When will we pay the bills? April 26, 2024

24:30And then the epiphany was, actually, it's probably perfectly high enough for a lot of people whose main consideration is capital preservation. Oh, yeah, totally. And I wonder if the monetary situation gets worse and the fiscal management continues to deteriorate, more and more people will come to look at that as that store of value proposition as opposed to that return proposition. And what am I trying to say here is I'm thinking I might need to be a little less militant on my hurdle rate expectations. You know, it's just like, I will only buy Woolies if I can guarantee myself, if I can be very confident of 10 to 12 % per annum.

25:14I might not ever get that opportunity. In fact, that's been the recent, you know, five, six, eight year history of Woolies. It's like for those waiting for a PE of long-term average of 60, you just don't get the share. I get it. Right? Yeah. Is that wrong, do you think? And I look at property as well, right? And I've always, you know me, right? I'm shaking my fist at the sky going, who on God's green earth is happy to accept a 2.5 % gross yield? It makes no sense. And then you go, wait a second. It's not about that. It's about just preserving the capital. I don't know. What do you think? That's a really good point, mate.

25:50I suspect that the bulk of the weight of people investing in those assets are not doing it for the reasons you suspect. So if they are lucking into the right decisions, I don't think a lot of property investors have gone, you know what, it's not about the tax deduction, it's not about the capital gain, I just want to preserve my capital. I reckon there's four investors out there doing that with property, the rest are chasing the tax deduction and the capital gain. With Woolies, I suspect it's a – I think it's a safe thing in terms of being blue chip and that just being a continued issue. I don't know – my speculation would be that your reasoning, though, it may be right.

26:23It's probably not what the vast, vast, vast bulk of people are doing it for. So if they get it right, they might get it right for the wrong reasons would be my guess. Yes, but just quickly on that, they are fake gains that people are chasing. Yeah. So let's say you bought an investment property four years ago and it's gone up 20%. It's a wash. You broke even. Purchasing power terms, there is no return. You've made a 0 % real return, right? My argument, though, is four years ago they weren't doing it to preserve the capital. That was never their aim. As I said, I reckon there's probably four property investors around the country who are doing it for capital preservation.

26:58The rest of it for the gains. And as fake as they might be, they're not doing it with inflation in mind. and they weren't doing it to combat four years of persistently high inflation. They were doing it because they wanted to make a lot of money. And if inflation happened to be high, then, oh, my God, I didn't get as much as I thought I did, as opposed to the other way around, where they were like, I'm going to have inflation, therefore I'll buy property so I maintain my purchasing power, which is kind of your argument. I said the question I would have for you, mate, and I haven't thought this through either because this is a new conversation we're having.

27:27If we do also say there's more units chasing the same assets, arguably we may well get the increase. You're talking about a nominal increase of 9 % or 10 % a year. We may get a nominal increase of 9 % or 10 % a year anyway. It just may be worth less. So I would suspect that if you don't. Definitely, definitely. Yeah. So if you're not looking at a real return of 6 % versus a nominal of 9%, for example, just around numbers, I would suspect that if you're right about your demand, the amount of money chasing the assets, there's not the same number of assets that in theory, The money chasing has to push those assets up.

28:03I suspect if you're right about all of that, you'd actually get more than a 6 % or 7 % return because you'll have that inflation, which would, if it's all happening, either come about because of higher profits, and again, higher paper profits rather than real profits, or a higher PE because more people chase it. So I would suspect, and this is absolutely off my head, I would suspect there's no change. You get your 10 % anyway, because while you might look at the capital preservation bit, At the same time, you're all that money chasing that capital preservation bit. That probably has the effect of pushing the price up anyway.

28:36So I would imagine in that scenario, they probably need each other out. But that's just off the top of my head. No, no, no. But that's it, right? That's kind of my point where it's sort of like, again, the people who are at this exact point in time looking at over the last five years and go, it doesn't actually seem that bad to me, are the people with assets, right? Yeah. Now, I'll make the argument and you're right. No one else is probably thinking this, but not many, but I'd say, well, you've made a nominal gain. You haven't made a real gain. Correct. Exactly. Yeah, but I've still done a hell of a lot better than someone who didn't own assets.

29:08That's exactly right. Because the person who didn't own assets, their savings have dropped to now 80 % of their savings. And your wages haven't gone up as fast, so you're going to hold twice. Yeah. So it's kind of like it's not a terrible situation on a relative basis if we continue along this path. And you look back in 10 years and go, actually, I made this nominal gain, which is really nice, but the real return is awful. It's like, yeah, but it's still better than if I was just in cash or I wasn't fortunate enough to do it. And so, again, acquire assets. Save and acquire good quality assets.

29:45I'm not saying it's going to be a path to riches and maybe your purchasing power terms don't change that much. But relative to those that don't, you will be significantly, significantly better off. And, yeah, it will always be better to have a very high real return. Yes. Yes. Of course it will be. But I tell you what, though, given the choice between a lump of, you know, just holding a melting ice cube that's melting faster and faster and something that's just basically managing to stay frozen but not growing, I'm torturing this analogy. But it's still a pretty good outcome, I would say. Can I extend that, mate, into investing land for a sec?

30:27Because you've taken us in the right direction. I have two thoughts. One is that the real and nominal thing, and just to – we kind of use those terms too easily. Nominal means just the numbers that you see, right? If something goes from 10 to 11, it's gone up 10%. That's the nominal return, just the numbers return. The real return or quotes real – I don't like real because it's sort of – it's not like the other one. It's not reality. It's just a different – I love real. I think it perfectly describes. The real return is after you subtract inflation from the return. So you go from 10 % to 11%, you're up 10%.

31:01But if inflation was 5%, to make my maths easier, even though you've gained 10 % in nominal terms, you've actually only gone ahead 5 % in real terms because the other 5 % is effectively just covering inflation. If that doesn't make sense to you, go and open up a bank account in Lebanon because they're going to give you 30 % interest, right? It's very simple. It's very simple. It's like the numbers don't matter. It's what I can get. I've got this bit of paper or more accurately a record in a bank's database. And what can I exchange for that? That's the only thing that matters. Correct. So I think that's really important.

31:38And I think it's worth thinking about. For the longest time, 30 years, maybe 40, 35 anyway, inflation has been reasonably dead. And so investors haven't needed to make that do that in any meaningful way. As company investors, by the way, when you're looking at a company's numbers, don't be fooled by revenue growth that is just pumped by higher prices if the costs are going up at the same time. There was a time you'd say, 10 % revenue growth, great. They sold 10 % more stuff. These days, you get 10 % revenue growth. You got to say, well, hang on. How much was the price up? Because if the price is up and the costs are flat, then that's even better because that's pure profit.

32:13But most of the time these days, you can say, well, hang on. My cost of goods are up 10%. My sales are up 10%. Well, all I've really done is sold the same number of things. There is no prosperity there. There is just trading water. And that's the other time when nominal and real is important to understand how fast your company actually growing in any meaningful way. At the end of the day, you want them to sell more units, again, at higher margins if you can, but higher prices don't matter much if all you're doing is covering your costs. And it's better to trade water than to sink, right? Exactly.

32:41Again, it's relative. But I guess the two things I wanted to draw out of this, mate, and two quick points, feel free to comment on either or both. First thing is when you are investing, I think you're talking about the 9 % return or the 6 % return or the 7 % return. As investors, you can choose to only invest when you get a certain level of return. In other words, I'm going to keep cash until that point. I've said before, I prefer not to keep cash. And so for me, as much as I just poo-pooed relativism before about the budget stuff, I'm looking for the highest return investments I can find. And if the best return I can find is 5 % because everything is really expensive, I'm going to take the 5, right?

33:17Because the alternative is, as you said, mate, staying in cash and having that erode. Now, if I can find 7, I'll take that. If I can find 9, I'll take that. So for me, while the absolute numbers are important, realistically, it's only ever a relative game above a threshold. No point buying a minus 2 instead of a minus 5 because you might as well stay in cash at that point. But if you can get 7 or 8 or 10, take it. And so while we talk about what can we likely assume we'll get, I think it's a worthwhile thought experiment and expectation setting. But for me, it's like, well, I'm going to buy Woolies.

33:47I'll buy Woolies if that's the best return I can get. If it's six, well, so be it. If it's nine, even better. If I can invest somewhere else and get 12, I'll take that. So it's kind of a relative game for me. The other thing I'll quickly add is just what's... We've said this a little bit before, but I want to really bang it home. For all the inflation conversations we've had, the beauty of investing, assuming inflation, is if it doesn't happen, you're even better off. Yeah. And if you're investing in a world where inflation is definite, guaranteed, probable, likely, possible, not likely, any of those scenarios, a business that has the best pricing power is still going to win 99 times out of 100.

34:23Yep. And so what's important is, again, over the last 35 years, you haven't had to think about pricing power because businesses have never needed to use it. Economies were growing. Inflation was low. You just, you know, everyone rising tide lifted all boats. at times of inflation. If we are going to have a period of sustained inflation, I'm less confident than you are, mate, that rates remain higher than they otherwise might be. But whether I'm right or you're right, buying quality companies with inflation protection, in other words, pricing power, is better in both scenarios. And this is one of those things where you get to plan for the worst and still win.

34:57Heads I win, tails I still win is a pretty good scenario. So I would encourage our listeners just to, when they're picking their stocks, Just think very cleverly or clearly about what happens in times of inflation. Does this business have price? Can they pass it on? As you said, mate, better to tread water than sink. And if X percent of the market is going to sink because they can't pass it on, they're not the business you want to be. You don't want to be in commodity companies. You don't want to be in businesses with no pricing power. You want to have pricing power. So at least in a relative and absolute sense, you're much better off.

35:28Well, that's Woolies, right? Can we talk about Woolies? Let's talk about Woolies. Let's talk about the Senate hearing. Yes, that. Good segue. Seamless, mate. Beautiful. Can I pull the curtain back just to touch for a second? We're on Zoom here, and Andrew is writing his notes with a red pen with a fluffy ball on top with antlers, best I can tell, and a little heart of the front. And I only say that because I'm trying to keep a straight face and keep this podcast going. I see this little pen kind of fluff around in front of me. My little girl has been writing on the desk, and I've been looking around for a pen, and this is all I've got.

36:02So, yeah, there you go. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

36:14Fascinating conversations this week. So speaking of holidays, mate, I only did, I think, two media things. One I forgot to cancel, so I kind of felt obliged. The other one, I got a phone call from ABC Statewide Drive, New South Wales, and it was, I think it must have been Wednesday, and it was in the morning, it's like, hey, can you come on Drive this afternoon and explain ROE to everybody? I'm like, oh, man. Talk about a hard assignment, right? You want me to explain to a radio audience who aren't finance people with no graphs or pictures or numbers, hey, talk about ROE for me. Talk about return on equity.

36:44I was like, yeah, I'll do that. I think I did a half-decent job. The producer seemed happy enough when I finished. But it all came about because Woolies was asked in a very heated exchange with Senator Nick McKim and Woolworth CEO Brad Banducci, Effectively, words to the effect of the Senator saying, Mr. Banducci, can you confirm the worst return on equity is 26 %? And Brad Banducci did his absolute level best to not answer that question. I don't know. I'm not sure. I'll have to get back to you. We use return on capital. Yeah, which point Nick McKim, that's right, got even more frustrated and threatened him with contempt of the Senate, which I thought was a slight overreach and maybe a little bit too over the top.

37:24But it was a fascinating exchange. And, of course, Brad Banduch just had a look who walked out of a 7.30 report interview. So he's not exactly covering himself in PR glory. What a self-owned goal. Just answer the question. You can say yes, that is true, because it is objectively, factually true, and it's unarguable. Then make the point that you were trying to make. But just to not answer it, I just kind of felt it was just like, Brad, come on. Can I say, mate, I reckon that whole exchange was about the worst of the Australian Parliament. Yeah. Because, firstly, you're right. Vanducci was obviously counselled not to say the number or not to agree with it or something going on.

38:07Did that help? Did that help, though? No, I agree with you. If he had just gone yes and then answered and then somebody said, we wouldn't be talking about it right now. Correct, correct. Isn't it called the Streisand effect or something? It's like the effort to – yeah. So, it comes from when Barbara Streisand tried to hide something about one of her properties. and the very act of trying to hide it highlighted it. So it's called the Streisand effect. And so this is the genius, and this is where the PR people advising him need to be fired. It's just like you have given him this advice because you don't want to talk about it, but by doing that, you have actually made the entire country talk about it.

38:39You idiot. I'm on statewide drive trying to explain it to people because Brad Badoocha won't answer the question. You never would have been otherwise. Now, that said, the question from the senator was also, frankly, stupid. and he knew the answer. So what was this about? This was about a senator trying to start a line of argument, which is, hey, Woolies, you're obscenely profitable because your ROE is 26%. Isn't that right, Mr. Banducci? And so you're right. Nick McKim's trying to set up a bit of a gotcha kind of line of questioning where he gets to narrow and narrow and call Brad Banducci all sorts of names, if not directly at least implied.

39:13Brad Banducci knows what he's trying to do and so he tries to avoid it and therefore causing the problem that it's created, as you say, mate. That's what I mean about the whole thing being about the worst of it. The question was dumb. The answer was dumb. The whole thing is just a blight on what otherwise. This inquiry has never been about trying to uncover the truth or trying to find solutions to perceived problems. It's not even about trying to define the problem. It's about saying people are complaining about the cost of living. I am going to bash up the supermarket because it makes me feel better and it looks like I'm doing something.

39:39If I get prepared, you should say it. It's definitely not our fiscal policy, everyone. Look at those guys. So it's definitely not all of this debt and profligate spending. And let's not talk about that. Let's talk about Woolies. Ironically, though, this is from the Greens who weren't part of any of that stuff. They still just want to make a populist point about I'm bashing up the bad man at Woolies who's charging you a fortune for your cheese. It's just the whole thing is just it's political theater gone bananas. As you say, the government wants to cover it up. The Greens don't care about covering up.

40:07We want to make some cheap political points. And here we are. And it's like, you know, the opposition are going, this is great. I don't have to do anything. Yeah, yeah. Let's define it. Let's define it, shall we? Correct. Okay, I'll go. So return on equity is pretty much what it says. It's the return you have on the net assets of your business, otherwise known as equity. So when you look at the balance sheet, you have all the assets, you have all the liabilities. Equity is a difference. You can also define it as the amount of money that was put into the company to set it up plus all retained profits.

40:43they're both equivalent same math same calculate differently but you're at the same point before we go any further conceptually it's different but like I I find it handy to think about it in in one of those two ways depending on on the context so go ahead what you're going to say I was going to the example I gave mate was just a rental property because people understand property a lot more easily so the and people know what their home equity is funnily enough and when we talk about equity in a company people kind of it's just harder to grab it's the same thing Glaze over, yeah. You own a million-dollar house.

41:14You've got a$750 ,000 mortgage. You have$250 ,000 of equity. Easy. I think we all kind of know that. Super easy. And companies are exactly the same. What do they have? Machines and cars and stores and fittings and whatever else. What do they owe? Well, they owe money to their suppliers. They owe some employee entitlements, got some debt. That's all the stuff they owe. Now, you take the difference apart. With a home, it's$250 ,000. Now, we talk about, and this is, by the way, the power of gearing and leverage, which works both ways. So that's the equity part. The return part is just take your profit and divide your profit into the equity.

41:45So in this case, let's just make, again, make my life easy. Let's say you're getting$25 ,000 a year in rent, less expenses from your property. You own a million-dollar property. You own a$750 ,000 debt. Including tax. Yes, including tax, including the interest repayments. Everything else comes out of it. And you have$25 ,000 left at the end of the year. Your$25 ,000 worth of profit in that year divided by the$250 ,000 worth of equity means your return on that equity is 10%. In other words, the stuff you've put into it. And again, your point about what you pay to set it up plus any of the retained earnings actually works exactly the same way.

42:21So let's say you put in 250 grand in cash, you borrowed the rest, you're getting a 25 grand return a year. That's a 10 % return per year on your equity, the money you put into the property. And the case is exactly the same with companies as well. Yep. And it's entirely appropriate. Well, let me just slightly go in a different direction here. Go on. This is why property only makes sense with debt. Yeah. Because the alternative, to use your example, is return on – there's actually a million ways to do it. You can return on assets, return on invested capital, return on just capital. So, the return on capital is just sort of like saying, well, forget the equity.

43:08What are all of the capital base that I'm dealing with? It's all my assets plus my long-term debt. This is the money I've got. Forget about how I've structured the balance sheet. I've got this much money. So, in this case, you've made$25 ,000 on your investment property. Yep. But the capital is a million dollars. Yeah. Which is the total assets, effectively. Which is, yeah, basically, yeah. Yes. And so, what's that? What's that return? Two and a half percent. And this is where I sort of scratch my head and go, that is a really bad asset. And people are right to point out, it's like, yeah, but that with debt is actually quite good.

43:47It's like, yeah, that's true. Both are true, by the way. Both are true. Both are true. But there's no free lunch. I can, you know, my return on equity, there's so many different directions to go here. If I was a CEO and I was incentivized, my bonus depended on return on equity. That which gets measured gets done. That which gets incentivized gets done. I would very easily get my bonus because I would probably just take on a bunch of debt. Of course you would. You know? You'd be able to. Yeah. And all of a sudden, without doing anything, my return on equity, because I'm just going to erode the equity base there.

44:31Is that appropriate? I don't know. Return on capital, Brad's right. That is an appropriate measure. I'm just like, I need to sort of look at the return I am getting with the assets I am deploying, and on that basis, it's not as good. Tell me why it would matter, mate. Why? I mean, if you can, every property investor listening to this says, well, who cares about the assets? I don't, I didn't put the money in for the assets. I didn't put the equity in. I'm getting a cash return from that. Money is money. That's all I care about. the asset could be worth$55 million or$1 million or half a million dollars.

45:06If I'm only putting in a quarter of a million dollars, I'm getting$25 ,000 a year back. Yeah. I'll take that every day. I mean, effectively, as shareholders, that's what we do. When we invest in shares in a company, we don't take on a portion of the debt either. We just say, well, I'll take the equity. Thank you very much. Yeah. So in what circumstances would it be worthwhile comparing the two and what would make one better or worse than the other? I think when you look at return on capital, it tells you the economic attractiveness of the undertaking that you're doing. And then return on equity is just sort of saying, well, how is that relative to me and what I have put in?

45:43So you often get companies that are pretty ordinary type businesses in terms of what those assets are generating. And it only makes sense to sort of gear it up to make sure that the numbers make sense. And frankly, I prefer return on equity when looking at shares. I think that's the appropriate measure. I'm the shareholder. This is the equity that is a portion to me. What return can you get on it? Just bear in mind, though, that that comes at a cost. If I see a company that has a very ordinary return on capital, but a very attractive return on equity, it just means that they've taken on, probably, there's maybe some mitigating circumstances at the fringe, but basically, I've just taken on a bunch of debt.

46:23And that's cool. That's cool. Particularly if I'm a toll road or I'm an airport or I'm something with lots of tangible, hard, quality, long-lasting assets that are real, that's probably not too bad. But there is a cost to that. And the cost is if the cost of your debt goes up significantly or for whatever reason you can't meet a repayment or anything like that, you're in a much more precarious situation. What you really want is a business where you get insane returns on capital. You don't even need to leverage it. You can maybe even leverage it and get more. You would, yeah. Yeah. So the Green Senator was right.

46:57really from a shareholder's perspective, they care about the return on equity. Just make sure that that doesn't come at the expense of over-leveraging the business. I pulled up the numbers here, mate, just for fun, out of Capital IQ. What was return on equity last financial year? 25.7%. Huge. Yeah, it's great. They have$5 billion worth of equity. Yeah. They also have$27 billion worth of debt. So their return on assets is only 5.5%. In other words, everything that's required to make Woolworths run, all of the money they had to put in, the shelves put in and kept in, all the money they borrowed, that's all required to open the doors.

47:37And those assets combined make 5.5%. And I think that's right. Now, Woolworths is a very high-quality business, right? So from an investor's perspective, but if you had to fund Woolworths, If I said, you can buy Woolies outright and pay off all the debt. When you do that, you're going to get a 5 % return. Now, again, I want to be really clear. Woolies is a high-quality business in a lot of ways. Financially, not so much. Why? Because it's an incredibly capital-intensive business. You need a lot of resources. You need warehouses and racking. Right, exactly. You need staff. You need registers. You need light to get air conditioning.

48:15You need all that stuff. Everything that goes into it. And you only make a 5 % return on that, which, again, it's fine. Woolies is a great company. Their debt is pretty secure because, frankly, who doesn't go to Woolies at least once every month? And if you do, you probably shop at Coles. But combined, the supermarket businesses are going to be completely fine because they are the only game in town. Now, by the way, at some point in the future, if Amazon or Kogan or Drink or someone else takes over, it's not guaranteed to be protected forever. Woolies is doing a really, really good job of fighting the online fight.

48:45I think their online stuff is really great for what it's worth, I think. I don't know, shares of Woolies. and that debt has got to be paid either way and that's to Andrew's point where the risk is, right? If everything goes fine, leverage is great. As Warren Buffett would say, leverage is the only way a smart guy can go broke. The other one, leverage magnifies gains and magnifies losses. You've used the example a lot of times, Ram, about banks. If property prices fall so much, their equity gets wiped out, the same is true of Woolies. I mean, they've only got, I say only,$5 billion worth of equity and$30 billion worth of debt.

49:17If you can't make those repayments, here's the other thing about debt, by the way, when interest rates go up, your profit goes down. So those returns, one of your key parts of your P &L is that interest line. If you've got a massive chunk of debt, you've got to pay the bill on that sort of stuff. So those are, I don't know, mate. Banducci was silly to play silly buggers in the Senate inquiry. I just thought the question was just, I think it was, I'll say it, I was going to say it dumb. It's clever because he was trying to make a political point. It had no policy value. No one knows what return on equity is who will listen to that thing except for a couple of nerds like you, May, and most of our listeners.

50:00Most other people, what McKim wanted them to hear was, Woolies makes 26 % profit? That's obscene. He wasn't going to try and explain it. He wasn't going to try and break it down. He wasn't going to try and explain why it was good or bad. He wasn't going to ask about the return on assets because why would you? And that's the kind of, you know, it's public opinion manipulation. And every politician does. It's not just McKim, it's everybody. For a particular point. And, you know, maybe he made his point, maybe he didn't make his point. Maybe he looks like a genius and a hero to his voters or to people who might vote for him.

50:29Maybe he doesn't. By the way, it's not just about the Greens. I'm not going to name individual others, but there's plenty of other senators who've done the same sort of thing in different contexts. That's what makes the whole thing a circus. Is 26 % return on equity unreasonable? if you're a supermarket, does that suggest to you excess levels of profitability or anything that should be addressed? I don't know if I could draw such a direct line. I mean, it does say to me that it is... I mean, the way they've chosen to structure themselves, yeah, they're extraordinarily profitable. Because the reality is, I mean, everything, you've got to look at everything through the lens of opportunity cost.

51:03So it's never going to happen, by the way. But in theory, shareholders could vote to sell all the assets, pay off all the debt, and the equity is what they're going to get. That's what they're going to get. And now it's like, okay, now I've got my equity. What did you say it was? $5 billion. $5 billion. I've got$5 billion. Where can I invest that and what kind of return can I get? Yes. Yeah. 26 % return. Well, that's talking about hurdle rates. Yeah. Actually, now that I've thought about it, don't sell the assets. Don't pay back the creditors. Let's leave the equity there and let's keep getting a 26 % return because that is incredible.

51:36That is more than double the long-term average of equity markets. It is, Woolies is a very, very profitable business. And for anyone to suggest otherwise, now it's partly that because of the way they have structured themselves, but they can structure themselves that way. Who has the lowest cost of capital, debt capital in Australia? I reckon you'd be hard pressed to find someone who has a lower cost than Woolies. Every bank in the land and in the world will lend money to Woolies. And that, because it is such a, it's such a safe pair of hands. So to say that, oh, well, it's only that because we've chosen to leverage ourselves that way.

52:11But why wouldn't you leverage yourself? You'd be negligent not to do it because your debt - I looked at a company that I own the other day. They're paying 12 % on their debt because they're a small, unprofitable business. Like, well, I'll lend you some money, but it's not going to be the terms that Woolies get. Woolies enjoys those terms and will always be able to enjoy those terms. So I think if you want to talk about profitability on the money that I have or what you have collectively as shareholders, it is absolutely appropriate to look at return on equity. But again, as you said before, it's like they're both right.

52:45Return on capital tells you what's actually being generated off the assets at your disposal. That's absolutely relevant too. It depends on the question that you're trying to answer. Yes. And I never – this is the point I always make with any kind of ratio analysis or fundamental analysis when you're looking at a company. People love to say, oh, you just look at this, this, this, and this will tell you everything you need to know. And if it's all green, then that's a buy. And we love these little formulas. But you need a holistic view. They will all tell you something different. And it's only when looking at all of them do you get a proper sense of it.

53:26And I just think when I look at Woolies, I just think that, yeah, relative to the assets, it's not super profitable. But given the positionality of the business, given the access to funding and that, no, it is absolutely appropriate to leverage it to a reasonable degree, which they have. And that is the return that they get by virtue of what they're able to do. And yeah, it's a damn profitable business. It is absolutely a profitable. I mean, look at the long-term returns. Return on equity is pretty much that you can draw. I won't do the math, but you can relate that directly to earnings per share growth over time.

54:03And what really matters at the end of the day for me is if my earnings on a per share basis rise, that is going to be an incredible tailwind for the share price. And they can talk all day long about what their margins and return on assets and return on capital and all of this kind of stuff is. But the return on equity is very good. That's driven some really impressive return on equity. So earnings per share growth, and that's helped drive the share price and dividend growth. It just has a fact. So it's a very profitable business. I think that's right. Is it too profitable? I mean, that's the question.

54:38That's the question. And I would say, well, I would say it is the duty of the board, their solemn duty as representatives of shareholders to ensure that they get the best return that they possibly can now they operate in society and society is governed in the way that we do it through a democracy and we can decide you know how much market power someone should have and the rest of it but as long as you're playing within the rules fill your boots absolutely and don't get angry at woolies right like i don't i don't you know So we expect too much, I think, from these businesses that are profit-oriented businesses.

55:25I'm not saying don't get upset by it. Absolutely. There's a lot of things to be upset by there. But you can't set up a playing field and a rule set, put players on the board, and then be upset when you don't like the result. Change the rules, right? Like, oh, but it's not the right thing to do. They should just do this because they're nice guys. I was like, no, whenever you're reliant on people doing the right thing just because, and particularly when it comes at a personal expense to them, it's just like, talk about being a Pollyanna. Like that is just pure madness. So get angry. And there are reasons to be angry, but don't, I just kind of think, I would do exactly the same.

56:03If I was made the CEO of Woolies, and everyone will hate me now, I absolutely would do the same. I would charge as much as I possibly can, and I would operate within the rules. and if we as a society think that is inappropriate for whatever reason then then yeah we we should we should change that not just an appeal to to morality which is just which is just not going to happen and i've said long and long and hard many times before it's just like competition is the solution to this problem and we should we should just do what we can to sort of foster that you know i think it's funny about speaking of people hating you it's funny how we um or some people look at woolies and say they shouldn't take advantage of the opportunity they should they should charge less.

56:42And I always kind of rhetorically ask people, when was the last time you said to your boss, look, I know you'd like to give me a 5 % increase, but I probably only need a 3%. I don't want to be too greedy. I don't want to profit you out of the inflation. I'll take 3%. Thanks, mate. I'm worried about the broader economy, so I don't want the pay rise. Exactly. And I think it's not exactly the same, but it's not miles different. Can I go back to ROE just for a second, mate? I would simply say there was absolutely zero ability to draw any correlation between how profitable a business is and its ROE.

57:13If Woolies paid off every dollar worth of debt tomorrow, then it would go back to the Senate committee in a year's time and say, Senator, my return on equity has fallen from 26 % to 5%, therefore I'm not making any money, which would be equally as stupid because it's just the capital structure, how the business is funded, nothing to do with the business. If it, by the way, went to the bank and said, actually what I'd love to do is can I borrow another$10 billion and I'm going to actually have negative equity, therefore my return on equity is incalculable I actually have no cost of running this business.

57:41There's no shareholder funds involved at all. This is just a debt machine spewing out a whole lot of money. Then it'd be an infinite ROE or not calculable ROE. Same thing. If they paid every dollar of equity down with debt to$1, the ROE would be in thousands and tens of hundreds of thousands of percent. And again, the business would be just as profitable as it is today, not more, not less, just because the ROE is different. This is where it's just a cynical kind of silly bugger play because it was never about the profitability of the business under any reasonable metric comparing the cost of the product that they bought or the way the operations were run.

58:16This is purely a funding question, which the centre either knew and chose to do anyway or didn't know, which is arguably, I'm not sure it's better or worse actually, but neither is ideal. I would simply say it's always irrelevant when it comes to the level of profitability and what's reasonable. And to your point, we should solve that with regulation or competition rather than trying to make them do something or expect them to because they're nice people. Even if that was true, 24 % or 5 % or 50 % is irrelevant. All it talks to is the amount of debt, not the amount of profitability, the amount of dollar profit the company rakes in.

58:49Yeah, yeah. Yeah, except that the capital structure choices available to Woolies are vastly more attractive and wide than they will with other companies. So it does enjoy a – I don't know if this is a privileged position. I don't know if that's the right term for it. It just does. So I totally get your point. But at the same time, it's just like given everything the way everything is, they would be mad not to structure it that way. Why would you ever do it? In fact, why wouldn't a competitor do it that way? Of course they're going to do it that way. So it's kind of, I know that they make these decisions on a return on, I don't know if we go in that direction, but a return on invested capital, which is a viewpoint, which is exactly the right viewpoint, by the way.

59:40I don't think you can ignore the fact that you do have that ability. Let me take it back to property. I don't, if all of a sudden someone made a rule, you can't borrow against property anymore. That proposition changes radically, right? But that's not going to happen. and I can, and therefore I do, and therefore return on equity is the only thing that matters. And so it is what it is. So to say that property investing would be really bad without debt, it's like, well, that's true, but we have debt, and it's not going away. So investing at Woolworths, the math would change dramatically if they had to pay back all that debt and fund it only with shit like that.

1:00:19But they're not going to. They're not going to. Exactly. So I think the reality is, if let's take them to my own point let's take a holistic approach here uh the gross and net margins of all these are superior they're best in class globally they're better than than most in the us and the uk and other places in the world they are fact yep uh return on equity is way up the top there uh one of the best uh return on capital no slouch either right maybe not as attractive as return equity but still it's good so i think you can objectively say that this is a company whose profitability is among the top of its cohort globally.

1:01:02Now, that's just fact. It's a different question to say whether or not that's appropriate or not. So this is where things sort of get a bit murky. And again, I would make the point, it's just like, well, their job is to maximize the return to shareholders. So I don't know. It's all a little bit of a circus. because it's one of these things too that let's wave our magic wand and let's reduce their profitability to the lowest amongst the global cohort, but make them still profitable so they're viable. You've made the point before, well, great. Your weekly shopping bill might drop 5%. No, no. I mean, if it dropped 5%, they would be unprofitable.

1:01:45So it drops 2%. Now, the inflation problem - So 2 % is$4 in a$200 grocery shop. The cost of living problem has not gone away. It's gotten slightly better, slightly better. And again, this is why it frustrates me. It's like, let's talk about the causal factor here. It's like all of this money that's just sloshing around and we're doing more of it. We're talking about stimulating things and all of this stuff in an economy with three and a half percent unemployment. Like, look over there. It's the greatest trick the devil ever pulled was convincing the world it didn't exist. and that's what the government's done.

1:02:21The greatest trick he's ever done is convince the world that it's not playing a hand in this kind of stuff. Can we finish off quickly with Woodside? This is another can of worms and it could go for a longer or a short amount of time. But I just want to talk about it because I thought it was interesting not to try and untie. There's a lot of people who would invest on so-called ESG, environmental, social and governance grounds. It's a new big thing. and basically people say, look, when I do my investing, I'm going to look at the company's environmental record. I'm going to look at the impact it has on the world around it, whether it's using slave labor in China or whatever it's doing socially.

1:02:59I'm going to look at this governance to make sure the board is comprised appropriately of experts and as a diverse board and all that kind of stuff. There's a whole lot of different ways to look at this ESG lens, but it's becoming more and more popular. And companies, for the most part, are responding to it, partly because regulators are making them, partly because they want to be attractive to shareholders. And they say, well, actually, look at this board. Look at our environmental track record. Here's our report on ESG itself. Here's our environmental report. So these things are having an impact on companies.

1:03:26And then you get Woodside. Now, Richard Gorda, and by the way, the vote's happening after we finish here, so I don't know whether Richard Gorda will still be the chair of Woodside in two days' time when you hear this. He is up for re-election. And there's a large number of institutional shareholders, pension funds, superannuation funds, who are voting against his re-election because the company doesn't have an appropriate climate change strategy. Now, I am on the record very clearly as saying climate change is real, the scientists are right, and we should do something about climate change. I also am on the record as saying, I don't think ESG matters a lot because whether I own BHP shares or Woodside shares or not, someone's going to.

1:04:04So my money on ESG grounds is not going to make a huge difference. But I don't want to really talk about any of those at the moment, mate. You're You're welcome to. The thing that really piqued my interest is Woodside, for those who don't know, is a gas and oil driller. Okay? It is literally in the fossil fuels. How do you have an environmental policy? This is my thing. So I don't - And if the answer is - If the shales are so worried about the existential reality, i.e. when governments stop people using fossil fuels, Woodside goes broke. That's fine. I don't know what they expect Woodside to do.

1:04:38What do they want them to go into making fluffy pens with little things on the Yukon? Do they want them to become a competitor at Woolworths? I'm not making light of the environmental realities here. If the government started to shut down Woodside, knock yourself out. But if you're a shareholder and somehow wanting the company to have some sort of environmental strategy that is somehow having fossil fuel-free fossil fuels, good luck to you. Because I'm not sure how that works. I don't think any side just got that answer. Not only that, mate. So that's the first thing, right? If you're a shareholder, you've got other shareholders who are, I think, if you don't like what they're doing, don't buy the shares.

1:05:13I get that. If you want to make government change, do it. Trying to kind of blow it up from the inside, it's not what they would say they're doing, but trying to reduce their profit or somehow find a new Woodside, which is in the business of rainbows and puppy dogs. I mean, good luck to you, but it just seems weird to me that that would be a desirable thing. And then you'd actually hold shares and then still try and make that happen. And I think if you're an investor in Woodside or any company, this is actually one of the newer, I'm not sure how big the risk ends up being, but it's a new risk you need to be aware of, is what are other shareholders trying to do with your company?

1:05:45And normally it wouldn't be a question you would have asked. I don't think at any point in the last 100 years, anyone said, hey, I own shares in General Motors, maybe, you know, 1950s. You know, there's a group of people inside who are trying to stop us making cars. You know, do I want to own these shares? And I think it's just worth, it's just worth as an investor thinking that through. The other thing, by the way, I think, and this is where it gets pretty dystopian, is what happens to companies like these guys or Whitehaven Coal? Well, eventually if the shareholder pressure is too much, they become private companies again.

1:06:14And then these shareholders who are trying to make a change have absolutely no access to these companies. They operate in the shadows, not on the public markets. And I think we kind of want to be careful we wish for a little bit because think about some of the unlisted fossil fuel businesses out there, the unlisted businesses that are in coal or something else. I don't know whether they are, frankly, Hancock If you don't like iron ore mining, there is not to, but if you don't, Gina's doing her thing and no one sees the public records. No one gets to vote or anything. She's not accountable to anybody.

1:06:42That's not necessarily a bad thing, but if you think Woodside should do something differently and it decides to delist or move to Erica or something else, I just think it's a really complex area, mate, and I think the simplistic ESG is bad, therefore X is fine, but the implications of that are, don't stop there, I don't think. I'm so against all of this ESG nonsense, and I've really got to explain myself there because - Good idea. That was the headline quote. Andrew Page of Straw Man says, go on. I mean, I love the idea of it. Yeah. But the trouble is, is it just gets gamed. It's a massive game of virtue signaling.

1:07:24Look what we're doing. Look what we're doing. And guess what? They're only going to highlight the stuff that's all fantastic. And it's kind of like, no company produces an ESG report that says, oh, we're just screwing the environment. And, you know, like, it's just all white dudes, all white dudes at the board. Like, no, they will sing the prayer and they will all be fantastic. And the consultants come in and they get a little cut of it. There's more snouts in the trough here that are trying. It's just so someone can feel good about their investments. And it's kind of like, I think if you want to invest through an ESG lens, I commend you.

1:07:55And I do myself. Like, there are certain companies I just won't invest in. But I don't need the company's ESG report or some independent consultant to tell me this. And I'm certainly not investing in Woodside if that's a concern for me. So it's kind of a bit like our carbon accounting scheme. It's just completely gained by the investment bankers. And the end result is that more carbon is going into the air now than it ever has before. But look, we've got this mechanism here that means that we can only do this and that. And it's all an accounting trickery. So it's very easy to get cynical on all of this kind of stuff.

1:08:34And it drives me mad just so we can all feel a little bit better about ourselves without actually making any change whatsoever. Do you know? That's my issue with ESG, even the so-called ethical investing in general, is that idea of I move my shares from X to Y, therefore I'm improving the world. It's like, no, you're kind of happy with what you're investing in. You've had literally, I know you slightly disagree, but to my point, you've had literally bugger all impact on anything. You just give yourself a pat on the back. You sleep better in bed. You smile a bit brighter in the morning and nothing has changed.

1:09:06Nothing has changed. And yet you convince yourself you're changing. And to be a greenwashing, fund managers sell this stuff. Some mob, I want to be careful. I won't name the specifics. effectively promoted themselves as saving, investors saved this much carbon emissions or whatever because of the portfolio construction. It's like, no, no, someone still owns those shares. The companies didn't produce any of those carbon. You just own less of them. That doesn't change. The environment doesn't say, oh, I feel so much better about myself now. Same amount of carbon, but at least John Smith changed his investing strategy.

1:09:37It's a marketing tool. The world's better. It is, isn't it? And at higher bloody fees too, that's what really gets up my nose is they charge more fees because that value signaling comes with a higher price tag. People are willing to pay it because they think they're improving the world. It's a very, very, very dodgy way to do it. Now, that all being said, should Woodside or any fossil fuel company have a long-term strategy to deal with a transition? Yes. Yes, 100 ,000 times yes. Because whether it's like it or not, the world that we live in is sort of going too slowly, but generally in the right direction.

1:10:13And you need to have a long-term strategy. around that and it's completely a dereliction of your duties and pure negligence if you don't but this is the this is the state of the world this is where the you know go to where the puck is going to be you know and it's it's going in that direction so so position yourself for it um the best example here is the cigarette companies altria and that's right yeah they they they handled it really well you know they made uh they they minimize their their reinvestment in their plant and equipment. They kept it running, but no new investment. They diversified into other areas.

1:10:51And they fought it. They fought it tooth and nail in their absolute... Careful. Trying to think of a clean word. You know, I've got no love. Bad people. No love. They are bad people, right? Like they are bringing harm to the world. But they were rational in the way that they managed their business. And I would argue that if I was an investor in these companies, I would want them to have some kind of a plan for the reality that they find themselves in. But just leave the virtue signaling aside, right? You know, I just, I feel it's sort of like the whole thing has been hijacked. So PR consultants and marketers have something else to go to market with.

1:11:35And it is, don't be suckered into these badges because it really doesn't make a lot of sense. And the other tricky part with it too is, particularly on the, a lot of this stuff, it's very subjective in the interpretation of it, you know. I mean, just to play with the example and the space that we are, let's say that for whatever reason, they're just going to, let's just get rid of all fossil fuels tomorrow. I was like, great. Less carbon in the air, brilliant. Crippling global depression that lasts for decades and our standard of living collapses back to the stone age. Poverty and unnecessary deaths, yeah.

1:12:14Just reality, reality, right? So it's just something you can't do quickly. So it's sort of, you have to balance all of these different competing things. Which again, it's not you saying we shouldn't do it, just we should do it as quickly as we possibly can, but no quicker. Absolutely, right? And there's trade-offs and there's costs and there's all of these other kinds of things. But, you know, this is just a bunch of people in the financial space trying to sort of all pretend that they're all holier than thou and look at that and we're getting rid of this evil man here because of this. And I'm like, dude, how can he possibly have – it's like the cigarette companies having a health policy.

1:12:51You know, I was like, what? Yeah, that's right. We want you to have a smoking cessation policy. Yeah, it just doesn't make sense. It doesn't make... So I do lament it. Again, just for the sake of clarity here, I'm very big on investing in things that you want to see more of in the world and not investing in things you want to see less of. My argument is that the fringe, it does make a difference because if enough people are against it, shares will trade at a lower premium. That infers a higher cost of capital. That makes business a little bit more tricky. And it's a little bit of a headwind, right?

1:13:27Like, it's not a game changer in and of itself. But if Woodside was trading consistently on a PE multiple, it was double what it currently is, it could do a hell of a lot more. And so you can have a bit of an impact. Just don't let others tell you what's ethical and what's not. Like, make your own interpretation. Yeah, fair. Nicely put, mate. I reckon that might do us for today. Will you join me again on Sunday? Yeah, let's do it, 100%. All right. Until then, enjoy the first half of your weekend and full on. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned.

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