2023-03-21 11:00:00 ET
Summary
- David Trainer joins to share 3 stock ideas that he likes in this market environment.
- We learn the stocks on his "zombie list" that he deems un-investable.
- He shares his opinion on what to expect from the FOMC.
Editor's Note: Due to time and audio constraints, the transcription below may not be perfect. We encourage you to listen to the podcast embedded above or on the go via Apple Podcasts or Spotify .
Read More Of David Trainer's Research
(0:00) - Intro
(0:41) - David Trainer's background
(4:30) - The type of investor who connects with David's research
(5:57) - Will The Fed raise interest rates on Wednesday?
(7:51) - Thoughts on Crypto
(10:43) - Are we in a recession?
(13:11) - How will tighter credit affect the everyday investor?
(16:04) - What's on the "Zombie Stock List?"
(17:59) - First stock pick
(20:19) - Second stock pick
(21:31) - Are these picks for dividends or capital appreciation?
(22:31) - Third stock pick
(25:18) - Why hasn't the stock price of David's 3rd pick not moved since 1994?
(27:38) - Does David expect interest rate cuts in the near future?
Recorded on March 20th, 2023.
Transcript
Daniel Snyder: Welcome back to Investing Experts, I'm Daniel Snyder and we're joined by long-time Seeking Alpha contributor, David Trainer. We get his call on what to expect from the Fed this Wednesday, stock names on his “zombie list” that he deems uninvestable, as well as a few names he thinks are primed for this market environment.
Quick side note, a huge thank you to everyone who tunes in to listen to every episode. The international community here continues to grow and I am all for it. I see listeners from Australia, Argentina, Canada, Germany, United Kingdom, Taiwan, and hello Slovakia. You guys all make these episodes worth it. Please do me a favor if you don't mind and leave us a rating. Now let's get to the interview.
Alright, let's go ahead and dive right in. David, how did you get started in investing and what is your background?
David Trainer: Yeah, I got started investing when I went to Wall Street in 1996, so 25 years ago, and I ran a special group within the Equity Research Department that focused on getting a better understanding of profitability and valuation with a special emphasis on understanding footnotes. All this, of course, before the tech bubble, right? And then Credit Suisse went on to be the single largest tech IPO investment banking firm in the world. And so putting it mildly, the focus on superior measures of valuation and footnotes kind of fell to the wayside there for a little bit in favor of doing the big banking deals. And that's where I kind of got this idea that look, this sort of research is important to the integrity of the capital markets. If we don't have someone out there actually scrubbing the numbers to look at what's going on, then how are we ever going to know how to intelligently allocate capital?
I also saw that it was effectively an almost impossible task because these annual and quarterly filings, Dan, were like 300 pages long, some of them 500 pages long. Who's going to do this, especially if Wall Street analysts weren't paid to do it anymore? And by not paid to do it anymore, I mean, there's a lot more money to be made selling investment banking business and doing IPOs for big tech firms than there is doing good, deep research on a company, right? The narratives carry the day. And so that's sort of when the seed was planted for the idea that there needed to be a technology to go through and do this work in the filings and in the footnotes in order to produce a clean model, a set of scrub numbers that people could trust. It was also apples to apples across all sectors, right? So you didn't have to have one metric here and another metric here, like different things, meaning different to having different meanings. And so, yes, that's what I did when I started new constructs, we created a technology to collect all this data from filings, especially footnotes. It's since been proven by Harvard Business School and MIT Sloan in a paper published in the Journal of Financial Economics, which is a top-tier peer review journal proven to provide a superior measure of earnings.
And I believe that it all starts with understanding current profitability. Valuation is about future profits. But the expectations for future profits are way more interesting and relevant when you can compare them to past profits. If profits supposed to be a gazillion and they're already making a gazillion, well, that's not an expensive valuation. If profits are expected to be a gazillion and they're only making a million, well, that's a very expensive valuation, a big gap to jump there, so to speak. And that's sort of how our research works, Dan. We're going to go in, we're going to give people the best possible measure of profits, and then we're going to juxtapose existing profits to the market's expectations for future profits. And we do that by employing what we call a reverse DCF, reverse discounted cash flow model that simply models out the cash flow is required to justify the current stock price. And we compare those future implied cash flows to historical cash flows to come up with a risk-reward rating, which a paper from Harvard Harvard Business School has also proven provides better ratings than legacy Wall Street human analysts.
And so we're doing we think we're doing some good work here. It's all under the umbrella of fundamental research, so it's not as sexy or as exciting, but we think it's a lot more reliable.
Daniel Snyder: So you're using an algo to provide research. What type of investor do you have as a client?
David Trainer: We, our clients tend to be folks who are analytically rigorous, like they care about understanding what's really going on. They're not the gambling speculative types. I think they're a little more long-term oriented. You know, generally, I kind of think of them, Dan, as people who want to be able to put their head on their pillow at night and get a good night's sleep because they've known they've done their diligence. And I think all of our clients would tell you that there's nothing, you know, kind of quite like having that peace of mind of knowing that someone's done the work. And you know, it's all fun and games until the bank goes belly up, right? Or the Fed starts raising rates aggressively, right, which sort of forces out the weaker players. And, yeah, I think my clients are really, really happy right now that they've been sticking to their guns in terms of doing their due diligence and not falling prey to these very seductive Wall Street narratives, very seductive, speculative themes, whether it's crypto or zombie stocks. I think this has been a very good time for people who've been disciplined enough to focus on making sure they're thinking about investing as intelligent capital allocation.
Daniel Snyder: So you mentioned the Fed got to ask you, are they raising interest rates this week?
David Trainer: I think they will. I think it'll be a 25 instead of a 50. And I think so for two reasons. Number one, I believe that the Fed in what's happened in the last couple of weeks with these failures is happy with exactly how things are going.
Look, when you put too much money into the system, you give rise to a whole bunch of companies and businesses that should never have come into being. Right. They need to be called out. These are bad businesses. They were bad allocations of capital. We have to clean that out so that we can repatriate that capital into good businesses.
That's what capitalism is really about, allocating capital to where it's most deserved according to its merit. Well, we put out a lot. We gave a lot of meritless companies a lot of capital. Think about WeWork ( WE ) is just a great example. Right. That one that one blew up at first, but they came back. But the idea that Wall Street was out there saying, hey, we should give 40 to 60 billion dollars to this. Right. And that a lot of people were willing to do it. Same could be said for a lot of IPOs during that time. All of our zombie stocks. So that's what the Fed wants. Also, I think the back off right now would signal too much weakness or fear of a recession from the Fed.
And really, honestly, a third reason is that there are plenty of stocks that are still trading way too high that need to be washed out. And I think the Fed understands, I think, you know, in the same way they understand that raising rates is going to sort of cut the oxygen off of or reduce the amount of oxygen and oxygen in the room for the weaker players. And you're going to have certain banks and certain companies go belly up. And that's part of the cleaning up and maturation process as we get our capital markets more aligned with intelligent capital allocation and not blatant speculation.
Daniel Snyder: So what do you think of cryptocurrencies and NFTs and all the money that flowed into that?
David Trainer: I mean, I think people are going to feel a lot of pain there. I believe that. Blockchain is good. Blockchain is extremely good for the world. That's just like a special invention, like a gift from outer, from aliens whatever, it’s just some good stuff. They just dropped on us. It's good stuff. But there's just like with the tech bubble, the explosion of the Internet was a good thing, but there were a lot of bad investments that went along with that. A lot of people got caught up in the hype and same is true with most NFTs and most cryptocurrencies. There's not a lot of underlying utility there. It's more of a Ponzi scheme. And I think a lot of people are going to get hurt chasing great returns. And it's going to be five, ten years from now before it all settles out, just like it was from the tech bubble. Right? During that tech IPO boom in the late 90s, all kinds of companies raised all kinds of great capital. And we were whatever. Everything was going to be amazing and all these great businesses were going to do a bunch of great things. And a lot of them were basically never going to make money.
And it took capital kind of goes into fast in some of these situations and in some ways that's good because we're really resourceful as a country and we can throw a lot of capital and innovation. In some ways, it's really bad, Dan, because Wall Street bankers and executives basically steal that from the American public. And let's face it, that's where the money goes because it doesn't get returned to the original investors. The bankers and the executives make out like bandits. And I know for a fact, having been on Wall Street during that time, people were getting paid huge amounts of money and they didn't have to give that back. And you look at things like Enron, like certain people made hundreds of millions of dollars while millions of individuals lost their retirement.
So I think we're trying to still figure that out as a country. It's good for us to be innovative. But I do think there's going to be a lot of pain for folks who don't do their diligence. This whole the moral hazard stuff, Dan, you know, that's been thrown around in the last few weeks with respect to these bailouts and things like that. It's extremely important point, extremely important point. If people don't get punished for making bad bets, what keeps them from continue to make bad bets? And right now, our banking system is like it's just asymmetrical. I mean, they get all the upside and they don't have to eat the downside. And this time around, I like the fact that they're making the banks eat some downside here because, let's face it, JP Morgan ( JPM ) and the other big banks that are bailing out First Republic ( FRC ) and others, well, they kind of killed First Republic, right? They competed with them, right? I mean, so they got what they kill and it should be them who, you know, who made money hand over fist even during the great financial crisis. They should feel the pain, not American taxpayers, not American taxpayers.
Daniel Snyder: So on the topic of recession, are we in one? Are we going into one? Is it going to be hard? Is it going to be soft? Any thoughts?
David Trainer: Yeah, I think that's a super difficult question, right? I mean, if my crystal ball weren’t in the shop, I'd probably have a better answer. I think it's going to be a little bit different than normal. It's not going to be it's going to be more sort of, I think, two-pronged, right?
You know, the consumer out there is really doing fairly well, but there are a lot of companies out there that are not doing well. And, you know, I love seeing more narrative around, hey, with these tightening credit conditions, there's going to be a lot of zombie companies that go bankrupt. And that's true. And so I think we're going to see pressure on corporate earnings. I think the consumer is going to be relatively okay. I think hopefully this means maybe we see a little bit of rebalancing. And so that the asset owners aren't getting super rich at the expense of people who aren't rich enough to own assets, right? People who own buildings and stocks makeup, you know, this is the one percent. And they've seen their wealth only go up during these bad times. And that's been at the expense of folks lower on the income ladder. And I'm hoping that maybe rebalances a little bit with this kind of recession. We're going to see a lot of property stocks and property companies and bad stocks, bad companies go out of business. And that'll be tough. But I think hopefully the consumer otherwise stays pretty solid. So it won't be like this really horrible Great Depression kind of recession. It'll be hopefully more of a. A culling of unintelligent, unintelligent capital allocation so that we can have more dry powder around for intelligent capital allocation.
And the best case scenario here, Dan, a lot of people learn their lesson. A generation learns a lesson around why it pays to do due diligence, why it doesn't pay to be a speculator and a trend chaser, why it pays to understand what you're doing with your money with respect to, okay, does this endeavor that I'm going to invest in, does it generate profits? Does it have the ability to generate profits in a sustainable way? And then what am I paying for those profits? Am I paying a valuation that applies profits that are drastically higher than what the company can do or lower? You know, am I getting a good deal or a bad deal? People can start to really think like that. We're going to be better off for decades to come.
Daniel Snyder: So you mentioned tightening credit. Can you for the listeners that might not understand what's going on behind the scenes here, what does that look like? What does that mean for the economy and for the everyday investor?
David Trainer: I think what that means is that there's generally not as much money around to invest. And so I think the first place you see that. You know, is I guess with the banks, right, I think that's that's what happened with Signature Bank (SBNY), Silvergate (SI), Silicon Valley (SIVB), right? They weren't able to go to these typical federally provided facilities and just get unlimited amounts of money in a way that they could before to cover their shortfalls. And a lot of those shortfalls are short-term and not really representative of the underlying solvency of the bank. But nevertheless, that's the way markets correct with liquidity crunches, right. When people start to take away the when the feds and the regulators start to take away the punch bowl, people can't get drunk anymore. They start to sober up. And that that applies not just to banks that have sort of short-term funding needs that they have to meet in order just to stay in operation, which is a risky way to run your business. And those guys deserve to fail for that. Right? They shouldn't have run their business, stretch the way they were stretched with so much concentration in these short-term funding facilities.
On the other hand, it's also going to mean that the banks in general, all of them, not just the ones going out of business, but all of them are going to be a lot more careful about who they're lending money to. And so all these businesses that have been losing money hand over fist for the last several years and then have been able to roll their debt over for some reason, people continue to here loan you more money. They're going bankrupt. Right? The end of the road is in sight.
We started our zombie stock list in last June when the Fed really definitively moved toward a tightening stance, because we said that's when the funding road ends for these zombie companies. Like when people aren't willing to fund bad businesses because the cash flows are negative, the interest coverage ratio is negative. They don't even have enough pre tax pre interest cost, enough EBIT to cover their interest payment. Right? Dan, are you willing to lend money to people who aren't making money and don't even have enough really revenue after initial expenses to pay the interest expense?
Not a good thing. Right? So those businesses, I think, are going to get cut off and they're going to go out of go out of business. The equity is going to get wiped out. Most of the debt is going to get wiped out. And they'll restructure hopefully in a way that allows capital to be allocated more intelligently going forward. And the people that made those investments will learn a good lesson. Oh, this is what happens when I invest like a speculator. This is what happens when I don't do my diligence.
Daniel Snyder: You mentioned the zombie stock list. I can't help but think maybe it's the meme stock list as well. Are there companies like AMC ( AMC ) on there or what kind of companies fall into that?
David Trainer: Yeah, there's several meme stocks on there as well as a lot of the big IPO stocks. You know, so AMC, GameStop ( GME ) on there, Robinhood (HOOD), DoorDash (DASH), Twilio (TWLO), Snap (SNAP), Shake Shack (SHAK), Rivian (RIVN), Peloton (PTON), Compass, Affirm (AFRM), Carvana (CVNA), Allbirds (BIRD), Wayfair (W), Sunrun (RUN). These are all, I mean, just businesses that don't ever have a chance, in my opinion, of ever making sustainable profits. They may like a quarter here, see, you know, eke something out, but they're not they're not going to stay in business. They don't they never should have been brought into business to begin with. They were IPO on a false concept, on a false concept about what the sustainability or what the even potential of the business was.
Same like with WeWork. It's just that with these IPOs, there was a lot less time from that from when they filed their S1 or their IPO financial statements to the actual IPO day. With WeWork, we had like three months and so we were able to publish a report and that was able to circulate. People were able to like read like, oh, my gosh, this is really bad. A lot of a lot of related party transactions or conflicted transactions also helped with WeWork to raise the red flags. But same was true with a lot of these other IPOs. It's just that they filed the S1 and they went public like within a couple of weeks. So our research didn't really, I think, have as much of a chance to inform as many people before it was too late. And, you know, Beyond Meat ( BYND ) had a multi-billion dollar valuation and Sweetgreen ( SG ) had a multi-billion dollar valuation. It's like too bad.
Daniel Snyder: So you have this long list of stocks that you are pretty much saying you're avoiding. What about maybe a couple of names that you're saying are perfect for this year and these markets?
David Trainer: Yeah, absolutely. Yeah, we're you know, a lot of people accuse me of being bearish all the time, but we're not. You know, we're very bullish, but we're selectively bullish. We like to be honest about what's bad about there because it helps you better understand what's good out there. One of the stocks we like a lot is Owens Corning (OC), much more defensive in the housing industry than people think. You know, there are a couple of trends that they're going to, I think, help these guys grow. Number one is the fact that people can't really buy new houses anymore. So they're going to have to remodel more. And that means fixing that roof up because the average age of the house is getting to the point where they're all going to need new roofs pretty soon. The second big trend is like this energy footprint thing. All these buildings are trying to be more green and Owens Corning sells the special insulation that dramatically reduces the energy footprint or energy needs for these buildings.
And yet you're dealing with a stock that is priced for its profits to decline by 40 percent. So remember before when I said we like to understand existing profits and then compare them to the market's expectations for future profits. So the stocks we like, the stocks on our focus list long, almost all the stocks we talk about, they have valuations that imply permanent profit decline.
What is investing about? It's about finding anomalies in the stock market where Mr. Market's got it wrong. We think he's got it wrong and Owens Corning. I'm not saying it's going to grow at 100 percent for the next 10 years. No, all I got to say, if it just maintains its current profit levels. As long as profits don't decline, you're talking like 30, 40 percent upside in the stock just to stay.
Now, we think it can grow. We think it can grow profits because it's grown profits consistently for several many, many, many years. But even if profits just stay flat, we think the stocks had a lot of upside. And that's the kind of risk-reward we like. Right. It's also a global business and the global construction industry is expected to grow about 8 percent a year in the next few years. So, yeah, that's that's the kind of thing we like.
Daniel Snyder: And that's within the construction space, which I find interesting. But what about technology? Is there anything in the technology sector? Because I know there's a lot of focus on.
David Trainer: Yeah, I think, again, it's about being selective. So one of the stocks we like and have like for a while, it's been on our focus list long is Cisco (CSCO). I mean, people don't realize like these guys are like the plumbers of like the whole data age. Right. I mean, like everything that's making data go around, as long as data is growing, as long as the demand for data is growing. And we know it is like everybody wants that that that phone to work a little bit faster, that tablet to work a little faster, that TV to work a little bit faster. Cisco is in the business of providing a lot of the plumbing for that. Think about it as like the picks and shovels for the data revolution, the digital revolution. Right. Yeah, we like the stock. It's always had a great return on invested capital, a great measure of profitability. So it's always been really profitable. Its valuation is super low. So it's expecting very little to no profit growth, four percent profit over the next decade. We think it'll do closer than nine to 10 percent profit growth. And so we think the upside is pretty strong there. We're looking at we think the stock's closer to being worth 60 bucks a share as opposed to 50 today.
Daniel Snyder: Now, when you're talking about these companies, are you are these also dividend plays for you as well? Are you just looking at capital appreciation?
David Trainer: I'm looking at capital appreciation. We like dividends aren't a bad thing. We in fact, we've got a couple of model portfolios where we focus on safe dividends and then dividend growers with an emphasis on businesses that have the cash flows to sustain the dividend. Right. That's a big deal for us. Right. We love these companies that are generating more than enough cash flow to cover their dividends over the last several years. And when I say more than enough, like five or 10 times the cash flow, right.
Some of the dividend payers out there are false, really. They're borrowing money or they're drawing down cash just to be on a people's dividend list. Cisco is one that has definitely generated enough cash flow to cover its dividend and it's got a got a decent dividend and they buy back a lot of stock. It's a super high cash flow business trading at a very low valuation. It's a good thing.
Daniel Snyder: Now, I also see over here on our show notes that you have a company within the automobile sector that you liked. Would you mind sharing that one as well?
David Trainer: Yes, we like the incumbents, Dan. We are sort of counter to, I guess, the prevailing narrative that loves these new upstart EV makers. We're not big fans of those companies, but we are big fans of Ford ( F ) and GM (GM). We think that those guys have, number one, a ton of cash flow that they have been able to plow into. Making EVs, so they'll be competitive. I don't think that the first-mover advantage that other companies have is actually sustainable. I think it's going away. We're seeing market share declines rather rapidly for the upstarts, especially in Europe and in China. And I think the legacy guys are just going to be better at scaling up.
I think the legacy players like Ford and GM were smart to wait. Until there was enough electric vehicle demand to justify building a large factory. That's a big capital expenditure. And people most people don't realize this, but Tesla ( TSLA ) burned tens of billions of dollars for years because they were making the market. It's a lot cheaper to be a fast follower in that situation. Come in, build a scale when there are enough people out there to buy the cars at scale who want to buy the cars at scale. And that's what that's what Ford's doing. I mean, you know, here's a great stat, right? In November of 2022, Ford built its one hundred and fifty thousandth Mustang Mach-E in under two years. Guess how long it took Tesla to build its one-hundred-and-fiftieth vehicle over four years. At the two-year mark, Tesla had only built fifty-seven thousand vehicles.
So we say scaling up more rapidly, that's what we mean. And I think they're going to have higher-quality cars, too. I think Tesla has continued and all of the new upstarts have really struggled to scale up to build lots of cars with the same level of quality. Whereas, you know, Ford is, you know, is crushing it. And what people have not been paying attention to, Dan, is the number of new electric vehicle models coming on the market, like over the next couple of years from all these guys. Like they're just like so many of them. And Tesla and a lot of these other firms are going to be just drowning in competition. And these bigger, more profitable firms that have a legacy auto business to like generate profits, to sustain them, are in a way better position to deal with this competition than these one-trick ponies that are electric vehicles only.
Daniel Snyder: To play devil's advocate, what would you say to investors that look at Ford stock and say this thing really hasn't gone anywhere since 1994?
David Trainer: Yeah, I would say that we've also been in a really kind of wild market for 20-plus years where interest rates have been going straight down and value has been kind of taken to the woodshed. And intelligent capital allocation has been forgotten. And Ford represents an intelligent capital allocation decision period. Right. It's got a valuation. Just to talk valuation, Ford's valuation implies its profits will permanently decline by 10 percent. Tesla's valuation implies its profits are going to grow like 10,000 percent and that it's going to have 60 percent market share of the electric vehicle market.
Which would you rather bet on at this point in time? Now, if you're an investor, it's obvious. If you're a speculator, maybe you want to just keep hoping the speculation game is able to persist. I think what we're seeing these days in the markets is that the speculation game is coming to an end. I'm not saying it's going to come to an end in one fell swoop on one day and one week. I think a big part of what the Fed is trying to do is to sort of break this boom and bust cycle that we've seen since the Greenspan days and even the Volcker days. Right. We let it get way out of control. And then once everyone agrees that its inflation is way too high and things are too bad and there's a rational exuberance, we jack up rates and we bring the train to a crashing stop. And everyone gets wrecked.
And then we have to loosen in order to lure people back in and we overdo it and the markets take it off again. This boom and bust cycle is not healthy. And so I think part of what Powell is trying to do and why he was sort of slower to bring rates up and why he signaled it for so long. Part of why what happened at Silicon Valley Bank is so unforgivable because the Fed was signaling for a long time that rates needed to go up before they actually raised the rates. So people had time to position their portfolios or reposition. I also believe that part of the purpose here is to do this in a more gradual way.
So do I have the ability to predict that all the stocks we like are going to go up tomorrow and today and all the stocks we don't like are going to go down? No, but over the next few months and years, that's the way the market's going to grind.
Daniel Snyder: What do you make of the Fed terminal rate projections predicting interest rate cuts in the future?
David Trainer: I'm in the higher for longer camp. I think it's what's best for our country. I think it's what's best for the world that we get back to intelligent capital allocation. Dan, look, we don't survive as a human race if we don't take the resources we're given and make them bigger and better. If we become a predator kind of civilization where we just take capital and destroy it, that doesn't work out well. And what we've seen in terms of the stock market going up is more capital ultimately is being destroyed than is being created because a lot of these valuations are just fake.
And that's why I'm saying there's zombie companies out there. They're not making money. They can't survive unless people continue to give them money. And where does that money go? It goes to executives and bankers. It goes from the banks to executives and bankers. And the banks are using individuals' money. And the bank that was doing that in a really big, bad way, super concentrated Silicon Valley Bank, what happened to that? It got put out of business because they weren't being good capital allocators. That's kind of what our society rests on, Dan. Like, if we don't do that, if we don't think about, hey, I have a dollar here, I want to give to someone who's going to make it more than a dollar. Prosperity doesn't increase. GDP is not able to sustain itself. And that's part of why, like, you know, it's important to be, I think, to be a little bit bigger picture when it comes to investing. It's not just about your portfolio. You want to make your portfolio better, but you want to make the world a better place. Right.
And the two can work hand in hand if you're giving your capital, you're investing your capital diligently to businesses that create value, real value.
Daniel Snyder: Just a reminder, anything you hear on this podcast should not be considered investment advice. At times myself or the guests, my own positions and the securities mentioned. But this is for entertainment purposes only. And you should seek advice from a licensed professional before investing. If you enjoyed the episode, leave a rating review on your favorite podcasting app and we'll see you soon with a new episode.
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Read More Of David Trainer's Research
For further details see:
3 Stocks David Trainer Recommends Based On His Direct Cash Flow Valuations