Good Investing Talks - Christopher Tsai, what is the ultimate goal of investing?

Episode Date: September 28, 2023

It was a pleasure to welcome Christopher Tsai of Tsai Capital as our first guest in Berlin to discuss Tesla and more.

The audience of Good Investing Talks. It's great to have you back and now I've changed setup as you see in this video. Normally I'm sitting here doing the videos for you and the podcasts, but today I change seats to welcome a special guest in my new home studio. It's Christopher Tsai of Cy Capital. Hi Christopher. It's great to have you here. Tillman, it's amazing to be here in your new studio. Thanks for coming over and I hope people like this format. And if they like it, please leave a comment and also subscribe to the channel if you haven't done. But now let's jump into the conversation. Christopher, you have built a Cy Capital for 23 years. And it's normally not like the usual thing to be in business.

23 years as a fund manager, a lot of funds churn and or leave the industry and go do something else or go broke or whatever. How did you survive for 23 years? We've had a consistent investment approach that has allowed us to outperform over time. I think that if you're not outperforming over time, you're not adding value to your clients. So there's no reason for you to survive. So that's the first element that has allowed us to survive is being able to navigate through various market conditions, bare markets, bull markets, flat markets. But more importantly, I think, is having a client base that is truly aligned with that investment approach. Having a client base for us that is aligned with a long-term investment approach.

And having clients who understand that often the best time to invest capital is when your stomach says something different. We need clients who think like we do. We need clients who think about investing, contributing capital when markets are down. And we have that aligned client base. And that's really been highly beneficial to us over time. How do you think, or how do you get relations with people who are interested to act against their stomach feeling? Well, that's not easy.

I mean, it's not easy for the investment manager as well, because we're all human. We all have a certain emotional response to different environments. I think that knowing the kinds of clients in their outlook up front is really, really, really important it's critical in other words as Charlie Munger said you should choose your clients as you would your friends and it's very true in order to survive over a long period of time you really need that alignment and it's it's an interview really between it goes both ways it's not just clients interviewing side capital but it's me interviewing clients and making sure that there's

that alignment in educating them making sure we're all on the same page We have a letter on our website that is written not to attract clients, but it's actually written to dissuade clients from investing. And the reason why we do it that way is in order to make sure there's transparency up front and there's a total alignment. How long does it usually take to the clients are aligned with you and how much back and forfeits this. Well, typically, if there doesn't seem to be an alignment almost immediately, then there's never going to be an alignment. So we tend to know that

fairly soon. Now, sometimes, you know, you need to sit down with the prospective investor and try to understand what his or her ultimate goals are. And we want to make sure that we can fulfill those expectations as well. But it's usually fairly evident to us from a very early stage of that so-called back-and-forth interview. In other words, if a prospective client asks how much money or what kind of return you think you can make over the next year, that's automatically a red flag because we don't think that way. There's I'm sure many, many firms that think that way, but it's just not our approach.

We're thinking in terms of five years plus. You mentioned the word ultimate goal. What is the ultimate goal of you as an investor? The ultimate goal is to continue to learn, continue to adapt to changing environments. You asked me earlier how we've survived. So we talked about an aligned client base and being able to add value to clients. But being able to add value to clients is also a function of being able to adapt to changing times so one of my one of my goals is really to be being able to to adapt to changing times

and because the investment landscape changes constantly so how maybe walk us through this adaption so you started out 20 years ago and like maybe your portfolio is a good signaling for this how was it then and how has it changed over time yeah that's a great way of looking at it uh focusing and on focusing in on the portfolio so in the early days the there was a such a fascination with the so-called new economy companies the internet companies of the time and many of them were just worthless businesses they had they had poor business models they had no viability to turning a profit but the market was really obsessed with them especially around going into the NASDAQ peak in March of 2000.

Consequently, so-called old economy businesses at the time, the industrial manufacturers, auto insurance companies, anything that didn't have that kind of tech element, those businesses were really hated. So if you look at our portfolio in those days, you can see that the portfolio was really full of these asset-heavy, old economy types of businesses that were trading at very low price-earning multiples just because they were overlooked by the street.

And the focus at that time, as I mentioned, was on technology companies, particularly anything with a dot-com in the name. So as time has gone on, we've realized that you don't necessarily have to be in those types of businesses that everybody was obsessed with at that time. But we do like the idea of asset light, highly scalable companies that are run by truly talented management teams. Businesses that have a ability to reinvest capital at high rates of return over a very, very long duration. So our portfolio over time has moved increasingly toward asset-like businesses, scalable businesses with large total addressable markets and with deep competitive modes. So how does Tesla fit into this framework?

Because it's far from being asset light and one of your largest positions. So that's really interesting question. So they're investing billions of dollars of capital per year. However, what's misunderstood by the street is that the returns on incremental capital are really, really high. So in last year we figured the returns on incremental capital were around 80%. I don't know of another $700 plus billion company that has returns on invested capital of about 80%. The returns on equity, returns on total capital are also in the mid-30s.

So this is a business that has a lot of the characteristics that we look for across the portfolio. So we're talking about large total adjustable markets. They're not only in auto, but increasingly in electricity, in power generation, power storage. They have multiple verticals in which they're moving into, which have massive addressable markets. So you have large markets, you have large markets, trillion dollar markets, you have high returns on capital and equity, you have high returns on incremental capital, you have a culture of innovation, you have a management team that is extremely skilled in allocating capital, and you have deep

deep economic moats in across those verticals. So if you step back and you look at Tesla and you actually you dive into how the business is performing, how the business has developed, it fits all of those characteristics that we look for in in the other 20 companies in the portfolio today. How do you come to this 80 percent? So we look at the capital that they contribute in terms of property plant and equipment. We look at their inventory. We back out any items on the balance sheet that are not part of that calculation, any cash and cash receivables. And we look at their net profits after tax and we calculate

that kind of return. So it's a truly incredible business. And I think that those returns on incremental capital are now showing through more obvious numbers. So you can easily calculate return on equity, return on capital. But returns on incremental capital, you have to do a little bit more work. But ultimately, the two start to come together. And that's why you're seeing returns on equity and returns on total capital moving up. And I think more and more investors are starting to realize that this is a business. Well, capital intensive in many ways is actually capital light in other ways. And as the company moves increasingly towards software

with 60 to 70% gross margins, you're going to see higher returns on capital or at least higher returns on incremental capital, and you're going to be able to kind of figure out, you know, with the direction of the company. And I think that will start to show through on a lot of the other metrics as well. It's time for a quick advert Tillman.

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Thank you for your attention. And now, Edward Tillman and the... You mentioned the talented management that's important for you. That's important for you and with Tesla, we know one of the key manager, Elon Musk, but he's now also busy with Twitter and other projects he got into. Maybe what are the other players at Tesla outside of Musk that have impressed you? I mean, Tesla has 200,000 or so employees. So this is a deep management team. If Elon were,

to disappear tomorrow this is not a company that disappears the foundation has been laid at this point for continued success if you look at there are two there are two wonderful biographies on on Elon Musk and Tesla that have come out over the past several years what one actually came out a number of years ago by Ashley Vance and what Ashley Vance so nicely talks about in the book is how Elon has always been involved with so many projects. And this is not something new to him. He's been involved with numerous companies at the same time from the very beginning. So he is skilled at allocating his time. He is skilled at managing multiple businesses.

And I wouldn't be surprised that in the coming years that you see him step back from the CEO role at Tesla. And who are the figures in the back that lead? Because 200,000 people are like, it's a wide definition of management. Yeah, you have share of alignment of members of the production and people. You can align with stock options, but like there are a few who make the key decisions. Well, I mean, there are many. And I think I don't want to speculate as to who actually winds up taking over. I do think it will come from somebody within Tesla, but I think there are many opportunities.

It remains to be seen as to who he'll appoint, and he can be erratic in that regard, as we know. But I think it'll be somebody from within Tesla. I think their management team is quite deep. Maybe let's jump from the framework of having many activities back to your business building journey. We already touched upon a bit. And what outside of the pure investing focus has helped to build your business? Focus is really super important. And I think different people are able to focus in different ways, right? They're the people, for example, I mean, everybody's life is different.

So there are people who like to get up early in the morning and they start their day right away. So that would be me. they're the night owls right I guess you're a night owl right so you work best in the evening I find that being able to go to sleep early and wake up early resonates with me and I'm the most productive that way how do I go to sleep early well with all this you know media and and and activity that happens during the day meditation at the end of the day helps so I practice a form of meditation called Transcendental Meditation, which I'm sure many of your viewers are well aware of.

It's been very helpful to me. You're supposed to do it twice a day for 20 minutes. I don't always make twice a day, but when I do make twice a day, I can feel the difference. So TM, or Transcendental Meditation, has helped me to focus a lot. Just regular exercise has helped me to focus a lot. And so it's, that just works for me. So sleep, exercise and meditation and it really hasn't varied you know I started my business many many years ago more than two decades ago I started out in in my apartment on the Upper East Side of Manhattan and I would literally get up

around 6.30 in the morning I would make breakfast and I would go to work on my dining room table and I would take a lunch break at 12 and then I would go back to work and then I would end the day at five and I would exercise. And that kind of routine hasn't really changed over those many, many years. I'm just very regimented in that regard. But that has helped me also to not get distracted along the way. Now you've talked a bit about the I or the you and the way of building your business and your focus and keeping this, which is important because I've talked to other investors that also tell me that I have to focus and be able to keep up with the

struggle investing means but let's switch to the we because also in our pre-talk you mentioned network network network is important to build a business like you did maybe you can elaborate a bit on this and also what helped you to network in spaces where you might have a competitive advantage to other investors sure we all have to use the cards were given some people are given more cards than others one of the cards that I was given is being able to live in York City New York City is an amazing city in which to live in terms of its networking opportunities there are just so many groups and organizations that you can become a part of and

so many other investors and prospective clients people, friends, they all come through New York City in one time or another. The problem is that it's also very distracting. So it's super important that when you're living in a huge city like Manhattan, that you're able to maintain that focus. It's one of the reasons why Charlie and Warren preferred you know building their business out of out of Omaha the networks that have been most beneficial to me have come from the field of arts fine arts in particular I've loved

art from a very early age both my parents were art collectors I've spent a lot of time with artists over the years I've spent time so many like countless hours in museums and through that exposure to museums, getting to know trustees of museums, getting to know other collectors. So that's been an area that's been a wonderful circle in which to build relationships that has worked for me. But there are so many different areas

when you live in a city like New York or London or Berlin where we are. What I learned from living in Berlin that you have to learn to say no to a lot of things to stay focused. Warren and Charlie made it easy or Warren made it easy. He just focused on being in Omaha, where it's easier to say no to a lot of things. How have you learned or how has it helped you to say no to a lot of things? Well, first off, I think it was Charlie Munger who said the difference between a successful person and a really successful person is that the really

successful person says no to almost everything. I did not say no to almost everything in the earlier days of my investing journey. I do say no a lot more often today simply because if I don't I will not have the time to dedicate to my clients. So it's very important that the number one priority is the clients. that in that means research being able to spend time looking at businesses but the line is sometimes gray in other words spending time with other investors networking with other investors fellow investors who are like-minded or who might be interested in similar areas or even different areas can be hugely beneficial to

being helpful to your underlying investors it's because you learn from them you know they help you uncover potential blind spots are there any people that inspired you so many in this sense so many I learned you know my late father Jerry Si worked for Edward Johnson senior at Fidelity Investments and they had a conversation once I was told Edward Johnson Sr. said to my father, once you buy a company, don't talk to management again because you'll never be told anything other than what management wants to tell you. That's, that was their philosophy in the very early days from what I understand. They've since changed,

but I don't think that's the right approach for me. And I've learned from people, friends like Ron Barron, who has just instilled in me this idea of understanding culture, understanding that a business is not an entity that exists on its own, it's made of people. So people, understanding the people, understanding culture, understanding what makes a business tick, what makes management tick, I think is super important. So we try to align our client capital with businesses that are innovative, with businesses that are run by skilled allocators, and with companies that are always trying to push themselves further and trying to understand what the competition is doing and doing a bit more than that.

Do you look for an investing community? And Good Investing Plus might be the place for you. Here you can make friends with other investors, get feedback on your ideas, and learn and grow. If you're interested in Good Investing Plus, please click on the link below. I'm looking forward to your application. You mentioned competition. What is your framework for competition for your business? Who are you competing with as a fund?

I'm competing primarily with myself. That's how I feel. that this is a journey that it's an ongoing journey and i'm just trying to get better at what i'm doing each day i'm trying to learn something new each day i'm trying to implement some sort of process or idea that that you know something new each day that is beneficial to the the the Cy Capital ecosystem. It's, I operate with this, there's this Japanese concept called Kaizen, which roughly translates to that continuous improvement over time leads to,

to large change. So everything that we do is based on this idea of Kaizen. So I think about competition first and foremost with myself, but of course also I'm competing against my benchmark which has been the S&P 500 and I'm competing against other investors if other investors can add more value to underlying clients then those underlying clients should be with those investors so there's this constant and that's what I love about the investing business it's it's hugely competitive and it always it is constantly pushed me to try to be a better investor, a better person, more thoughtful person. It's a constant

like yin and yang. It's a constant struggle. And I like that. Chris, thank you for your insights. I want to make a cut at this point because like not only competition brings you forward also role models. We have two role models embedded in this picture, but in the next video we're showing soon we will talk about other role models that play the role for you informing you as an investor thank you for coming for this first episode and if you're interested in learning more about chris we recently had in our community good investing plus for an in-depth interview with a lot of cool questions it's not only me asking questions there and you can find the link to apply for good investing plus below feel free to apply and thank you very much for your attention looking forward to

again at the second video.