10/10/2022
For those keeping score, this will be the second week in a row that we dive into a Michael Burry tweet.
Not to keep riding Burry’s D here, but for those who are into value investing, there’s no better time to start paying attention to these pros. I expect value guys like Burry, as well as David Einhorn, Buff Daddy, and others, to kill it in our current environment after everyone put them down for years.
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Cash Flow Monsters: These Stocks Could Have Explosive Upside
Last week, everyone’s favorite grumpy value investor/permabear must have been in a good mood. The inspiration for The Big Short uncharacteristically tweeted that he was “feeling greedy,” and later followed up with some additional color.
Let’s break down this statement, because it ties together several themes from this year.
We’ll start with cash flow. As we recently discussed, an era of tighter monetary policy from the Fed means that ultra-low interest rates—free money, for all practical purposes—are going bye bye. For the many unprofitable companies (Uber, Teledoc, Carvana, etc.) that rely on cheap debt or equity to fund operations, this is a death knell. Meanwhile, companies that generate a shitload of cash flow, especially those that require minimal capital investment, will remain unaffected from a business standpoint.
Debt + Inflation = Huge Profits
The most interesting part of Burry’s tweets, though, is his emphasis on debt. In another statement, Burry encouraged investors to look at highly-leveraged companies with “cash flow and termed out debt,” because they will be able to reduce debt loads at a “significant discount brought on by higher rates.”
What does Burry mean by this? To illustrate, we’ll use the example of buying a home.
Let’s imagine in 2020 that you were smart or lucky enough to borrow $400K for a 30-year mortgage at rock-bottom interest rates. At 2%, you might be paying something like $1,500 a month. That’s a significant expense for the average American earning $60K a year.
But if inflation averages 6% over 10 years, and your wages (hopefully) keep up, then your $60K salary eventually increases to over $100K on a nominal basis. Yet, your mortgage payment remains fixed at $1,500. In that scenario, you would be paying off a year 2020 debt using 2030 dollars. That huge expense suddenly becomes more manageable—without you doing anything!
That’s the power of inflation for borrowers with increasing incomes. In real terms, it makes your debt shrivel away (for those keeping score, we talked about this exact example nearly a year ago).
For companies, it’s a similar story. When Burry talks about businesses with “cash flow and termed out debt,” he’s referring to companies that have stable revenues and debt that isn’t due until years into the future.
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