Earnings season is now in the latter innings, but it wouldn't be complete without reviewing results from Mastercard (NYSE:MA), Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B), and Markel (NYSE:MKL). Plus, Fool.com contributor Matt Frankel, CFP, discusses some interesting tax benefits of real estate investing, and he and Industry Focus: Financials host Jason Moser reveal the stocks that are on top of their watch lists.
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This video was recorded on Nov. 4, 2019.
Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, November 4th. I'm your host, Jason Moser, and joining me in the studio via Skype is Certified Financial Planner Matt Frankel. Matt, you made it back from Vegas it sounds like in one piece, right?
Matt Frankel: I did. I'm still a little jet lagged, I think. [laughs] The time difference is a killer, plus it was daylight savings time. I'm all confused!
Moser: Man, oh, man! What was it, two hours' time difference? Maybe three?
Frankel: Three. That's significant.
Moser: Come on, man! Talk to me after you've done the all-nighter from Astana, Kazakhstan to Washington D.C. So, your wife went out there afterwards, so you guys were able to have a little time away from the house and enjoy the vacation out there as well, right?
Frankel: Yeah, she did. We saw a concert. We saw Lady Gaga live, which was kind of cool.
Moser: Very cool!
Frankel: A lot of the restaurants out there, can't beat them. We had a great time!
Moser: Sounds like a very wise way to invest your time, Matt. I'm sure she appreciated it. I'm sure you did, too.
OK, well, hey, listen, we've got a lot going on this week. We've got on this week's Financials show more earnings. We're going to talk some real estate. We've got more what's the last stock you bought and why, as well as stocks to watch for the coming week.
So let's go ahead and get it started with Mastercard's most recent quarter. Earnings came out early last week for MasterCard. MasterCard is a big company. It's not going to be something where you see some big pop or big drop, one way or the other. But it did seem like a pretty good report from what I saw, Matt. Revenue growth of 16% for a business this size is just really impressive. What did you take away from the quarter?
Frankel: Obviously, you said revenue was an impressive point. International was really what stood out to me. Domestic was only up 12%, and Europe was up 16%. That was a big takeaway to me. Margins grew about 80 basis points year every year, which is always nice to see, especially for a company of this size. Spending money hand over fist on buybacks. You always mention that their dividends are really low, but when they're spending 5X the amount of their dividend on a buyback, and the stock's been up since then, so I really can't fault them for it.
Moser: No, I guess you can't. To that point, one of the things I was looking at with these companies -- because you're right, they are buying so many shares back -- is the share count. Share count is down, it looks like about 12% since 2014. That clearly is something that is helping investors. Listen, I'm a shareholder of MasterCard. I'm not complaining really at all. I feel like over time you'll see that dividend grow. I can be patient and hang in there. But yeah, generally speaking, there's not a lot to this business other than the ongoing investments that they're making in the network and pursuing new opportunities like cross-border, obviously, the ever-changing payment space here as technology changes the way that everybody's moving money around.
To give some context on how the stock has done, I was updating that war on cash basket -- to remind listeners out there, the war on cash basket, it's equal holdings in MasterCard, Visa, PayPal and Square. We started this back in July of 2017. As of today, the war on cash basket is up 103.6% vs. the market at 29.5%. That's what you call a good old fashioned butt-kicking where I come from, Matt. MasterCard is pulling its own. It's up 118% as a component of that basket. MasterCard has just done really well, particularly in the face of what is the biggest competitor in the space, Visa.
Frankel: I'm actually looking at the chart right now. MasterCard, fun fact, over the past 10 years, is up 1,160%. Since about 2005, when it first went public, 5,900%. And you have to think, when they first went public, we were still pretty much a cash-based society. We're still in the very early innings. That's been amazing progress so far. A $10,000 investment in MasterCard would be worth about $600,000 today if you'd gotten in at the beginning. And that wasn't even that long ago. I was an investor back when MasterCard went public.
Moser: It does feel like every quarter, we look at these businesses and think, "Oh, wow, they just keep on performing so well. I'm waiting for that window to be able to go in and buy shares and invest. Is it too late? Have I missed the boat?" I don't think you missed the boat with a company like this. I don't know that you're going to find big-time buying opportunities for businesses like these, because they are pretty well-known. They're pretty darn reliable, given what they do. Sometimes you have to bit the bullet a little bit, maybe pay up a little bit more than you'd like to. But that's also an argument for building a position out, not buying it all at once, but maybe buy some, and then you can add more when you feel like there's an opportunity that arises. But yeah, I certainly feel like there are plenty of great days for MasterCard to come. As a shareholder, I remain very pleased with how the business is progressing.
Let's move over to, I think this is probably one of your favorite businesses, Matt, Berkshire Hathaway?
Frankel: Oh, yeah! It's a big, big staple in my portfolio.
Moser: They had earnings that just came out. I was glancing through that 10-Q earlier. Another steady as she goes business. I feel like maybe there's some questions that I have for Mr. Buffett and Mr. Munger regarding a dividend, but we'll get to that. Matt, what'd you think about the quarter?
Frankel: [laughs] No, don't say that word. The earnings were good all around. Operating income was up by about $1 billion year over year. That's about a 14% gain. That's excluding its investment portfolio, which is doing pretty well. Apple, its biggest holding, just hit another all-time high. I think Berkshire has something like $70 billion in Apple stock now.
The thing that stands out to me in a bad way, and this is where you're going with the dividend, is the record high cash hoard. They have $128 billion of cash sitting in their accounts.
Moser: Sounds like a lot.
Frankel: It sounds like a lot and it is a lot. Here's three names, and guess what they all have in common. Netflix, PayPal, and IBM.
Moser: Netflix, PayPal, and IBM. I don't know, what do they have in common?
Frankel: Those are three stocks that Berkshire could buy in full with its cash just in its bank account. If you include a reasonable amount of debt, you open it up to companies like McDonald's or Nike or something huge like that. So this is a lot of money they have sitting on the sidelines right now. They're putting some to work. The buybacks went up a little bit in Q2, which was nice to see. Berkshire's underperformed the S&P significantly this year, like 6% to 22%. Berkshire's one of the ones that's going to be a great performer when the market's doing terrible and there's tons of big opportunities out there, they're putting their cash to work, stuff like that. But they're going to underperform when the market's going crazy like it has been in the past year or two.
You said you'd like a dividend. I'd like to see them put more money into buybacks, personally. You have $128 billion, and you're spending $700 million on buybacks? That's really nothing in the grand scheme of things.
Moser: That's also on top of, they essentially eliminated that 20% premium to book value mandate. They had said for a while that they would buy shares back only within that 20% premium to book value at any given time. I understand that perspective. They want to make sure that they feel like they're getting a good value, and that's an easy way to understand if that's a good value. They eliminated that and basically just said, "Hey, we're going to buy them back when we feel like it's opportunistic and shares represent a good value." And I trust that judgment. I like that they lifted that. But yeah, I am getting to the point where -- and I'm not a Berkshire Hathaway shareholder anymore. I used to be. But it does feel like they're trying to have their cake and eat it too. If you're going to sit there and make the argument that we're not going to pay a dividend because we feel like we can do better things with that cash, but yet on the other hand, you've got this cash balance now that stands at like $850 trillion dollars... I'm trying to get those two things to square, and I can't quite get there. I'm not really looking at it from the short-term perspective here of, the stock has underperformed this year. I agree with you. I think that Berkshire Hathaway, for the most part, steady-eddy business. It's going to probably do better in difficult times because of its diversity, because of the markets that it's in. But I do feel like this is a good point in Berkshire Hathaway's life to maybe get a dividend going and try that out. There's a lot of goodwill, I think, that you could gain from shareholders by doing that. Everybody loves cash in their pocket.
Frankel: That's true. One thing I will say is, you're no stranger to hearing that there's a recession coming sometime in the next few years. Berkshire is a stock you really want to own going into a recession. $128 billion will look fantastic if and when the market really goes on sale. And it's a question of when rather than if. That's the kind of position you want to be in in a down market. Market crashes by 20%, Berkshire's going to clean up.
Moser: That's what you call a war chest, isn't it? They've always prided themselves on being in an enviable capital position. I like that. It makes sense to me. I don't know, $128 billion sounds like a lot. I don't know if I'd feel different if they said it was $88 billion. It certainly seems like the business is in as good of shape as ever. That's the bottom line for shareholders.
Let's pivot over to what we call our baby Berkshire Hathaway oftentimes here at The Motley Fool, and that is Markel. Markel Insurance, built very much in that Berkshire mold. Three big drivers for the business in insurance, investments, and the Markel Ventures operations. Having gone through the call there, looking at the business, the results, I continue to be very impressed with what they're doing. I always immediately go to the Markel Ventures part of the report. For whatever reason, to me that's the neat part of this business where the future seems so bright. They're doing that same sort of Berkshire Hathaway thing where they're investing in these little businesses that cross all sorts of different markets and do all sorts of different things. It looks like revenue from Markel Ventures grew to $1.6 billion year to date from $1.4 billion a year ago. It's really gaining a lot of traction there. They've made some new acquisitions. Continues to be nicely profitable. EBITDA for Markel Ventures was $219 million for the first nine months of 2019, compared to $128 million from last year.
But wondering what you gleaned from the quarter there. Any concerns or anything you thought is working really well for the business?
Frankel: Markel Ventures is definitely the strong point of the quarter. Book value grew 18% just in the first nine months of the year. That's a big reason why. The rest of the business is doing fine. Insurance took in almost 10% more premiums this quarter than the same one last year. Not for nothing, Markel has the same cash problem as Berkshire Hathaway, on a smaller scale. Their cash and equivalents went from $2 billion to $2.7 billion over the past year. For a company of that size, $2.7 billion is a pretty good cash hoard. It seems like they're having the same issue of putting money to work. I don't hear anyone clamoring for a dividend from Markel, though.
Moser: No. I am a Markel shareholder, but I don't expect a dividend from them until maybe they get bigger by about 10X. Then I'll start beating that drum. How about that?
Frankel: To be fair, they don't they don't need what Berkshire would consider a needle-moving acquisition to make some money. They can buy a company for $100 million and it be a meaningful impact. Berkshire, why even bother?
Moser: Absolutely. Well, we had a good question from Twitter. To that point, talking about Berkshire and Markel, talking about how these companies perform in good times and bad. We had a question from Twitter. I thought it'd be fun to kick around for a second. It comes from @12packradio. The question is, "It seems like Markel is a good business. I'm a shareholder. But shares have remained stagnant relative to the market for the last two years. Any insights into why?" Wondering what your thoughts there are, Matt.
Frankel: My thought is generally just because they haven't had any major acquisitions. Markel and Berkshire are both down market stocks. Berkshire's performed so well over the years not necessarily because it does well when the market's up 30%, but because when the market's down. I don't know the statistics for Markel, but I can tell you, in Berkshire's case, the S&P has been down 11 times in the past 50 years. Berkshire has outperformed in all but two of them. That's what makes their money over a long time. They thrive during the bad times. Just recent investments they made were Bank of America and Goldman Sachs during the financial crisis. Those were wildly profitable for them. They bought Amex way back in the day when the stock was in trouble. I could go on with that list. Markel does it to a smaller extent, but same thing. The down times are when these companies are really going to shine and make up any last ground. So, during the good years, we said these are both underperforming the market, but don't think of it that way. Think of it as, they're holding their own during the good times, and they're going to really shine and outperform during the tough times. And over the long run, that's what really makes a difference. They're doing great no matter what the market does.
Moser: Yeah, I like that way of thinking there. These are businesses that are slow growers. We're talking about insurance. In Markel's case, specialty insurance. It's even more of a unique market there. It's one that they're really good at. But it's not some kind of SaaS or tech company that's going to be just lighting the world on fire with its profitability. To your point also, even when times are good, it seems like the entire market is just doing nothing but going up, companies can run into little snags. It's easy to forget, because really, at the end of the day, it's probably not that big of a deal. But it wasn't all that long ago, and this is still an investigation that's not been resolved yet, there's an investigation going into Markel's CATCo unit in regard to setting up reserves and disclosures related to those reserves. That could be one of those things that's hanging over their heads just as a dark cloud. Listen, it's not something that is terribly meaningful to the business. It's not something that's going to be fatal to the business. But I remember when that news came out, and the market really did overreact on that news. And then as context became a little bit more available, we could see that it wasn't really that big of a deal, but it's something that still has not been resolved yet. My point is, there can always be a dark cloud or two hanging over a company that is preventing it from maybe realizing its true potential. I do agree with you there on Berkshire and Markel. These are companies that really prosper when times are tough because they prepare themselves so well for those times. I suspect we'll see that same type of value unlock for Markel, but it comes in dribs and drabs.
Frankel: Yeah. Like I said, it's a long-term-focused stock. Don't pay attention to any of the short-term noise with these. That's really the best advice I can give anybody who wants to look at either of these two stocks. I generally tell people not to pay too much attention to quarterly earnings, but it's especially true in these cases.
Moser: Yeah. Let's pivot over to real estate. Let's take a look at something you have here, Matt, for us. Everybody knows here that you are part of our Millionacres team. That is our investment service focused on real estate, helping investors learn more about real estate and ways that they can invest and build real wealth in real estate. That's over a millionacres.com. Make sure to go check that out! Hey, listen, it's free, so there's that, too.
But Matt, you wanted to talk a little bit today about the tax benefits of real estate investing.
Frankel: Yeah. A lot of people don't realize just what a tax-advantaged asset class real estate is. Before I get into the discussion, I just saw that the President lost a hearing about his tax returns. They keep saying that his returns are likely to show no income. My theory is, the reason for that is because his primary investment is real estate. See, I was going somewhere with that. [laughs]
But, let me just give you an overview of what I'm talking about. The first major tax benefit to owning real estate for an investment, not as your primary home, is known as depreciation. Each year, let's say you have a rental property that takes in $20,000 of income. You can first deduct all your operational costs out of that $20,000. Your property management fees, the interest you're paying on the mortgage to own the property, things like that. Then you have this benefit called depreciation, which means you can gradually write off the entire cost of the house over a set period of years. For residential, it's 27.5 years. This is a big tax deduction every year that you can use to further reduce your rental income. The effect of that is, rental income on an investment property is usually barely taxable, if anything. I have a few investment properties. Last year, one of them had had negative taxable income, even though it was a profitable rental property. The reason is depreciation. You can use this every year until you've deducted the entire value of the property. It's a huge benefit. It's why a lot of real estate income is not taxable, which is why I say on the President's tax returns, it's probably going to be so low. He has a portfolio of hotels and office buildings and things like that.
The negative to that is that when you sell the rental property, the IRS wants that benefit back. It's called depreciation recapture.
Moser: I went through that once. I do know what you're talking about. You have to be aware of it. It wasn't anything fatal. It wasn't something I wasn't prepared for. But I did recall that. At some point or another, the tax man wants his money.
Frankel: Yeah, it's not as much of a tax break as it is deferred taxation. But there's one loophole that you can use to even get out of that. It's called a 1031 exchange. What that means is, if you sell one rental property, as long as you use the proceeds of the sale to buy another one within six months, you can avoid capital gains and depreciation recapture, and essentially roll it into the new property. Theoretically, if you do that a few times throughout your life, you can avoid rental property taxes forever, effectively. What's more, even if you do wind up with some taxable rental income after all your expenses and depreciation, real estate income counts for that new 20% pass through tax deduction. So you get that right on top of it. That's true for rental properties and REITs, by the way. If you get REIT dividends, it qualifies for that 20% deduction.
So, this is a really tax-advantaged type of investment. It really gives long-term investors an advantage, especially compared to other investments like stocks that you're holding outside of tax-advantaged accounts. Obviously, your IRA is a great place to invest in stocks, and that's a pretty big tax advantage all by itself. But when you're comparing things that you hold outside of those tax-sheltered accounts; real estate really has some big advantages.
Moser: Yes, it does. Great insight there as always, Matt. Appreciate that.
Listeners, we want to hear about the stocks that you're buying. You can email us at firstname.lastname@example.org, or you can hit us up on Twitter @MFIndustryFocus. Let us know the last stock you bought and why. We got a tweet from Mark Hyman @investorhyman. He tweeted in to tell us that, "The last stock I bought was," guess what it is, Matt? "Berkshire Hathaway."
Frankel: It's a good plan. I don't even need to hear the reasons.
Moser: Mark says, "The last stock I bought was Berkshire Hathaway because one, it's a long-term safe holding that I'm confident in, it allows me to sleep at night, and two, so I can go to the shareholder meeting in May 2020 with my dad and girlfriend, who are also shareholders." Well done, Mark! Having been to that meeting, I can say that I think you will enjoy it. It's a fun event, for sure. Busy, busy, busy. But fun. Make sure you get in line early for the See's Candy because it's well worth it.
Frankel: I've actually never been. I think I'm going to try to go in 2020. Every year I just had something else going on at that time of year, a kid being born or something like that.
Moser: See if we can't make sure to let Mark know. You guys can hook up at any Fool sanctioned event that we may have there, Matt. We'll keep that on the radar.
Matt, I also wanted to jump in here because I recently bought another stock as well and I can now actually tell people about it because the time for silence has passed. I just opened a position recently in Shopify. For all of you folks out there looking for that dip in Shopify to go ahead and start buying shares, you're welcome, because I have a feeling it's coming any day now. I feel like Shopify, financials notwithstanding, because we know they're not profitable yet, I think one day they will be, but regardless, it's pursuing what is a massive market opportunity on a global scale. I think that what Amazon has done to date in really changing the face of commerce, bringing e-commerce to the forefront there, there's a lot of demand out there for that. I think we need more players in that space than just Amazon. I think Shopify recognized that early on. They're making a lot of those investments to play a part in that market. I think there's a lot of neat things that the business is doing. It's a little bit of a riskier stock, no question. The stock has been on fire over the past several years. But it's a business that I ultimately want to own. It's one where I bought a small position to open it up. I'm thinking that if it's a stock that goes down in difficult times or on a tough report, I wouldn't mind adding to it, assuming all things are still as they seem today. I did just recently open a position in Shopify, and wanted to let everybody know that.
Anyway, before we wrap up this week, Matt, we want to just give the listeners our Ones to Watch here. What is the stock you'll be watching here this coming week and why?
Frankel: I think Green Dot is finally ready to turn the corner. I know I talk about them a lot on the show, but they just extended their Walmart partnership, which is their most important part of their business by far. That's how they got started, by doing those Walmart money cards that you see by the checkout. They extended that. They're starting a fintech accelerator in partnership with Walmart. I can't think of a more deep-pocketed partner that you'd want to do that with. They expanded their Uber relationship, as we discussed on the show last week. I think Dan Kline also talked about it on his show. I think they have a whole lot going for them. The stock price popped a little bit after they renewed the Walmart partnership, and it's still way, way down from where it used to be. I think now's a great time to get into it. It's toward the top of my list. I still haven't pulled the trigger on Green Dot just yet, just because I keep talking about it and I don't have very many opportunities. But if you don't hear about it from me next week, that might be why, because it's toward the top of my list.
Moser: Alright, I'll hold you to it, man. Then we have to get you on the last stock you bought and why list.
Frankel: It's been a little while.
Moser: I'm going to be keeping an eye on Disney. Disney earnings are out on Thursday. This is just always a great one to cover because they do so many different things and make their money in so many different ways. But clearly, the big questions are all going to center around the Disney+ streaming service that's getting ready to launch here in about a week, I guess. It's been a decent year for the stock. The market, it seems like it's outperforming it ever so slightly. But generally speaking, a pretty good year. I'm really looking forward to getting some more insight on the Disney+ streaming service and how they see that impacting their business here over the coming years, particularly as they're offering such a strong value for what you're getting there with those three channels and the bundle and everything.
With that, Matt, I appreciate you joining us this week as always!
Frankel: Always good to be here! I love our conversations! Hopefully I'll have something to add to last stock you bought next week.
Moser: I'll be waiting! Listeners want to know. Alright, man, catch you next week!
As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Austin Morgan. For Matt Frankel, I'm Jason Moser. Thanks for listening! And we'll see you next week!