Invest Like the Best with Patrick O'Shaughnessy - Aswath Damodaran - Making Sense of the Market Pt. 2 - [Invest Like the Best, EP.349]

Episode Date: October 24, 2023

Today’s guest is Aswath Damodaran, who is joining us for a second time on Invest Like the Best. Aswath is a Professor of Finance at NYU’s Stern School of Business and is often referred to as the Dean of Valuation for his clarity of thought on the subject. This conversation picks up where we left off 18 months ago and covers a wide range of topics from macro risks to Nvidia and the process of crafting a personal investment philosophy. Please enjoy this great discussion with Aswath Damodaran. Listen to Founders Podcast Episode #311 James Cameron For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Tegus Converge — the first virtual event centered on the world of investor research. When twin brothers Tom and Mike Elnick realized that the research process for investors was broken, they founded Tegus to fix it. Now the people behind the most trusted research platform are bringing institutional investors together to investigate the state — and the future — of fundamental research. On November 8th, join industry luminaries like IGSB Founder Reece Duca and Daniel Gross, AI Expert, Entrepreneur and Investor, to dig into the latest research trends and breakthrough technologies shaping the investment landscape. Register today at tegus.com/register. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes.  Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes (00:02:45) - (First question) - The general prevailing narrative in markets today (00:05:00) - The biggest business implications given the current market landscape   (00:06:45) - Why it’s bad to have risky founders with cheap capital trying experiments (00:08:53) - The natural rate of interest and how it’s priced  (00:09:55) - His updated view and thoughts on what’s currently driving inflation   (00:11:05) - What it’s felt like valuing companies given rates being where they are (00:13:35) - Macro variables that most have his attention today (00:18:45) - Whether or not international equities will become a place of interest (00:21:53) - The unique absolute basis of NVIDIA’s growth  (00:23:25) - His take on the new wave of AI in a broad sense  (00:29:15) - Trying to value AI companies without tangible business models (00:32:45) - The parts of his own valuation process that are beyond automation  (00:34:20) - Thoughts on a natural end state equilibrium for active management   (00:35:55) - Commonalities between investors who beat the benchmark  (00:38:35) - Episodes on his own path that lead him towards his investment philosophy  (00:42:05) - How he goes about valuing non-traditional companies like sports franchises  (00:46:45) - The world of entertainment and how he sees it as a business today  (00:53:45) - The best business models he’s ever seen  (00:55:40) - What valuing Instacart taught him about online grocery shopping (00:58:55) - The most interesting company he valued over the last year (01:03:25) - How bank failures changed his thinking on our financial systems and banks as businesses writ large  (01:06:15) - The changing attitude towards ESG investing  (01:11:11) - Why there are still so many pools of capital that pursue an active strategy (01:11:06) - Being sick and tired of the conversation always revolving around central banks (01:15:53) - What he’s most excited to look into over the coming year (01:17:53) - Major differences between a financial and an accounting balance sheet

Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at join colossus.com. Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO. of O'Shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive sum or O'Shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as a basis

for investment decisions. Clients of positive sum or Oshonnessy asset management may maintain positions in the securities discussed in this podcast. My guest today is Aswath Demoderate, who is joining us for a second time on Invest Like the best. Aswath is a professor of finance and NYU Stern School of Business and is often referred to as the Dean of valuation for his clarity of thought on the subject. This conversation picks up where we left off 18 months ago and covers a

wide range of topics from macro risks to NVIDIA and the process of crafting a personal investment philosophy. Please enjoy this great discussion with Aswap Demotin. So Aswatra, about a year and a half ago now we had our first conversation which was I think at the time our most listened to ever. So let's see if we can top it here today. To do that, we have to do a whirlwind tour of the world of markets and business and investing. And I thought I just began by asking you for your state of the union on the market overall. Just started kind of the last part of the year, the last quarter, been kind of a wild

year, last 18 months. I'm just curious for your take on the general prevailing narrative, as you see of what's going on in markets today. I think there are two prevailing narratives. And one of them has to be right, and the other one's going to be wrong, with profound implications. The first is that the last 18 months is actually the aberration, that we're going to revert back to where we were before that, that the Fed is going to reimpose its power, rates are going to go down, everything's going to go back to the way it was. That's one perspective. And a lot of people are doing mean reversion to the last 10 years. That is the perspective they're taking is, hey, you know what, this two shall pass and everything's going to be okay. The other is that maybe the

last 18 months of the norm, not the exception. And what we saw in the decade leading into that was actually the aberration. And you know what, there's a pretty good argument that the latter is, in fact, the more reasonable assumption. And here are the implications. You look at a four and a half percent rate, you're shocked, especially if you're 25 or 30. You're saying T bond rates at four and a half percent, nobody's seen anything like this before. Not true. we've seen much worse than this. But I think because you had a decade of low inflation, low interest rates, complete access to risk capital, it kind of altered, it skewed our perspective in psychology of how we frame what we're looking at is huge. And for people who are

framing the last 18 months in terms of what happened the previous 10 years, it looks odd. But if you frame it in a larger perspective, looking back over time, this is perhaps more closer to the than what you saw in 2021 or 2020. So I think as we look at where will we end up after all of the shakes out, recession, inflation, I would be surprised we ended up where we were in 2007, 4% rates and 3% inflation and a market that reflects it. What are the biggest market and business implications of that new normal or status quo, if that is the case? I think for those companies that got used to using 6% or 7% cost, of capital, it's time to let go. I know there are companies that still hang on to those hurdle

rates, they said in the last decade saying, you know what rates are low, therefore, those costs of capital are not coming back. So the way we assess projects if your companies has to change, the mix of debt and equity, when you have 1% risk-free rates, your cost of debt is 2.5%, your cost of equity is 6.5%. The mix of debt and equity uses a company is affected by that. That too has to be revisited. And in terms of dividends and buybacks, when you think, about what you have to be to be able to give cash back to investors. In fact, everything about the way companies get run is altered when you have 4% rates as opposed to 1.5% or 2% rates. As investors, I'll tell you from a personal perspective, there's a very, very specific change I've

noticed. And three years ago, you asked me how much cash I had in my online brokerage account. I didn't know and I didn't care. After all, what was I going to do with the cash? Put in Teebles and make 0.03%. Today, I'm acutely aware of cash when it's sitting around. That's something that people have become used not to doing, that you have to start, because idle cash is losing cash. Because when you have 3 or 4% inflation, that cash is losing value,

and you've got to get it into places. Deble rates might not stay at 5.5%, but they're definitely not zero. So some of the things we got sloppy on as investors and companies over the last decade, I think we need to revisit. The other, and this has got to do with the risk capital question, which I think is a separate issue.

Sometime in the middle of last year, we noticed that risk capital went to the sidelines. Just to put in perspective, for a decade risk capital was not just accessible, it was excessively accessible. I mean, I know that sounds like a strange word saying, how can you have too much risk capital? Because when you have too much risk capital, companies are able to raise money too easily. So as a consequence, businesses that should never have become businesses with founders who are borderline sociopaths, were able to raise billions of dollars and then burn through them because risk capital is through money at them. That's hopefully not going to come back.

So I think that there are things that you saw in the last decade that reflect the environment where we're in, low rates, lots of risk capital. they don't think we're going to revisit even after we come out of this downturn into a recovery. Can you explain why it's necessarily bad or that we don't want borderline sociopaths with cheap capital trying crazy experiments? Because those experiments have larger consequences. You provide capital to, let's say, a bike app company, the line, the bird bikes. You probably saw them. And I remember looking at them saying, this is a horrific business model. I don't see how this works. But those bi-cap companies raise billions of dollars of capital. They came into cities like San Diego where I left. In a period of

months, they destroyed an infrastructure of bike rental businesses that used to be in this city. They were able to do that because how can those bike rental companies compete against somebody who's giving away the product for free, which is what they were doing because it's so much capital. Those bi-grantal companies are gone. They're not coming back. And these app companies that replace them have now run out of capital because they're bad businesses. The only problem is we can't go back to where we were.

So there is really economic damage created when you allow businesses that really shouldn't take off to become large and threaten the status quo. Could you riff a little bit on the natural rate of interest, whether or not interest is ever really priced and set by a market mechanism versus by. central banks or the Federal Reserve? I'll give you my simple rule. It's inflation plus one to one and a half percent. So expected inflation in the long term, not last year's inflation plus one to one.

That's your natural interest rate. So then when people ask me, where will interest rates go? I turn the question back and say, where do you think inflation's going? Because without answering the inflation question, the interest rate question becomes a search in emptiness. You have really nothing to anchor it to. And it's a rule I've followed even during the last decade, when people told me that the Fed set rates, I said, that can't be right. The Fed doesn't set rates.

So I would say the natural interest rate I would expect to see would be, and that's why I said in the long term, I see 4% T-Bond rates and 3% inflation. Because even though we might have broken the back of 8, 9, 10% inflation, I don't think we're going to go back to the 1.5% inflation we saw in the last decade. Talk more about inflation. We spent a bunch of time at the start of our conversation a year and a half ago talking about it. That was right at the beginning when it was very uncertain, like hard landing, soft landing, all these things that everyone was talking about. What is your updated view of what is driving inflation, the past that it could go from here, and anything that surprised you about the story and how it played out? Not at all.

I think it's taken center stage, and like all stage hoggers, it refuses to leave. This is why, when we talked a year and a half ago, I said, you know what, you let this genie out of the bottle, putting it back in the bottle is not going to be easy. And a year and a half later, guess what we're talking about. We're talking about inflation, the economy and interest rates. And that's always been the case with inflation. It's not a macro problem that you can get a handle on quickly. That's why if you look at how little resolution we've had of uncertainty in this year, it's partly because one of the big uncertainties is inflation and getting resolution on it in terms of hasn't gone down, will it stay down, takes a long time.

So I wouldn't be surprised if this fills over into 2024 and we're still struggling with where will inflation end up? And that's partly what's driving the Fed crazy is because until they have a handle on inflation, they're kind of stymie. You're someone that values by hand, lots of different kinds of businesses. You're a dabbler in valuation and the king of valuation in academic circles. What does it felt like for you valuing companies with rates the way that they are relative to the last decade or so? What are the things that you've noticed as themes when you're valuing companies, let's say, in the last year? quite a while ago, well before the low interest rate environment even kicked in, I decided I wanted

to make my valuations as insulated as I could from macro variables. And the reason is very selfish. If you're spending all your time thinking about inflation and interest rates and economic growth, you don't have time to think about the company of value, whether it's Coca-Cola or Instagram or Facebook. So the way I've constructed my valuation models is to make the macro variables cancel up. Let me give you an example. Now, in the last decade, low rates allowed every company to have low cost of capital. It's the truth. You can't override and say, I'm going to use a high cost of capital. I don't like these low rates.

I used to low cost to capital. That's a benefit. If you think about having a low cost of capital, it should push up value. But here's the counter. Those low interest rates also told me that there was going to be low inflation and low real growth in the future. So when I projected out growth for these companies for the long term, I also pushed the growth rate down to reflect those same views. So the same low inflation that pushed interest rates

aren't also meant my growth rates were lower. My pricing power was lower. The effects in a sense offset. That's why my valuations don't change dramatically. That's why I'm not surprised the market hasn't imploded. Because if you left everything as is and kept the same cash flows you had two years ago and you raise the discount rate by two or three or four percent, which is what we have, stock should be down 40 or 50% they're not. And the reason for that is companies are flexible. They're adaptable. As inflation comes through, guess what they do?

They pass that inflation on to U.S. customers. And the companies that are better suited to doing that are more protected against inflation. So when I design valuation models, I try to keep my focus on the company and not get distracted too much by macro variables. Not because it won't affect my value, but because they affect everyone's value. My job is to assess the value company, given where the market is now, and given macro conditions now. And I try to stay in that here and now as much as I can. What macro variable or trend most has your attention now today? When I look at all of the macro variables, my worry is more about political risk and crises coming through.

The last one of the dark sides of globalization is everybody's problem, is everybody else's problem. The biggest macro issue to me is China, because China is in trouble. And the problem is, unlike Russia, if China goes down, it takes the rest of us down with it. When you're the second largest economy in the world, and you've created interconnections with every big multinational in the world, troubles you have as a country spill over into every company. So to me, that's going to be the country to watch and the biggest macroeconomic. risk, and that macroeconomic risk would become a political risk. And I am not looking forward to the

kinds of damage that will create for investments for companies, for businesses around the world. Do you describe the nature of the trouble that they're in as you see it? I think that, in a sense, to see why we're all in trouble, we've got to go back 20 years and look at why companies jumped into China with both people, without. even thinking through. One of the big selling points for China was, we can tell you what policy will be, not just for next year, not just for the next five years, but for the next 40 years. I've talked about, would you rather, as a business, invest in a democracy or an authoritarian regime? And the answer that many businesses often give is democracy is chaotic. People change

their minds, government change, policies change. I'd much rather go with an authoritarian regime. which can give me the guarantee that policy will not change. And that bargain worked out in their favor for many of those 20 years until perhaps three or four years ago, it was viewed as an unmixed blessing. In fact, companies in trouble often use the China card. Look where in China and all of a sudden their price would pop up 5% or 10%. But we're now seeing the dark side of being an authoritarian regime, which is the same forces that make things predictable can create what I call discontinuous risk.

can change overnight. And you saw this first with big Chinese tech companies, Alibaba and Tencent and JD, which for a long time were rewarded because Beijing was viewed as being on their side. And suddenly magically in 2019, Beijing said, no, we're not on your side. We are adversaries. Have the value of those companies because effectively, if Beijing is your adversary and you're a Chinese company, you really are stymied in almost everything you do. So I think China problem is the same government that guaranteed predictability is now going to be fighting for its political life. And in the process, they're going to make decisions and create policies that are going to cut against everything they told you they're going to do for the last 20 years.

And companies are looking at that saying, well, what will that mean? They're trying as fast as they can to move their production from China. But even if you moved all of your production to China, which will take a long time. China is still one of the largest markets in the world. How do you walk away from 1.4 billion people? And that's where 20% or 30% or 50% of your growth is going to come. So this is going to be a dilemma that not just Chinese companies, but multinationals, big companies around the world are going to face. And as invested in those companies, we're going to have to face as well. Do you think that it's a situation of mutually assured economic destruction,

given how intertwined everything is that they're both manufacturer and consumer? partners to so many companies in the world? No, I think I'm less worried about the U.S.-China political tension than I am about companies finally coming to the recognition that China is a mixed blessing. I think even if you took the U.S.-China political relations and put them to the side and say, we can deal with that, I think the gloss is off. I mean, companies now recognize the dangers they've exposed themselves because some of them made a Faustian bargain to enter China. They set aside everything they told us they believed in,

whether it's Apple or Nike, because the market was so big. They went into the market saying, we're okay with that Faustian bargain because look at how big the market is. And now they're looking at that bargain and saying maybe it's not worth it for us. So to me, this is, I think, a much bigger issue than getting the politics fix. This is something which is going to lead to withdraw from China of many companies, the question is where they're going to go is going to drive the next big market to look at, whether it's India or whether it's Vietnam or it's Brazil, I think it's going to be a question of where will all that money go, whether it's investor money or company money. And that's going to be a big factor in where you're going to make money

as an investor and where you're going to make money as a business. There used to be this chart that would float around a lot that was this rolling 10 or 20-year return chart comparing the S&P 500 to like MSCI-EFA or something, showing U.S. versus international. And you got this very nice back and forth pattern. There'd be a period of U.S. dominance and international dominance. And it went back and forth a few times going back to the 70s. And then you got just straight line up for the U.S., just completely dominating the equity markets internationally for a really long period of time. How do you think about that relationship going forward? As investors look for interesting things to do that are not the same as everybody else, do you

think that international equities, which have become completely ignored for a lot of investors are a place of interest now? I think it largely reflects the fact that the U.S. has been the country that benefited most from the shift from a 20th century economy to a 21st century economy. If you look at the 10 largest market cap companies in the world, you've got five of the six bang, Amstocks, other than Netflix, the other five are all on there. And then you got invidion, you got Tesla. And in a sense, the U.S. in spite of all of its faults, has created at least an environment where the companies that are most suited for the 21st century economy are most likely to grow up. They're definitely not going to show up in Europe. In fact, you can almost guarantee that

the next great company is not going to come out of Europe because it creates an ecosystem that makes it almost impossible to challenge the status quo. So the same things that worry is about the U.S., the chaos, the fact that you really can't keep control are what's allowed these companies to explode in value. So as you look at that straight line of the U.S., I wager that almost all of that gain came from these big tech companies. In fact, we know that the Fangam stocks alone accounted for one in six dollars a market gap created across all U.S. companies in the last decade, the kind of like $8 to $10 trillion of value just in those six companies.

that's mind-boggling. The question to ask then at looking forward is that big runover. Probably for those six companies, but I'm not sure the next six would come from the U.S. as well. Now, we can debate which the next six will be, and maybe NVIDIA and Tesla, two of the six, but we really have no idea. But I think in a sense,

the kinds of companies that benefit from the uncertainty, from the shifting status quo that you've seen in the 21st century are exactly the kinds of companies that are most likely to grow and develop in the U.S., not in the rest of the world. So I wouldn't be surprised if the U.S. maintains its lead in that return table. But only if you invest across the board. So if you're a U.S. investor who's invested in Coca-Cola and Washington Post for the last 20 years, guess what? You haven't seen that straight-line benefit that you've seen by investing in U.S. stocks collectively. So I think you've got to be careful about not being diversified, about not spreading your bets,

because this isn't just for betting on geography, it's betting on a subset of that geography. In this case, it's tech in the U.S. that's carried us. Have you seen anything like the recent results from Nvidia in business that you've covered? On a percentage basis, yes. On an absolute basis, no, because you added $700 billion a market cap in one year. astounding. You know, you to do it that fast. Tesla may be in early 2021 and added a half a trillion. I think that it reflects the fact that it caught the mood at the moment almost perfectly, which is AI. For all the talk of AI and chat GPT, Nvidia is one of the few companies that actually has a

tangible business in AI. It's a 25 billion dollar market now for AI chips. Its estimate could be as large is 350 billion. Invidia has an 80% market share. And if it preserves a large market share of that $350 billion market, that is a huge market on which it makes almost 50% operating margins. So there is a story for why it took off. Whether it justifies the amount of market cap added is different because, as you probably know, I did try to value the AI piece of Nvidia. I double the value of Nvidia as a company with AI in there. But I was a lot. still 40% below the market price. So I think a market's gone a little over the top in terms of reacting to the AI aspect. But I think that it captures what happens if you're in the right place

at the right time as a company and invalienced in the right place or the right time. It feels like AI is this year's inflation for you and I to discuss. It's pretty amazing that almost all of the AI storyline has happened since our last conversation, like the models that have gotten everybody so excited, ChatGPT and Dolly at Mid-Journey and all these things. I'm just going to step back and get your broad take on the technology, the implications, the pros, the cons, everything. We ask people, when did AI start? They probably will trace into the first news story they read about ChatGPT,

which was just what a year ago, a year and a half ago. The reality is AI is a culmination of two trends over the last 20 years coming together. The first is big data, data collected, not just, the fact that you can collect and put data online, but data is collected on our personal lives, buy apps, all coming together. So that's been building up. The other is the building up of computing power, where as chips get more powerful, computers are getting more powerful. Big data plus powerful computing power is effectively AI. So AI has been building up for years. What Chad GPT did was it brought that to the public consciousness, because people could see the

effect on their daily lives. I remember my wife coming back. She's a fifth grade teacher and saying, you know what? Now, I use chat chief BT to send emails to my parents because it writes a very good email. So chat cheap media, which is really low tech AI, if you think about it, it's been the door that open that people say, oh my God, there's a whole world there of how things could change in the future. So I think AI has been building up to where it is. It's not something that happened last year, last year and a half, it's something that's been building up over the last 20 years. That said, though, the question is, what exactly will AI deliver over the next decade? We've seen lots of these buzzwords come and go.

For instance, the metaverse. Remember how hard it was for a while? Nobody talks about the metaverse anymore. And I'll confess, I was never excited about the metaverse because unless you're a 25-year-old who loves virtual reality glasses, nobody wants to spend the rest of their lives. in a virtual universe. This is not healthy. So the metaverse never struck me as something. The cloud business, great business, but you can see it's a niche business. It's not a business that most of us can relate to as individuals or even as companies because it's a service provider

companies. I do think AI offers the promise or the threat of changing the way we live and work. In fact, I'm lucky enough or old enough to remember four big shifts in my lifetime, the AI being the fourth one. The first was PCs. I came into a world where I actually did my first valuation on a ledger sheet with a pencil and a calculator. So I did my first valuation before PCs and Excel. The PC business changed the way we work, changed the way we compute things.

So the PCs really made a difference, not just to business. but to individuals. The second big shift was the internet. The internet broadly brought together online retail. The third was smartphones. And basically what that created in terms of changes in the way we interact, the way we do business. And AI offers that promise or threat

of changing the way we live and work, that it could have an effect. If you notice it's screenwriters. One of the big issues that they were fighting over was, will you let AI write scripts for you, or are we guaranteed that we're still going to get paid to write scripts? So you could see this is permeated every aspect. I would be surprised the auto workers, one of the things and their demands is an AI component as well. So AI, you can see, is coming to people's consciousness where they're aware, whether true or not,

that it could change the way their work and live. The question, though, is what will it do to us as an economy as markets, as a society. There I'm a lot more muted than some of the biggest AI advocates. Their conviction is, this is going to be amazing. Life is going to be so much better with AI. And the reason I'm skeptical is I've heard this before. They told us that PCs would reduce the mechanical stuff we did. They would take this grunt work of entering numbers in a calculator and therefore free us to be creative and thoughtful. Not true. It actually made us more mechanical. We were told the internet would give us this incredible reach in terms of being able to get information.

Instead, we drowned in data. They told us social media. We'd be able to keep our friendships alive with people who are further away. It actually has destroyed friendship as we know it because everybody's got a virtual friend and very few people seem to have real friends. My point I'm making is every one of these changes is a dark side. With AI, we see some of the dark side up front, which we didn't with the others. But I think it will have a dark side. For every winner, there will be losers.

For every disruptor, there will be disrupted. So as I listen to all of these sales pitches for how great chat GPT is and how much AI will do for us, I keep thinking 10 years from when we look back, what will be the net effect? There will be a few big winners. There will be a lot of wannabes. And there'll be quite a few big losers. You just have to hope you're not on that loser's side because every big movement creates losers. I'm a little more cynical about the AI pitch than most people.

I understand that it's going to be a big business. I understand that companies like Nvidia and perhaps Microsoft that can make money on this business. Collectively, as a society or as an economy, are we going to be better off because of AI? I'm not so sure. Have you tried to value any of the big AI companies like OpenAI or something like this? same way that you did in video, understanding there's less information? It's not even that there's less information. You need a business model to value a company. Unless you tell me how you plan to make money, you're not a business. You're just a movement. So if your business is that you're going to create

the subscription model, then we're ready to talk. If you're saying, look, I'll charge for transaction. I'm ready to talk. But a lot of so-called AI businesses are not businesses yet. They're AI movements, ideas, and until they start to take some form, you're buying an option. There's no reason why you shouldn't buy an option. Maybe Open AI is a great option to be part of a business, but you're not buying a business. Do you think that investment firms will change a lot and trends of investment firms will change a lot as a result of the interest rates and AI and other big trends? Like, one thing that pops to mind is private equity firms that have relied on very, very low-cost debt for a long time to earn fantastic returns. Obviously, that picture has changed.

maybe that affects private equity at large, that or other trends like in the investing world, institutional investing world specifically, anything that comes to mind for you that you're thinking about? But the question that every active investing group, P, VC, mutual funds is asking is, will this check the slide? Because let's face, they've been on a 50-year ride down. They've been disrupted. They've lost market share to passive investing, to automatic investing, to mechanical investing. And I think each new movement they looked and said, maybe this is what would stop the slide. Maybe this will bring us back. And I actually think it's going to make the slide worse. Because let's face it, 80 to 90 percent of all active investing, including PE, including VC,

including mutual fund investing, is mechanical. And it's mechanical. And machine's going to do it much better than you can. I mean, that's part of the reason over the last decade, active investing lost so much money to pass investing, you could create an ETF to replicate what mutual fund managers did by just watching them. And it's got to be able to do that almost effortlessly. Everything you do is going to be replicated in milliseconds. So if you made money as a high frequency trader by trading quickly, a little more quickly than everybody else, you were able to do it for two years in the middle of the last decade.

You might be able to do it for two months now. Active investing is only going to get more difficult. And when you say P and VC benefit from low interest rates, they did, but collectively, it wasn't a good decade for either. The average VC investor, the average P.E. investor made about as much money as the average S&P 500 investor. Of course, there were winners. There's a selection bias with P.E.N.V.C. We'll look at the winners. One of the talks I give is who put the smart and smart money? Because I've looked for 40 years for the smart money, money that presumably gets in before every. everybody else and gets out before everybody else. There is no group of investors that I can point to and say, that money is smart money. It's just greedy money that ultimately runs into a wall

sooner or later. So I think there's going to be more accountability sooner with higher interest rates. But collectively as a group, I don't see groups benefiting or paying a price because the average is still the average. What parts of your own valuation process remain outside the reach of automation? I'm not sure. And I keep asking myself that question because I'm open to the possibility when I teach one of the things I tell people is, look, I want to make myself unnecessary, dispensable. That's the essence of good teaching is you want to make yourself not necessary. We've taught people a way to think where they don't need you to think through a problem. Every year before I start teaching, I say, is this the year I need to stop teaching? Can I basically

say, hey, I'm not necessary anymore. And I ask the same question as an active investment. I'm not married to active investing. If next year I discover that what I'm doing is really doing nothing for me, I don't make a living on active investing. I don't have to put on a front. It works even when it doesn't. So if it doesn't work, why would I want to waste what's left of my life trying to value stocks and invest on that basis? But it's really not giving me any payoff. So I'm open to the possibility that a lot of what I do, be mechanized. I've passed on all of my blog post to a friend of mine who's an AI specialist, and he's trying to create an AI engine that can replicate what I do in my blog post. And he said, would you have a problem with it? I said, not at all. If you can do it, all the more power to you.

I'd love to see a blog post valuing ARM or Borkenstock, which is what I'm working on right now with your AI engine. It's not quite there yet. Thank God for that. Could it be there a year or two from now, absolutely, and I'm open to that possibility. Do you think that there is a natural end-state equilibrium for active management and its role? Obviously, we need some of it. Someone has to price securities. What do you think that end state might be or when it might be? It's actually a good question, because one of the most famous papers written in the 1980s was a paper titled, This was an Efficient Markets for at their peak. There's a paper written by Sandy Grossman and Joseph Stiglitz, won the Nobel Prize,

called on the impossibility of efficient markets. And they made a very simple case. If markets are efficient, you create the seeds of inefficiency because nobody's looking for information. Nobody's looking for mistakes. Markets don't become efficient automatically. They become efficient because people look for mistakes. They catch them, try to make money on them. And in the process, they drive mistakes out. So you're right. There is going to be some floor on active investing where it ebbs and flows. My guess is it's going to drop too low. There are going to be too many mistakes.

Active investors are going to come in. But here's what I can say. The steady state number of active investors is going to be far lower than the number we see out there. There are far too many active investors, and we're going to see the numbers drop off. So all those buildings that Fidelity and State Street and TRO price fill up

are going to be only one quarter as full in steady state. because so much of what's done there is just creating noise. It's not adding value. You said earlier, I can't remember the number you used, let's say 10% of investors that are successful in terms of beating simple benchmarks or something like that over the longer term. Have you noticed anything in common between those investors? In fact, I have an entire class I teach called Invest in Philosophy's because I started with that question. When I started looking at it, I assumed they'd all be students of Ben Graham. The old legend is.

And I discovered that when you look at the most successful investors over time, consistently successful investors over time, they're a mixed bag. You've got value investors, obviously Warren Buffett, from that group. You've got growth investors like Peter Lynch. You've got traders like George Soros. George Soros, I've never seen George Soros talk about the value of companies, a macro trade. So as I looked across these investors, what I noticed is there's no one pathway to greatness, God. There are multiple ways in which people seem to win. So then I start looking at what do they

have in common? Two things. One is they have a core philosophy that remains unchanged over their investing lifetimes. Now, I've had disagreements with Warren Buffett on things he says, but here's what you've got to give him credit for. He has a core philosophy. You know exactly what it is, and it guides every strategy he adopts. So there's a core philosophy built around beliefs about markets and data that makes sense. The second is they have personalities that match up to that philosophy. We talk about everybody wants to be a long-term value investor, especially after you read three books on Warren Buffett. Of all those people who try, very few people succeed. He said, what goes wrong? Because to be a long-term value investor, first, you've got to be

incredibly patient, which often is not under your control. Warren Buffett has insurance capital, he's investing, you and I might be investing our own money or client's money, so we've got to be able to be patient. And second, you have to be able to withstand peer pressure because you're often moving against the crowd. Those are psychological factors. If you're naturally impatient and you're swayed by the crowd, I don't care how many books about Warren Buffett you read, you're not going to be a successful value investor. When I teach that class, I tell people, look, there is no right investment philosophy, but there's one that's right for you. And to find that philosophy, the person you've got to understand is you. Not Warren Buffett, not Peter Lynch,

spend less time reading about other successful investors, spend more time looking inward at the things that make you comfortable and uncomfortable. Because that is at the heart of building a successful investment philosophy that you can stick with in good times, which is easy, but also in bad times, which is not that easy. What were the important episodes of your own path to of finding the investment philosophy that's right for you. Couldn't agree more with the alignment of personality and style and commitment. But it's always helpful to hear an actual story about how that came to be because it sounds simple when you say it, I think it could be quite hard to actually pull off in practice.

I think with each big movement I talked about with PCs, with the internet, with social media, what I realized as I went further and further in is the tools I came in with and the beliefs I had coming in for shaken. So when I came into the dot-com boom, I came with the old-time value investor out. You need earnings, you need cash flows, you need them now, you need them on the balance sheet. And the more you went through that.com boom, I started looking at that and saying, maybe that's not right. We have to start to think about cash flows for growth companies, but there's very little here. So with each big shift where I've been wrong for an extended period, there's a point in time you have to make the judgment. It's not the market that's wrong.

It's something you're missing, that you have to start to incorporate into your philosophy. It doesn't mean you abandon the way you think about markets. I still believe value matters and I have to invest based on value. But the way I estimate value, I've got to be pragmatic enough to expand it. I'll give you a very simple example. The first time I valued Uber. I valued it by looking at the car service business as it existed then. car service business when Uber came into the market was composed of taxi cabs and limousine companies and I went around the world, added up all of those, came up at the total market of about a hundred billion.

And he said, that's the total market. I ended up giving a value to Uber based in the total market. And Bill Gurley, very rightly pointed out that I was missing something very critical that these disruptors in addition to taking share away from existing players could actually change the size of the total market. He said, you know what? There are people who are not taking car service now who might start taking car service if an Uber becomes ubiquitous. And he was absolutely right. And in subsequent valuations of Uber, I had to factor in the reality that this is a company that changed the size of a car service business. It was too late for me to fix my 2013 mistake,

but when I valued Airbnb. I brought that learning into the process when I said, How big can the market for hospitality be? And I used to market three times the size of the hotel business. So again, sometimes accepting the fact that you're missing something significant in the way you're approaching some aspect of your investing can be a learning moment. People talk about this all the time. One of the reasons I like writing my blog is I'm accountable because I can never say. I never said that because it's right there.

In 2014, this is what you said. And it's also become a place where I can confess my mistakes, not because confession cleanses my soul, but because it's in the process of saying, I screwed up that you can start thinking about what can I do differently going forward. It's been useful for me to be able to verbalize when I miss something, saying, this is what I miss, this is how I'm going to try to fix it, because it's on the record that I made a mistake and that I'm trying to change the way I do things. I love the exercise of valuing non-traditional things.

How do you go about valuing something like the Washington Commanders or an NFL franchise? The value of a sports franchise now is almost entirely as an entertainment business. Why? Because 50 years ago or 70 years ago, if you bought a football team or a baseball team, most of your revenues came from people coming into the stadium and what they spent in the stadium. But TV changed that. But TV contracts, increasingly high percentages of revenues at these teams come from their media contracts. That's one reason why the Oakland A's have to leave the Coliseum. It looks terrible on TV.

It's a terrible reason for leaving, but when your entire revenue stream is based on how you look on TV, you can see why teams are actually going to build smaller stadiums that look better on TV. Fenway is a great stadium on TV. accidental because they didn't build it for TV. So if you asked me to value a sports franchise, I would project out the gate receipts. I'd project out the merchandising and I'd project out the media revenue. Now, you could value it as a business. But two things. One is teams can sometimes alter the magnitude of those revenues by actions they take. Let's take the Golden State Warriors. 15 years ago, the Golden State Warriors were a mid-level NBA team in terms of visibility and

value. Then there are two strokes of luck. One was in signing Stephen Curry to come and play for them. And the second was their ownership shifted to a group of tech people who decided that this was a game about streaming and getting a higher profile. The Golden State Warriors are now the second or third most valuable NBA franchise because their revenues in terms of media and streaming reflect the fact that they're now a national team. Taylor Swift alone has probably increased the value of every NFL team by 15 or 20% because she's bringing in women viewers to TV

who are going to increase the value of streaming. So if you ask me to value a sports franchise, I can value, but I can also tell you almost before I do it, that what people will be willing to pay as a price for that franchise is going to bear no resemblance

to that value. It's going to be two, three times why? Because if you look at the owners of many of these sports franchises now, This is not the art Rooney, Pittsburgh Steelers, where you live in. The Rooney's have owned the Steelers. For them, it is a business. They need to make cash flows.

In fact, it is probably 95% of their wealth. Same thing is true for the Marys. Much of their wealth is in the Giants. Or the Steinbrenner. The only problem is that the rest of the franchises in the league are held by billionaires. Private equity investors, VC investors, Steve Palmer. Why do they want to franchise? franchise because it's a great toy to have. I remember valuing the clippers when Bomber bought them

for $2 billion. And I came up with the value, even my best case numbers about $1.2 billion, allowing for higher TV ratings and revenues. And then I said, you know what, I'm not going to keep trying to push my value up because clearly Steve is not buying this team because it's a business. He's buying it because he wants an expensive toy. What better toy can you have, especially if you're a steep going, in front of all of his successes as an investor. If you ask him which investment he tracks more closely, he won't even be close.

This guy's been a Mets fan since he was a kid. He now owns the team with all the pain and the gain that comes from it. So increasingly, sports franchises are being bought as toys. What does that mean? The pricing is going to bear no resemblance to value. And if you try to explain the pricing based on fundamentals, it's all going to come apart. As long as the number of billionaires exceeds a number of sports franchises, I'm afraid this game is done.

We're playing a pricing game, which means what these franchises do will also make no sense from a financial perspective. I'm going to sign Showy at Otani for $650 million, even if he never pitches again, because think of the Japanese viewers I can get on my streaming with him on my team. Think of how much more lucrative my toy looks when I have the best baseball player in the game. So I think that it's not always good news. As fans, as people who follow sports, you're going to see strange things happen in the sporting world now that it's billionaires owning toys. A wonderful adjacent topic is the world of entertainment writ large.

You mentioned streaming and that being a key component of the, of those businesses, I would love you to talk for a while about how you see the world of entertainment as a business, as a cultural phenomenon, as a business model and how that's shifting. What do you think about media and entertainment today? Let's take a component of entertainment, where in fact the damage has already been done. The disruption has happened, which is the music business. The music business, if you're old enough, you remember, was structured very differently. It's studios.

The studio sent out talent scouts who signed stars. those stars were effectively signed to long-term contracts by the labels, who then put out albums where you were required as a consumer to buy an album with 16 songs, even if you wanted one. It was a business that was built around bundling and studios controlling the entry and exit parts. That's how the market business looked like in the early 1990s. Then along came Napster. Napster, of course, was barely legal or potentially illegal,

operation with stream music for free. And of course, the music studios shut it down. They managed to get the legal apparatus behind them. And I'm sure there was a heaves of size of relief across music studios in the late 90s when Napster was shut down. But what Napster did was it revealed the weaknesses in the business. Why make somebody buy 16 songs when they needed only one? and Apple iTunes stepped into the breach, and the disruption continued, especially with the coming of Spotify and Pandora. In 2015, the revenues of the music business had halved relative to 1999. In nominal terms, the business had become half what it was. There's been a bit of a comeback, but not in real terms, in nominal terms.

And the business now looks very different. The biggest player are the streaming company, which includes Spotify, but also includes some of the tech companies, Apple Music, Amazon Music. If you look at the landscape, it's entirely different. The way music gets produced, the way it gets sold, who gets the rewards is entirely changed. Movies and broadcasting put off that disruption. Netflix, of course, started the process with original content. Until 2012, until Netflix created its original content, they thought they still

control the process. The process that was created over a century built, built, on movie theaters. Now, if you remember, you produced a movie, you got Gatrice to the movie theaters, a few months later, you released it to cable. So there was a sequence that studios, if not perfect, it had worked at that worked for them. Then Netflix rocked the board. They rocked the board because they changed the way content gets produced. Because until Netflix came along, the way you created a new show, if you remember the old days in the network, new show came along, they'd allow the show to create three episode, the episodes worked, did have a season. The season worked. You signed for a second.

Everything was done in pieces because you don't want to create hundreds of shows and have three work. It's too expensive. But Netflix said, no, we're going to produce a hundred shows, throw it against a wall and hope something sticks. Why? Because people judge us and the number of subscribers we have. They're not judging us based on revenues and earnings and cash flows. And when it first happened, I remember talking to somebody at a movie company, they said, this is not going to work. This is stupid. Look at what Netflix is doing. they're going to go bankrupt. Seven years later, Disney joins the Netflix bandwagon. They start spending $30 billion on content as well. And of course, COVID along the way upended the process

as well, because if you remember during COVID, some studios started releasing movies directly to streaming and bypassing movie theaters. The entire structure on which the movie and the broadcasting business was built, which is theaters and networks and cable are coming apart. We're replacing it with streaming. The only problem is people are not sure how to run a streaming business. Netflix with its make 100 shows, throw it against the wall, hope something sticks, is trying. Disney with its huge big budget shows built off existing franchises, the Mandalorian, Star Wars, or whether it's Avengers is trying.

HBO kind of has this internal conflict of what it is. The old HBO model was just make big by the Game of Thrones model, but now you've got it connected to Warner and you don't know where it's going, but everybody here is trying, and nobody has a sense of what's going to work. It's not a good place to be, either an entertainment company. And it's at this stage that the writers and the actors both walk out, you're effectively taking a business that's already on the precipice, and you're risking pushing it over the precipice.

Here's one thing we can guarantee. We consume entertainment. We need entertainment as consumers. So that part is not changing. But 10 years from now, you ask me, what will that structure that provides content look like? I really have no idea. And I don't think people at the entertainment companies have any idea.

Will there be movie theaters left after this? There's the single healthy movie theater company left in the world. Half of them are bankrupt. of the other half are run by CEOs who seem to think that their job is to run a mean stock rather than a company. I'm not sure where this game is ending. But I think for the moment, I'm looking for entertainment companies that are adaptable because if you don't know how this model will shake up, you want either a status quo company that's able to adapt to the streaming world or a streaming company that learns enough from existing movie makers that they can be a little more discipline

in how they produce content. But we're at a lot of it. in motion. I don't know how this will play out, but we're going to be watching it play out. I'm fascinated by this. Do you think any of them are really amazing businesses? Because it's interesting that there's unlimited demand for the products. And yet, here we are talking about how maybe none of them are insured a great, right, business future with lots of free cash flow. Right now, none of Netflix. Netflix might have the highest market cap. The analogy I give is Netflix is like a hamster on a wheel because it's created a model where it's got to create more content to keep its consumers and still more content.

And it's trying by moving its content outside of the U.S. 90% of the shows now in Netflix or Spanish or French or Indian. But I think from the perspective of actually being a good business model, Netflix doesn't have it nailed down. Disney clearly doesn't. I mean, it struggles to reflect that. And every other company in the status quo spaces is actually in worse shape than Disney. I cannot think of a single company or I can point to that company say, those guys have a model that they've actually figured out.

So I think everybody is in motion right now and none of them is a solid business model right now. What are the best business models you've ever seen? Take a business model like Patagonia. I've said, look, I don't believe in ESG. But Patagonia, in a sense, plays within its limits. It recognizes that it has a particular agenda to push, but it also keeps things scaled down. I have respect for companies that essentially create businesses that reflect the vision and stay true to them. I mean, I'm valuing Birkenstock, and one of the things I find impressive about Birkenstock is how well they've nurtured their brand name while growing and being profitable at the same time.

I mean, they've actually turned away partnership models because they think it puts their brand name at risk. I mean, along the way, of course, they benefited from being lucky, but everybody does. I'm sure nobody planned for Barbie to be wearing pink Birkenstock, but to create a buzz that pushed up their revenues 30% over the summer. But I think if you look at the company and he said, this is a business model that's internally consistent where the management and the company is acting consistently with the story they're telling us. It's what's always impressed me about Amazon. When Jeff Bezos ran it, this is a company that was built around the story. I called it the field of dream story, which is if we build it, they will come. And in every step in the process, they stayed consistent with that story.

They acted consistently. So what I'm looking for is companies that have a narrative about themselves, where their actions are consistent with the narrative. That's actually rarer than you think. A lot of companies tell stories, but then they act very differently from their own stories. So if you're looking for good companies, that's what you're looking for, companies that have crafted a narrative that they stay true to. And sometimes that means turning away growth and turning away profits because it doesn't fit into the narrative they've structured for themselves. What did you think valuing Instacart and what do they teach you about online delivered groceries

and just that entire market, which has been extremely controversial amongst investors of private and public investors as to whether or not this business model is a long-term viable one or not? Sometimes asking common sense question about a business. can help us plumb through the depths and get away from the tunnel vision? Ask yourself, do you want to shop for your groceries online all the time? And the answer will get from most people are not homebound or who have issues with their health is grocery stores are usually closed by,

and it's one of the few areas of shopping where you'd prefer to do it yourself. It's not that you're impulse buying, but you want to make sure the eggplant you put in your card. Not all eggplant is created equal. I mean, that's the essence of shopping. I think that even at its height, of course, with COVID, we all were forced to shop online. But even at that height, you could look forward and say, this is not steady state. This is not what the world is going to look like. This is a niche business.

And what I saw when I valued Instacart is how easily people can let loose or leave their senses in the midst of something happens. In the case of COVID, the reason you saw $39 billion pricing is for whatever reason. Sequoia and Fidelity and Tiro price, I think there were the three big investors, the $39 billion pricing, managed to convince us that half of all Americans would from this day on the grocery shopping online. And what we're discovering is, in hindsight, that was clearly overwrought. But I think we knew it was overwrought then if we'd step back and had some perspective. The other thing I did note with Instacart, and this goes back to the point I made about VCs and P.E investors being a lot more average than we think they are, is I did track every VC round in Instacart, going back to 2012.

It's a company that has had a seed round and rounds that go from A through I, so lots of VC rounds, $2.9 billion in venture capital. And I looked at the returns you'd have made as a VC investor if you invest in 2012, 2012, 2013, 2014, 2015, all the way through 2021. And what I saw was every VC investors since 2015, that's, I think, Series C, has essentially done worse than the S&P 500. Put that table out to show that VC investors are bad. I put that out to kind of counter the notion that VC investors are smarter than the rest of us, better gauges of businesses, much of this is pricing. And you get caught up in the mood of the moment. You could push up the pricing these companies well about what they should be. And I think at $8 to $9 billion, Instacard is valued as a niche business, but about 10 to 15 percent of Americans

will stay with online grocery shopping for one reason or another. Of course, it could be an option on the next pandemic if you want to make a bet on it. But I think that as a niche business, I'm okay with 8 to 9 billion, but not with 20 or 30 or 40 billion. What has been in the last year, or since we last talked, the most interesting company or thing that you valued? I did value the Adani Group. Adani Group is an Indian infrastructure company. And of course, was targeted in the short selling, the Hindberg targeted it of fraud and

self-dealing and manipulation. So I did value the Adani Group. It's an infrastructure company that trades at about. a 50 to 60 times ever done. It doesn't get priced like an intruder. And as I valued it, you could see how we talked about being in the right place, the right time. The reason Adani's stock price were up was that two things going for it. One is it's an Indian company and India is the next China in many investors' minds. And second, it's an Indian infrastructure company, which is the biggest missing ingredient in the India story. So they're the infrastructure company

is going to create the airports, the ports, the physical infrastructure that will make India into the next growth destination. And it's got a third connection, which made it a fascinating company to value. It's a company with connections, political connections, government connections. Something we don't talk about explicitly in valuation, but could be a source of value. So one of the fascinating things about valuing Adani was the interplay of politics, markets, and economics in a company valuation. You can't avoid it. You've got to bring in all of those factors in. And as a consequence, it made valuation more uncertain because your valuation is conditional who will win the next election. And that is not a great place to be as an investor, but it is the reality that you face. So I actually found it to be a fascinating company to value because it's got good things going for it, bad things going for it. And on top of this issue of this issue of as it committed fraud and what can be the consequences of that on investing. various what kinds of companies, maybe even one specific company that you feel falls in the

too hard pile for your method of valuation. So if you had to think of the landscape of decently well-known companies in the world, is there one or two that pops out as like, ah, I wouldn't even bother trying to apply my method to it. And I'm curious the reasons why, if so. I mean, I'll take a come like Moderna. I will steer away from valuing a Moderna because, I mean, what it has going for it is a technology that it has proprietary rights on. the MRNA technology. But knowing what that technology is going to be useful for and what kinds of things that can come out of it that can create revenues are beyond what I know about medicine.

And I could sit there and price Moderna like everybody else. But if you want to do an intrinsic valuation of Moderna, it's going to be really difficult to do, perhaps impossible with what I know about medicine and healthcare. So it's a kind of company where I'm going to say, look, it might be a great company. to invest in, but from my perspective, I can't put a value on the company. No. So that's one group of companies, companies that are operating in the space where I really don't understand this space well enough to be able to flesh out the biggest item. I'm willing to value more traditional pharmaceutical company because there it's about blockbuster drugs and revenues and earnings and

cash flows. The other group of companies are put into the too hard to value pile are the companies where you have what I call discrete risk. And you come to me with a Russian company, now and say, can you put a value in a Russian company? I'm not even trying. In fact, I've reached the point where I probably will not invest in a Chinese company anymore because what do you value when you value equity in a company is a share of the ownership of the company. But if ownership itself becomes a fuzzy concept, there's no legal protection for ownership, then what exactly you're getting? You can get great earnings and cash flows, but you can't even tell me what your share of it is, which in Russia is effectively what's happened. You might have a company,

which has earnings and cash flows, but your ownership stake in the company was effectively eliminated if you're non-Russian in 2021 or 2022. And I would say that the more uncertain you feel about protection of legal protection of your ownership rights, the less willing you should be to value a company and invest based on their value. So Chinese companies are getting rapidly moved into, I don't want to value the company, but not because I can't get a value for the company, but getting from that value to what my share of that value is, it's become a much trickier exercise. Another huge storyline since we last spoke is banks, which might fall the other end of the interestingness spectrum or something. But SVB and related bank failures and crises was a huge

storyline in the past year. What was it like for you watching that happen? How did it make you think differently about our financial infrastructure, banks as businesses, and so on? We talk about the effects of social media and the internet. What I thought about as I watched SBB meltdown in the subsequent meltdowns in First Republic and Signature Bank is how those same issues that we talk about as social issues are starting to permeate how we think about economic issues. You think about it, SVB did things right. If you think about the lessons that came out of 2000, they didn't invest in risky stuff. They invested in T-Bonds. That should be safe, right? they had a duration mismatch made in hell.

But at the same time, we're taught that deposits are sticky. People don't pull money up. But those assumptions fell apart in the case of SVB simply because we discovered that deposits are not that sticky, especially if your depositors all are homogeneous. They come from the same group and they talk to each other all the time. Almost every player in the bank was somebody in that VC startup space. And guess what? They're the most interconnected group in history because everybody's on the phone with everybody else. So the space of two days, the bank went from being healthy to effectively die. So after that happened, I actually wrote a piece on the stickiness of deposits.

And I looked across banks and I said, what are some of the things that are going to make me worried about a bank? Do you have younger depositors or older depositors? I want older depositors. Do you have depositors that are concentrated in one business or in one geography or you have depositors spread out across the country? I want depositors spread out across the country. And are you a high growth bank or a low growth bank? I want a low growth bank. If you increase your deposits 50%, these are new people you brought in. They're more likely to turn and run if there's a problem.

So it made me rethink about the stickiness of deposits and maybe our bank. rules have to be written in terms of deposit stickiness. How much need to maintain as a regulatory capital ratio should be much higher. If you have younger depositors all happen to be tech people. Maybe we need to keep track of what percentage of your depositors are on Twitter. The higher the percent, the more regulatory capital. Sounds absurd, but in a sense we discovered the things that drive deposit stickiness, things that are not the old factors that we used to look at, 20 or 30 or 50 years ago. I think that the rule writers have got at least a period where they have a chance to do this before the next big run happens because there will be one.

It seems like the attitude towards ESG investing changed a lot in the last 18 months. Do you think that in some ways some of the focus there was like a zero interest rate phenomenon to some degree like an indulgence of sorts that has gone away in the last 18 months? I think virtue is always a good mountain to be on top of. For ESE people, it's over, look how much good we're doing for the world. So I will give them that starting point. The reality is when use virtue as your primary selling point, you get no debate because who wants to push back against goodness.

So for the decade, ESC advocates got no pushback. And that was, I think, a problem because they overreached. They overreached in what they claim. basically sold it as all cake, no calories. And I think in the process, they missed a chance to actually develop a movement that was healthier because there is a market out there for people who want to invest in goodness, using whatever definition of goodness you have. And these investors are probably willing to give up returns for being good.

And if ESG had been crafted that way right from the beginning, we would be in much better shape. So I think that it was long overdue, and the reason the backlash has been so harsh is because when it was sold, it was so oversawed. I've turned my attention entirely from ESG because I think that it's an acronym that run its way. But I know that it's going to be replaced with something else. Now, I'm actually writing a piece on impact investing, and I'll give you the title of the piece, because it's going to tell you a little bit about what I think. good intentions with perverse outcomes and essentially where it's the impact and impact investing. It starts with two presumptions. One is that whatever the issue you're trying to impact is real, climate change.

Real, let's accept it. And second presumption that your intentions are good. So I'm not going to question what you're fighting. I'm not questioning your intentions. I'm questioning your approach because impact investing. And you can say the same thing about ESG investing can take one or three forms. you can invest in good companies. Good is whatever increases the impact.

You can pull your money out of bad companies, which in the case of climate change will be self-phosphory fuel companies. The third is you can invest in the bad companies and try to get them to change. Those are the three moments. What I basically did was I looked at the impact outcome that is hoped for. So when you sell bad companies, is what you're hoping.

You will push down their price by selling them. By doing so, you increase their cost of equity and cost of capital. By increasing the cost of capital, they do less exploration, less growth, so there's less fossil fuels. The weakest link in that argument, you can get Exxon Mobil and Royal Dutch to do less exploration. But if the demand for energy is still there and that energy is being delivered from oil, somebody else is going to step into the breach and do the exploration for you. In the last 15 years, and we talked about in the context of ESE, it's been pre-eased.

private equity investors. It's been people who've taken advantage of the seams in this argument to make money. So what we end up with is the same amount of oil being produced, but now being produced by different people. With good companies, it's supposed to be to push their prices up, and by doing so lower the cost of equity and allow these companies, therefore, invest more. So we've got green energy companies. You can't tell me that not enough money has been invested in alternative energy. In fact, we've invested tens of billion, perhaps trillion. billions of dollars in alternative energy. But my question is, where's the beef? Where is the energy from this alternative energy? Getting 82% of energy from fossil fuels. And the weakest link in that

argument is you might be pushing the wrong alternative energies by supplying capital because you decided that wind power was the alternative energy when, in fact, it might have been better nuclear power. The problem with trying to pump money into good companies and push their prices above where there should be easier, essentially giving them an artificially low-cost to capital, too much capital to invest. So what I do with each argument is, look, I know this is the outcome you're expecting, but this could happen. And then I say, let's let the facts tell us wherever. So I take the fossil fuel business and I look at what's happened over the last 15 years. Initially, fossil fuel companies dropped in value. You look at the stock prices. But then they came back. Why? Because in the process of doing

what you did, they pushed up the price of oil. You made oil, again, a valuable commodity get out. So the price effect has gone away. You've got private equity investors making tens of billions of dollars in their fossil fuel investments. If you look at the evidence, the evidence is that the perverse outcomes are the ones that have come out of this rather than the good outcomes. Maybe there's a better way to do impact investment. But I think we need to have a healthy discussion of what are you impacting? Because one thing I can guarantee impact investing will impact is your returns in a bad way. Everything else is up in the air. You were forced to fly in the face of something you said earlier, which is probably active management is in a secular decline in

terms of market share, maybe not in terms of absolute. You know, in absolute the market grows. So there's a countervailing force there. But I said there's some sort of hunger games or something and you have to try to enter this contest to build the biggest possible investment. firm than you could. How would you think about approaching that problem? I would actually change the starting point. Instead of making the biggest, I would want a firm that I can sustain, which often means settling for smaller scale, looking for a portion of the market where I have something to bring to the table, and then not getting tempted. This is tough to do, right? Because when you're successful, more money comes in, is saying, look, this is not scalable. This can be done only up to a $10 billion,

$15, $20 billion amount, I can't do much more. But that requires discipline. And I think the active investing that I see surviving will be active investors who found a niche, something special that they do, and stay disciplined enough to stay in that niche. So the Patagonia strategy, we'll call that. Why do you think that there are still so many huge pools of capital, we'll call them LPs writ large that pursue a mostly active investment mandate and strategy. We don't have more of the guy from Nevada that just put it all in the S&P 500 or something. Hope springs a tunnel in human beings. Who wants to be average?

Everybody wants to be above average. I don't think that search is ever going to go away. And in a sense, active investing takes advantage of the fact that you want to be better than average. So I think as long as that is part of human beings, you're going to see people trying. And they'll be attracted by stories of winners. And that's why in VCNP, the stories that are promulgated have that selection by them, look how much money you could have made if you'd invest in Uber on the ground floor. Is there anywhere else that we have topics that we have not covered today,

where you feel like your opinion is the most off consensus narrative today? probably something we talked about last time, which is the Fed. I am so sick and tired of discussions that revolve around central banks because I think it's become a reason for copping out. The reason for not dealing with fundamentals is the Fed will do it. Or the Fed did it? How many active money managers I've talked to in the last few years? If you asked them, why did you underperform the market over the last decade?

Their answer is the Fed did it. It's the Fed. or we say, what will happen in the future? The Fed's going to set rates. I mean, it's very unhealthy because it means we're not talking about the things we shared. But it's still the conventional wisdom. Every time there's an FOMC meeting, the entire world, at least the investing world, comes to a standstill. It's like watching a Pope get selected, right?

Smoke's coming out of the smokestack. There's a new FOMC policy. Let's see how the world will look. If I would wish, it's over the next day. decade, we stopped talking about the Fed. I mean, there was a time when if you asked people who the Fed chair was, they wouldn't have been able to give you the name or when the next FOMC, they had no idea what the FOMC even was. This is a recent phenomenon. And it feeds into all kinds of conspiracy theories, which is the Fed and a few hedge funds and these smart money are all together

in a room and that the rest of us are essentially being taken advantage of by this Kovall. The problem with conspiracy theories is you'd no longer take responsibility for your own mistakes. So if there's a page on which I am entirely off the page, it would be in giving power to the Fed in determining what the future is going to deliver. I think the Fed is just as confused as everybody else in the market about where inflation is going and where the economy is going and it terrifies them. What do you think the ideal alternative would be? there is not. Markets are ultimately set by demand and supply. Inflation is not something that magically comes from above. It comes from our behavioral factors. So I think in a sense,

we have to give up expecting somebody up there to give us answers. The answers are in the market. And I think that if nothing else in the last three years, we recognize when experts and markets diverge, it's the experts who are usually wrong. At every time, turn in this road. I have a new respect for markets after the last three years, in spite of all their mistakes and their foibles, in terms of coming to a judgment on the big issues of the day. What do you think you have the best taste in? And how did you come to that taste? Leisure activity, basically. I enjoy my walks to the beach, two blocks from the beach in San Diego. So what I find I enjoy doing the most is letting problems clatter around my mind, sit there,

watch the ocean, try to think of answers. I have the luxury of doing that. I admit, I mean, most people have jobs that they have to go to and they have to get things done. I have nothing to do. I can sit there and think about issues. And I've often said we read too much and we think too little. I don't have that problem. I have lots of time. I know there's an old saying, an idle mind is a devil's workshop, but an idle mind is often where you get your best connections of ideas, is your best thinking is done when you have nothing in your mind per se that you have to get done. So to me, I think the advantage of not having a to-do list on most days is I get more done when I have no to-do list than when I do.

Power of an open schedule. What are you most looking forward to studying, thinking about learning in the next year? Something new. I mean, as I said, I'm a dabbler. I lose interest very quickly. So I'm always looking for what's interesting. For instance, in Birkenstock, the reason I find the valuation, fascinating is it's giving me a vehicle to talk about intangibles, this big issue with accountants

and often badly misused by praises who use intangibles as an argument for adding premiums on. With Birkenstock, I'm actually breaking the value down into how much of this is branding. How much of this comes from the fact that you have celebrities, Steve Jobs, Birkenstocks, just went on sale, I think, and sold for $216,000 or some absurdly high price. of celebrities who essentially are your best brand carriers and you don't even pay them. This is not today's TikTok and YouTube celebrities. These are celebrities who have roots who basically reflect the history. How much of the value comes from that?

How much comes to the Barbie bus? There is a bus. You can't fight it. How much is the Barbie bus? And how much of it comes to the fact that they managed to find, I mean, after all, this is a 250-year-old company. By all chronological age terms, this should be a. old company. But 10 years ago, got a new lease of life because the family let go of the company

and essentially hired an outsider to come in a CEO and the guys. I don't easily fall for management as great management, but he's actually done an incredibly good job in keeping a balance between growing the company and preserving what makes the brand special. So I'm actually breaking down the value, asking how much of the value per share comes from each of these. Because the point I'm trying to make is when people talk about intents, it's my response, it's already in there. And this time, I want to be able to say, this is where it's in debt, this is how much it's worth. So it's keeping me occupied this week. But next week, I'll be back to what will interest me next week. So who knows? Is there any other major difference in your mind between a financial and an

accounting balance sheet? The biggest difference, I think, is the financial balance sheet is forward-looking. The accounting balance sheet is backward-looking. I am less concerned. concerned about breaking things down in a financial balance sheet. What I mean by that is I really don't need to know how much of Coca-Cola's value comes from the brand name. Why? Because it's not like they can sell off the brand name and keep what's left to the company because there'll be very little left. So I'm less concerned than accountants in deconstructing balance sheets levels of detail, which I think is the problem with accounting rules is they want to get customer list. They want to get brand name. They want to get each of these intangibles separately

value. And in my view, that's an impossible task. You're going to create very artificial numbers for these. So I'm willing to accept aggregated values on a financial balance sheet because I don't have to pass it by gap or any other rule writers. All I have to do is be okay with it. And I'm okay with generically saying 80% of value this company comes from intangibles. A bunch of them. The case of Apple, it's style, it's brand name, it's having your own operating system. Why does it matter to me? portion of the value comes from each one, because none of that is separable and for sale. As well, every time we talk, I love hearing you as an example of someone in the investing world who is clearly passionate and curious about the thing that they're doing. I know in the next

year you'll have another 25, 30, 40 posts of great interest, and I hope we can make this an annual tradition. Thank you again so much for your time. Thank you, Patrick. If you enjoyed this episode, check out join colossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.