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Are wayward CEOs costing you money? · The Money Puzzle

0:10
Speaker 1: Hello and welcome to the Australian's Money Puzzle podcast. I'm
0:13
Speaker 1: James Kirby, the Wealth Editor at The Australian and welcome
0:16
Speaker 1: aboard everybody. Now, issue, issue of the week, issue of
0:20
Speaker 1: certainly one of the biggest issues of the year. Hasn't
0:23
Speaker 1: happened for a long time. Cheap executives behaving badly in
0:28
Speaker 1: many different ways. Does it matter to you as an investor?
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Speaker 1: We're going to look at that today. It does matter,
0:34
Speaker 1: by the way. We can show you in many ways
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Speaker 1: how it does matter. What if you had shares in Qantas,
0:40
Speaker 1: for instance, and you would have paid a price for
0:43
Speaker 1: the reign of Alan Joyce, who was so good for
0:45
Speaker 1: so long. But in the end, of course, he was
0:47
Speaker 1: ruling like an emperor in that airline. And he was
0:51
Speaker 1: beyond question, it seems. And it's caused all sorts of problems,
0:54
Speaker 1: including political problems. But put that to one side, there
0:57
Speaker 1: were issues right across Qantas. after the nature, if you like,
1:03
Speaker 1: and the sort of reign that he had where he
1:04
Speaker 1: was the king and the board really seemed to roll
1:08
Speaker 1: over for him. Chris Ellison at Mineral Resources, big lithium play.
1:13
Speaker 1: Lots of our listeners would have interest in lithium. He
1:16
Speaker 1: is under investigation for an alleged tax fraud. This is
1:21
Speaker 1: just an old-fashioned, I would have called it, small-time way
1:27
Speaker 1: of thinking. doing little deals on the side. We haven't
1:32
Speaker 1: seen that for a long time in billion-dollar companies, and
1:35
Speaker 1: there it is. And then, of course, the spectacular case
1:37
Speaker 1: of Richard White of WiseTech, where that stock lost billions
1:42
Speaker 1: of dollars because the CEO was enmeshed in a sex scandal. Now,
1:46
Speaker 1: these aren't typical CEOs, keep in mind. These are larger-than-life CEOs,
1:51
Speaker 1: and they often create the company and run the company,
1:55
Speaker 1: and they completely, how they behave... is integral to how
1:59
Speaker 1: the company performs. Look at Elon Musk. Can we think
2:03
Speaker 1: of Tesla without Elon Musk? Elon Musk at the Trump rallies.
2:07
Speaker 1: Do you think that matters as an investor? Is it
2:09
Speaker 1: relevant to you? So you can see how there's layers
2:11
Speaker 1: in this. Roger Montgomery is a regular on the show.
2:14
Speaker 1: He's also a regular contributor to the Australian's Wealth Section.
2:17
Speaker 1: And indeed, this week, he has written on this. And
2:21
Speaker 1: when I saw the piece, which he sends me early
2:23
Speaker 1: in the week, The minute I saw it, I rang
2:25
Speaker 1: him and I said, Roger, we have to do a
2:26
Speaker 1: podcast on this. And you are the person to do it.
2:29
Speaker 1: How are you, Roger?
2:30
Speaker 2: I'm really well, James. It's always great to be talking
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Speaker 2: to you in person.
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Speaker 1: I'm trying to think of a period where we had CEOs.
2:38
Speaker 1: I mean, do we have to go back to the
2:41
Speaker 1: 1980s and the bonds and the cases and all that?
2:48
Speaker 1: And by the way, folks, their scandals were all financial, right?
2:51
Speaker 1: They were just financial, really.
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Speaker 2: Yeah, we've had a conga line. examples of CEOs behaving
2:57
Speaker 2: unsatisfactorily or inadequately. And as we get into the talk today,
3:02
Speaker 2: we'll probably discover that boards have a lot of explaining
3:05
Speaker 2: to do. You could go all the way back to
3:08
Speaker 2: Enron and WorldCom, as far back as you, even further
3:11
Speaker 2: back to those that you mentioned. There's been ABC Learning Centers.
3:15
Speaker 2: We've had MFS. We've had Allcode, Babcock & Brown, Credit Corp.
3:20
Speaker 2: I was the first fund manager in Australia to launch
3:24
Speaker 2: a class action against a public company because of failure
3:27
Speaker 2: to continuously disclose information that was happening in a company,
3:32
Speaker 2: in the Credit Corp case. Timber Corp, we've had Great
3:35
Speaker 2: Southern Plantations, and most recently WiseTech and before that, Qantas.
3:40
Speaker 2: And in all of those situations, or in many of
3:43
Speaker 2: those situations, what happens is there's a personality in the business.
3:49
Speaker 2: They might be the founder of that business. In the
3:52
Speaker 2: cases where a founder has built a very successful business
3:55
Speaker 2: and they've brought directors underneath them, often the directors will
3:59
Speaker 2: feel a debt of gratitude to that founder, that chairman
4:04
Speaker 2: or that CEO. Then, of course, you have the examples
4:07
Speaker 2: where they've grown the business or a CEO comes in,
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Speaker 2: they've grown the business, they might not be the owner,
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Speaker 2: but they've done a phenomenal job of that business. And
4:15
Speaker 2: what happens is the media lavishes praise on that particular person.
4:19
Speaker 2: That particular person then starts to drink their own Kool-Aid,
4:22
Speaker 2: so to speak, and then they become bigger than Ben-Hur,
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Speaker 2: so to speak, and then the directors again fawn over
4:30
Speaker 2: these directors and they're scared. They're scared to actually stand
4:33
Speaker 2: up to them. James, if you'll indulge me, there's a
4:36
Speaker 2: terrific quote from a University of San Francisco professor back
4:39
Speaker 2: in 2001. His name is Richard Pantillo, and he famously
4:44
Speaker 2: mourned the loss of the corporate moral compass. If I
4:47
Speaker 2: can quote him, he said, in theory... publicly traded corporations
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Speaker 2: have shareholders as their kings, boards of directors as their
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Speaker 2: sword-wielding knights who protect the shareholders and managers as the
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Speaker 2: vassal who carry out orders. In practice, in the past decade,
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Speaker 2: and he wrote this remember in 2001, managers have become
5:09
Speaker 2: kings who lavish gold upon themselves, boards of directors have
5:13
Speaker 2: become fawning courtiers who take coin in return for an
5:16
Speaker 2: uncritical yes-man function, and shareholders have become peasants. whose property
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Speaker 2: may be seized at management's whim. And I think a
5:25
Speaker 2: lot of listeners today can relate to that. The shareholders
5:30
Speaker 2: are the owners of the business. But in many cases,
5:33
Speaker 2: when a founder decides to offer some shares to the market,
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Speaker 2: those shareholders aren't considered at the same level of ownership
5:42
Speaker 2: as the founder of that business. And that's where the
5:45
Speaker 2: problems begin.
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Speaker 1: Yes, and that's the problem, of course. that when these people,
5:50
Speaker 1: and they are, we have some, I want to talk
5:53
Speaker 1: about some companies that are, for listeners, that are very,
5:56
Speaker 1: for the person, very important. And by the way, there
5:58
Speaker 1: are no scandals, okay, that we are aware of, none whatever.
6:02
Speaker 1: But they're marvelous companies, but they're also terribly linked with
6:06
Speaker 1: one person. We think of something like the Goodman Group,
6:10
Speaker 1: which comes up all the time, because not only is
6:12
Speaker 1: it a top-class property trust or REIT, it's also a
6:15
Speaker 1: play on AI for many people. a company which isn't
6:19
Speaker 1: listed like Mecca, Joe Horgan, she's completely personifies that company.
6:24
Speaker 1: What the issue is, when you have one person that
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Speaker 1: personifies the company, Richard Branson at Virgin, marvelous example, Jerry
6:30
Speaker 1: Harvey at Harvey Norman, how does the board ever get
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Speaker 1: around that? Especially if these people are charming, they're strong,
6:39
Speaker 1: they're brilliant sometimes, they're charismatic. You've made the point that
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Speaker 1: With all these, with this particular issues, the three issues
6:48
Speaker 1: we've listed in particular, Qantas, Minres, Mineral Resources, and also WiseTech.
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Speaker 1: You mentioned the professor and his talk about how it seems, seemingly,
6:59
Speaker 1: there's a structure, but in effect, it's completely the other
7:02
Speaker 1: way around. You mentioned in your piece, which I was
7:06
Speaker 1: talking about earlier, that there's In recent years, there's a
7:09
Speaker 1: big push for independent directors. So the theory was bring
7:12
Speaker 1: in people who are really smart, really good, a really
7:14
Speaker 1: good lawyer, a really good accountant, someone who's already been
7:16
Speaker 1: through the hoops in another company, put them around the board,
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Speaker 1: and then the CEO is answerable to these people who
7:23
Speaker 1: dominate the board. That looks good from the outside. The
7:27
Speaker 1: problem is sometimes these people have no clue of what's
7:30
Speaker 1: going on in the company, and their only window is
7:33
Speaker 1: the CEO who talks their own book. How do you
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Speaker 1: get around that?
7:36
Speaker 2: Yeah, look, most boards, despite the conga line of disasters
7:43
Speaker 2: that we've seen, despite that, most boards actually adopt conventional
7:47
Speaker 2: wisdom and sound practice when it comes to procedures and
7:49
Speaker 2: structures for their operations. They meet regularly. If you look
7:53
Speaker 2: at the best and worst companies or companies where nothing's
7:57
Speaker 2: gone wrong and companies that have imploded, they held the
8:01
Speaker 2: same number of meetings. So it's not meetings that changes
8:05
Speaker 2: the outcome. So there's an argument that you should have
8:09
Speaker 2: members on the board who are invested heavily in the business,
8:12
Speaker 2: but there are very famous examples. GE is an example
8:15
Speaker 2: where there's been great success and the board of directors
8:19
Speaker 2: had little or no money invested. And then on the
8:21
Speaker 2: subject of independence, which you raised, James, the conventional wisdom
8:26
Speaker 2: says that you need plenty of independent directors. You don't
8:29
Speaker 2: want to have too many mates or insiders because that
8:31
Speaker 2: muddies the board's operations. It can also corrupt the decision-making process.
8:36
Speaker 2: But then Warren Buffett once said, if you have too
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Speaker 2: many people who are independent and their professional gig is
8:42
Speaker 2: being an independent director, then their bread is buttered by
8:46
Speaker 2: the fees that they receive for being independent directors. And
8:50
Speaker 2: so they don't want to rock the boat because they
8:51
Speaker 2: don't want to lose their income. And speaking of Buffett,
8:54
Speaker 2: as an example, today, Berkshire Hathaway has 11 board members,
8:58
Speaker 2: but once upon a time it had seven. Three of
9:00
Speaker 2: them had the Buffett surname. Three of them were very related.
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Speaker 1: Was that good or bad?
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Speaker 2: We can have some incredibly admired companies that have done
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Speaker 2: great things, and there's very few independent directors.
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Speaker 1: Your point is that the insiders did fine at Berkshire Hathaway. Indeed.
9:19
Speaker 2: And I think this is the really important point. If
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Speaker 2: following standard governance protocols doesn't protect investors from the sort
9:27
Speaker 2: of things that we've seen at Qantas and Minres and
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Speaker 2: at WiseTech, then what is it? What needs to change?
9:34
Speaker 2: Because those those prescriptive tools haven't prevented people from losing
9:41
Speaker 2: a lot of money by being invested in businesses or
9:44
Speaker 2: companies where there's been a corporate failure or a scandal.
9:48
Speaker 2: And I think what needs to happen is you need
9:50
Speaker 2: to acknowledge, and we talked about it right at the start,
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Speaker 2: or you mentioned it in your introduction, it's about personalities.
9:57
Speaker 2: Boards are social systems. And in so a social system
10:02
Speaker 2: is a group of people that combine, sounds like a board,
10:05
Speaker 2: to create a functioning society with goals. That sounds very
10:09
Speaker 2: much like what a board does. So they're not just
10:12
Speaker 2: formal structures. They're a dynamic social system, exactly the same
10:17
Speaker 2: and a more mature version of but exactly the same
10:20
Speaker 2: as a sandpit in a kindergarten. And there's going to
10:23
Speaker 2: be interpersonal dynamics that greatly influence the effectiveness and the
10:28
Speaker 2: outcomes of what happens in that sandpit or board meeting.
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Speaker 2: So the prescriptive stuff is vital, but really it comes
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Speaker 2: down to the personalities and a couple of key ingredients
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Speaker 2: that those personalities need to bring to those boards.
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Speaker 1: You had an idea that the boards would run better
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Speaker 1: if they all had basically a performance review every year,
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Speaker 1: a personal evaluation. Yeah, can you imagine?
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Speaker 2: Let's talk about that for a minute.
10:55
Speaker 1: Yeah, I want to talk about it because here's the thing.
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Speaker 1: Who would do it?
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Speaker 2: Who would do it? As I was writing the article
11:01
Speaker 2: for the Australian wealth section, I realized that the founders
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Speaker 2: and the CEO, they should have publicly listed companies where
11:10
Speaker 2: there are lots and lots of investors who are depending,
11:13
Speaker 2: their superannuation is depending on their success or otherwise, should
11:18
Speaker 2: be willing to submit to individual accountability and performance evaluations. Now,
11:23
Speaker 2: as I wrote that, I could hear CEOs, some of
11:27
Speaker 2: whom you've mentioned, saying, yeah, that's not going to happen,
11:30
Speaker 2: stuff that. I own the most shares. I am the CEO.
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Speaker 2: I built this company. I listed it on the ASX.
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Speaker 2: I've made it the great success that it is, and
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Speaker 2: the rest of you can all go and get lost.
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Speaker 2: There'll be people who behave that way, which is precisely
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Speaker 2: that treatment of shareholders as peasants that Richard Pantillo described earlier.
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Speaker 2: That's where you'll see really smart directors leave the board
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Speaker 2: and arguably shareholders should probably do the same thing because
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Speaker 2: eventually it's going to come a cropper.
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Speaker 1: Yes, eventually you pay for this, don't you? Yes, that's right. Okay,
12:08
Speaker 1: and just a quick word about how important for you,
12:11
Speaker 1: when you're assessing companies and you're putting money, large licks
12:16
Speaker 1: of money often into companies. And obviously, I know you
12:20
Speaker 1: for a long time, and I know that your quantitative
12:23
Speaker 1: analysis is always very important to you. But the chair
12:27
Speaker 1: and the CEO. Now, this is a thing. The two
12:31
Speaker 1: companies come to mind. Tesla has an Australian chair, Robin Denham.
12:36
Speaker 1: And she's been in all sorts of trouble for, quite simply,
12:40
Speaker 1: letting Elon Musk get his way. She's also in trouble
12:42
Speaker 1: because she's chair of the Czech Tech Council.
12:45
Speaker 2: Yes, that's right.
12:46
Speaker 1: Which should have been across the WiseTech thing ages ago.
12:49
Speaker 1: That's one person. The other person is Richard Goider, who
12:52
Speaker 1: was greatly admired, had run West Farmers, was the chair
12:55
Speaker 1: of Qantas while Joyce was, particularly in the later period,
13:01
Speaker 1: not running that company in the optimal way for anybody.
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Speaker 1: So how important is that dynamic and what can be
13:07
Speaker 1: done to improve that situation so they don't become chums?
13:12
Speaker 2: You mentioned there's a quantitative or a measurable aspect to
13:16
Speaker 2: investment analysis, and you're looking at the outputs of the
13:20
Speaker 2: company and the inputs as well, the money that's going
13:22
Speaker 2: into that particular business to produce those outputs. But it's
13:25
Speaker 2: much harder to analyze that qualitative aspect, particularly if a
13:31
Speaker 2: great board has a culture of open dissent and it
13:34
Speaker 2: values diverse perspectives to help avoid groupthink and to help
13:38
Speaker 2: enhance decision-making. how do we as external shareholders actually assess that?
13:44
Speaker 2: It's really difficult. You can ask questions. You're probably always
13:47
Speaker 2: going to get the answer you want to hear, but
13:49
Speaker 2: ultimately that's what it comes down to. And unfortunately, sometimes
13:52
Speaker 2: the founder or the CEO has a personality or a
13:55
Speaker 2: celebrity status or a wealth status. They're billionaires and it
13:59
Speaker 2: makes challenging them almost impossible, but that's what you really
14:02
Speaker 2: want to find. You want to find a culture of
14:04
Speaker 2: open dissent.
14:05
Speaker 1: Open dissent. Yes.
14:06
Speaker 2: Yeah, indeed. And I think If you can have that,
14:09
Speaker 2: then we wouldn't have the situation at WiseTech. We wouldn't
14:14
Speaker 2: have the situation at Qantas. Nothing would have happened that
14:18
Speaker 2: merited headlines in newspapers that would have been nipped in
14:23
Speaker 2: the bud much, much earlier.
14:24
Speaker 1: All right, we'll take a short break and we'll be
14:26
Speaker 1: back in a moment with some of our listeners' questions.
14:39
Speaker 1: Hello and welcome back to the Money Puzzle Podcast. James
14:41
Speaker 1: Kirby with Roger Montgomery of Montgomery Investment Management, fund manager.
14:46
Speaker 1: I'm sure you all know him, though I should introduce
14:49
Speaker 1: him properly to you at this stage. Okay, lots of questions, Roger,
14:53
Speaker 1: and they're pretty interesting. I'll just quickly read this. It's
14:56
Speaker 1: not so much a question, but it was a comment.
14:59
Speaker 1: I had been talking about a piece I had read
15:02
Speaker 1: in the Wall Street Journal, which was so good, and
15:04
Speaker 1: it was by The chief scientist at Facebook, and he,
15:08
Speaker 1: of all people in the world, completely downgrades the excitement
15:14
Speaker 1: around AI.
15:15
Speaker 2: Yeah. I've written a lot about that too, James.
15:18
Speaker 1: I know you have. And he says that where we're
15:21
Speaker 1: at at the moment, that AI, in terms of intelligence,
15:24
Speaker 1: is at the same level as a household cat. In
15:27
Speaker 1: other words, he's saying, be very careful. It's highly developed,
15:32
Speaker 1: advanced computing and retention technology. but it's not thinking. So
15:38
Speaker 1: Stephen's question is, I was thinking about your comment on,
15:43
Speaker 1: and this was about Jan LeCun, by the way, Jan, L-E-C-U-N,
15:47
Speaker 1: who is the chief scientist at Metas, comparing the intelligence
15:51
Speaker 1: of AI and a cat. I just asked ChatGPT to
15:54
Speaker 1: calculate the cash transfer value of a UK defined benefit
15:58
Speaker 1: scheme using the variables, years worked, salary, etc., It gave
16:03
Speaker 1: me an approximate answer in second and showed the mathematical formula.
16:07
Speaker 1: I personally don't know any cats that could do this,
16:10
Speaker 1: says Stephen.
16:11
Speaker 2: That's true, but both are right. Both are actually right.
16:17
Speaker 2: It's producing that answer, but it's producing it based on
16:20
Speaker 2: a probability analysis of what the next word should be.
16:24
Speaker 2: And it's looking at stuff that's already been written by
16:28
Speaker 2: humans and then pulling that in and consolidating it for
16:31
Speaker 2: the user. Look, scouring the internet to find the answer,
16:35
Speaker 2: so to speak. And where it doesn't find the answer,
16:38
Speaker 2: where it ad libs, it's using probability to work out
16:41
Speaker 2: what the next word is likely to be. And it's
16:44
Speaker 2: not thinking. And so it's not making a decision. It's
16:48
Speaker 2: just following a protocol. And that is quite different to
16:51
Speaker 2: a cat. And with respect to hype around AI, look,
16:57
Speaker 2: I think that artificial intelligence, there's a lot of use
17:01
Speaker 2: cases for it. I use it. Most people I know
17:04
Speaker 2: use it, but we use it in a limited fashion.
17:07
Speaker 2: And more importantly, we don't pay a lot of money
17:09
Speaker 2: for it. So there's a couple of issues here. Share
17:12
Speaker 2: prices are currently reflecting the technology being transformational, not only
17:21
Speaker 2: for life on earth, which it may be, but transformational
17:26
Speaker 2: for all shareholders in all businesses that are related to AI.
17:31
Speaker 2: And what we know from past experience is that not
17:35
Speaker 2: all players are going to make money and not all
17:37
Speaker 2: players will survive. Yet they're all being priced as if
17:41
Speaker 2: they're all going to be enormously successful. Now, we've seen
17:44
Speaker 2: this in the past. We saw this with the advent
17:46
Speaker 2: of the motor car. If you'd been in Germany in 1880,
17:51
Speaker 2: I think it was 88, if you'd been there when
17:54
Speaker 2: Carl Benz drove the first horseless carriage, I think it
17:57
Speaker 2: was called the Ben's patent multivagon, and he drove that.
18:03
Speaker 2: You might have spotted that this was going to be
18:04
Speaker 2: transformational for life on Earth. But even if you had,
18:08
Speaker 2: and by the way, not everyone did. Famously, Henry Ford's
18:12
Speaker 2: lawyer told Henry Ford, we don't need a motor car,
18:15
Speaker 2: what we need are faster horses. And so not everyone
18:18
Speaker 2: picked it. But let's say you did pick it. After
18:20
Speaker 2: that event, there's been something like 1,600 car manufacturers in
18:24
Speaker 2: the United States, of which four exist. today. And two
18:30
Speaker 2: of those four were bailed out during the global financial crisis.
18:34
Speaker 2: So really, there's only one or two that are profitable
18:37
Speaker 2: that still exist. And shareholders lost a ton of money.
18:41
Speaker 2: The same can be said for television. The same can
18:43
Speaker 2: be said for commercial air travel. Commercial airlines have now
18:46
Speaker 2: been running for something like 80 years, 79 years. And
18:50
Speaker 2: in those 79 years, the total aggregate, and I did
18:54
Speaker 2: the calculation using the official data, the IATA data, The
18:58
Speaker 2: total aggregate profit of all airlines that have ever operated
19:04
Speaker 2: commercially to transport people, the total profit today is $ 20 billion.
19:10
Speaker 2: And that seems like a lot of money, but let's
19:12
Speaker 2: remember Microsoft does that in three months. This is 80 years.
19:17
Speaker 2: The shareholders haven't made a lot of money.
19:19
Speaker 1: Only a handful of winners.
19:20
Speaker 2: Yeah, that's right. So it's really hard to pick the winners.
19:23
Speaker 1: Having said that, you like NextTC, don't you? And you
19:26
Speaker 1: like Macquarie Technology and you're in them, aren't you? Am
19:28
Speaker 1: I right?
19:29
Speaker 2: We're in Macquarie or have been in Macquarie rather. And
19:32
Speaker 2: the reason for that is that we think that data
19:36
Speaker 2: centers are going to capture the lion's share because they're
19:39
Speaker 2: upstream providers. So you've got upstream and you've got downstream.
19:43
Speaker 2: Downstream are the people who try and adopt the technology
19:47
Speaker 2: to make products to then sell. And upstream are the
19:50
Speaker 2: suppliers of the picks and shovels. And we think, and
19:53
Speaker 2: the numbers bear this out, that the upstreamers, they're making
19:57
Speaker 2: the lion's share of the money at the moment. In AI,
20:01
Speaker 2: the biggest use case, the biggest commercial use case, or
20:04
Speaker 2: the most popular commercial use case for large language models
20:08
Speaker 2: is which is the chat GPTs and the perplexities of
20:11
Speaker 2: the world, is chatbots or companion bots. So these are
20:16
Speaker 2: people who might be lonely for various reasons or don't
20:18
Speaker 2: like talking to other real people. And so they keep,
20:21
Speaker 2: they subscribe to a chatbot to keep them company. That's
20:25
Speaker 2: the biggest use case at the moment. At the moment.
20:28
Speaker 1: Just on the investment side then, is there any stock,
20:32
Speaker 1: stocks that you think have a potential to be the
20:36
Speaker 1: long-term winners?
20:38
Speaker 2: Well, I think all of them at some point in
20:39
Speaker 2: the next few years are going to have a valley
20:44
Speaker 2: through the, sorry, a shadow of the valley of death moment.
20:47
Speaker 2: And I think out of that will emerge, there'll be
20:49
Speaker 2: some sort of correction. And I think that, I'm guessing,
20:53
Speaker 2: completely guessing, I don't know. I'm trying to predict these
20:57
Speaker 2: things as a fool's errand. But if in the next
20:59
Speaker 2: couple of years we have some sort of correction, then
21:01
Speaker 2: out of that will emerge some winners. And those that
21:05
Speaker 2: are less likely to win, won't receive ongoing funding, and
21:09
Speaker 2: they'll fall over and disappear. And it's then that you'll
21:12
Speaker 2: be able to, I think, be more certain of a
21:15
Speaker 2: great return on your money from AI.
21:17
Speaker 1: See, the big super funds are certainly dropping large wads
21:21
Speaker 1: of cash into data.
21:23
Speaker 2: The prices, data centers are fine, but it's the AI,
21:26
Speaker 2: the LLM produces. Perplexity, I mentioned a moment ago. Yes.
21:30
Speaker 2: It had a valuation earlier this year of about $ 500
21:32
Speaker 2: million US dollars. It did a funding round in March,
21:36
Speaker 2: I think it was, or April, and it was valued
21:39
Speaker 2: at $ 4 billion. And it's now looking to raise some
21:43
Speaker 2: more money at $ 8 billion. So that's a big jump
21:46
Speaker 2: in value in less than 12 months. And its last
21:50
Speaker 2: official run rate for revenue was $ 10 million. So an
21:55
Speaker 2: $ 8 billion valuation for $ 10 million of revenue. Now, there
21:58
Speaker 2: are that it's increased its revenue to $ 50 million. But
22:02
Speaker 2: $ 8 billion for $ 50 million of revenue, there's a lot
22:04
Speaker 2: of optimism built into that price.
22:08
Speaker 1: There's a lot of optimism built into that price. Okay,
22:10
Speaker 1: so listeners, I think, I mean, looking across this, it
22:14
Speaker 1: does seem, Roger's talking about the upstream and the difference
22:18
Speaker 1: between the language modeler creators, but the data centers being
22:22
Speaker 1: something of an approximate for the picks and shovels in
22:25
Speaker 1: a boom. Is that a fair thing to say?
22:27
Speaker 2: I think that's fair, and it's worth remembering that there
22:30
Speaker 2: are people who believe that large language models are going
22:33
Speaker 2: to lead to artificial general intelligence, or what's called AGI.
22:38
Speaker 2: And there are other experts who say, you know what,
22:40
Speaker 2: for LLMs to evolve into AGI, there literally is not
22:45
Speaker 2: enough energy on Earth to produce the computing power for
22:49
Speaker 2: that to happen. So that's a widely debated point. And
22:55
Speaker 2: I think some of the optimism in share prices at
22:58
Speaker 2: the moment is are betting on large language models becoming
23:03
Speaker 2: AGI or becoming Artificial General Intelligence.
23:06
Speaker 1: That's why Google has bought directly into nuclear power, directly
23:10
Speaker 1: into the Three Mile Island, believe it or not, of
23:12
Speaker 1: all the plants, of all the nuclear plants in the world,
23:14
Speaker 1: the Harrisburg one.
23:15
Speaker 2: Yeah, Google's purchase of a nuclear power plant is an attempt,
23:19
Speaker 2: I think, to capture some of the energy that's needed
23:24
Speaker 2: to do that. And they're aware of it.
23:26
Speaker 1: Thank you, Stephen, for that marvelous question. Could have been
23:28
Speaker 1: a whole show. We'll come back to it. We come
23:30
Speaker 1: back to it regularly. Just a quick one from Sean.
23:32
Speaker 1: On the show last week, stock market crashes and the
23:35
Speaker 1: crash of 87. I saw no real info in this episode,
23:38
Speaker 1: just a lot of reminiscence about 1987. Okay, Sean. The idea,
23:43
Speaker 1: I think, of that.
23:45
Speaker 2: No, I know that.
23:46
Speaker 1: I think the show, what we did, Sean, was to
23:50
Speaker 1: try and remind people what a crash is like. And...
23:56
Speaker 1: Most people have never really seen one. There was, of course,
24:00
Speaker 1: a ferocious downturn in COVID, but in many ways that
24:03
Speaker 1: was entirely explained by COVID and we recovered quite quickly.
24:07
Speaker 1: What a lot of our listeners on the show have
24:09
Speaker 1: never experienced is 25% in a session or 50%. Yeah,
24:11
Speaker 1: but we both have. Or 50% over two years that
24:14
Speaker 1: we got once upon a time in 2009. And I
24:15
Speaker 1: just wanted... to have someone on the show to articulate
24:25
Speaker 1: what it's like, folks, because I'm just saying to you,
24:28
Speaker 1: as a share investor, if you are really worried and
24:31
Speaker 1: you find it stomach-churning when you get up and find
24:33
Speaker 1: the market loses 3% in a night or four, just remember,
24:37
Speaker 1: it can go 10, it can go 20, and you
24:39
Speaker 1: should be able to accommodate that and know that it
24:42
Speaker 1: can happen. Okay, short break. We'll be back with the
24:45
Speaker 1: last three questions, which are very interesting, from Tommy, Paul,
24:48
Speaker 1: and Fred, back in a moment. Hello, welcome back to
25:00
Speaker 1: the Money Puzzle Podcast. I'm James Kirby with Roger Montgomery,
25:04
Speaker 1: fund manager and author, regular guest on the show. Tommy says,
25:10
Speaker 1: long time listener, first time caller. Thank you, Tommy. Do
25:13
Speaker 1: annual capital growth rates for Australian property accurately reflect the
25:17
Speaker 1: value appreciation of the land underneath the underlying land or
25:20
Speaker 1: are they distorted? by neglecting the cost of capital improvements.
25:25
Speaker 2: Great question.
25:26
Speaker 1: Yes, it's a really good question, isn't it? The land
25:28
Speaker 1: out there isn't really going up in the same way,
25:31
Speaker 1: is it? What do you think, Roger?
25:32
Speaker 2: Well, I think it raises an interesting discussion about where
25:38
Speaker 2: value in property lies. And we have to go back, gosh, James,
25:43
Speaker 2: we have to go back maybe 10 or 15 years.
25:46
Speaker 2: And I wrote an article for you talking about property
25:51
Speaker 2: in that light. And if you look at the very
25:55
Speaker 2: long-term returns and 100-year returns or 80-year returns for a
26:00
Speaker 2: CBD office tower, then you might be surprised to hear this,
26:05
Speaker 2: but pretty much all the rent that is ever received
26:09
Speaker 2: from owning one of those buildings is eventually poured back
26:13
Speaker 2: into its upgrade. In CBD buildings, we have A-grade buildings, B-grade, C-grade, D-grade,
26:20
Speaker 2: and so on. And everyone... with any kind of big
26:24
Speaker 2: brand wants to be in an A grade building, particularly
26:26
Speaker 2: if they're employing thousands of people. They want to be
26:29
Speaker 2: in the newest, latest, greatest building. And those buildings don't
26:32
Speaker 2: stay A grade forever because eventually technology changes and newer
26:36
Speaker 2: buildings are constructed with newer technology that surpass the A
26:40
Speaker 2: grade building of 10 years ago or 15 years ago
26:43
Speaker 2: or 20 years ago. And so they have a limited
26:46
Speaker 2: life where they're A grade buildings. Then they become B
26:49
Speaker 2: grade and then they don't earn as much. And so
26:52
Speaker 2: eventually the owners have to pour money back in and
26:55
Speaker 2: engage in what we call capital expenditure to upgrade the
26:59
Speaker 2: building to make it competitive again. And so with a
27:03
Speaker 2: CBD office tower, you have a postage stamp of land
27:08
Speaker 2: that appreciates, and you have a very large building that depreciates.
27:14
Speaker 2: And those economics are great over the very, very long run. Now,
27:17
Speaker 2: people do make money out of office buildings, but they
27:20
Speaker 2: make it tactically rather than strategically. So they're saying, okay,
27:24
Speaker 2: prices are really low now. I'm going to buy one
27:26
Speaker 2: of these buildings. I'm going to do really well because
27:28
Speaker 2: I think prices are going to recover. And they make
27:30
Speaker 2: a tactical profit out of that. But if you owned
27:33
Speaker 2: a building for as long as the bricks and the
27:36
Speaker 2: cement lasted, you would find that over time, you'd be
27:40
Speaker 2: pouring back pretty much all of your rent into upgrading
27:43
Speaker 2: that building. What you really want is a big piece
27:46
Speaker 2: of land and a tin shed on it, which is
27:49
Speaker 2: like a Bunnings... building. That's what you want. You want industrial.
27:53
Speaker 2: Industrial property, I think, makes a lot more sense economically.
27:57
Speaker 2: From a business economics perspective, industrial properties make more sense
28:01
Speaker 2: than CBD office towers because you've got a lot of
28:04
Speaker 2: land that is appreciating and you have only a cheap
28:08
Speaker 2: shed that is depreciating.
28:10
Speaker 1: It is so interesting. And in residential, that version obviously
28:13
Speaker 1: is the landlords who have a row of pretty beaten
28:16
Speaker 1: up old houses that never change and are rented for generations.
28:21
Speaker 1: And it's the same sort of thing in the middle
28:22
Speaker 1: of the city. Very interesting. Okay, we must get through
28:24
Speaker 1: the other questions. But thank you for that, Tommy. Paul,
28:27
Speaker 1: are Australian and other share markets approaching long-term PE value peaks?
28:33
Speaker 1: Don't they correct at this point? What does history tell us?
28:36
Speaker 1: If only we could answer that in a reliable fashion, Paul.
28:40
Speaker 1: But Roger, we'll have a go.
28:42
Speaker 2: The short answer is no. It has nothing to do
28:45
Speaker 2: with the valuations by themselves. It will be a change
28:50
Speaker 2: in the... PE ratio, which measures the willingness of people,
28:55
Speaker 2: the popularity or willingness of people to pay for a
28:59
Speaker 2: dollar of earnings. The more popular or the more willing
29:02
Speaker 2: investors are to pay for a dollar of earnings, the
29:05
Speaker 2: PE expands. There is a relationship, a correlation between interest
29:08
Speaker 2: rates and PEs, but there's also a correlation between sentiment
29:13
Speaker 2: and PEs. And sentiment, all else being equal, sentiment is
29:17
Speaker 2: going to drive what people are willing to pay for
29:20
Speaker 2: a dollar of earnings if interest rates remain constant. When
29:24
Speaker 2: interest rates go down, that acts like, I think it
29:27
Speaker 2: was Warren Buffett who said that interest rates are like
29:30
Speaker 2: gravity on prices or on PEs. And so when interest
29:35
Speaker 2: rates go up, the gravitational force is much greater and
29:38
Speaker 2: the present value of future income goes down. PEs go
29:42
Speaker 2: down because people leave the stock market to put their
29:44
Speaker 2: money into safer securities that are paying a higher interest
29:48
Speaker 2: rate or what they perceive to be safer and paying
29:52
Speaker 2: a higher interest rate. So that process of moving money
29:54
Speaker 2: out of the stock market into interest-bearing securities because interest
29:58
Speaker 2: rates have gone up that reduces prices, that selling pushes
30:02
Speaker 2: prices down. And then prices follow the intrinsic value, the
30:06
Speaker 2: intrinsic values, because the present value of future earnings goes
30:11
Speaker 2: down as interest rates go up. But to try and
30:15
Speaker 2: to say that, oh, PEs are very high at the moment,
30:17
Speaker 2: now there's going to be a correction, that's wrong. And
30:19
Speaker 2: you only need to look at Robert Shiller's CAPE chart.
30:23
Speaker 2: You can Google that, just type in Robert Shiller CAPE chart,
30:27
Speaker 2: and it'll be the first It'll be the first entry
30:30
Speaker 2: on Google or the first listing. You can pull up
30:32
Speaker 2: that chart, and what you'll find is that there have
30:35
Speaker 2: been lots of times in the past where the CAPE
30:38
Speaker 2: ratio has been high and it's just kept going higher.
30:42
Speaker 2: So no, you wouldn't say that just because PEs are
30:45
Speaker 2: high that the market is going to correct. That's a
30:48
Speaker 2: mistake that only young players keep making.
30:51
Speaker 1: Maybe you're a young poet, but here's the thing. If
30:55
Speaker 1: there was a bell, That rang at the top of
30:58
Speaker 1: the market, Paul. Everybody would know. And we'd all be
31:01
Speaker 1: out and we'd all be wealthy and we'd go back
31:03
Speaker 1: in at the bottom. But it doesn't work like that.
31:05
Speaker 1: And as Roger says, when you see these headlines, and
31:08
Speaker 1: it's a great old trick, you see it in media
31:10
Speaker 1: all the time. This ratio, some ratio, is gone high.
31:14
Speaker 1: Be careful. The last time it happened, the stock market crashed. Yes,
31:17
Speaker 1: but there's no evidence, proof whatsoever it'll crash again because
31:22
Speaker 1: of one ratio or another. I think, as Roger alluded to,
31:25
Speaker 1: it's sentiment, really. You can have all the ratios you like.
31:28
Speaker 1: It's sentiment on the day that turns a market. I
31:32
Speaker 1: think the best one, too, for that is 1987. It's
31:34
Speaker 1: one of the reasons I used that crash, because it
31:36
Speaker 1: was the one that had no clear, outstanding explanation, except
31:40
Speaker 1: for the fact that the market had run so high. Okay.
31:44
Speaker 1: And other crashes, we knew why. COVID, GFC, et cetera. Yeah,
31:48
Speaker 1: way much.
31:50
Speaker 2: I was just going to say, James, it might be
31:51
Speaker 2: that there's a huge amount of global debt, which hasn't
31:54
Speaker 2: worried anyone for many years. And then suddenly everyone starts
31:57
Speaker 2: to worry about it because there's a refinancing of it.
32:00
Speaker 2: Or China decides to annex Taiwan. It decides to put
32:04
Speaker 2: all of its ships and all of its planes over
32:06
Speaker 2: the top and suddenly sentiment changes. And that's more likely
32:10
Speaker 2: than just the fact that peers are high.
32:12
Speaker 1: Yes, exactly. The sentiment rather than the actual numbers. Okay,
32:16
Speaker 1: final question from Fred. We'll try and do it quickly.
32:18
Speaker 1: It is impossible to see how my super fund is
32:20
Speaker 1: really doing against the market because tax is a distortion.
32:24
Speaker 1: Tax may exaggerate the returns if the tax rate is negative.
32:28
Speaker 1: Due to franking credits, for example. In addition, the tax
32:32
Speaker 1: on super can vary a lot depending, for example, if
32:34
Speaker 1: the fund is in accumulation or pension. Isn't it difficult
32:38
Speaker 1: and dangerous to discuss returns on investment? without acknowledging the
32:42
Speaker 1: tax overlay. Yes, Fred, absolutely it is. Do you think
32:46
Speaker 1: it's a particular issue for super funds and their returns
32:51
Speaker 1: and those advertising panels we see on the highways telling
32:55
Speaker 1: us that such a fund did 9% for 10 years
32:58
Speaker 1: in a row or whatever? Are they misleading? Do you think, Roger?
33:02
Speaker 2: Look, I think, James, the reason why it's done that
33:05
Speaker 2: way is precisely because of the points that the questioner raises,
33:10
Speaker 2: and that is, then everyone's tax is different. Imagine an
33:13
Speaker 2: advertisement for a fund's returns that took into account everyone's
33:18
Speaker 2: different tax rates. The numbers would be so small, you
33:20
Speaker 2: wouldn't be able to see the ad.
33:22
Speaker 1: Yeah, or even the bands. Yeah, absolutely.
33:24
Speaker 2: And so what we do is we take that out
33:26
Speaker 2: of the equation and we let people make their own
33:29
Speaker 2: assessment of what the return would be for them given
33:32
Speaker 2: their tax rate. Everyone deals with their own taxes and
33:35
Speaker 2: we just present the numbers pre-tax. But after fees, but
33:39
Speaker 2: Before personal tax rates, because we don't know people. If
33:42
Speaker 2: you're in pension phase in your superannuation fund, you're not
33:45
Speaker 2: paying any tax. So the advertised return is your return.
33:49
Speaker 1: Up to $ 1. 9 million. Okay. Thank you very much, Fred.
33:52
Speaker 1: So I hope that's useful to you. None of this
33:54
Speaker 1: was advice. It's all information. And the last piece of
33:57
Speaker 1: information there was that you want to see those returns
34:00
Speaker 1: before fees, but actually on taxes first. it's just not
34:04
Speaker 1: feasible to do it after tax because of the tax bans,
34:06
Speaker 1: because of the tax position, because of the fact that
34:08
Speaker 1: you don't pay tax when you're retired and you pay
34:10
Speaker 1: half your income in tax if you make a good
34:12
Speaker 1: salary before you're retired, as many of our listeners would
34:17
Speaker 1: be aware of. Okay, Roger Montgomery, thank you very much.
34:21
Speaker 1: Marvelous to have you on today.
34:22
Speaker 2: Always a pleasure, James. Great to be with you again
34:24
Speaker 2: in person.
34:25
Speaker 1: And thank you very much for listening. Let's have some emails, themoneypuzzleattheaustralian.com.au.
34:30
Speaker 1: Talk to you soon. Thank you.