Invest Like the Best with Patrick O'Shaughnessy - Mike Zapata – The Darkest Night: Lessons from Battle and Value Investing - [Invest Like the Best, EP.89]

Episode Date: May 29, 2018

My guest this week is remarkable. He now applies his talents on Wall Street, searching for smaller cap companies trading at huge discounts in an effort to compound wealth for his investors. He is classically trained, having earned his graduate degree from Colombia, a school known for producing value investors. But his method also reflects what he learned across more than a decade of active duty in the U.S. military. Mike Zapata served us all as a Navy SEAL in the aftermath of 9/11 and ultimately as a member of the SEAL’s “Development Group,” commonly known as SEAL team 6. I think everyone listening strives for excellence in what they do. This week we get to hear from someone who has pursued excellence on our behalf. I’ll let him explain the meaning of his firm’s name, Sententia, but for now suffice to say we are lucky to have quiet professionals like Mike. If you are interested in supporting the families of soldiers who fought with Mike and lost their lives, I encourage you to check out the Tip of the Spear foundation and make a donation along with me, small or large. Please enjoy my conversation with Mike Zapata. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Books Referenced The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel Fearless: The Undaunted Courage and Ultimate Sacrifice of Navy SEAL Team SIX Operator Adam Brown Boyd: The Fighter Pilot Who Changed the Art of War   Show Notes 2:23   2:23 – (First Question) – A quick overview of Mike’s career leading up to his time at Columbia 3:43 – What led him down the path of value investing at Columbia              3:51 – The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel 5:57 – The focus and goal of the firm 7:12 – Where the name of the firm, Sententia comes from 8:04 – His experience in the Basic Underwater Demolition/SEAL (BUD/S) program and lessons learned from it 13:14 – How much grit is innate vs can be learned 14:59 – What the actual job was in BUD/S 17:33 – Difference between the broader SEAL community and being part of the more exclusive development group 19:03 – The team dynamic within the SEALS 20:26 – Fearless: The Undaunted Courage and Ultimate Sacrifice of Navy SEAL Team SIX Operator Adam Brown 21:18 – The sacrifice that SEALs make with the story of Adam Brown as an example 24:35 – Waiting for darkness before deployment 27:23 – How do you know when to violate your best practices for a risk 29:26 – A look at three pictures in his office and why they are meaningful 31:36 – Lessons that would be useful to other people             33:10 – Boyd: The Fighter Pilot Who Changed the Art of War 33:17 – How is Mike’s skillset applied to the investing world 39:24 – Factors that would be seen as good alignment in businesses 40:18 – How the view the profiles of other investors in these small businesses 41:46 – Examples of “smoke and fire”, markers of an attractive investment 43:42 – Other investors that he has learned the most from and what those lessons were 44:54 – Importance of balance sheets in value investing 47:33 – Is value investment oversaturated 50:28 – Market blind spots that are attractive to Mike 52:03 – What point in Mike’s career has he felt the most alive 53:14 – Any other lessons Mike would want to share 55:12 – Kindest thing anyone has done for Mike   Learn More For more episodes go to InvestorFieldGuide.com/podcast.  Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on twitter at @patrick_oshag

This podcast is sponsored by CFA Institute, the Global Association of Investment Professionals whose mission is to lead the investment profession by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society. CFA Institute serves a global community of investment professionals working to build an investment industry where investors' interests come first, financial markets function at their best, and economies grow. The chartered financial analyst credential is the most respected and recognized investment management designation in the world.

The views expressed in this podcast do not necessarily represent the views of CFA Institute. 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, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investorfieldguide.com. Patrick O'Shaughnessy is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management.

This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaunacy Asset Management may maintain positions and the securities discussed in this podcast. My guest this week is remarkable. He now applies his talents on Wall Street, searching for smaller cap companies trading at huge discounts in an effort to compound wealth for his investors. He's classically trained, having earned his graduate degree from Columbia, a school known for producing value investors. But his method also reflects what he learned across more than a decade of active duty in the U.S. military. Mike Zapata served us all as a Navy SEAL in the aftermath of 9-11 and ultimately as a member of the SEAL's development group, commonly known as SEAL Team 6. I think everyone listening strives for excellence in what they do.

This week we get to hear from someone who has pursued excellence on our behalf. I'll let him explain the meaning of his firm's name, Sententia, but for now, suffice to say, we are lucky to have quiet professionals like Mike. If you are interested in supporting the families of soldiers who fought with Mike and lost their lives, I encourage you to check out the tip of the Spear Foundation and make a donation along with me small or large. Please enjoy my conversation with Mike Zapata. So Mike, a neat place to start would be with a sort of thumbnail sketch of your, let's say, post-college life and career.

It's one of the more unique ones of any guests that I've had on the podcast, and we'll go into all stages and aspects of that career. But to start just as framing, maybe you could give the 22nd version of, I started here, I went here, I went here, and then we'll dive in. Well, it's pretty quick. I mean, I graduated from undergrad. I got commissioned into the Navy as an officer, and I was in May of 2001. And just quickly after that, I checked into Buds, which is basic underwater demolition slash seal training. So I went to SEAL training, and I was in SEAL training when 9 and 11 actually kicked off. And I knew that day it was just an incredibly fortunate place to be.

And the idea was, you know, you just know that the years ahead will be well spent. And they were. Ten years seeing sort of this ramp up in combats, having incredible experiences. And that took me to 2010 when I transitioned out. So, you know, without going into too much detail, we can. But it was just that experience of being in the SEAL community, working with teams. working in those capacities at that level over those years, just a perfect 10-year time window that we were able to do. And it was a fortunate place to be. And that was sort of preceded my time up until 2010

when I got out and did the Columbia MBA. When you left Columbia, I know Columbia is famous for a value investing tradition that goes all the way back to Ben Graham. And I know intelligent investor was kind of a seminal book for you as well. So maybe quickly describe your experience at Columbia. did you go in specifically with the intention of learning about value investing or was that something you sort of discovered while there? That's something I discovered just before I started actually. I wanted to be an investor and I thought the right script was sort of an emerging market investor because I had been in these uncomfortable positions, uncomfortable places where most people don't like to go and that's an opportunity for us to go in and sort of create value and infrastructure and investing.

About a month before I started Columbia, I was in the accelerator program in January. I went to a mixer and met some friends and somebody said, hey, do you know about the value investing program? I said, no, what is that? And they said, what do you know, Warren Buffett? Yes, read the intelligent investor. And I did. And it was Lightning Bolt. What very specifically was the Lightning Bolt? Was there a core idea or just overall message? It was the idea of the principles that were expressed in intelligent investor. And the idea is that stocks are less risky when the prices are much lower. And that sort of defines value, whether it's going to be a net net or whether it's going to be reduced multiples compared to competitors or historical. Something is driving that stock

price down and that is driven by emotion. And I think that in my mind, we mitigated a lot of risk in the SEAL teams, a lot of our operations. But most people think that what we did was high risk and dangerous. And we simply didn't see it that way. And I think that that's what value investing sort of replicates. Value investors are able to sort of cut through the noise. They're able to sort of isolate positions, isolate ideas and test them to see if there actually is an opportunity. And most people don't want to touch that. So we tend to get attracted to that smoke and fire. Value seems to be along that same line. So there's a lot of risk mitigation. There's a lot of assessment. There's a lot of looking at managers and looking at their incentives. There's all these

things that have a direct correlation to what I used to do. And it's just fascinating. And I liked that idea of low risk, but high reward. The question is how do you do it and value presented that. So let's just complete the thumbnail real quick and then we'll go back to the beginning with what you're doing now. So what does the firm look like? What is your key focus? And maybe just a couple quick words on the goal of the firm. When I got out of Columbia, I had a couple of options, places to go to. I ultimately decided to put together family friends funds and we launched in January 13. So we've been doing this Cententia Calab for about five years. We are a, I would say long biased, primarily U.S. equity, some outside exposure, concentrated about 20 positions,

and we tend to focus on small microcap right now. And that's sort of the flavor of the fund. We find a lot of our mispricing opportunities in that small microcap space, potentially because of indexing. There's a lot of reasons for that. But we have the ability to invest in that because we are a small firm. And I have one analyst with me, had a part-time sort of helper for the business side. And I think what we talked about it, my goal, frankly, is just to sort of be the best investor that I can be. That's ultimately where it's at. And I think that we will take a pause. We're looking for anchor investors now. And the goal is to get to $100 million where we think that we want to take a hard pause and we want to make sure that we're very thoughtful if we want to

breach that. We'll come back to the intricacies of the small and microcaps space. It's a world that I've long been interested in. But first, I'm curious what the names and tend to. means or where that came from? When I left the community, I liked investing, and I was investing in my own, and I thought, how do I give back to that community? And so me, I created this thing called the purpose fund. And I put

sort of the money in there, and the idea was that any gains that we did, we were going to give a portion back to, ultimately, the wives and children that are left behind if anybody doesn't come back. And we've had that. I mean, I tell people that I've been to more funerals than weddings in my 20s, and so the ultimate burden is carried by

the families that are left behind. So a portion of the funds go into that. So when I created Santantia and launched, Cententia is a Latin fancy word for purpose. So it still means the same thing, but that's the genesis of it. It's a purpose fund. It's purpose driven. A portion of all of our gains goes back to the families. The part of our conversation when we met in Omaha a few weekends ago that I most enjoyed was this really rich way that you overlaid what you've learned at different stages of your life onto the next stage. So the investing program as being very informed by what you learned in a seemingly completely unrelated field. And the best way to do that is to kind of go

through that experience and go through that story and try to extract lessons that you apply now in your day job, but that maybe are even more broadly applicable to people doing all sorts of different things learned in a very difficult, unique environment. So maybe you could first describe the development of your own capabilities, starting with buds. I don't want to take for granted that anyone knows some of this terminology and kind of what this group of people is tasked with doing. So maybe starting with describing the training and then I know there's a transition from the regular SEAL team to the development group and we'll describe kind of what that difference means. So maybe starting with Buds, describe that experience and maybe some of the lessons learn there.

Yeah, absolutely. Buds test you to the nth degree. And that's really just a proving ground to show whether you can actually be part of that environment and you can put up with it. And I think the fascinating thing with Buds is that most people, when they look at careers of guys that what we have done, they assume that we've never failed. And their idea is that we've never failed in anything because you have to be good to get through that. But the fascinating part about Buds is that it's designed for every single person to fail. And it's not about failure. It's about metal and grit and being able to get up and keep pursuing the mission no matter how you feel, no matter how tired you are, no matter how mentally fatigued you

are, get the job done. How do you do that? And I think that Buds defines that. So if you want to get a little more granular, I look at Buds as three phases. First phase, second phase, third phase. First phase is, you know, I say, are you dumb enough? Are you, are you hard enough to put up with the pain that you're about to feel and not quit? And really, we lose most of our guys in that first phase. We lose about half of the guys. And the culmination is hell week where they keep you awake for about five days. You have about four hours of sleep over those five days. And you're just constantly running and you're just getting, we call it getting beat, but just physical exercise and you're getting worn down. Most guys quit during that time. That's first phase. Are you hard

enough to put up with it? And can you, will you not quit no matter what? Second phase is, are you smart enough? Can you stay calm and duress situations? This is a lot of underwater navigation. It's a lot of pool competency where you have to stay calm in situations where you feel like you're going to drown and you're nine foot underwater. How do you do that successfully? Can you follow directions in a very high pressure situation? And you can't get any higher pressure than not being able to breathe. And your time is very limited and you know that. So how do you navigate outside of that in the proper way?

That's second phase. We lose more guys there. Third phase is, are you safe enough? Can you shoot and move with a team and do it in a safe way? use explosives. And once you get through that six-month period, you graduate buds, and then you have another six weeks of advanced training. So after about about a year of training, you become an official seal. Was there a particular moment, and I'll harken back to a conversation I had with my best friend from growing up,

who was an Army Special Forces guy, and just retired as a young kid and wanted to focus on being a dad. And one of the things he told me was a key criteria was just finding people that wouldn't get hurt. So sometimes people would have, you know, remarkable mental resiliency or whatever, but their shoulders were prone to being dislocated or, you know, whatever the problem might be. And when I asked them what drove their success, he said, look, it is literally just pure persistence. We're given a task and we just keep going until it's done and we don't get hurt. Was there a similar, like, simple idea like that or period in buds that stands out most in your memory as like, okay, I realize what's going on here? The idea of not getting hurt is very true because there's a proponent of luck there. It doesn't matter how hard how physically able you are, how mentally strong you are.

If your leg is broken, then you can't do it. But you'll see somebody dragging their leg. You know, you'll see somebody that, it sounds a little grim, but you get an ankle that's fractured or broken. One person will stop. They should stop. The smart thing is to stop. You'll get somebody that is not as smart. And it goes back to that person will keep dragging their foot and they'll just hop on one leg.

and they will be so persistent to get the job. That's the guy that we want, and that's the guy that we'll make it through. And the thing with injury is it becomes a new normal. I always often say that it'll either, and it's very simplistic, your injury will either get better, which no problem,

or it'll get worse, which will force you at some point to get it worked on, or it'll stay the same. And if it stays the same, it's just pain. You've got to work through it. But injury is a big aspect. The guys that shine,

even in their time of injury, they will actually be kept on to recover and to try it again. Whereas people that don't shine, they will be let go after they're recovered. How much of this, you know, this idea of grit and persistence is, is a huge and popular topic these days, both in terms of books and also in terms of investment principles, sticking to a strategy or whatever through a lot of pain, you know, value investing comes with a lot of pain. How much of that do you think in your own, based on just your own experience, is innate, meaning like you went into buds and you were just like this versus how much it can be learned. And hopefully at least you think some can be learned because I do think that experiences like this, although most people can't go through them,

can increase grit. So do you think that that's possible or is it just what you're born with? I think there's a balance of nature versus nurture. I'm not sure if I was born with grit from day one, but I can tell you my circumstances sort of helped provide that. So I mean, grew up in Texas, my parents got divorced when I was pretty young, have a good relationship with both parents. my mom was single, raising three kids. I was the middle one. We grew up on food stamps. And talking about government cheese, powdered milk, you're shaking this thing. You don't have a lot of money. You've got to figure this thing out. My mom's working. We're going to school. But there's that level of grit and determination that gets developed. You see the work ethic in your parents. You see what

they're doing and what they're trying to overcome in order to give us a better life. So very early on, I mean, I was working at the youngest of eight, like nine, I remember working. And you keep doing this. In high school you're working, college you're working, everything's working. And so that's a challenging environment when you have to do that. But it develops you. And so I think that it's a little bit of both, you know, because as you get older, you're sort of developing this grids and synacity and focus. And you just, it's determination. And I think that that is a little bit of my upbringing. And you take that in the buds. You want to prove to yourself that you can do the impossible. When we were talking again a couple weeks ago, you did,

describe part of the experience before development group as this kind of repetitive, I think it was, I can't remember what the frequency was, maybe nine months or 12 months where you could sort of go through this cycle of planning, executing, planning, executing. Maybe you could describe what that actual experience was. So how does this then work? So you're this kind of incredibly tested and trained force of operatives. What's then the actual job? Maybe we'll segment this by pre-development group in post. Sure. So, and I'll refer to the regular seal teams.

I won't be telling you anything that you can't discover open source. Yeah. So this is there. When I started 2001, they had just done Force 21. And it was a sort of a restructure of the seal community. Ultimately, what that turned into is it turned into one seal team, an entire seal team that left and they deployed. And that seal team was broken up into three divisions or three task units.

It was a two-year cycle. So before you even deploy, you're talking about six-month blocks. So the first six months, you're getting individual training. You're going to communication school. You're going to sniper school, breacher school, something to hone your individual skills. The second six months, you're doing your core unit training. So your seal platoon, your seal unit, you're going out as a team, and you're conducting land warfare training, river training, boat training, swimming.

You're doing that as a team. That's the second six months. that third six months is you're putting on top of your team and your unit helicopter squadrons boats support. And you're putting this big package together. And all that is a ramp up to actually deploying at the end of that 18 month block. And then you deploy for six months. And so you have this two-year cycle where you're doing this. And so even though you're home for, in quotes, you're home for 18 months, you're really not.

You're traveling, you're training, you're doing a lot of things. You're rarely home. and then you're gone for six months. So it's a cycle. You come back home and you do it again. You're just probably in more of a higher leadership position than you were before, but you're doing that cycle again and you're honing your skills again. How big is the SEAL community of soldiers?

I would say there's probably about 2,500 active guys and active roles. And development group, what a lot of people know is SEAL Team 6, what is that subset of the SEAL community? It's a, I'll just say it's a fraction. I think that it retains probably 5 to 10% of that force. And you have to have done well for multiple years to even put a package into there. So they take a look at you. Can you contrast those two experiences?

So the broader seal community with being part of the smaller community? I can. What I will say, though, is that I was really fortunate in my timing. When I got into the community 2001, that's when 9-11 kicked off, the global war on terrorism kicked off. And there was a lot of work to do for everyone. So the SEAL community in general is doing a lot of these operations on our own. And we saw a lot of action. As the combat progressed and you have this move from chaos to stability, which has to happen,

I will say the regular SEAL community became less combat focused because the rules of engagements change. Their ability to go out and conduct operations has been sort of compressed a little bit. They're not going to get as much work. And you could see that. And at the same time, the other side of that, development group, they ramped up a lot more. So they became much more active. And so after being in the regular teams for about six, seven years, I got picked up and I put a package in and I went to a development group.

And again, it was just a matter of timing. They were being really active. We hit there the right spot. We got a lot of incredible experiences. More than I'd once, there's a lot of publicity around that. And I think that most of the guys in our community, contrary to just a few guys that have broken that mold, they do it for the job versus the recognition. Yeah. Yeah, it's a delicate balance that I actually honestly thought about in preparation for this conversation is I've heard that, that same idea from a number of people.

Again, just because I happen to have a friend kind of in this world where the recognition is not at all what it's about. Yet at the same time, because I understand the service, it's nice for me as an outsider to hopefully like shine a little bit of light. on it because I think that understanding the sacrifice that's being made on our behalf is very important. And that's something that the general population, I guess, should value. And so maybe we can dance around it in the appropriate way. It's not about you. It's about the teams and the service itself. Maybe we could talk about the teams, the dynamics of how big they were, how you work together, what that kind of brotherhood was like, and then go from there. Yeah, absolutely. And I think to your point, it's a strange balance because the core values we hold on to are being a quiet professional

and how do you do that? Your job is to be the best, not to be recognized as the best. Anytime an individual is isolated, there's just a natural tendency to sort of have self-qualification. And unfortunately, when a living author writes a book about their journey and similar, you know, I'm not going to, I'm recognized that I'm telling some stories from my journey. So even in this, there's a little bit of self-qualification that naturally happens. very cognizant of that. What I will say, though, is that the books that I recommend to people are books that Fearless, Fearless was written about an incredible person, Adam Brown.

The only reason that I recommend fearless is because there's no self-qualification, the guy, we lost him in combat. And so to read his story, to read about his journey, read about his life, read about what he did in the SEAL teams, what he did at Development Group particularly, it's incredible to read. And that gives a glimpse of what the community is made of, which is a bunch of individuals that will give themselves up for the greater good, the team. And I think that that's something that I will always miss is having that team component

where you know everybody that is with you has been through the same sort of trials and tribulations that you've been through. And they've succeeded and they succeeded well. And now you're going into combat with this group of incredible people that you will give your life for in order to win. That's what we're there to do. We're there to win. And that team dynamic feeds to the,

that. I love this idea of quiet professional. It's such a good term. I've not read the book Fearless. I actually haven't even heard of it until just now. But maybe that could be a great example of just quickly describing that sacrifice. Would you mind just telling that story very briefly about Adams' his name? I won't go into too many details. But when you read the book, you'll understand Adam had to overcome a lot. It was drugs, his family upbringing that he came to prior to becoming a seal. And so he overcame that. It's a little similar to sort of having this sort of adversity when you're younger. He had to overcome sort of his own personal demons. had to fight through that, and he had to prove to himself that he is worthy of having this

incredible opportunity to be who he always known he is. And so that's Adam Brown. So when he got to the seal, you know, I was actually, I got to SEAL Team 2, my first command a little bit after Adam. I think Adam had already been there for one rotation. He had his eye shot out. His primary, his main eye, his right eye, primary eye, was shot with a ammunition round. It came back and he lost vision in his right eye.

So you have a person that is a shooter and you have your right eye dominant, you have your right trigger finger, and you're going to town and you've trained on that, and that's how you do it. Adam lost his right eye. So now he's going to a weak eye, his left eye, and he's taking shots, and he's still being one of the best operators. You fast forward a couple of years, I believe it was Iraq where he, there was a Humvee that flipped. Now he lost his trigger finger. So now his trigger finger is gone. And within the book, you'll hear stories of sort of these, these, these, these, type of incidents that affected Adam that happened to Adam, but they didn't affect him. And I think

that's the difference again. He's overcome this adversity where it doesn't impact what he's doing and what his purpose and what his role is. So now he has, his dominant eye is not there, has gone, or he can't see out of it. His trigger finger is messed up. And so now he's doing a weak hand shot, completely changing a shot, and he's using his weak eye. There was a chance where he was going to, he tried to put a package in to go to development group. It wasn't accepted because of his medical condition. They thought he was going to be medically retired from the service. He made a deal with one of the captains and the captain, he said, you know, hey, sort of like, give me a shot.

And if they, and don't, don't give me a special treatment. Let me go in there. And if I do it, awesome. If I don't, I'll medically retire. No problem. And so they did. And they gave him a shot. And Adam, I mean, you understand.

development group retains the top 5% of the entire force and you have to be top tier to even try to go there and then not everybody makes it through there they take half of those guys that make it through after another six month selection so incredibly highly selective Adam shined and he made it through that as a weekend offhand basically shot and you have to be a premier assaulter to get through this thing he was that so then he goes and he now is part of the the troop or the squadron and we ultimately lose them in a battle and in one of the mountains of Afghanistan. And he was covering fire.

He jumped onto a tree. They'd taken advantage shots on a couple of enemy personnel. And they shot him as he shot them. And they did everything they could to save him as they were coming down the mountain in this brutal, brutal operation that they had. It's a remarkable story. It reminds me of this idea of preparation again. So we've already talked about this incredibly long lead time,

preparing in a lot of different ways for what then is sort of acute period of deployment. And it's remarkable how much this maps over with kind of how you think about markets and investing. And I can't remember the exact term that you used when we were talking, but I'd love to somehow recreate it, which was something about like waiting for like the absolute darkest point for deployment. Maybe you could talk around that a little bit if I'm remembering that right. No, that's right. I think it's taking advantage of the darkest night. And that goes back to sort of this idea of what value investing is. Typically, people are scared. They're worried about a stock. They sell it.

and there's force selling, and they don't want to touch it because they're just worried about that. So when I think about the times in our combat operations, we had a, the example, there's always risk. No matter what, no matter how much you know about a company, no matter how much you know about a target you're going after, when you do something, there's always going to be risk that you cannot control. So I think that that's important to understand. So when we think about it, let's say that we're tracking a high value target in my former life. and we find that person in Pakistan. Well, you already have operational risk that's embedded in every operation,

but now you've added a sense of political risk. If something goes wrong, then you have a much higher chance of political risk happening and there being blowback. So that adds a level of complexity to it. So what do you do? You wait, and that high value target happens to present himself in Afghanistan. That gives us a much cleaner picture. We take away the political risk because we have more control of the area.

But now let's see you found this person in a valley with the moon full. Well, now you, again, you've increased your operational risk. We can't take advantage of our night vision. We're level in playing ground by having a full moon, having us being able to get sort of seen at night. So we wait and we wait until that darkest night moment where there's no moon. It's really scary. People don't want to go out.

And that's when we go and we do our best work. And all that is contingent on having studied the target, having understood that, hey, how do we mitigate this risk? And when I think of value, it's kind of that similar aspect where you see something that is potentially high reward, but it's risky. Whether it's a high multiple, whether it's high stock price, whatever that is, something's happening. And so you wait. You wait for that thing to start presenting themselves in a much lower risk environment, which is where the price gets pushed down. And that same time where we go out of the darkest night is when the stock is a bit of. just completely punished. But the precursor of that is have you done the work involved in

understanding that target? And because at the end of the day, you can have mitigated all those risks, but something can still bite you. What was the decision-making framework for knowing when to compromise on that idea? So, first of all, fascinating idea that the least risk happens in both situations there at like what seems like the hardest time. Basically because of the value of preparation. So preparation creates lower risk in a difficult environment in the future, which is just an awesome idea. But how do you know when that might be wrong? Think about this in terms of some of the expensive companies that have been very high multiple and then gotten higher multiple and higher multiple and have led the market overall.

Or perhaps in your former life, it's a target that's critical and the good combination of conditions just never presents itself. Like, how do you know when to violate that general idea? Experience. And I'm learning that even now. We're always learning that. But I forgot the quote, but it's the young man who understands the rules and the wise or experienced man that understands when to break the rules. And that's very true. So what happens is something that jumps out in my head is I wasn't deployed, but I was aware, maybe I was deployed. I wasn't part of that assault unit. But there was a high value target that looked like a high, a low risk, high probability of success. And so you had leadership that was forward leaning and they were sort of

dictating, hey, we go get this guy. I know it's not ideal, but go get this guy. The experience of that troop chief, and ultimately his recommendation to the troop commander was something doesn't feel right, so let's hold off. And they did an offset. They were away from the target. What happened is that target actually completely exploded. So they had a houseborne IED that was there in order to sort of suck in the assault force. But the experience of that troop chief, the experience those team leaders, that stood out and they saved guys in spite of being sort of pushed to sort of do this. But you have to have that experience. You're not right all the time. Again, no matter how much you sort of mitigate that, like we've lost incredible, incredible men that have

been much more prepared than myself. Just a couple closing questions on that and then we'll really focus on the investment process. So we're in your office and there were three very neat pictures. And maybe you could just describe those three pictures and kind of what they mean. Those are meaningful to me. So the first one is a jump trip that we had taken, and that was during the selection process for development group. So it's me and my class that's there at the end of the jump trip. And what I like about that is just the idea of that preparation. I went to that jump trip without, with zero experience on free fall.

My head static line, but zero free fall experience. Within a three-week period, you have to go from zero free fall jumps all the way up to 25,000 feet, jumping on full oxygen, full combat year into a dark HLZ and do it successfully. And I like that because of just that ramp up that's required. I like it because the team is there. The second picture is a year later, we were able to use that training, another training that we had done to do a Hayho, a high altitude, high opening combat jump into Afghanistan, where we were pursuing one of the 9-11 facilitators.

So a year after that original photo, that's us. We took a jump in combat. and it's just a camaraderie. It's that group that we did it, and it'll always be with us that operation. What's the purpose of Hayho? Why jump high or why release so high? So you can fly in.

The idea for Halo is you have this really high altitude, and you're there to sort of defeat the radar. So you just drop all the way down underneath radar, and then you pull, and then you're like sort of on the X, or exactly where your infill spot is. For a hayho, it's more of an offset, where you jump out and you deploy quickly so that you can then coast and you can fly over and you can cover terrain and then you can get to your infill spot. Interesting. So sorry, I interrupted you. So then

the third one is when, you know, just recently a couple years ago, the guys came into into the city and we walked up to the Brooklyn Bridge. And that was a, you know, again, it was pre-development group. Now we're in the assault squadron and then that same squadron when they came in, you know, still friends. We all went up, and this is post my service where we're sort of reconnected and we're taking a memorable shot on top of the Brooklyn Bridge. So New York City, we're my hometown now. It's a special place. So just kind of closing the chapter on that and looking back on your experience and recognizing that, you know, the vast vast, Madrid, 99.99% of us will never have an experience like that. Are there any lessons that you would

highlight or extract that you think would be in service of other people that you think would be useful to them that you and only people like you have gleaned that we might appreciate? I think it's the value of team and being purpose driven. And I think that everyone in that team was served by a higher purpose and we're pursuing that purpose. So to the extent that you create a firm or you have a company or you're managing a team, it's how do you get that team to understand what the goals and objectives are, to buy into that and then to support that on their own accord. Because at the of the day, it doesn't matter of your seal officer, doesn't matter of your enlisted guy, you're all part of the team. And a smart officer will seek the guidance of the senior

enlisted because they have typically had more experiences. So it's understanding that. There's, there's no room for ego. We want to win. And it's not about being right. It's about winning. So sometimes, you know, you have to understand that dynamic. And it's difficult for a lot of people because when you reach a level of seniority, you want to be sort of recognized. And you don't necessarily want to be challenged. And for us, we love challenging. So it's a good place to be. It reminds me there's a little line in a book about John Boyd. Have you ever read that biography? I have not. The really simple line where he says, you can either do something or be somebody. It kind of frames everything that you've said quite nicely. So then what does this same mentality

and skill set look like applied to, you know, a very unique part of the investing world, which is very small companies. You said smoke and fire. So I'd love to hear kind of what that means to you, what's smoke, what's fire, which one do you prefer? And how do you go about applying this same kind of framework of deep preparation, kind of waiting for the right conditions, et cetera, in the investing world? Sure. So I'll give an example of a stock that we were involved in. This stock was a small stock. It was a $65 million market cap. And we found the stock, just to go over the stock price, it went from $4 down to $250. And so we looked at this company and the question was, is there something attractive there and if there is why?

Another aspect of why we looked at the company is because we saw alignment of management. So we saw a board member that was named CEO. He took a dollar salary and he took $600,000, $900,000 or not $900,000 shares of restricted stock for three years. So the question is, why is he doing that? So we started looking at the balance sheet. We started sort of pull this thing apart. So we realized that, hey, if we did. do a hard liquidation on this company, we're getting to a $75 million company.

And that's being conservative. So we're saying, okay, we can buy a $75 million company at a $65 million market cap. We just have management come in. That's aligned. That is attractive. So we started to build a position. As we started to pull this apart more, we want to talk to management. We want to figure out what is his incentive.

He's either smart or he's just really cocking arrogance and he's just going to, he's not going to understand what's going on. So we find it, we have to sit down and come. conversation with him. This company was actually, so I'm born in San Antonio. My family's in Houston. This company was actually headquartered across the freeway from where my mom's and my house was. So when I go back to visit, I go to Texas A&M to do an investing class, I pop over there. They wouldn't really answer the call, so I'd just go and knock on the door. And I said, hey, I'm Mike. I sent you some emails. I'd love to sit down and talk with you. And so they did,

probably because they didn't have a choice, but they were nice enough to. have a conversation. And we started to sort of assess management. So now you're talking about a $65 million company. The reason that there was smoke and fire, and this is where the attraction was, and this is the difference between sort of that psychology of fear, is that there was a revolver that a bank that says, we have a $40 million revolver. We're going to wind that down over the next six months. So there was a liquidity issue. So now you go back to the balance sheet and look at the assets. And this was a heavy civil construction. They have a lot of heavy machinery. They had about $90 million worth of assets that they could put up for an asset back loan in ABL.

So we talked to management. They said, we're not concerned. We can do an ABL. We probably will or we will do an ABL. And they told the market this too. And the market just didn't believe them. And they pushed that stock down. And we, like, there's no liquidity issue.

So we know we're protected on the downside. Now the question is, where does the upside come in? And that's where the CEO is. So it was Paul Varello. he had his entire career has been in this heavy civil construction industry and we sat down with him and we said Paul you have a restricted stock for three years to take a dollar salary. Why? What is your game plan? What's your first year, second year, third year and what's your exit plan? And he walked us through that process. First year we're going to just like any turnaround we're

going to stop the bleeding. Second year we're going to bring in the team or we're going to start to build this company the way it should be. Third year we're going to continue to do that, bring in the right management and oversight. And that was a very simple game plan. But that was all predicated on the fact that we did a lot of work on this company. We saw a heavy civil construction company, low margin, high operating leverage. And I equated it to a starfish. There's a starfish with five tentacles out. They had Utah, Hawaii, Colorado, California, and Texas. And Texas, that one sort of tentacle was bleeding out the entire company. And if you sort of pull the thread on it, you find out that there's a lot of negative margin contracts that they signed just by lack of discipline.

And those were in the pipeline. So Paul was coming in there and he said this is very simple. They've done X, Y, and Z. We're going to fix those three aspects. And just by fixing that, we're going to be able to get taxes back to profitability. Once they do that, it's going to take time. Once they do that, then the market started to see this. So there was a, you know, probably an overhang about, I would say about $8, $9.

And so, Ken, you know, the goal is to test sort of Paul and say, hey, if somebody came to you right now and offered you, why are people not approaching you? So my God's going to offer you $8. Would you take it? And he's like, no way. We see an easy run to certain levels because they, and they will see it as well once we get this business up and going. We still have to do it. So then you fast forward a few years. And we're still talking to the company and we're keeping contact with them. The stock ultimately gets to. So it's beautiful when you can buy on assets and you can sell on earnings. And that's kind of what. we ultimately did. And that was a great example. And I think what I like about it is being able to assess management. There was a portion before I went to development group where I was in a special activities role. And I was a, you know, it's part of a small five, ten man team.

I was the only officer. I was pretty lucky to get into there. I did a ASOT level two, level three, which is really just source development. How do you go and have conversations with folks and understand their incentives? that was really valuable because you're talking about sort of battlefield interrogations where you're reading body language, you're understanding sort of that the nuances of people being honest with you or trying to evade answers, being very direct.

And you don't really understand what you're learning because it becomes ingraines. But I look back at it and that was really valuable because now when we talk to managers, we understand their incentives. We see what the alignment is. We see where their goals are. And we can easily have conversations. What are your favorite? You described one, which is a dollar salary and three-year restricted stock, and that's pretty straightforward.

Are there other recurrent indicators of good alignment that you look for in businesses? There has be a level of integrity there, and integrity is based off of, again, it's actions. Never believe somebody on their words. Look at their actions. So how are they aligned? Other incentives that we like to see are restricted stock units getting pushed to directors at a much higher share price. Not just blind options, not just blind RSUs, you know, where you're going to stick. to it, but you have goals. You have mile markers there where that manager is incentivized to

create shareholder value. Now, that's positive and that could be negative because you want to make sure that they're not shooting for the stars. And so there's that little balance of saying, hey, you are aligned, but we want to make sure you're taking smart shots on goal and not just trying to hit grand slams, which could have a negative effect. What are some other features of this small world where I was going to ask before how much you care, who else owns a stock when you're looking at it. This is something we've become kind of interested in, which is what is like the profile of all the other owners? Is it retail investors? Is it hedge funds? Is it institutional capital? Do you care about that? And do you see anything different in that regard, like ownership profile down in the

small and microcap space than what you're used to maybe with like an apple or a big cap stock? Yeah, you see a lot less institutional, a lot more retail, a lot less hedge funds. And again, a lot more retail. And I think they're, you know, I say that, but there are big firms out there that have tremendous amounts of money and they understand the value of small microcaps. So they will actually own a good portion of these, these companies. Aerial investments is one of them. You know, there are companies that people are like, well, you're a multi-billion dollar investment arm. How can you put money into a $100 million or $50 million company or even $20 million? But they do. And so it's important to know who they are. We find out who they are.

and we give them a call. And we have conversation to figure out why are they in it? Is it just a passive investment? Is there a thesis there? Because most of the time those heads of those states, you know, whether it's aerial, they don't necessarily get down into those level of details. They have someone else as managing that. So the conversation is who is there, why are they there? What do they see long term? And, you know, leads to good conversations. What are some other examples of smoke and fire? So wind down a liquidity crisis would be an obvious one. Are there other markers that you look for? often? I think management changes. Those are a little trickier. We have a portion of the portfolio that's focused on management, new managers coming in. One thing that we like to see is we like to see a

completely, a company that's going out of the market and telling them that they're changing. And again, it's not about what they say. It's about what they do. So when you start looking at the cues and the tens and the transcripts and you start reading these things, they are in fact taking the steps they said they were going to, but the market doesn't believe them. And there continues to be this sort of widening of the gap of intrinsic value versus what they're being priced at. And that's, when that happens, it's a question of what are we missing? Why are we seeing this? And is it sometimes it's a matter. The market's smart. And sometimes it's a matter of the market doesn't believe it. Why don't they believe it? It's because management has been telling the same

thing. They don't trust management. That's important to understand. Why aren't they trusting management. Do we have a different stance on that? Have we been able to sit down and have conversation with management? So those are really interesting dynamics. And you have these opportunities in the small microcap space where we are finding and we're involved in net nets, right, which don't really happen in the market. They happen down there because people can't put money there. But some of these net nets have tremendous amounts of NO wells that are on the books. And that's really attractive. And so again, the market has sort of discounted these companies. There have been money losers for multiple years, but now they're sort of a

shell of what they were. And now they just had a line manager that comes in with good experience who's done that playbook before. The question is, is the market believe them? A lot of times they don't. And so you're sort of, you know, you could be stuck down there for a little while. But when they start doing the actions that they say they're going to, then the market, you know, will recognize that over time. Who are some of the other investors that you've learned the most from? and what have you learned from them? Oh, I mean, it's, we stand on the shoulders of giants, really. And especially nowadays, you have just tremendous amounts of investors.

You have, you know, you have the cloud. You have Buffett, monger. How can you not learn from them? Michael Price, been doing this for decades successfully, right? I consider him a mentor. I don't know much about Michael. What is his style and what specifically you learned from him? He was one of the original, he learned from Max Heiney.

He was one of the original value investors. He was the first mutual fund activist back in the day. And he ended up, you know, selling mutual series in the end of the 90s, which he basically has effectively been retired since he was about 44. But he's been doing the same thing that he's been doing up until he was 44. And it's about understanding sort of with Michael, I was fortunate to work out of his office for about three years. And it's just incredible how much he can distill in one sentence

what he's experienced over the 40 years. So balance sheet, like how do you test the business? balance sheet. How do you avoid high leverage? How do you not care about macro? How are you a pure value investor? And Michael is that, and he's been successful over decades. Do you think that that's true of value investing and maybe of your philosophy, which is that a value investor should start with a balance sheet? I love that idea of buy assets and sell earnings. Yeah, you know, I think that that's where your safety comes in. You are protected on the downside with the balance sheet. That's it. If it's high multiples, those multiples don't matter. If it's a lot of goodwill, you know, you've got to

be concerned about that. You've got to test the balance sheet. I think that's, that's where we like to see the protection to come in. Can you talk about your favorite ways to approach that? What are the details around testing a balance sheet? You're doing hard liquidation. So we're pretty, you know, we're pretty discounting everything. We're discounting everything. You got cash. You go down that. You have a counterceivable. You discount that. You find out what's depreciated with the market value is a lot of times. If you're lucky, you get property that's worth a good amount of money, but it's completely depreciated. And then you look at goodwill and intangibles. And then you really have to, I mean, we don't count that at all, just to be safe.

And then you count 100% of liabilities. And then even then when you sort of get down this, if you look at a hard net net liquidation, you still discount that even further because if you did decide to liquidate this company, it's going to cost money. It's going to cost money to sell. It's going to take time.

So you discount that even further. So when we do hard liquidations, we look at that balance sheet. And a lot of times, especially in this market and this environment, those have been picked apart. There are not very many opportunities. like that. So the class, I think the old days of having a lot of net net opportunities is not.

Yeah, it's gone. Market got smart to that. Yeah, that's right. And so now it's like, okay, before it was a good investment to look at, you know, 0.5 times book value, right? A hard, hard stop. Now that level has probably gone up a little bit where you have to understand that, you know, there's going to be a little bit more, less margin of safety you're going to get because the opportunities are not there as they used to be. But I think the fascinating thing about value is that when I think about it, there's a bicycle wheel there. There's a spoke and there's a hub. That hub is like Graham and Dodd. They created that hub.

They're at the nucleus of value. They have all these spokes that go out. And I was fortunate to go to an ideas dinner where there was like a who's who of value investors. Michael Price was there. Lee Cooperman was there. Mario Cabelli was there. There was a few other, you know, Harvey Eisenstow was there. There's a few other gentleman that are on that table.

And what I liked about it is that in this investment, you know, in this idea's dinner, we had each investor go around for two minutes and talk about two ideas. And none of those two ideas were the same or similar. And that's what sort of value goes into where there's so many different little similarities or there's so many differences in value that no two personal eyes are going to overlap. But ultimately at that center is Graham and Dodd. Do you think that this has gotten so competitive? It's one of the most popular questions right now in markets is that value as a broad category.

has done not nearly as well as growth for 10 plus years now, really since the financial crisis. Do you think it's possible that that whole style is just, like we said, the market's just gotten too smart and is more appropriately pricing, very distressed companies, or said differently that growth profiles have just changed. The value investing relied on fundamental mean reversion in sales, earnings, et cetera, and we just haven't seen that. How would you assess kind of that landscape for your investors or even for prospective investors? No, I think it's a, it's a great question. You know, I had a conversation with my goal a few weeks ago, and it's the idea of sort of old world versus a new world. In the old world, it was a lot easier to find these

sort of balance sheet, hard tested that would go back or aversion to the mean. Right now, there's so much dislocation that's happening. And to try to hold on to something that used to work in the past that may not be as relevant today, you have to be careful about holding onto it too hard, which you also have to be careful about being sucked into sort of the sirens of growth because when growth works well, it works really well. And if you're a value investor and you're not part of that growth, you're missing out. And you feel it. And I think you see the, you see that grittiness being tested. You had sort of a, you had sort of a, I wouldn't say waffling, but when Einhorn came out last year and he sort of said, he alluded to the fact of value of being different and something's changed.

He quickly adjusted that. He went back on the CMC and sort of modified that a little bit. But it's testing a lot of investors right now, a lot of value investors because it has changed. So I think that you have to be, you have to understand there's a lot of secular adjustments that are happening right now. This growth aspect with Amazon and Netflix and, I mean, it's incredible what they're doing. It's incredible the market share they're taking. But at the end of the day, you're talking about paying incredibly high multiples for some of these companies. And I'm frankly, I'm just not smart enough. I mean, I Bill Miller is an incredible investor. He called it years ago. And, you know, Amazon, and he knows it. And if you sit down with Bill, it's fascinating to hear him talk through it, this growth aspect. And it's interesting because you're seeing a lot of that happen now. You had Bruce Greenwald, who sort of oversees the Hygrim Center until, I think, coming up here soon. You know, he's talking about the idea of value and growth.

You know, he's talking about the idea of what does that mean? And, you know, there's a lot of that question. questioning right now that's happened, I think, in the value side. But at the end of the day, you've got to stick to your niche and you have to sort of adjust where it makes sense. And I think a perfect example is like Seth Klarman. He's had such an ability to sort of adapt to the markets and be successful throughout all these cycles. And I think that it's impressive when you see that happening with some of these incredible investors. Are there any other blind spots that you're a fan of? So I always ask people about blind spots. Like where does the market seem to

repeat mistakes and maybe create opportunities? And maybe they're not all. opportunities and some are fires that you want to stay away from. But are there other places you've already mentioned liquidity problems or change in management? Are there other blind spots that you feel like the market gets wrong that attract you? That could be an industry. It could be a type of situation, really anything. Yeah, we get sucked into stories quite a bit. The market gets sucked into stories and they like stories. And I've been bidden by a couple of stories where you have good management, you have somebody coming in and changing it and they have a good story that goes behind it and you want to believe it. But it goes back to sort of testing and verifying that story.

And so you have to have this mix between the story, the qualitative side, understanding that, but then also the quantitative side. You know, can this company actually double revenue in five years? And a lot of it sounds fantastic, but the question is, how are they going to do that? And is it really valid? And I think that that's something that we look at. Those are sort of blind spots that sort of stand out. I mean, more on the short side. But we've, we've been pulled into some of the stories on the long side. And then at the end of the day, again, one of the things that I bring from my former life is the ability to have to do hot washes where we finish an investment or we finish an operation. And now we go back and say,

what do we do well? What do we do wrong? How can we improve? And so I've been in these positions where I've had a couple of these and I've reached out to other investors that I know called it. And the question was, what did I miss? Why did I miss it? And how do I not repeat that? At what point in your career so far have you felt sort of the most alive? In this life, doing what I'm doing now. I don't know. I think that my former life was just doing the job, being there, being at that sort of tip of the spear and serving a higher purpose and actually getting in the work and doing

the work. Being in combat, being in that environment, we're surrounded by this. And you have to rely on sort of like your skills. You have to rely on your team and you have to do the best you can. can do. And right now in this new life, it's kind of the same thing where we're testing that. You know, we're pushing ourselves. We're making sure we're not missing something. We're just doing the work. And I think, I don't know, to me it's like a journey. It's not about where you think you want to go. It's about just doing well with the process and getting into the weeds with that.

And that's what makes me sort of feel alive. And, you know, I look at priorities. I think priorities are very important, right? You have to understand our priorities. And for us, for me, particularly, it's family and funds. I've got two boys now, five and a three-year-old, and I've got a young fund, five-year-old. And, you know, I tell me, like, that's my focus, the family and the funds. And the goal is to grow both of them well. Just because I've learned so much from you in a short period of time, before asking my standard closing question, I would just love any other lessons that you feel that I haven't asked the right question to extract or just things that you'd want to leave the audience with before we close. No, I mean, I think first is I appreciate the time. Yeah, just the opportunity to sort of talk about the story and the journey. Life and experiences about progress and you have to have alignment in that progress. So what you're doing as a 30, 40, 50 year old is going to be different when you did, you know, in your teens and 20s. And so there's a. that ability to evolve and to just learn and get better and know that there's this idea of perpetual beta where you have a program that's inside of you, but it's always in beta because it's always going to change and not those core values, but that program is going to always

modify and adjust. And if you don't, if you try to say that it's locked in, then that's where you stop growing. And the other interesting thing is like it's again, it goes back to what gives me the sort of why how can somebody be so arrogant to come out and start their own font how can you be arrogant enough to try to go and become a seal you have to have a mix between confidence and humility because it's one thing to be confident enough to do it but you have to be humble enough to understand how do you improve how do you get better and it goes back to sort of trying just being the best you can be and I think that you know that confidence that balance between confidence humility can be found in

investing are you confident enough to buy a position why are you confident enough to do it. It has to predicate on the process and research. But then you have to have enough humility to know that you could be wrong. And if you are, where could that be and how can you get hurt? I think without those two balancing each other out, I think we're all prone to sort of ego. I think you have to keep that in check. Seems like ego is the number one risk when it comes to keeping yourself in perpetual beta. Like that's the thing that's going to get in the way the most. Do you agree with that? Yeah, I absolutely agree. I mean, if you have enough ego, then why should you change? Yeah, it's a high place to fall from. So my closing. So my closing

question for everybody is to ask what the kindest thing that anyone's ever done for you is. Believe. I mean, it sounds like a, it sounds like a, just a broad answer, but, you know, the fact that people have trust and confidence in you to do well, to take that and to be able to prove that is something that's really, really important. So I think that throughout my life, there's been supporters. Like I said, we stand on the shoulder of giants and, you know, without the support that I've had from the mentors, without learning from them, their time, they're, they're, insights is incredibly valuable and to be able to learn that and I'm really appreciative of that. People like Michael and Mario and Bill, like even Michael here in this office is just incredible

to be supported by that. And, you know, to me, another component of it is, of Sententi is, you know, again, how do we give back? The better we do, the more we can give back. And I think that we want to return that to people that we can return it to. And I think that our, um, our community gives a lot and those families give a lot. So how do we best support them? And it's trying to, you know, take what we learn here, give it back to that community. But yeah, time and mentorship, I think is, is valuable. Well, thank you so much. I obviously, I think I speak for most everyone. I say, thank you so much for your service. This is something, like I said, a world that I happen to be more familiar with, I think, than most is because of proximity. And I fully appreciate the fact

that it's, it's not meant to be expository. So I appreciate you being willing to do this. And and share some of the ideas and experiences with everybody, I think it was chock full of lessons and a level setting of perspective that was extremely valuable. So thank you very much for everything. Thanks, Patrick. It was a privilege. Hey, everyone.

Patrick here again. To find more episodes of Invest like the best, go to investorfieldguide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com forward slash book club. After you sign up, you'll receive a full investor curriculum right away. and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick underscore Oshag, OSHAG. If you enjoy the show, please leave a quick review for us on iTunes,

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