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LIVE YIS interview with Donald Yackman Transcript
James: Donald Yacktman may not be a household name like Warren Buffett or Carl Icahn, but for those who know investing, Donald Yacktman is a legend in the industry. He started Yacktman Asset Management. He’s the founder and portfolio manager since 1993. In 1994, Donald Yacktman was voted Morningstar Manager of the Year. He has provided tremendous investment results over his over 30-year career. In 2010, was voted the Morningstar Manager of the Decade and also in 2011, won Portfolio Manager of the Year after handily outperforming in the market for years.
Donald graduated magna cum laude from the University of Utah. Graduated and earned his Harvard Business degree at the Harvard Business School, a Degree with Distinction. In the time I have had with him, I can tell you is just one of the best people you’ll ever meet. Don has seven kids, 23 grand kids, is that right, Don? 25 grand kids. We’re just thrilled to have you here with us today.
On the other line, we have Agoura High School, Brandon Schwartz is the President of Young Investors Society of the Junior Advisory Board. We have some tremendous students there with him. With that Don, I am going to give you 10-15 minutes. Can you talk about how you got into investing? I understand that you were thinking of going into engineering and then had a change of heart and went to business. Any lessons, big picture lessons that you can give us would be great. And then we will jump into questions.
Donald: My background is that I grew up in the Sputnik era in the 50’s. I graduated high school, the first graduating class of Highland High School in Salt Lake City. When I graduated, I was good in Math and Science and because of that they really thought it would be good that I go into Engineering. I started out that way in my first year in college. I took Chemical Engineering. I didn’t know about investing in high school. I didn’t know much about business, although my dad was in business. I ended up getting a degree in Economics and went on to Harvard Business School. And then, I had the opportunity to go into the investment field from there.
One of the things I learned out of this and I told my children as they were growing up and that was to look in the mirror and whatever they saw, be the best at it. Don’t worry about what it was. That doesn’t mean in today’s world that doesn’t mean go and play video games all day. There’s an importance in what you do and the enjoyment level. My kids tease me about what they call my “Dadism’s.” One of them is, “Monday mornings are fun. Life is good.” That’s another way of saying: “Do what you’re good at and enjoy doing.”
So that’s kind of a brief background how I ended up here. Anybody who goes into investing, there are probably certain areas that will show up of interest but classes that make more sense than others. I think microeconomics is very important because I think investing is more a function of micro than macro-economics. It’s what you buy, and what you pay for it. I think statistics are very important. I think accounting is very important. A little psychology is a good thing as well. I love history. I remember taking a, in my period of time in the early 60s, I ended up taking courses on the depression period of time. I took it from a political science viewpoint, economic viewpoint and historical viewpoint. So, I got it from three different levels, because I thought it was an important period to understand.
James: Why don’t you take us on a history lesson of your history in the market? Reading through your background, it looks like you had a tremendous period in the early 90s, and then I think there was a time in the late 90s where maybe you were lagging and then, in 2001, the tech bubble happened. In 2008, the global financial crisis you performed strongly. Just kinda walk us through the couple of those milestones of your career where you were invested and maybe what went right and what went wrong.
Donald: I think the main thing is to stay consistent in a strategy that you feel comfortable with. In the 80s, I worked and managed Selected American. For the 8.5 years that it was run as an equity fund, it was ranked number 5 in the country. In the last 4 years that I managed it was 1991, and that was when I got the Morningstar Manager of the Year award. I think over the years, 80s, 90s, and even further out, I think hopefully we are constantly learning a little bit more over and over again. What happened really in the 90s was particularly at the end of the 90s, it became kind of the bubble period, where tech became what everybody seemed to want to own. It was this two-tier market. We had one back, by the way in the early 70s. We had a bubble period in 72, early 73. You saw a real divergence then, where it was the “Nifty Fifty” at that time. I think you have periods like this that people take things to extremes. If you go back even further, all this was before I invested, in the 1962 period, the number of the consumer nonverbal stocks which I tend to like a lot, they were really overpriced relative to other things at that time. You get these bubbles with certain things. So there’s a degree of flexibility. Ultimately, I think the best thing I can tell you, and it’s a pretty sophisticated concept, is what we call, “Risk Adjusted Forward Returns”. And so, what you are trying to do to the best of your ability, is use probability distributions as to possible outcomes. Attach those to basically looking at growth rates, profitability and reinvestment rates and trying to come up with forward greater return. Something that is sustainable for a very long period of time if you bought this stock today, and then try to adjust those like you would a stock, like a bond and then grade the stocks like a bond. Therefore, you get risk adjusted forward return.
Then again, I don’t know in what degree you have looked at and studied bonds. They are a little bit simpler because you have one static coupon rate where stocks will change overtime. The other thing is the reinvestment rate on a bond. It takes a lot longer to change the rate of return on a bond because the coupon is such a small percentage. In other words, the cash that the assets generated is so much smaller than it is with an equity, where not only is the cash the income but it’s also the cash flow that comes out of depreciation. Looking at cashflow is really important, but when you put those two pieces together, it is easier to make adjustments with the stocks. I think the classic example of what I am talking about is looking at somebody like Warren Buffett who started out with some pretty trashy businesses. Berkshire Hathaway is his company, but If you look at it what it did originally, it was a pretty crappy business, frankly. What he did, he re-allocated the cash flows to much better businesses because he bought it so cheap. He bought the cash he was generating so cheaply that it made sense.
I remember after 2000, we looked dumber than we really are up until at the peak of the market. We were up in 2001 and 2002. Virtually, nobody I don’t think accomplished that. In 2003, most people were up. We were ahead of the market even in that year and it was up like 30%. But then what happened is, we started to lag behind because we started to see more floppiness and more speculation. And of course in 2007 and early in 2008, we did very well in 08 and 09. The reason for that is, we were using this concept that I talked about. What happened is some of the things that we held, held up so well that the rates of return were not nearly as good as some things that really collapsed. So we were shifting not only buying what we had left over but shifting into things that have a higher rate of return. In other words, like Procter and Gamble, for example, where you are maybe getting 10, 11, 12% on your projections and shifting it into something like at that time was News Corps. Today, it’s 21st Century Fox, where you are looking at 20 plus percent compounded rates of return.
The market, when it tends to go down, it does down rapidly. That’s when the people that don’t lose their head can really makes a difference. Because they don’t freeze, they can take advantage of these opportunities. Maybe a better or another analogy, I am not a card player, but If you like playing Gin Rummy or you’re getting rid of a weak card and replacing it with a stronger card in those periods of time. So we did very well going down but then we were positioned because of having made these moves, do extremely well in 09 when the market went up like a rocket.
And then now, we are kinda like in an unusual period today in a sense that you’ve got a stock market that is expensive but the bond market is even more expensive. I think the real risk is in the bond market more than the stock market. You have to have a long term 10-30-year bond with lower yield on it than you can on some AAA stocks. That should tell you something.
James: Your investment philosophy, Don, is really well appreciated. I think there is a couple of things that really resonated with me. One is I think I learned about the triangle. I think you talked about good companies with good prices with good management. And, another analogy you had is the beach ball. You like to own beach balls that are so good that they’ll rise to the top like a beach ball under water. Maybe just talk to our kids about your investment philosophy. How do you look for a stock?
Donald: I think the triangle is very valid. I don’t know of any investor that says they buy overpriced stocks. First of all, make sure you buy at a good price. That’s the base of the triangle. We talked a lot about that one already. The business model one is very, very important too. Again, it boils down to what you buy and what you pay for it. On the business model, I know I sent you some graphs and you can share those. The business model think of it as two axis as being fixed assets and the other one being economic sensitivity or cyclicality. What you will find as you move towards businesses that have low capital requirements and don’t have a lot of cyclicality to them, that they have the ability, if they are good business or in other words they have a big market share; they have product per service that has sustainability to it. They can run those assets all up 24/7 and get very high what we call ROTA’s (Return On Tangible Assets.) One that has made money for virtually a century now has been, Coca Cola. Because basically, they are a syrup manufacture and it doesn’t take a ton of capital. The capital is in the intellectual property, which is the formula that is used to make Coca Cola. Again that concept, one cute story is when this guy went to a 25 year class reunion at Harvard. They said, “Joe, we haven’t seen you since you graduated, where have you been?” He said, “Well, I came from this little town in Illinois.” He said, “I know I couldn’t compete with you guys with your fancy jobs in consulting and finance. I barely made it through. I had to work like crazy just to get through. So, I went back to this little town and we developed this little product. You probably use it everyday. We make it for a dollar and we sell it for four. You would be amazed at how that 3% adds up.” He didn’t get the Math right. He got the concept right.
That’s how the triangle works. It’s the management and what you’re talking about there is the reinvestment of the cash flow that we elluded to with the bond analogy. A good manager, by the way, better businesses tend to attract better managers so that makes the issue. But good managers and capital allocators. they know how to allocate by going with R&D, marketing, mass productions, distribution; things that will enhance the existing crown jewels or add to them with line extensions or acquisitions, like that.
There are really only five basic options that they have, put money back in the business, make the acquisitions, buy back stocks, pay a dividend or reduce debt…that’s pretty much it. So, how they behave is what you want to study because the best predictor of the future behavior is the past behavior. To get a little bit political on this, it’s really more economic than political. If you look at history, what you will find is that virtually every economy, some of the money is allocated by free enterprise and some of it allocated by government. Free enterprise, historically has done a better job than the government on average. Not that everything free enterprise does is wonderful and perfect or that everything government does is miserable and bad, but on average. And so, what you have is free enterprise. The more money that is allocated by free enterprise, the faster the society can grow and the standard of living can rise. Well, the same thing happens with businesses. The better the allocation process, and this is again, if you want to go back to the Granddaddy of this is Warren Buffett, Berkshire Hathaway. He’s like a human computer.
The combination of these three. So that’s how you end up with an effect of what I said earlier. You want the better businesses. You want to be able to buy them at a decent price. And with a good manager, that means the value will rise so you will own more escalators than moving sidewalks. Therefore, you end up with beach balls pushed under water with the water rising.
Agoura: When investing in a company, do you invest in a company, say you were an investor, would you invest in a company that you wouldn’t be interested in? Otherwise, would you invest in a company that you wouldn’t buy the product yourself?
Donald: That’s a very interesting question. I think in most cases, you would be a buyer of the product or user of the service. There are some exceptions to that. The one that stands out to me is the stock that some of my clients have made a lot of money on. Today, the dividend exceeds what they paid for it, the annual dividend. That’s Philip Morris or Philip Morris International. They obviously are not very healthy if you use. I don’t own it personally, but I respected my clients who didn’t want to own it and they don’t own it. Most people when it comes to investing, they pretty much aren’t making a moral judgement call. You know what I mean by that? In other words, they aren’t making a moral judgement. But the people that do make a moral judgement, I certainly respect. I don’t use it. I don’t believe in it. You are right I don’t buy it directly for myself but my clients, there are some of them that have it still.
The other day, we were talking about this at lunch the other day. I was with a couple of my sons and we were talking about branded product versus a house brand versus generic. During periods of recession, typically what happens is that people will tend to want to retain their standard of living so they may slip down from the branded product and go to house brand or to a generic, temporarily. Because when they come out of a recession, they usually say, “You know, I’m really worth the better product.” Because they view it, and so they go right back and buy it. But I’m a little bit more like when I buy Claritin, I buy generic Claritin at Costco or something like that. It’s pretty much the same thing. Classic is my wife said to me she wants me to buy some Clorox, I said, “Is it alright if I buy some generic bleach?” She said, “No, I want Clorox.” That happens a lot. One of the one’s I thought I tested once is the dishwasher soap. There was this house brand. After trying it once, I went right back to using Cascade. It didn’t work as well. But sometime they do.
Back in 1983, we went through a little recession. The same thing came up. I did a little test. I went to the store and I bought something called “Tasty-O’s” which were like generic Cheerios. Now Frosted Flakes or Raisin Bran, there isn’t really much difference. It’s almost a commodity. I didn’t know this but with Cheerios the process is really a little more difficult so you can really tell the difference between Tasty-O’s and Cheerios. I put it in the cupboard because my kids like Cheerios. Guess who ate all that box of Tasty-O’s? Yours truly.
James: You’ve been one of the great investors along with Warren Buffett in consumer brands. Consumer durables, consumer staples, your Coca Cola’s, your Proctor and Gamble’s and your Johnson and Johnson’s. And, I completely understand and I see why you invest in these businesses. They’re asset light, they have high returns on capital, they have a brand which we talked about with our kids which is an economic moat which you can create around your business. But, the counter argument that I’ve heard at least these days is that the great consumer brand companies or the economic moat of a consumer brand maybe narrower today than it was in the past. That would be because of technology, the cost to advertise is going down so that the cost to build a brand maybe has declined. Maybe the channels have changed for some of the consumer products. What would you say to the investor that said you know 30 years ago, consumer brands were great businesses than 20 or 10 years ago? But today, you post a Youtube channel and all of a sudden, you have Dollar-a-Day Razors. All of a sudden, you have a new product with a strong brand, do you think the moat today is narrower today than it was in the past?
Donald: That’s the question what we were talking about the other day at lunch. Here’s my assessment on this, there’s been a competition between brands, house brands and generic for a hundred years. Yes, technology changes and it’s possible that things will change. I know it’s much more difficult to get eyeballs today than it was 50 years ago. I get that. I will tell you that there’s something called an experience curve. And when you go down the experience curve, and you have bigger market share, you can spread your cost more. I remember once looking at Anheuser Busch. The same thing would apply to Coke. The cost per advertising per unit that they sold was much lower than somebody that had a lower market share. That’s why, what in effect happens is, as you get bigger market share, you get a lower cost structure. What happens is the guy that has the big market share, he can blow it. He can make mistakes and blow it. The little guy can’t take it from him. He has to blow up. Has it ever happened? Yes. Like Philip Morris was number five in cigarettes and ended up number one over a period of decades as they moved in on Reynolds and took the market share. Nike, certainly was, although there was more competition in sneakers. But, they came up out of nowhere and ended up with half the market in sneakers. This was existing even then.
It does happen. Things can happen today. I remember coming back to my former days, Budweiser and Schlitz both had like 20% market share. They were in a dog fight back in the early 70s. And then Schlitz made a really big mistake. They decided to make their beer cheaper by only once brewing instead of twice brewing. Again, I don’t drink beer, so I can’t tell you what the difference is, but the consumer knew it. Basically, what they did was destroy the brand. Now, you don’t even hear Schlitz. It’s gone. Now Budweiser has 50% of the brand. I think the dollar shave thing has caught people’s eye today. I think what Gillett could do… I don’t know what they will do. But, they can bring down the hammer buy lowering prices. Or, what they can do is segment the market by having a competitive razor and basically, do the same thing as these guys do. Or, they can buy them up. There are various ways to deal with it.
Agoura: I am sure over the years, you’ve acquired a lot of financial assets, but what do you think is the biggest non-tangible asset that you’ve acquired to kind of form yourself as the investor you are today?
Donald: I think being in school and being a brainchild, you end up with a lot of knowledge in your hard drive, so to speak. And the concepts after you’ve been doing it for 50 years, the concepts make more sense and come a little easier. I just turned 76. I worked for 15 years at Harvard Business School. I roughly got 50 years of experience. I did some investing before I went to Harvard, before I took a class at the University of Utah. My first class in investing.
I’ve made tons of mistakes. Tons of mistakes. Fact, let me put it this way guys, one of the things I want you, if you go into investing, recognize, that we make mistake all the time. Because nobody buys stocks at the bottom and sells them at the top. It’s impossible to do that all the time. It’s just so ineffective. What you’re doing is, what you are saying is, “I make mistakes all the time. Just get used to it.” Just try to make fewer mistakes than a lot of other people do.
Agoura: You have been an investor for so long and are very knowledgeable, Is there anything you told yourself when you were just getting started buying bonds and stocks?
Donald: I think there is a lot of material out there that I think helps. Given your background, guys at your level are really rare. People that want to be investors at your age are unusual, I think. Like I said, when I was in high school, I was clueless about investing…no concept about investing. I took a business math class because I had one semester where I had a filler. It was a different era and you couldn’t even take calculus in high school. So I took all the math that I could and I still had this one class left over, so I took a business class. It was fun. But again, I was kind of clueless.
I think probably having some experience really helps a lot. Because what a lot of it is, is really understanding what business is all about. I still make some investments outside of public companies. We have done two or three of them in our family. One of them turned out to be very successful, was a company called 1-800 Contacts. They sell contact lenses through the mail. You’re probably familiar with them. When we first made the first investment in that, they were doing a million dollars in volume out of a house in Orem, Utah. Then, we bought a percentage of the company because they needed some working capital. When within a couple of years, they were doing 20 million in volume. That was clearly a risky thing. When you go into something at that level, you are dealing with human beings. You are making a judgement call on the business model and the human beings. The business model was phenomenal, in my book, because you have all these SKU’s going through one place and you had a product that had a low shipping cost. So, what happened is, it was convenient to have a warehouse full of all these SKU’s of different lenses. And you were competing with very inefficient outlets. Basically, Mom & Pop operations that people would go get fitted and they would have to go back and get their lenses from their optometrist. So, this was just the ideal alternative. So, it made sense. The fellow, Jonathan Coon that started it, was a phenomenal marketer and businessmen. That was important.
So, get some jobs where you have some opportunity to see things at different levels. I think that helps. I looked back at all the things I read and I’ve read a lot. There are a few things that really stands out. Some people like certain things more than others. Some are very numerically oriented. I think you have to understand the numbers, but I think that the so-called value and growth camps really are joined at the hip. It’s more than just numbers. I think you need to understand the business model as well. A couple of books that I think are really good and help with that and understanding the concepts that I’ve tried to explain to you today. One of them is out of print, it’s a book called, The Money Masters written by a fellow named, John Train. It was written back in the late 70s or early 80s. The first chapter is on Warren Buffett. It’s about 20-30 pages, but he really covers the concepts. I read it many times over to really understand the concept.
Early in my career, I would look at what different money managers did and I used to keep files on them for maybe 15 years. I haven’t done it for the last probably 35 years. But I didn’t want to copy them. I wanted to understand what they were doing exceptionally. So, that I can hopefully take the best concepts and utilize those concepts. Because, in this business, one has to stand on their own two feet and have to be convinced that they are doing it the way what makes sense for them.
There are more than one way to do it. There was a great story about this. Benjamin Graham wrote a book that a lot people just love called, Security Analysis. He also wrote one called, The Intelligent Investor, but they are very statistically oriented. The Analyst Society put out a book all about his life story in 1974. When they did that, there was a great story in there. The story goes like.. there was a fellow named Newman, No, I forgot his name but he was the fellow who started GEICO, Government Employees Insurance Company. He came in and he wanted to sell the company. They had a little partnership and they bought 50% of it for a pretty good price. The bottom line is, he broke every rule that he had for investing in this partnership. They ended up having to spin it off, because legally, if you own more than a certain percentage of a financial company like this, you couldn’t own it in this investment company. He had to spin it off to his shareholders. The bottom line is he ended making more money on that investment in GEICO than all of his other investments combined. Isn’t that a great story?
James: And Warren Buffett ended up earning a lot of money from GEICO as well.
Donald: The other book is called, The Real Warren Buffett. The author is a guy named, James O’Loughlin. He’s a Brit with an Irish name. What he does is, he compared Buffett’s allocation style with Jack Welch and his management style. I think the subject of the book is manager of people and allocator of capital or something like that. I’d actually like to get Brigham Young University to use that book to start a course because I thought it was that good. But it’s at higher level, it’s almost at an MBA type of level, I think. He compares them. One of Warren Buffett’s great strength and why it’s worked for him, is because he delegates. He totally delegates. He says, “I am not here to operate it. You’re going to operate it.” They feel empowered and they really want to run the company. I think that style is very important but very few people can pull it off. They don’t feel secure enough usually, to pull it off. Buffett obviously does. Then again, we talked about his capital allocation ability. But those are the things that I would tell you.
James: Don, I wanted to jump in here. We have a number of listeners tuned in on Youtube channel. They’ve submitted a number of questions. I wanted to give them a chance to ask a question. We have one question from Vishnu Namberi. He said, “Mr. Yacktman, do you think the rise in interest rates to a level that surround 3% could be a possible cause of the next market crash, especially considering how stocks are already priced into earnings?
Donald: That’s a good question. I’ve learned over the years to forget about trying to predict interest rates, inflation and the economy. Focus in on individual issues and buy great business at good prices, the rest takes care of itself. I think the market is very sensitive to interest rates. One has to look at the both ends of the yield curve, the short end as well as the long end. Stocks truly are competing with 30 year treasuries in my estimation because the life of the company is even longer than that in most cases. Realistically, stocks should be priced against bonds and the best bond should be priced against, as a starting point, would be the 30 year US treasury from a forward rate of return.
James: So you are saying you can still get some pretty good value in the stock market relative to bonds?
Donald: Part of it is that bonds are so overpriced that it takes awhile before they get competitive compared to stocks.
Agoura: What gets you through the tough times? When, as an individual, you are not doing well in the stock market or as a company. What allows you to keep going instead of giving up?
Donald: I have an interesting story, Fortune Magazine. A fellow came up and talked to me about that in 1999 or early 2000, something like that. I would say there are a couple of things. He actually came to my home. I took him on the train, took him home and I actually took him to one of my children’s rehearsals for the show choir. First of all, I’ll answer from two different angles. One angle is in the business angle. If one is really convinced that the process makes sense and that it’s an orderly process that inevitably, the stock market over a long enough time becomes a winning machine instead of a popularity contest. To me, it was just wacko. The 1999-2000 period where basically people were walking out on the street and giving people dollar bills for 75 cents. I thought, “It just doesn’t make any sense. It’s just not rational.” So I think holding rational feelings and thought process, I had conviction that this would work out. I was more feeling badly for the people that had left our mutual fund and went other places because I was worried that they were going to be more damaged by doing that.
The second thing is, I think, is being grounded. This is from a personal standpoint. Anybody that listened to me on personal note on Youtube when I was at Google. I joined the Mormon Church when I was 15. It was the best decision I have ever made. It really has grounded me personally into looking at things from a very long time horizon and recognizing that the highest priorities in life are really my wife and my family. Business never was the top priority. So it wasn’t like my lifestyle was going to change, whether I was making X or Y. It didn’t change my lifestyle. We continued to do just we were doing. I’ve never been a big spender. I tend to be a better giver than I am a spender, frankly. Yes, I think there’s a certain level that makes life easier and so on and so forth. I think being grounded is really important and having a support system. Some people who care about you and love you and you can do things with them when you go through those tough times, that helps. A lot!
James: Don, I think that’s a great way to end it, that’s beautiful. So, thank you so much Donald Yachtman for being on and Agoura High School, thanks for being on as well. I think there’s a number of other questions we have from the Youtube, but we have to respect your time and we are going to have to call it good. But can I just say, Donald, this has been a tremendous pleasure. I think we all have learned a lot, and just your insights into the market, it’s just a breathe of fresh air, you know, relative to what we hear on CNBC and what we hear on the noise of the market and just your steady hand, it’s just a breath of fresh air, so thank you.
Donald: Thank you! Best to all of you.
James: Have a good day, Don!
Agoura: Thank You!
