In one sentence: Phil argues that real estate should be valued as a business by its cash yield (cap rate) rather than by what a neighbour sold for, and ends with a tangled but useful link between cap rate, payback time and the PE ratio.
Key ideas
- The tools apply beyond stocks. A listener said they preferred real estate, so the podcast didn't help. Phil's answer: the same valuation tools apply. [00:00–02:00]
- Comps are not value. Investors in 2005–08 valued property by what a similar one sold for last year, so they overpaid. Phil calls "the price you pay is what it's worth" the heart of the efficient-market idea and says it ignores emotion. [01:00–04:30]
- Greater-fool thinking. "A greater fool will pay more" works while a bubble grows, which is why flippers are right repeatedly, until they aren't. Phil mentions a friend's family tragedy after a collapse. [04:00–07:00]
- Intrinsic value protects you. Diamonds or art trade on market views. A business or building produces cash, which sets a floor on value. [06:00–07:30]
- Your home is different. A home you'll live in is consumption. Phil's advice here concerns investment real estate. [07:00–08:00]
- Real estate seems easy, until it isn't. Phil tells of an investor who followed Bill Nickerson's Oakland apartment approach for years and then lost a million-dollar sale's proceeds on a single commercial building he didn't understand. Looking at it as a business (tenants, location, structure, track record) would have shown the risk. [08:00–12:00]
- Buffett's Greenwich Village building. A government-owned building with a below-market tenant for nine years. Buffett saw a good business with an income that would jump, so a 10 cap with a nine-year wait made sense. Cap rates are calculated as if you paid all cash. [12:00–15:00]
- Apple at a "12 cap". Phil says Apple's free cash flow was about 11.9% of its price in mid-2016. Only illustrative and unchecked, with his bronchitis and medication joke. [15:00–16:30]
- Multiples in one place. Phil's class numbers: private business 7–8× earnings, public non-growing business 10–14×, public growing 15× and up. See's Candies bought for $25 million and later made about $65 million of free cash a year without growing. [16:30–19:00]
- Buffett prices at the private multiple because he doesn't need liquidity. [19:00]
- Cap rate vs PE. A $1 million business bought for $7 million gives 1/7 ≈ 14% (Phil says about 13% as a round figure). The cap rate is roughly the reciprocal of the PE ratio, although PE uses earnings and cap rate uses owner or free cash flow. [20:00–24:00]
How it maps to RuleOne
- Free cash flow yield on the stock pages is the stock-market cap rate. A 10% yield equals a 10× price-to-cash-flow multiple, as in 050.
- RuleOne doesn't cover real estate directly. The holdings page treats REITs as stocks, so use funds from operations rather than earnings.
- Compare PE with cash yield: if they disagree, look at capex and working capital.
Buffett, Munger and Graham links
- Buffett's 1990s purchase of a Greenwich Village building from the Resolution Trust Corporation (the government agency for failed savings and loans) is Phil's example. Details are from Phil's memory.
- See's Candy: Buffett bought it in 1972 for $25 million. The 1983 letter and later letters describe how little capital it needed.
- Graham's The Intelligent Investor (ch. 1) separates investment from speculation by analysis and safety of principal.
Words to know
- Cap rate: first-year cash return on the price paid, assuming no mortgage.
- Greater-fool theory: buying something expensive on the hope of selling to someone who pays more.
- Comps: recent sale prices of similar properties.
Try this
Choose a REIT or any company on /stocks/. Compute free cash flow (or funds from operations) divided by market cap. Compare it with the 10% target and with 1 ÷ PE.
Check yourself
- Why did investors in 2005–08 overpay for property?
Answer
They valued it by recent comparable sales and assumed a greater fool would pay more, instead of by cash yield. - What is a cap rate?
Answer
The yearly cash return on the purchase price, as if bought for cash. $1 million on $7 million is about 14%. - How do cap rate and PE relate?
Answer
Roughly reciprocals, but one uses owner or free cash flow and the other earnings.
Short quotes
"The intrinsic value is what saves you from market pricing." (Danielle, ~06:30, auto-transcribed)