'm just in now. Let me make a better, more important point about this. In Charlie Munger last year, the Berkshire Hathaway's annual meeting said, if you're not confused about what's going on in the economy, you don't understand it. And that is the key point. I feel like we are living through this enormous experiment which we don't know exactly how it's going to play out. So as a portfolio manager, as a person responsible snl somebody else's mind money. What we try to do in our stock picking is to own companies that do fine in either environment. And this is important point. No, they have to have a pricing power, not just an inflationary environment, but also in case there was deflationary environment as well. So we just really don't know exactly how it's all going to play out.

Right, Right. So pricing power is critical to any company's success not to be in a commoditized industry, because that's the end of every business eventually. Is commoditization what companies would have pricing power in either environment? Give us an example of that.

Well, think about pharmaceutical companies. They should be able to maintain prices if you have deflation and should be able to raise prices if you have a high inflation. That would be a good example. And we have a lot of health care stocks in our portfolios.

But at some Point. Isn't it fair to say that even with something as critical as healthcare, people run out of money. Money. And they just can't pay for it or governments run out of money. I mean, you know, in England you basically die waiting in line and that's why the socialized medicine thing doesn't work.

Let me tell you this. I saw this cartoon where a broker calls his client, he says, you know, stock market is down 90%, the economy collapsed globally. But you know, I have a good stock for you. My point is if you are talking about, if you, if you start describing this apocalyptic scenario, the then no matter, there is no stock and there is no asset class or stock that is safe. Except when I'm making investment decisions. I'm assuming we're going to have a rule of law and I'm going to assume we're going to have some kind of ordinary society and then therefore, yes, evacuate under assumption that when I get turns into Zimbabwe or something like that. When you operate on these assumptions that you say yes, even if you're going to have a tough time times, pharmaceutical companies may not grow as much and they may have to, but they should be able to maintain, at least maintain the profitability which is in deflationary environment is a big deal. So that would be just an example of that.

Good. Yeah, fair example. On the Japan analogy, I like everything you said. Here are some of the differences that I see and the famous last words of the investor who's about to get himself into a lot of trouble are this time it's different. So knowing that and going into it with that, there are some actual differences. Right. And you, you mentioned some of the similarities which are completely accurate. But one of the, you know, I could say, well, you know, the US has the largest economy, the US has the reserve currency, the US has the biggest military. I could say all of those typical things. But here's what I'm going to say that's actually kind of different. And a lot of people just don't mention this. And I think this is where I really go over to kind of the hairy dent and frankly Pat Buchanan side of the equation. And that is Japan's problem is more than an economic problem. It's more than a monetary problem, it's a demographic problem. Japan is very closed. It's a very insular society. And because they do not welcome immigrants and there just aren't young people to replace the aging population and do the work, I mean their birth rate is terribly low. They're basically like Russia. They're Becoming inexplicable, extinct country. Putin is paying people to have children. That's what Japan ought to do. Or they ought to be more open like the US and welcome immigration because they're just dying a demographic death. China is headed that way in 20 years or so.

Everything you said I agree with. In fact, I did a presentation about China and Japan a while back and those exactly the points I made. I mean, I think Japanese society is slow. You're absolutely right. It's a closed society. Unlike United States. Unlike United States where our birth rates are not terrific, but at least we have immigration.

We're importing our birth rate. We're importing deflation. We import it mostly from Mexico.

Yeah, exactly. That's a great point.

If we didn't have everybody in America is complaining about close the borders, control the borders. Which on its face is a logical thing to say. I mean, I'm saying the same thing. If we did not allow the illegal immigration from Mexico, if we were to become protected with China, we would have massive inflation. I think we wouldn't be allowed to hide the true inflationary pressures in our economy by importing cheap labor from Mexico and importing cheap goods from China. That's what allows us to put a band aid on the underlying bad monetary and fiscal policies.

Yes, I think you're absolutely right. And also what helped Japan in the past were very high savings rate. The problem with savings rate is people get older, the savings rate starts to decline. And that savings rate allowed government to borrow money internally and pay very low interest rates. Savings rates turns negative in the near future. And it might already happen, by the way, the Japanese government may have to start either by buying out their own bonds or have to. More importantly, they're going to have to start shopping their bonds outside of Japan. The reason it's important is that I forget the rates right now, But I think 10 year Japanese bond yields, maybe 20 basis points or 50 basis points where you like. States 10 year treasury, even though its yields are down but still yields 2.5%. And I would argue everything you know about Japan and everything you know about the United States, we are still in a better shape economically than Japan. If the Japanese government decides to start shopping its debt outside of Japan, suddenly it would be paying interest rates not 50 basis points, but 2.5, 3 or 4%. And if they do that, the interest expense itself, I think they are, right now they spend 25% of the budget on interest. Interest, interest expense would skyrocket and it would absolutely kill.

And, and, and by the way just, you know, for the benefit of the listeners, that would happen to the US too if we weren't able to bully our way into getting other countries to buy our Treasuries because we have the biggest military and we have the biggest economy. Other countries want us as a customer and it's a false economy that's going on there. China knows we're going to debase their investments when they buy our debt. They know the value of that debt will decline as we'll inflate the dollar away slow or fast, ultimately will decline either way.

And you're absolutely right. And China chose that as their way to help the exports. But I think you're absolutely right. When you invest today, it's difficult because the standards you should apply to your stocks should be higher than any other time of the last 100 years. Maybe not 100 years, but last 50 years for sure. Because you are right that we are facing a very uncertain future. If you look at probability trees, there are some positive outcomes for economy but there is also some high probabilities of fairly negative outcomes for the economy. And if those negative outcomes happen, you want to make sure that you own company that are not just cheap. I mean that's not enough. They have strong balance sheets that have price in power that are not dependent on a particular segment or like let's say not too tight to the government, which you can fault my pharmaceutical companies as a lot of the revenues comes from the government. So it's very difficult to find. It's impossible, I would argue, to find a perfect investment. You want to find the best investment you can.

Sure.

And if you can't just do nothing, hold cash.

Absolutely. If you hold cash, inflation will kill you first and then taxes will kill you second. If you get any return, you'll get taxed on it, but you probably won't get any return return on it. So the cash is a dangerous position. But to be on the sidelines. As I mentioned in the beginning, there are periods where being in cash is much better than being in the market.

If you can't find good stocks in the United States, look outside of the United States.

Sure.

In the past, US Investors always looked at international investing as almost like you had to be in Indiana Jones. You always thought it was riskier. I would argue that investing in many countries outside of the United States is less risky than a lot of people think. You own a company in Norway and I would argue that it's probably one of the least risky ass companies we own. And I hope you.

Yeah, and when you say that, are you referring to the corporate governance risk or market risk?

Yeah, I'm talking about political risk, I'm talking about corporate governance, I'm talking about currency risk. I'll give an example. And this is a lot of value. Investors have been buying Gazprom, which trades, I don't know, 2, 2.5 times earnings. A very cheap company. But when you buy in Gazprom, you're basically taking a huge political risk. You could argue that a 2 times earnings that's already priced in and maybe. And the difference, the reason why we are not buying it because we assign different probabilities on what's likelihood of Russia nationalizing Gazprom. In my mind, probabilities are much higher. Therefore I mean Russia.

So why wouldn't they nationalize?

To me, Russia became an investable in the early 2000s when government basically took one of the largest oil companies away from its shareholders. Absolutely took it away. And after that I realized, you know, this could happen to any company, especially to Gazprom, which is the biggest source of revenue for the Russian government.

To a smaller extent, it happened here with General Motors, otherwise known as Government Motors. Right.

Well, at least because you know, the union. Well, my biggest problem is that is that the union instead of the union has benefited sort of bondholders.

I'll tell you why. It's really simple, Vitaly. The unions have more voters than the bondholders do.

I actually wrote an article about this. I remember some newspapers ran headlines or something that instead of benefiting hedge fund managers or something.

Those aren't hedge fund managers, those are bonds. You know, America retired people from probably.

It's very easy to say all the bad things about hedge fund managers. But you forget they are managing money in the pension funds which basically their investors are average joes, teachers, doctors, etc. So it's very easy to line to go against hedge fund managers. But they just manage somebody else's money, right?

Exactly. That's what they don't understand. These corporations and hedge funds, they're all pass through entities. Whatever happens to them, they just pass it through to their customers or their shareholders. It's a pass through circumstance. So that's a good point. Well, Vitaly, this has been a very interesting conversation. Give out your website if you would tell people where they can learn more.

Sure, they can read my articles on the contrarianedge.com contrarianedgeedge.com our company's website is imausa.com imausa.com Fantastic.

Well, Vitaly, thank you so much for joining us today.

Thank you, Jason.

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