Benchmarking Against Treasuries -- Is It Aiming Too Low?

Hailed by The New York Times as a "guru to Wall Street's gurus," value investing expert Bruce Greenwald takes some time to offer his insight and advice to The Motley Fool. A professor at the Columbia Business School, Greenwald has also authored multiple books, including Value Investing: from Graham to Buffett and Beyond.

Looking at Nestle as an example, Greenwald looks at long-term risk, investors who target extremely high rates, and why debt returns may be higher risk than you think.

Full transcript below.

Matt Koppenheffer: We were listening to Donald Yacktman speak yesterday, and he was talking about comparing to low Treasury rates, and you can justify stuff looking a lot more attractive against that. But then I think about, I'm pretty sure it was Mohnish Pabrai who talks about targeting a specific -- I think he wants to double his money every three years or so, and that's like a 25-26%.

Bruce Greenwald: Lots of luck. As a target.

Koppenheffer: It's a high mark, yeah. I guess what I'm curious about is benchmarking against Treasuries, particularly when they're low. Maybe you shoot and score and you get a 5% return. That's a low return, but if you are targeting a really high rate -- even if it's not that high -- then if you hit and miss by a little bit, maybe you're getting 15%.

Is there any advantage to targeting a specific...

Greenwald: Look, I think that if you do the kind of calculation I just did, there are no stocks that are offering safe 20-25% returns, so what he's implicitly counting on is some sort of improvement in multiple, and lots of luck forecasting that.

OK, but let's go back to the Nestle versus Treasury calculation. You're getting 3% in 10-year Treasuries, 4% in 30-year Treasuries. You've got all the risk of inflation.

Now at the moment, and for a while, inflation has been incredibly stable between 1-2%. Except for a while it was a little bit -- because of the natural resource inflation -- it was a little bit above 2, but it's basically fluctuating around 1.7.

On the other hand, you have an absolutely unprecedented monetary environment. But you've had long-term deflationary pressure in the international economy as a whole, whether it's from Europe or the United States or Japan, or all these other now-emerging market countries.

Who the hell knows what's going to go on? But there's got to be at least a one-third chance that we're going to turn into a much higher inflation environment. You have to be aware of that risk. You're getting a 3-4% return in a very high risk context.

Now look at the Nestle return of 9-10%. In the long run, is inflation going to affect Nestle? No. We've seen it. We've seen the worst kind of inflation we could have, where it's in their input prices and not the competitive output products since 2003, and they do just fine.

We've seen, do they face recession risk? No, we've seen the worst recession since the depression, in 08-09, and they do just fine.

You have to ask yourself, what's the long-term risk in owning those things? Where I would come out and say, "Look, what's clear is that the debt returns, even at these levels, don't compensate you for the risk you're taking on." That's clear, No. 1. Those are overvalued assets.

Koppenheffer: It's not as much a risk-free return as people might think it is.

Greenwald: Right, as they want to believe. OK.

But I think the second side of it, ask yourself this. Even by historical standards, in a very diversified company like Nestle, in very stable product markets where the damage they can do from the current stupidities is fairly limited because there's a long history of their learning about the stupidities after a while, with very low leverage, is a 10% return a good return by historical standards?

I think the answer is yes, it is. What you're talking about is that that's a stock that probably is, in some long-run sense, a good buy.

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