Motley Fool Hidden Gems Investing - The 37% Rule

Episode Date: September 30, 2016

Costco serves up bulky earnings. Frito Lay delivers for Pepsi. McCormick spices things up. And a beer maker gets a whole lot bigger. Plus, Brian Christian, co-author of Algorithms to Live By, talks computer science, decision-making, and the 37% rule.  Thanks to Pearl Auto for supporting this episode. Go to http://PearlAuto.com/Fool to get free 2-day shipping! Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode of Motley Fool Money is brought to you by Pearl Auto, the folks that make wireless rear-view cameras for your car that retrofit around your license plate and sync with your smartphone so you can drive safer. Check it out at pearlauto.com slash fool and get free two-day shipping. Everybody needs money. That's why they call it money. From Fool Global Headquarters, this is Motley Fool Money. It's the Motley Fool Money radio show. I'm Chris Hill, and joining me in studio this

week, for Million Dollar Portfolio, Jason Moser. For Motley Fool Rule Breakers and Supernova, David Kretzmann. And for Motley Fool Pro and Options, Jeff Fischer. Good to see you as always, gentlemen. Hey, hey. We've got the latest headlines from Wall Street. We will talk about the computer science of human decisions with author Brian Christian. And as always, we're giving an inside look with the stocks on our radar, but we begin this week with retail and beverages. Costco's fourth quarter profits came in higher than expected, thanks in no small part to the lower

cost from its new credit card deal with Visa. Looks like a good deal, but what else did you think about the quarter, Jason? Yeah, I think it was good to see that they were able to present this whole transition with Visa in a positive light. I mean, there have been some questions, I think, at least over the quarter and how it was actually working out. I do think the market is probably making a bit more of this quarter than is probably warranted. I think Costco is a great business. No concerns there. But I think it's very difficult to make the case from today's valuation that it's actually a market-beating investment. That was the concern we had in the million

dollar portfolio for quite some time. We did actually end up selling it from the portfolio. But again, I must reiterate, it wasn't because we think it's a bad business. We love this business, it's just the valuation presented a tough case there. We had questions like, how much longer is the market going to assign a premium multiple to the business? How are younger generations actually viewing Costco, given the move to e-commerce and the other opportunities that are out there? What kind of pricing power do they ultimately have? I think it's worth noting that they have a very high premium on these executive memberships, which I know our guy behind the glass here, not Steve, but Mac, is a big Costco addict.

Is that safe to say, Mac? Addict? Enthusiast. Enthusiast, okay. I don't know if Mac's an executive member, but ultimately, while it accounts for one-third of their member base, it actually accounts for about two-thirds of their sales. And so, I think the idea over time is trying to get people to move up to that executive membership. And I'm not sure how well they're going to be able to execute on that front. So, there's just some questions there in regard to growth that we ultimately felt like presented more challenges than opportunities. So, again, good quarter. I think the market's probably

a little bit overly enthusiastic about it, but what are you going to do? Well, in terms of the pricing power, what we have seen in the past is, anytime they have moved that basic membership fee up, members don't bat an eye. So, that is one more lever they could pull at some point if they need to. Jason, are they attacking the e-commerce market, or are they letting that go to Amazon? I think it's safe to say that they could be doing better on this front. It ultimately accounts for a very small sliver of the business, and it's growing at fairly anemic rates when you compare it to something like Amazon. They're definitely picking up share in that world.

By the same token, a lot of qualities with Costco, they share a lot of the same qualities with Amazon. Just an interesting little nerdy statistic here, but if you go through this most recent quarterly earnings call, some form of the word member appears 64 times in that call. This is a very member-centric business, much like Amazon. I think when you have businesses that are very member-centric like that, they tend to make very good decisions that ensure for long-term, sustainable success. So, again, I think this is an attractive investment. I think you have to be very particular with the valuation. Again, positive quarter. We would just love to see this take a big hit, honestly.

I know. Matt Kerr gets a lot of his dress shirts from Costco. So, if he starts to change his shopping habits, then we know he's the canary in the coal mine. And he looks pretty sharp. There's the red flag for all of us. Let's move over to beverages. Pepsi's third quarter profits and revenue came in higher than expected. They raised guidance. And, Jeff, once again, the Frito-Lay division just continues to get it done for them. Frito-Lay is about 30% of sales, but a larger percentage of net profits. PepsiCo is doing well. It's outperforming Coca-Cola, for sure. It trades at 21X estimated earnings

for the next year. Revenue hasn't really grown for a long time, Chris, but by cutting costs and buying back shares, they're growing earnings per share on the bottom line. The best thing Pepsi may have going for it is, this company started a health and wellness program, and right now, 45% of their products are what they call guilt-free products. So, they're recognizing that, at least in North America, we're becoming more health-conscious, and they know they need to get their snacks there and their drinks there. So, they're trying to move in that direction. Chris is smiling wide-handed. O' Guilt-free snacks hold no appeal for me, whatsoever.

for me whatsoever. The guiltier, the better. The more interested I am when it comes to snacks. 55% of their products still suit you. As a salt tooth. When I think of Pepsi, I really don't think of the drinks, I think of the salty snacks. Hey man, I know what I'm getting into when I pop that bag of chips. I don't worry about the guilt, and it doesn't worry about me. It's still a tough road. Pepsi shares are up 66% in the past 10 years. Coca-Cola has done a bit better in the past 10 years. but neither has been a market-beater in the past 10 years. They're still working hard

just to make these large businesses grow. By the way, this week, Anheuser-Busch got final approval for the $100 billion takeover of SAB Miller. When we talk about big beverages, this behemoth is now going to sell one in four beers on Earth. That's incredible. That's about eight beers to Jason every Friday night. They'll be the fifth largest consumer product company ahead of Coca-Cola, so they'll be a giant. Interestingly, Altria, of Philip Morris fame, will own about 10% of this company, and a Colombian Santo Domingo family will own 40%. So, this is a worldwide conglomerate. It's the beer empire, really.

Yeah, we're in a big beer bubble, I think, right now. As far as the craft industry goes, I think we'll see more consolidation. Yeah, there's been a lot of consolidation. no beer volume growth. It's like 2-3% a year volume growth, so the real way to grow is through consolidation. But after this, there may not be much for a while. Not many companies can say they were founded in the 1400s like Anheuser-Busch, so when we're talking about a long-term view, I think this company has it down. Sticking with beverages, Dunkin' Brands is teaming up with Coca-Cola to bring bottled coffee to grocery stores nationwide. David, this isn't going to start until early next

year, but this move is already getting a thumbs-up from Wall Street. Definitely. This is a case of Coke trying to catch up to Pepsi, which has had a long-standing relationship with Starbucks with prepared coffee that's been sold in stores. Starbucks has 75% market share of the space. Coke actually owns a portion of Monster Beverage, which is the number two player with its Java Monster line. So, Coke has a stake in Monster, but still way behind Starbucks. So, this partnership with Dunkin' Donuts, I think it makes sense. It's another way to possibly tackle that market, ideally capture a little bit of share from Starbucks. If I'm Starbucks, I wouldn't be overly worried. I think they have a pretty nice stranglehold

on that market. But in the case of Dunkin', this is a brand that for a long time has been expanding beyond just donuts. Coffee already makes up about 50% of their sales in the U.S. So, this is a coffee brand. So, this move, I think, makes a lot of sense. Well, and I think one thing to watch here is, how does this brand do nationally in grocery stores? Because for the longest time, if you're just talking about Dunkin' Donuts locations, those have been very heavily concentrated in the Northeast United States. So this may be a leading indicator of where they could roll out additional locations. Certainly. And I think, looking bigger picture, this is also a battle of the beverage giants,

whether you're talking about Coke, Pepsi, or even Anheuser-Busch, along with Starbucks. Looking at that beverage market from the coffee and tea perspective, obviously soft drink consumption continues to drop, even though JMO has his Diet Coke here. But that is a larger trend that we're seeing. So, we're seeing these big giants trying to get a bigger share of that market. I'm less concerned with Wall Street's approval here, and I'm more concerned with Chris Hill's take on the matter. Do you approve of this? Oh, I absolutely approve of this.

As much as Mac loves Costco, I think you have that same affinity for Dunkin', if I'm not mistaken. Here's the thing. I go to Dunkin' Donuts every day. Mac doesn't go to Costco every day. We've got a box of munchkins sitting right here on the table. Shares of McCormick on the rise Friday after third quarter profits rose 31%. Another strong report for the Spice Maker, Jason. Jason Moser. Death, taxes, and McCormick. I think that sums it up, every quarter. The thing that astounds me with this company is, there's never anything really astounding. They just keep on making it happen. They just do a really good job of maintaining a presence

in probably every home in the entire country, and working towards global domination. And the market is proving to really want to pay up for the quality of this business. And just to put some numbers around that, I mean, the stock today, trading around 27X earnings. But if you look back over the last five years, those earnings are only really growing at about a 5% annualized rate. Typically, you're going to see a bit more parity there. But high-quality businesses are going to garner high multiples in most cases. We've seen it happen with Costco for a long time. We're seeing it happen with McCormick. As the cook in the house, I use that stuff daily. I have to say, even today, we visited their headquarters

in Hunt Valley five years ago or so. Just one of my favorite field trips ever in my entire life. Very impressive operation. Yeah. McCormick is really in a phenomenal position. When you look at the U.S. market, the company is nearly 14 times the size of its closest competitor in terms of sales. So this is not a very disruptable business, this is just slow and steady eddy business, churning out pretty impressive results on a regular basis. Yeah, the competitive advantage period, as it's called for this company, it stretches years and years ahead, as David said, so that's part of the reason you see this strong valuation

on it. I wonder too, a little bit in jest, if you know how the spices have expiration dates on the bottom. If they could just inch that a little bit shorter over time and get more volume that way. Coming up, we've got sports, semiconductors, and stocks on our radar. Stay right here. This is Motley Fool Money. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Welcome back to Motley Fool Money. Chris Hill here in studio

with Jason Moser, David Kretzmann, and Jeff Fischer. Nike put up a solid report for the first quarter, but said that future orders were going to be light. And Jeff, they're also doing a little bit of discounting, which is kind of cutting into the gross margins a bit, too. Yeah, and the market never likes to see inventory go up, and that's what's happened, and that's why discounting is happening a little bit. But I'm not concerned longer term. Nike's been such a strong performer. 9% annualized revenue growth the past five years, 14% earnings growth over that time. Trades at 21 times expected earnings. But longer term even, it's

been such a great stock, Chris. 146% up the last five years, 380% the last 10 years. It has an $86 billion market cap. Under Armour, which came public in 2004, has a $15 billion market cap. So, Under Armour is certainly taking some market share, and that's another concern. But I would also argue that Under Armour has grown the entire market as well. It's kind of reignited, especially in younger people, but people of all ages, that desire for sporting athletic wear. And that's spread into Nike's advantage, too. Yeah, I totally agree there. And I think it's also interesting to note on the Under Armour front, and I saw this on one of their calls recently,

that we have a generation now, because Under Armour's 20 years old, the generation that is now entering the workforce is the first generation of all to come that don't know a world where Under Armour didn't exist. And so, to your point about growing that entire market, I think that's a very good observation. And it's a big leap to say, oh, well, Nike may have trouble being successful because of Under Armour and Adidas. I mean, we own Under Armour in a million-dollar portfolio, and we have Nike on the watch list. And the only reason it's not in the portfolio is strictly a valuation thing. We're attracted to this stock really sustainably sub-50, then we start looking at it as a potential opportunity. Just another very high-quality

business that the market historically has paid up for. We should keep in mind, the Olympics were just this summer, of course, so that drove a lot of sales. This next year may be a little bit light in comparison to that. Fools may get an opportunity to buy some shares cheaper. Shares of NXP Semiconductors up 25% week on reports the company is going to be bought by Qualcomm. David, NXP Semiconductor is not exactly a household name. It is, however, a $35 billion company, and I'm wondering, how good a move is this for Qualcomm if they go through with it? This move would really provide instant product diversification for Qualcomm. Qualcomm

is a company that owns more than half of its profits by licensing wireless patents to mobile phone manufacturers, whether we're talking about Apple, Samsung, you name it. That's been a lucrative and high-margin business for the company, but it's slowing as the smartphone market worldwide matures. So, Qualcomm really set the mobile communication standard with 3G and 4G, but they've been running into some antitrust and monopoly concerns in South Korea, Taiwan, the U.S. There was an activist investor last year who wanted the company to separate its semiconductor business from that licensing segment. So, NXP gives Qualcomm an avenue to kind of address those concerns and diversify the business. The company would become a leading supplier

of chips used in cars, as cars increasingly become computers with four wheels. So, I think it makes sense. It would give them more exposure to the automotive segment, mobile payments, security, and different segments. So, for Qualcomm, I think it makes sense. And shares at Qualcomm, we're also up with reports, so investors like the idea. You can follow us on Twitter. The show's handle is at Motley Fool Money. A couple of weeks ago, bestselling author Bill Taylor told us about PALS, the amazing quick-serve restaurant chain in Tennessee. And thanks to Joel Riddle, one of our listeners in the volunteer state, who tweeted us photos from his wedding day when he and his bride stopped by PALS,

I guess to pick up a little snack before they hit the wedding reception. And last week, week, we talked about McDonald's selling pumpkin chocolate french fries at locations in Japan. Thank you to long-time listener Shiraz Cedeno in Tokyo. He tweeted us a photo. He gave the pumpkin chocolate fries a try, gave them a thumbs up. It sounded like he gave them a thumbs up, but maybe his better half was a little bit more on the fence, maybe? She thought they were OK, I think. OK, yeah. So, we'll call that a mixed review. Well, she's right, no matter what. It doesn't matter, right? I think we all can

kind of agree there. It's time for the stocks on our radar. We'll go to the other side of the glass with our man Steve Broido to hit you with a question. Also on the other side of the glass this week, long-time listener Jeremy Brat is visiting us from the 202. So, thank you, Jeremy, for stopping by. Alright, David Kretzmann, you're up first. What are you looking at this week? David Kretzmann I'm looking at Electronic Arts. This is the video game giant known for its EA Sports franchises, The Sims, Plants vs. Zombies, and a lot more quality entertainment. They have 300 million registered players in 200 countries. They

have an exclusive license with Disney to develop Star Wars games at least through 2023. So, I think we'll see a lot more great Star Wars games coming out in the years ahead to go alongside the new movies. So, all in all, I like the business. Steady, free cash flow production, a strong balance sheet with $2.3 billion in net cash. I think there's a lot to like here. Steve, question about Electronic Arts? So, I'm a shareholder. My question is, are platforms where this business thrives? Is it PS4 and Xbox, or is this PCs? What's going on there?

It's all across the board. The company is increasingly becoming digital, so whether it's PC, different platforms, mobile, the company wants to be there. Jason Moser, what are you looking at? Yeah, one to keep an eye on, Cognizant Technology Solutions having a bit of a tough go here with a nasty investigation into possible corruption. This is a bit of a red flag, Chris, when we see investigations like this, and the stock is reacting accordingly. I would not make the leap that this is just automatically a buying opportunity. This is a good business seemingly. They're in consulting, particularly with information technology and other business

processes. But this is something where, if we have to call into question its actual growth, that they've been getting that growth in corrupt ways, then you have to certainly look at that going forward and readjust. And that may be what the market's doing here. There could be some reputational damage. The people really are their assets, and if people don't want to go work there because of this stuff, the business is going to suffer. So, one we're going to be keeping an eye on. O' And the ticker? Ticker is CTSH. Steve, question about Cognizant? Who's their biggest client? I don't know, actually, their biggest

client. It is a very widespread business with plenty of governments and Fortune 500 companies, though. Jeff Fischer, what are you looking at? So, Fitbit, ticker FIT, is on my radar, mainly as a case study. Can a young electronics maker survive and thrive with a single platform device that they have? When competing against giants like Apple and Samsung, who offer a lot of what Fitbit offers on an operating system that so many people use already. So, it's a $3 billion market cap on this company, 30 PE. The stock is down 60% the last year. This week, Aetna announced that they will reimburse Apple Watch purchases for its insurance users for their health reasons. So, Fitbit

got hit on that as well. So, it's going to be interesting to see how they can do. Steve? My wife has lost a Fitbit before. We now have another Fitbit. Is that a good business model, just something so small that people lose it? It may be, unless you don't buy another one. All right, guys, thanks for being here. Brian Christian is next. This is Motley Fool Money. All right, before we get to my conversation with Brian Christian, I just want to say thanks to Pearl Auto for supporting this week's episode of Motley Fool Money. Here's the thing with Pearl

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Let's get to my conversation now with Brian Christian. Welcome back to Motley Fool Money. I'm Chris Hill. What can computer science teach us about decision-making? That is at the heart of the new book, Algorithms to Live By, The Computer Science of Decisions. It is co-authored by Brian Christian, who joins me now from San Francisco. Brian, thanks for being here.

It's my pleasure. Thanks for having me. Algorithm, for me anyway, and I'm not a math person, but it's always one of those words that instantly takes me to abstract thoughts. I associate it with abstract thoughts, but really one of the things that you and Tom Griffiths, your co-author, do a really nice job right at the outset of your book is just sort of laying out that it's really just an algorithm is just a set of rules. And in this case, you're taking computer science and looking at ways just to make better decisions in day-to-day life. I'm curious, what got you interested in this topic in the first place? Yeah, I mean, this is something, you know, Tom and I, we've been friends for, you know, 10, 11 years at this point. And we both come from a background that's rooted on the one hand in mathematics and computer science. And in the other hand, in philosophy and psychology.

And so I think for both of us, I mean, certainly for myself, I have always thought of, you know, the problems that I was facing in my own life in the language of computer science. And I think it's attractive to want to find the underlying structure or the underlying rules that help you make sense of the things that you're kind of grappling with in your everyday life. And, you know, I really found over the years that the vocabulary and the conceptual arsenal of computer science contained, I would say, a surprising number of tools for helping me think about my own everyday decision making. And so this book was both a chance to, you know, convey some of what I learned along the way, but also an opportunity to go a lot deeper and see what else was out there. Well, let's stick with you since you brought this up and let's stick with your life because, again, when you think about the decisions that we make just separate from whatever we do for a living, when we think about dating, when we think about making decisions about where am I going to live, how do I pick an apartment, how do I pick a restaurant when me and my five friends are going out to dinner, how does that come into play? and also how much of that did you share with your friends let's let's just use the dinner example because that's one that you use in the book i'm curious do you actually share with them that you're working out algorithms in your head of how you're going to decide where you go to dinner or

do you just use it not really tell them no i i actually am pretty explicit about this and i think it's a testament to my friends that they uh either put up with it or you know find it somewhat endearing um but the example that you raise of deciding where to go out to eat um resembles very closely one of the canonical problems in computer science i'm sorry i'm sorry what was that word uh canonical you're gonna have to explain that for me oh sorry sorry it's uh deciding where to go out to eat whether you go to your favorite restaurant or you try something new this is one of the classic problems in computer science it's called the multi-armed bandit problem. But the basic idea is, you know, you have a bunch of options. And in the computer

science literature, they think of them as slot machines, but you can just as easily think of them as restaurants. And, you know, some of them are better than others, but you don't know ahead of time which are which. And so the basic idea is, what strategy is going to get you the most money or the most, you know, pleasure, it's going to involve some combination of trying out different options, which in computer science is called exploring, or mixed with spending a certain amount of time just going to the places that you know and love, and you know you're going to have a good experience. And in computer science, this is known as exploiting. So in regular English, to most people, the idea of exploitation has a very negative connotation. But to a computer

scientist, it just means going with the thing that you know and love. And what we've learned specifically about this exploration exploitation trade-off is that it all depends on how much time you feel you have left. And so in the restaurant example, you know, if you've just moved to a new city, the very first place you go on your first night in town is literally guaranteed to be the greatest restaurant you've ever been to in that town. And the second place you go to has a 50-50 chance of being the best restaurant you know in that town um but as you stay longer um two things start to happen one is the odds of a new restaurant being better than the best one you know about just go down the more you explore um secondly as you start to run out of time you know if you're if

you're about to move out of town let's say um well then not only is it pretty unlikely that you're going to find a new restaurant that's better than your favorite. But even if you do, you've run out of time to enjoy it. And so for both of these reasons, the math tells us, we should be basically on a kind of a trajectory from exploring more at the beginning of our time and exploiting more, spending more of our energy on the things that we know are good when we're at the end of our time. And that's something that you hit upon with looking for a place to live. This concept of optimal stopping and just sort of how if you're looking for a new apartment, how much time do you give yourself before you actually decide on a place? and the number you've come up with is 37%. Can you help me understand how you arrived at that

and what's so magical about 37%? Yeah, absolutely. This is another one of these famous problems in the field. So if you're looking for a place to live, whether buying a house or renting a place, there's a very specific problem that you run into, which is that you have a series of opportunities, but they come up kind of one at a time.

You know, if you're in a big city, you go to an open house and it's mobbed with other people that are trying to get that apartment, you kind of have to decide on the spot. Do you just take the place in front of you and never know if there might have been a better option, you know, still out there? Or do you walk away to keep exploring your options, but you lose the opportunity to have that place? You typically don't have enough time to change your mind and get it back. And so there's this classic tension between wanting to look at enough places to feel like

you can set a meaningful standard, but not wanting to spend so much of your time just kind of gathering information that you miss out on your best opportunity. And I think this is a tension that we can all relate to in a lot of areas of our life. And there's this famous result, which is that you should spend exactly 37% of your time noncommittally exploring your options. And after that point, be prepared to immediately commit to the first thing you see that's better than what you saw in that first 37%. And this does not guarantee that you will always walk away with the best option that

you possibly could have. But what it does give you is the best chance. And so that's something that I think is rather comforting when we find ourselves in that situation of even if we didn't get, even if things didn't go our way, we can rest easy knowing that we at least followed the best procedure and followed the best kind of decision making process. Non-committally exploring your options is one thing when you are apartment hunting. What about when you're dating?

Yeah, many people over the years have referred to the optimal stopping problem as an analogy for dating, where, you know, you're dating someone and you inevitably have a decision to make about, you know, do you commit to that person, you go all in and never know who else might have been out there, or do you walk away, you know, you break up with them to date other people, but maybe you have a change of heart later, but it's too late there with somebody else. And so there is a sense in which, you know, you can think of our, you know, our typical dating life, our typical love life as an optimal stopping problem. And in fact, in the book, we give some cautionary tales of famous mathematicians and computer scientists

who have applied the 37% rule directly to their love lives, occasionally with disastrous results, I should say. And so, you know, that's an opportunity to look a little bit more deeply at the problem and say, you know, what are the mathematical assumptions being made to arrive at this 37 percent rule, and what are the ways that they do or don't map to everyday life? And in some cases, there are ways that we can adjust the strategy to try to take some of that real-world complexity into account. Although, let's face it, if you're using the phrase optimal stopping challenge in your romantic life, you're setting yourself up for disaster as it is. I think it's probably ill-advised, you know, to approach your romantic life in a purely by-the-

numbers way. You know, we give the example in the book of the Carnegie Mellon professor of operations research, Michael Trick, who, when he was a graduate student, had this epiphany of, oh my God, you know, my love life is basically an optimal stopping problem. And so he calculates, okay, you know, I'm hoping to find my partner somewhere between ages 18 and 40. What's 37% of that interval? Oh, it's 26.1 years old. And it turns out he was exactly 26.1 years old at the time and so the algorithm told him exactly what to do and he proposed to the woman he was dating and she rejected him so he experienced firsthand one of the ways in which you know life life is not always perfectly uh like the the mathematical models that we have of it that's almost it's

almost hard to believe it didn't work out for that romantic son of a gun you're listening to Motley Fool money, talking with Brian Christian, co-author of Algorithms to Live By, The Computer Science of Human Decisions. One of the insights from the book that you cite is that psychologists have found less information, less computation can improve accuracy. Absolutely. That's one of the usually counterintuitive things. So for people who are investing, what does that mean? Yeah, there's a famous example of this from the world of finance.

um, where the economist, uh, Harry Markovits, who, you know, has won many awards over his career for, um, you know, his work on optimal portfolio selection. Uh, he was asked what he did for his own, you know, personal retirement account. And he said, oh, I just put, put 50% in the stock market and 50% in bonds. And he said, well, wait a minute, you know, you, you invented, you know, portfolio, modern portfolio theory, you know, how can you just, you know, have such a completely straightforward, simple, off-the-cuff kind of approach to finance in your own life? And he said, well, you know, it's very simple. I just figured if the stock market went up and I wasn't in it, I'd, you know, regret that. And if it went down and I was too heavily in it,

I would regret that. So I just hedged and I put half my money in. And I think that really points to an area in which I think computer science has been able to contribute a lot, which is the use of heuristics or deliberately simplified strategies. In particular, there's this problem that can sometimes happen in computer science when your model of a system is too complicated, which is called overfitting. Basically, you would think intuitively that the more data you gather, the more variables you consider, the more complex you make your model, the better predictions that it can make, you know, in this case of whether an asset's going to go up or down. But in fact, there's this very real danger that statisticians and computer scientists have identified of what's

called overfitting, in which case your model only becomes good at predicting the data that it saw, and it doesn't generalize well into the future. And so there are many cases in which the correct approach, the most mathematically sound approach, is to deliberately simplify the model, even at the cost of what appears to be accuracy on the data that you have. And so this, i think it's just a tremendously powerful idea that um in in many cases more complex thinking gathering more information uh spending more time kind of stewing over the decision uh not only fails to help but it may in fact make the outcome worse and so you know there there is in fact a rigorous uh a thinking person's argument against thinking too much coming up more with brian

Christian. Stay right here. You're listening to Motley Fool Money. Welcome back to Motley Fool Money. Chris Hill talking with author Brian Christian. So because of the research that you've done on this book, are there examples from your life where you find yourself making different decisions? Yeah, I do. I think, you know, to go back to the restaurant example, one of the key principles, like we were saying earlier, is thinking about how much time you have left, that your strategy towards trying new things or just going with your favorites should really hinge on whether you feel you're at the beginning or end of your time period. And so this for me has come up. I just got engaged recently. And my fiance has been living in Oakland, and I live

in San Francisco. And so we originally thought that I was going to move into her place. And so this meant, okay, my time in San Francisco is coming to an end. Let's exploit, you know, let's only go back to our favorite places while we still can. And even though we have a lot of places in oakland that we like we should nonetheless spend all of our energy trying to discover new ones because we have this whole new chapter of our lives in front of us um and then the the plot twist was that we changed our minds and we decided she would actually move in uh with me in san francisco and so it was like okay wait 180 uh let's only exploit in oakland let's only go to our favorite places in oakland and only try new things in san francisco and so you know that that

is a case where having the language of the explore-exploit-trade-off and having a sense of just at the broadest level that the strategy depends on kind of how much time you have gave us a way of thinking about the problem and a way of thinking, I think, just more clearly and more precisely than we would have, you know, just left to our intuitions. So that to me is an example of just being able to leverage some of those insights and apply them even just in these daily examples of things that don't seem like the kind of things where computer science would have something to say, but it really does. And when you proposed to your fiancé, did you get down on one knee, take out the ring and say, honey, will you reach an optimal stopping point with me? You know, she claims, and I do not remember saying this, but it is possible, she claims that shortly after we met, because I was working on this book and I was researching it, and I explained to her that 37% of the average American male lifespan is 27.8 or 9 years old, and we met when I was 28. And so she remembers this very clearly. I said something to the effect of like, well, you know, do you know what that means? Which is if this really works, then I'm all in. And, you know, fortunately, it did work. And I did propose to her. But for her, it's kind of, it's tied to this cute story from the very beginning when we met, which, of course, I don't remember. But it sounds like something I would say.

Before I let you go, I want to make sure I have this right. You graduated from Brown University with a degree in computer science and philosophy. And then you went to the University of Washington where you got a master's degree in poetry. Do I have that right? That is correct. That is a pretty uncommon set of degrees. So my first question is, are most people as surprised as I am when they hear that about you? Yeah, yeah, certainly.

I raised a few eyebrows at family gatherings and so forth when I announced that I was going from the computer science program to do a master's of fine arts and creative writing. But at the time, I was just following the things that interested me and excited me. And I don't think I quite realized how interrelated those areas would turn out to be. So it's cool looking backwards and realizing that I really was able to connect the dots. All right, last question, then I'll let you go in the poetry community is there a form that's considered overrated is like the haiku just seen as like well that's pedestrian anyone can knock one of those out i'm just i'm just curious when when you're amongst poets yeah um you know there's uh there's a form that's called the sestina

that every poet has to learn in which it's this really complicated form with six different rhyming words that you have to use in every possible order. And it's kind of the consensus of the poetry community that no one has yet written a truly great festina, and yet we still keep teaching the form and practicing it. So maybe someday someone will finally pull it off and write the first good festina. The book is Algorithms to Live By, The Computer Science of Human Decisions. Brian Christian, thank you so much for being here. Absolutely my pleasure. Thank you. That's going to do it for this week's Motley Fool Money.

Thanks for listening. We'll see you next week.