We Study Billionaires - The Investor’s Podcast Network - Classic 08: Jim Collins' book - How The Mighty Fall

Starting point is 00:00:00 You're listening to TIP. On today's classic episode, Preston and I are reading Dean Collins' best-selling book, However the Mighty Fall, that was published as episode 167 back in December 2017. The inspiration for selecting this specific book comes from Charlie Munger's motto, Invert, Always Invert. This wonderful and insightful book is all about the things you don't want to happen with your company. Also, stay tuned for the end of the episode where Preston I answer a question from the audience about currencies. I hope you'll enjoy this episode as much as we enjoyed reading, Jim Collins'

Starting point is 00:00:34 wonderful book. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right, how's everybody doing out there? You got Preston Pish and Stick Broderson with you. and today's podcast we're covering Jim Collins book, How the Mighty Fall. And I really, really enjoyed this book. When we covered good to great on the show, Stig and I were very big fans of the book and really gained a lot out of that.

Starting point is 00:01:22 And so I had high expectations, but I was also kind of expecting to hear maybe some of the same stuff. And I was pleasantly surprised. I really liked the way that he laid this out. And I think the thing that I like the most about this book was how simple it was. It was simple to follow. It made complete sense. He got straight to the point.

Starting point is 00:01:43 I'm kind of curious if you had a similar opinion. I don't know what you think about this one, but I really like this book. I thought it was a very good one. Yeah. You know, Preston, I think I probably like this book more than his most popular book, which is from good to great. I guess the reason why that book is so popular is that people want to know what a great company is and perhaps also how they can work for one or invest in one, I kind of feel that you learn more about companies

Starting point is 00:02:08 if you understand why they fail more than anything. And I think especially as an investor, it's important to read a book like this because you really understand how to sustain a competitive advantage. Whenever you're doing your stock analysis, it's always something about, yeah, it has economies of scale, which is basically just a fancy way of saying it's big, so we can do a lot of things at a very low cost.

Starting point is 00:02:34 But what we can see in this book, as simple as it is, is that there's just so much more to the story. And while there is more or less only one or two ways to build a great company, there are so many different ways of failing as a company. All right. So let's go ahead and just kind of summarize what the five stages are. Let's talk about the five stages. And then I also want to start off with this story.

Starting point is 00:02:56 So I really like this analogy at the start of the book. He talks about this person that he had recently seen that was out running and that he had found out that the person ended up having cancer and that they had this massive decline. And he couldn't get through his head whenever he saw this. He kept thinking back, you know, I just saw this person like a year ago climbing up the side of a mountain, running up the side of a mountain. They were so healthy and they looked like they were in perfect condition. And little did we know that at that moment that person had the seed of their ultimate downfall. from a health standpoint. And so he said, when I thought through this scenario,

Starting point is 00:03:35 I thought how fitting that is for also businesses and how a business on the surface might seem like everything is perfectly fine and that they're going to continue to do great things, they're going to continue to grow market share. But fundamentally, if a person really understands what makes the business tick, the seed for their destruction or their downfall or their pullback is already embedded into that company. And so he thought to himself,

Starting point is 00:04:02 how can I identify what that is before all this starts to unravel? And I really like that analogy, and I think that it's very fitting when you're thinking about a business because so often management is going along their merry way thinking that everything's fine and dandy

Starting point is 00:04:18 and then all of a sudden it's quickly unraveling itself faster than they could ever imagine. So he describes this process, a company that falls from grace, in five stages. The first stage is the hubris born of success. The second stage is undisciplined pursuit of more.

Starting point is 00:04:36 The third stage is denial of risk and peril. The fourth stage is grasping for salvation. And the fifth stage is capitulation to irrelevance or death. So what we're going to do through this episode is we're going to talk about each one of these stages. We're going to talk about the things that kind of identify and signify whether you're in stage one through five. And just for the progression, stage one would be you're that runner that has the seed of the cancer and you don't even know it versus stage five is everything is falling apart and you're at your death phase with the business. So did you have anything else you want to add for the intro and the overall summary of what we're going to be covering Stig? No, I think the only thing I want to say is I think it's important to have respect for why it's easy to look back at call it Lehman Brothers or Bear's.

Starting point is 00:05:26 sterns and say, yes, this is a very simple narrative of why things go wrong and how difficult it can be when you are in the middle of the situation. And I think it's important so we don't make this too simplistic. There are some very smart people running these companies that we're talking about and also that failed. And it's just one of those. It's easier to explain what has happened than what's going to happen, I guess. Yeah. No, that's a great point. The other thing that I want to quickly highlight is, like any Jim Collins book, there's just a ton of research. He backs this up with case studies. He backs it up with research from actual companies. That's the one thing I really like about his writing is it's not just anecdotal. He has a lot of

Starting point is 00:06:09 examples to substantiate his claims. So let's go ahead into the stage one. Huberus born of success. So when we're talking about this first stage, what we're talking about is that a company, I guess the easy way to say would probably be a company has an ego problem. We're successful because we do these specific things, and they're going around touting that. What Colin says they should be saying is we are successful because we understand why we do these specific things and understand what conditions would prevent those from happening or that they wouldn't work any longer. So understanding why the specific things is the important part.

Starting point is 00:06:50 He provides an example with Motorola. They invented the StarTac cell phone, which were the smallest phones in the world at the time using analog technology. But at the time, this is where digital was starting to come out. And you can kind of see that phrase that he was saying, we're successful because we do these things, but they're not understanding why they do the specific things. And he talks about how the amount of impact that that had and how that set them back. Yeah. And it's actually a very interesting speech. speaking about a company like Motorola. I mean, for decades, it has been praised as one of

Starting point is 00:07:25 the very best companies. And you might be thinking it's because Motorola didn't reinvent itself. They kept on with the analog technology and they didn't go digital. That's definitely a huge explanation. But Jim Collins talks about how complacency is really not important. I mean, it's easy to come up with a narrative saying that the company didn't change the way they should. It's not a question about changing. It's not a question about innovative if you look at the stats. That was something that also surprised the author whenever he was conducting this research. A company like Motorola, they never had as many patents as when they were all filing for bankruptcy. They just have the wrong patents. They couldn't understand why they were successful

Starting point is 00:08:09 and in which situations they were not successful. And it's very important just to read between the lines. And he's starting out this chapter of perhaps it was even the preface about United States leather company. And there was once one of the biggest companies in America, I think it was like the 15th or the 17th at the start of the 20th century. But they just didn't reinvent itself like they kept producing saddles, which was not a good investment. It's turned out when the car came out. Basically, he's telling that story to tell you that the stories are not as important as the data that you're looking at. And it's a It's all about understanding why you're successful, not all the other, what you would call noise.

Starting point is 00:08:55 So concluding this first stage, let's talk about some of the indicators that help you identify whether you're in stage one. And this is the one that I really liked. And this is the thing that I always say to Stig whenever we're thinking through our strategy with our business. And that's neglect of the primary flywheel. So going back to Colin's first book, he talks about this thing. the flywheel. What's that fundamental thing that the business does and does better than anybody else

Starting point is 00:09:25 on the planet and is really their competitive advantage that they're really, really good at? And they're very efficient at. And he says that when a company starts getting away from that thing and they start drifting off and maybe focusing on other things or leaders get distracted by the exciting potential earnings that they fail to focus on, that's when the company's setting themselves up for this stage one. And I like this point too. He talks about refusing to attribute luck to random events. He says that the management thinks that every success that came to the company was 100% due to their actions, opposed to, you know what, we did this really well, but if we didn't have this lucky circumstance over here that happened, we would have never been

Starting point is 00:10:11 able to have been catapulted to where we're at. They're basically attributing all success, completely to their actions. And that's a dangerous thing. And that's where the ego is really stepping in and not accounting for the why. And I think that's the big word in this first stage that you've got to really understand is, why did we do this?

Starting point is 00:10:30 So just a couple points. It really comes back to the episode we did. I think was episode 108 called The Outsiders about the very best eight CEOs. And they really owned their mistakes. And they owned everyone else's mistakes. So if something went wrong, it was always his CEO saying, it's my fault.

Starting point is 00:10:47 What can I do about it? Even when it was not his or her fault, it was just the approach that they have. And every time things went well, the author would have what he called, like, look outside of the window principle or something like that, which basically meant that he would attribute all the good fortune to someone else, like his team, the market conditions, whatever you could come up with. And that's just such a healthy approach and really makes you humble.

Starting point is 00:11:11 One of the best stories that Jim Collins comes up with, To exemplify this in the first stage is he's talking about Walmart versus Ames. And Ames was a retailer came out four years before Walmart and they basically have the same concept and save opportunity. But the reason why Walmart was so successful compared to Ames, that was really because of Sam Walton's humility and his willingness to learn. And the anecdote that he attached to this story is that at some point in the 80s, a Brazilian investors bought a discount chain.

Starting point is 00:11:44 They was only going to run in Brazil. They sent out letters to 10 CEOs in the U.S. to consult with them and have a brainstorm meeting on how can we best serve our customers. And nine out of 10 people ignored. The one person who came to those meetings who met up and spent a week with the Brazilian CEOs, there was Sam Walton. And he did that not just to teach them how to run retail because he said, I'm not sure I know why.

Starting point is 00:12:11 he said, I might just have been lucky with Walmart so far. What can I learn from you? What can I learn from you that is useful so I can sustain the success that we're having so we can keep on growing? That just tells you the opposite side of this arrogance of being, of course, we're successful. We're aims. Of course we're supposed to be successful. Because look at our track record the past 10 years. Whereas Swanson would say, I don't care about the past 10 years. What's going to happen to the next 10 years? And how can I get that? And how can I own? to it. Yep. So I've got a funny story that I can tell you. From whenever I was young, I got out of high school, I go off to college, and I ended up going to West Point. And at West Point, they have

Starting point is 00:12:52 an interesting way to introduce you to the school. And on the very first day when you show up, you were taught that as a freshman, you have four responses if you're talking to an upperclassman. The four responses are, yes, sir or ma'am, no, sir or ma'am. I do not understand sir or ma'am and sir, no excuse or ma'am, no excuse. And I think for a person hearing that from the outside, they might be like, that is ridiculous. You know, like, that's the only thing you're allowed to say unless they ask you to expound on something. And the last one is the one that I want to highlight because I think it fits into this stage one where we're talking about taking ownership. And when you are forced to say no excuse, even if in your mind there's an excuse, there's a reason.

Starting point is 00:13:41 why something happened. Maybe your friend did something and you got in trouble for it. The only thing that you can respond with is no excuse. And I had no appreciation for this at the time. But looking back decades later and looking at the experience, what it forced me to do personally after going through that for an entire year of saying there's no excuse. And sometimes the comeback would be, well, yeah, there is an excuse. Tell me what you failed at. And so then you would have to say, well, if I would have done this better, then that circumstance might not have played out. And it forced me to take ownership for every single thing, even when it wasn't my fault. Even if it was my friend's fault, I had to take ownership for it.

Starting point is 00:14:22 And that was a really, really powerful thing that I learned at a young age that I still hold with me today in that when something doesn't go wrong, I like the feel like maybe, you know, other people in my life might argue that this is how I handle things. I'd like to feel like I always look internally at myself first and say, how could I have done that better? And it comes back to that lesson that I learned as a young cadet years ago. So moving into the second stage, this is undisciplined pursuit of more. I loved his example in this stage here because he talks about rubber made. And he talks about rubber made making so many products that they were actually making a product every single day of the year. They got to a point where they were making so many products and they had so many products on the shelves that when they went back and looked at how many products they had versus

Starting point is 00:15:15 the time that they did it in, they had literally made a product for every single day in the year. I mean, anybody looking at that from the outside can say that does not make any sense whatsoever. You have to know what your market really wants. What's going to give you 80% of the return for 20% of the effort? And you've got to just optimize the living heck out of it. And the example that he provides with Rubbermaid was quite amusing. Stig, I know you've got some notes on this idea. I think the best example I came up with for this undisciplined pursuit for more, that would be Starbucks.

Starting point is 00:15:49 And Starbucks was actually not mentioned in the example. He used Merck as an example, but it's basically the same. So what happened with Starbucks, I want to say it was around 2005, 2006, when it really took off, was that they decided to grow. but they decided to grow for the sake of growth. So the metrics that they started to look at, that was not bottom line at all. It was not expenses.

Starting point is 00:16:14 It was just one of the key metrics. That was the number of stores, which is probably one of the most ridiculous metrics to look at because you can always get a higher top line by just opening new stores. But what happened was that they opened up very unprofitable stores. Another thing would be hiring X amount of people. But I think I want to tie a bow on this long spiel about talking about Paca's Law, which was something that Jim Collins highlighted in this chapter.

Starting point is 00:16:43 And that was that you can grow faster than finding the right people to implement that growth. Think about how is it measured. And it is not measured on the bottom line. You should be very, very careful. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the first. the height of the summer. You've got long days of daylight, incredible food, floating saunas on the

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Starting point is 00:21:05 Back to the show. You know, you see this so often with businesses that go and buy or acquire another business and it has no correlation to the underlying assets of the original business that they purchased. If a company's doing this from a non-operational standpoint, it works, kind of like the Berkshire Hathaway model where it's kind of like a non-operational role. and even in an operational role, if you have the right people in place and the headquarters doesn't try to go down there and change everything. I think that's when it gets, when they try to really do the merge and they try to bring

Starting point is 00:21:40 their headquarters in there and start bringing some of their leadership down there and it gets messy. I see that fail so much more than it actually works that I think we get easily nested up here into this stage two, which is undisciplined pursuit of more. So some of the indicators that you're in stage two, I really, really like this one. So easy cash erodes the discipline that sustained the company in the first place. How many times do you see a company that goes and does an IPO or raises a bunch of money, maybe an early startup? They raise a bunch of money. I mean, you're seeing this in fintech

Starting point is 00:22:17 right now, like to the extreme, all this cryptocurrency, Bitcoin stuff. Like, you're seeing so many companies that are getting very large checks being thrown at them, and they're just going out there and spending and trying to grow, and they're not, they're not getting hardened, is the way I like to describe it. When a company is strapped for cash, they have to get hardened. They have to develop these protocols inside of their organization to be efficient, to be lean, to do things in the most optimal way possible to generate net income. And I think that's a really healthy thing for a company to go through. And so anytime you see a very large check being written for a company, the immediate question needs to be. So what is this for? Like, what in the world are you

Starting point is 00:23:04 going to use all this money for? Another thing that's really a red flag. And this is probably not so much from the outside, but whenever you look inside an organization is if people start to think in terms of job instead of responsibility, that's something I've seen so many times that people are saying, no, that's not me. That's not my job. That has not been delegated to me. So what can I do about it? And that's just the wrong approach. You have a responsibility and you can always ask for more. One other point that I have for the indicators for this second stage is, will these activities that we're doing right now help the organization's economic engine or is it going to basically create a resource engine? So a lot of the times when these companies grow,

Starting point is 00:23:51 and they expand, what they're really doing is maybe adding more risk to the business because there's more cogs in the wheels and there's not really much economic benefit or margin being added on the income statement that then gets banked and can be used as retained earnings into the future to give the company that flexibility to maneuver in the market dynamically. Instead, they're just adding more and more and more people to the churn and you're not really seeing much more net income being added to the bottom line. And that's when you're getting yourself into this situation that I look at it like a person walking a tightrope.

Starting point is 00:24:26 If you add more and more and more weight to that person, as soon as you get a little bit out of balance, the whole thing's going to fall over. That's, I guess, the best analogy that I could use for this stage two piece. Something that's important that Collins talks about in the book is you could start out at stage one and recognize it and pull yourself right out of it. You could get to stage three and recognize it and pull yourself out of it. So a lot of these companies, they might start going down this path, but they can get themselves back out of it. The ones that just continually go stage one, two, three, four, and don't do

Starting point is 00:24:57 anything to mitigate or correct or self-correct themselves. They're the ones that eventually have the slow and sometimes even quick death. So let's go ahead and jump into stage three. Stage three is called denial of risk and peril. So this is where you're really starting to see the numbers demonstrate what's actually happening. here. Instead of the company still grow in their top line and there's like this thing that's kind of growing inside of the business, this mindset that's kind of grown inside of the business, now you're actually starting to see it play out. You're starting to see maybe the Starbucks example, and this isn't necessarily what happened. But let's just say they continue to add more

Starting point is 00:25:37 and more stores. A lot of them are profitable. Then it's a strain on resources at the headquarters level when it just compounds and it gets to the point where it's not sustainable and you're actually seeing the top line start to contract. And then management's way of handling that is, oh, well, it's this outside thing, or it's the economy, or it's anything but us. It's not us. It's everything else. It's the competitor that's coming into the space.

Starting point is 00:26:04 We need to just keep doing everything the way we're doing it. We need to keep expanding. That's what we're talking about here in stage three. So he actually gives some really good partners in terms of how to read the financial statements. And he found in his research that three key ratios are more important than others. And he mentions gross margins, current ratio, and debt to equity. And all of the following companies that he studied, there saw deterioration at least one of those three ratios in states three,

Starting point is 00:26:35 which will then lead them to stage four. So the gross margins is basically what you see a lot of in retail right now. So it's basically just the difference between the revenue. So the price that you charge for a product and then the cost you have to that product. If you ever start to see that you road, it's a big red flag. Now, that's also why retail is so cheap. And I guess some people would say it might still be oversold. So there might be some value there.

Starting point is 00:27:00 But it's definitely a red flag. And there's often a good reason why companies like that are trading at a very low multiple. And so the current ratio would be how much cash is expected to go in and how much cash is expected to go out within the next 12 months. And if you see a change in that, it's also a red flag. Tell the audience what a normal current ratio would look like as far as the number. I would recommend that you have a current ratio of around 1.5 or more.

Starting point is 00:27:30 And if it's 1.5, it basically means that every time we have $150 coming in, we have $100 going out. This is very different from sector to sector. There are some good reasons why it's different for a company like Walmart than if you have it already. company. Yeah. And if you guys want to go do like a graduate level study of the current ratio, go look up Amazon and look at their current ratio. And what you're going to find is that it's actually under 1.0. I think we talked about this on our form, maybe like four or five years ago. There was a big long discussion on our forum about this. And it really comes down to their operational effectiveness and how they're able to do this and their dealings with vendors.

Starting point is 00:28:11 Yeah, I think it's less than one. It's something about like the credit terms that they can negotiate because of the size. It's more like a math thing. It's not like we're not saying that Walmart is going bankrupt. That's not for saying it all. If you look at the numbers, it's a different type of business. But yes, it is in general a concern if you have more cash going out than coming in. And it's just a trend that you should definitely look into. And then the last thing, that's the debt to equity, which is also a metric we talked about multiple times here on the show. And the easiest way to think about this metric is basically that a company would slowly build equity whenever they have a profit. But then we look at how much debt do they have in comparison.

Starting point is 00:28:51 And basically, we just don't want the company to have too much debt compared to the wealth that they're accumulated. Another sign that he's pointing to that's not like a key ratio, that would be multiple reorganizations. That was another thing that he pointed to. And for me, it has been very relevant. So, Preston and I talked about McKeeson here a few weeks back, and that as a very interesting stock pick. And I picked up some. And I think Preston, correct me if I'm wrong, but I think you also picked up a little.

Starting point is 00:29:21 And it was a very good price, and it shows some very good numbers. One thing that was concerning for me whenever I was going through the financial statements, that was that they are doing some restructuring right now. and they had some things going on in the UK and they're going to write that off. And I'm not saying it's a huge issue, even though whenever I look back at some of the previous financial statements, I can see very little, but a few restructuring. And basically, this ball is down to how do you present your data? Because if something is restructured, it doesn't appear as your normal operating income. And the way that McKeeson and a lot of other companies are reporting operating income is that they have something they're called adjusted a bit.

Starting point is 00:30:06 And whenever they're doing their adjusted a bit, it's a different number than the profit that they're actually making because that would include all the costs that they're basically just running off. So whatever I see something like that, it's not so severe that I will never invest in that company. That's not what I'm saying, especially if I get good value and if not like a big position. but it is something I definitely plan to monitor closely also for this company whenever I find that. So anybody that's listening to this and they're interested in how something like the current ratio is calculated, this is all on the balance sheet. When you go under the balance sheet, there's current assets listed and there's current liabilities. Those are items that are going to be either paid out or collected within 12 months. So all you do is you just take the current assets and you divide it by the number for the current.

Starting point is 00:30:55 liabilities and that's how you come up with that ratio of a 1.5 or whatever the number is that Stig and I were talking about. So let's talk about the indicators that you get when you're in stage three. Just listen to some of these. And you guys are just going to be nodding your head, be like, wow, this is what my company I'm working for right now sounds like. Okay, listen to these. Amplify the position and discount the negative.

Starting point is 00:31:18 So if you go into a meeting and all they're talking about is how awesome they are and any negative is just kind of washed away, that's a stage three sign. Bet big on new goals without empirical evidence or validation of previous small wins. I love this one. If you're going out there and you're just, you know, you're putting all the chips down on something that you have no idea what it's actually going to do, that's a sign of stage three. Here's another one. Debate and dialogue is replaced with consensus. You know, if the boss is sitting at the head of the table and he's not saying, so what's wrong with this idea? Shoot some holes through this idea. Tell me why I'm wrong. And instead, all you hear is people just kind of nodding their heads and

Starting point is 00:31:59 saying, oh, sir, that's a great idea. We love that idea. Those are some signs. Here's another one. Externalizing blame rather than accepting failures. I mean, that one's obvious. And here's one more. Obsessive reorganizations within the company. So all of these, I think everyone has seen. in their days in the workplace, but whenever you're seeing these, just permeate your workplace. You're in stage three. And I don't want to talk too much about stock investing necessarily, but here goes anyway. Whenever you're listening and reading through the reports, of course, it's a natural tendency to emphasis good news, but it just can be so, so dangerous.

Starting point is 00:32:45 And I just need to bring up this one example. So I called Preston last night, and we talked about. just business general. And then I said that the stock pick that he pitched, I think it was like two or three mastermind meetings ago, which was GameStop. And I don't think, actually, I don't think you ended up buying that, but I bought some stock in that. And they were sending out a new quality result. And the market was like training at 8 or 10% pre-market up. And like everyone was just so happy. And I was kind of thrilled too, because I'm usually to never ride about my stock picks. And then I read through the statement. And so basically,

Starting point is 00:33:20 they have two growth drivers. I don't want to talk too much about the stock pick, but it's more for the example. They have something that called technology brands. Technology brands is very important to them. That's one of the primary driver for growth and already like a really important business unit. And I was actually very surprised to learn that the earnings or the gross profit has decreased on that. And I was because they actually took up a sizable debt to buy a lot of AT&T outlets and to really grow that. I mean, that was definitely the expectations. They were asked into that twice, and the response went something like this, yeah, there's a delay in iPhone X. So that's just why, next question.

Starting point is 00:34:01 Like, they didn't talk about that at all, but then they had another business unit that there's also a growing is called collectibles. And it's significant less severe. And they just talked 60% of that earnings call, wherever that was all about the growth that they have and the collectibles, completely neglecting the problems they had with technology brand. there was actually an even more important business unit. And I haven't sold my positions since I read that. It's probably, I don't know, two or three hours ago since I read that. I was just so taken back about what I felt was a very insincere handling of problems

Starting point is 00:34:35 with the management. And hey, they might have some good reasons for why that has been the case. But nonetheless, they need to own that mistake. They can't blame it on Apple because they're delaying one of their releases. that's, for me as an investor, that's not good enough. So for me, that was definitely a flag. So perhaps Preston was right after all. Who knows? Yeah, I did not buy it. But I, you know, like I said, when we recorded that, the numbers were just so interesting. You know, when you bring up this point stick about how they're not owning up to the failures in really kind of

Starting point is 00:35:06 making those the focus, when you go to a Berkshire meeting and you watch Buffett and Munger talk about their decisions, they are so comfortable talking about their failures. In fact, I think that they almost prefer to talk about their mistakes and their failures, because you can see them trying to learn and also teach people how to not make that same mistake, and they're almost obsessive about focusing on that area, as opposed to talking about all their wins, which they just have so many of them, you know? So it's quite interesting to see the dynamic between what he just described and what we see every May when we go out to their shareholders' meeting. All right. So stage four, grasping for salvation. So this is the point where things

Starting point is 00:35:49 start getting a little scary. And the business is not only seeing financial decay, but they're also seeing talent decay. They're seeing flight of investors that have been around for a while. They're seeing all sorts of things that are happening here, and they're reaching for straws. They're getting desperate. They're trying anything and everything. They're firing people that have been there for a long time because they think that they're the reason that they're underperforming. And really, this is just the mindset is kicking in even deeper and pointing more fingers. So for the example in the book for Stage 4, Collins talks about HP and IBM. So Stig's going to cover the recap of this. Yeah. So for HP, they had the problems at the end of 1998. And basically what they can

Starting point is 00:36:38 up with was that they needed a bold new leader. And not only did they want like a new leader, they want like a different expression, especially in the media. One of the reasons also to attract talent, at least that was the narrative. So they wanted a new leader and they found one. And they found like really charismatic woman. She was featured on Oprah. I think she was even on the front page of Vogue. I think actually paid $3 million for that front page. And she was very determined, we need to do these two or three things or whatever it was. And when we do that, we have turned this company around and this just needs to go like this. She was definitely in a hurry. And obviously what happened after not a short period of time, these initiatives didn't pan out and she was let go. And then he compares

Starting point is 00:37:24 that to the previous IBM CEO that almost went underground after he was appointed. He didn't go public at all because whenever he was actually said that he did not have a grand plan because how could he? He didn't know the company well enough. So he spent nothing less than three months before he made the first public statement in terms of where they were heading. And he still said, I just really trying to understand what we need to do. And that was how IBM and perhaps they can use a CEO like that today, who knows, that was really how they turned it around. And this really comes down to some of the markers in terms of when this is happening. Are you seeing someone who is in a hurry to implement a solution? For instance, like HP, you know, then.

Starting point is 00:38:06 that's probably a bad thing, and vice versa. Do they look at big acquisitions? Like the silver bullet solution, you see a lot of that whenever you see a new management, focus on M&As, usually not the best thing. It's usually focus on the core competence for that company. Do they have good stories and good narratives in terms of how to go out of the crisis, or are they performance and fact-based whenever they're making arguments, both internally and externally? That's really what you should be looking for to turn around stage four company. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA

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Starting point is 00:41:55 fundrise.com slash income. This is a paid advertisement. All right. Back to the show. So the behaviors that exemplify and perpetuate stage four, listen to this one. Seek a big game-changing acquisition based on hope for it has yet unproven synergies to transform the company in a single stroke. That would be something that would exemplify stage four. Here's another one. Embark on a program of radical change, a revolution to transform or up and nearly every aspect

Starting point is 00:42:30 of the company jeopardizing or abandoning the core strengths. So if those are things that you're hearing inside of a company, then you know you're in stage four. What Collins recommends something that could get you out of stage four would be gain clarity about what is core and should be held firm and what needs to change building upon proven strengths and eliminating weaknesses. So whenever I read that, the thing that immediately comes into my mind, if anyone's read the Steve Jobs book, I just,

Starting point is 00:43:00 I distinctly remember when Jobs came back to Apple. This was after he had started next. He had came back to Apple. And he comes in and they've got all these odd end projects going on. It was just kind of like a mess. It was exactly what would be classic stage four company. So Jobs is sitting there with a whiteboard and he's jotting down all the different products, the assets within the company.

Starting point is 00:43:24 He's asking them about the competitive advantage of this. What's the competitive advantage of that? well, what's the technology? How long is this technology good for? He's like mapping this all out on the whiteboard. After he's done hearing all these different people show up and is like, it seemed like there was just yet another department that came out of another department as he's writing this stuff down.

Starting point is 00:43:43 And after he was done, he had heard everything. He took out his marker on the whiteboard and he circled four things. And then he wiped everything else away. And he said, these are the four things we're going to do. And we're going to do them better than any. on the planet. And if anyone comes to me with anything else, we're not going to do it. We are doing these four things. And that's what set Apple on the trajectory that it's at today. And that is exactly what Collins is getting at with how to recognize what is stage four. What a company needs to do

Starting point is 00:44:18 to get through stage four and start coming back out is what are those core assets that are bringing home the bacon? And how can we optimize those? How can we refurb? find those. How can we be really, really, really good at that and cut all the excess fat off this company because if we keep running around at 300 pounds, we are going to die. So we've got to figure out how to save this thing and focus on those things that will save the company. I found that to be a really profound chapter and I really found a profound, the insights that he gives on how to self-correct at this point, because this is your next to last phase. And if you don't self-correct here, you're done. All right. So the last stage is capitulation to irrelevance or death. In this section,

Starting point is 00:45:05 he doesn't have any companies that he provides that reach stage five. Most of the companies that he studied throughout the book, got to stage four, and then they started to self-correct. Some of them did in a great fashion and some of them just continued to stumble around at the bottom. A company that I would like to talk about today, that in my personal opinion that's in stage five is Sears. The reason I feel like Sears is in stage five is because the company has set themselves up for a situation where they have structured the way that they compensate their employees in such a manner that no outside investor is going to have a lot of interest in buying or merging

Starting point is 00:45:47 or taking on the responsibilities of that company. There are laws in place that if you have all these obligations, and I'm talking about basically retirement obligations to a lot of the employees that you have at Sears. That is not something that you can just swipe away and make those disappear. Those are obligations that must be paid at a certain order if the company would liquidate or if the company would be purchased. Those obligations are going to be carried over. I think that's a big, big concern. And that was very, very, very bad, poor decision-making by the management of this company years ago.

Starting point is 00:46:23 Think of it like this. If you're going to structure something inside of your company, you know what that means financially. So if I offer somebody a retirement package that's going to be paid if they work for the company for 30 years and it's going to be X number of dollars, I have to value that in today's terms. So these managers that would have structured all these deals with all their employees, they were making promises that they knew could not be held. or at least I would suspect they had no idea that they could be held. That was the death of this company, not to mention many, many other things, but the reason that I think that company is going to go into stage five is for all those reasons. And like I said, he didn't provide an example in the book of a company that got there,

Starting point is 00:47:08 but I think if you're studying this book and you're looking at real world examples, I personally think that that's a company that'll get there. Maybe I'm wrong. Maybe somebody will come in and happily pay all those benefits out. but I think it's a big concern, and I think that it's a great example. And States 5 is really where the company's leader, perhaps even the founder, typically just sells out. And it might be to a competitor, it might even file bankruptcy.

Starting point is 00:47:34 And it's obviously it's not a good stage to be in. But I think the best way at least for me to talk about this stage is how to avoid it. And I know that we're giving a lot of pointers so far in the first four stages. But if there's one thing I really wanted to point out, that's the sense of urgency. I mean, it's easy to feel the sense of urgency if you're just about to go bankrupt, but obviously you need to feel that a lot sooner than that. If you feel urgency, both in good and in bad times, and if that is ingrained in your culture, that's really the roadmap to success.

Starting point is 00:48:08 Whenever I read about a company that might be stage four, stage five, and they talk about how they will now improve the bottom line by starting a cost-cutting program. That's some of the worst thing I can ever read. It's kind of like me telling my wife, you know, I want to be a good spouse the next two weeks. I'm going to put a really great offer into being a good spouse. You should not do that just over the next two weeks. You should just be a good spouse. You should not have a cost-cutting program.

Starting point is 00:48:39 You should just always cut cost. I know this comes out like a rant, I guess, of some sort, but that's the best way of not getting there to stage five, I guess. You know, it reminds me of dieting, a person that gains a bunch of weight and are like, now I'm going to go on a diet and it lasts for two or three weeks and then it's just right back to square one. It's not based in some fundamental change of the person's lifestyle or the habit in the person's lifestyle that allows them to keep the fitness or the diet or whatever it

Starting point is 00:49:08 might be into perpetuity. And trust me, folks, I'm not some beacon of excellence when it comes to health, but I'm using that as an example that a person could tie back to a company. And what Stig's point is is if you're just saying, hey, we got to start a cost-cutting program, that means that it's temporary in nature, that it's something that we got too fat. If you're getting too fat, the problem is, is why are you getting too fat in the company? Why are you not developing very optimized flywheels, as Collins would call them, before expanding those and growing them out into bulk and into volume throughout your organization? And I think that that's the really critical part when you're building the company and also as you're trying to optimize it if you're in a decline. All right. So in general, love the book.

Starting point is 00:49:55 Highly recommend this book. This is a really quick read. And all five of these stages are so critical. And I think it's something that a person should probably read often to try to remind themselves and think about these things thoroughly enjoyed this book. It was fantastic. We actually read quite a few books that we don't talk about on the show. So we want to ensure that you're actually getting the very best book. So that's why we, I guess, sometimes we sound overenthusiastic.

Starting point is 00:50:21 We probably only do like two of every four books that we read, wouldn't you say, Stig? Yeah, yeah, easily. Yeah, not more than that. All right. So at this point in the show, we're going to play a question from the, audience and this question comes from Antonio. Hey guys, thank you for taking your time and answering my question. I'm a huge fan of the show.

Starting point is 00:50:39 Recently, there has been some speculation that China is looking to replace a petrodollar by convincing oil supplying countries such as Russia or Saudi Arabia to accept payments in yuan backed by gold. Is this a death of the petrodollars as we know it? How will this affect the American economy and can Bitcoin profit from such a scenario? Thank you. All right, Antonio, fantastic question. Stig's going to take this first stab at this one.

Starting point is 00:51:06 So, Antonio, thank you for asking this question, first of all. Without trying to put on my tweet jacket and talking to you about the PetroDolar and history, like in a professor kind of way, please allow me to just provide the foundation for the concept that you introduce here. So PetroDolar really was something that came up after the collapse of Bretton Woods gold standards in the early 1970s. And basically what happened at the time was that the U.S. struck a deal with Saudi Arabia to standardize all prices in dollar terms. And it had a lot of impact. The dollar was already the main currency, the world's resorts currency, actually. And it really became even more important after that.

Starting point is 00:51:47 That's also one of the reasons why the U.S. is able to enjoy persistent trade deficits. And it also provides the U.S. with financial markets, which is a very impressive source of liquidity and foreign capital outflows. And actually, the latest number I could find on this just to talk to you about the magnitude was back in 2013, 87% of international deals were settled in USD on one side. So basically, what you're talking about is, is this changing now and what will then happen? And the answer is yes, it is changing now. Now, that's not the same as saying that the US probably won't be the world's premier reserve currency. They have been that since 1945. where they replaced the British pound.

Starting point is 00:52:32 So first of all, I think that's actually fascinating, that it's not longer than 1945 that the US dollar was not the reshorter currency in the world. Thinking about how fast that has basically changed. So if you're asking, can that change one way or the other where it's going to be China? I mean, the answer is obviously yes. Time is infinite and yes, it will happen at some point in time.

Starting point is 00:52:54 Will this happen and will this happen with China, for instance? If we look at a list of the biggest all importers in the world aside from the US, you have China. Yes, China, they probably would like to sell things in their own currency if they could. You have India too. And China's actually primarily important in terms of export for them, but the total trade with China is actually slightly more than is the case for the US. It's the same with Japan. That's a three on the list. And with South Korea, where I want to say,

Starting point is 00:53:26 China is even two with a five or three times as important in terms of a trading partner. So you can come up with many good reasons why in the future a commodity like oil will not be settled in USD and why it would be another currency. Now, with this dramatically change, we talked about having the Chinese currency as a primary resource currency multiple times before. It's just now being included in IMFs, the International Monetary Funds basket. of short currencies and it's very, very little. I don't see that happening anytime soon, despite the facts that I just gave to you.

Starting point is 00:54:04 The second most important currency in the world, after the dollar, that will be the euro, being European and seeing everything that's going on. In my wildest dreams, I can't see how the euro can overtake the US dollar, with the membership countries being so inconsistent of what they say and what they do and the goals they have for the monetary policy. So I guess my response to the first part of the question would be the U.S. dollar and the current system we have, it's not perfect, but it's the system we got. And I guess I have a hard time seeing how that's going to change dramatically, at least over the next decade too. That being said, your points about China, definitely.

Starting point is 00:54:46 You will see a shift, but perhaps not to the extent that one might argue. I agree with what Stig's saying to the extent that I don't think that you, you know, you're going to see any kind of drastic change in the next couple years. I think when you get out to 10 years from now, I'd say seven to 10 years from now, you might start to see things start to change around a little bit. But I think in the near term within the next five years, I don't see too much changing. I do find this very interesting, though, what you're talking about. And I think that it's more representing the frustration that a lot of countries in the world have with everything being priced in dollars. And I think that that is probably maybe more important.

Starting point is 00:55:24 than anything else because I think that that might be what drives the big shift maybe in 10 years from now to some other type of currency emerging as maybe a global reserve currency. And so I guess that leads us to the Bitcoin conversation. So, you know, you look at Bitcoin just this past summer. I want to say in like June, you looked at the market cap of Bitcoin and it was around, oh, I don't know, maybe $80 billion was the market cap of Bitcoin. Today, the market cap of Bitcoin is $137 billion. So that's just a couple months ago.

Starting point is 00:55:58 That was like four or five months ago that you've seen that much growth in it. But let's call this what this is. $137 billion of a market cap on a currency is very small, like insignificant as far as how small it is. But I will say watch the trend on this thing. Because this trend is like something I have personally never seen in my entire life. and I don't know that we'd ever see it again if this trend persists. So when we look at like the market cap of various currencies, so like let's just start off

Starting point is 00:56:29 with gold, seven trillion for gold, when you start talking about like the US dollar, I have no idea how big the market cap is on the US dollar. But if I had the guess, I mean, you're talking tens of trillions of dollars. It's way up there. It also depends on how much you include as the market cap of the US dollar. I mean, we're not just talking about like notes and coins here. It really depends on what kind of, you have all these fancy terms, call it M1, M2, whatever you want to include as a currency and how much is credit and how much is not.

Starting point is 00:57:03 And if we start seeing a currency backing a commodity, whatever it is, it's a different world. I mean, I know that $137 billion, it sounds like a lot and obviously it is a lot. But, yeah, as Preston said, for a currency, it's next to nothing. And I don't want people to hear us say that right there and say, oh, well, Preston and Stig don't think that Bitcoin can be a really big deal in the next five or ten years because we definitely think it can be a very big thing in the next five or ten years. We just think that where it's at today as far as market cap, that's not going to happen in the next couple years where Bitcoin's now going to be but oil and things are priced in in the next three years. That's not happening. Even at the pace that Bitcoin's going at, it's not going to be there in three years. but give it 10 years and it keeps trending the way it is and you see all this money that's stuffed

Starting point is 00:57:52 up into fixed income with a zero percent return starts flowing out and a lot of people are selling out of that and they start chasing the 300 or 500 percent return that Bitcoin's been returning every single year for like the last seven years. Yeah, you might start to see some interesting things happen if that trend continues. And I think that's our best advice for people when they're thinking about Bitcoin is, if you're not studying it and you're not aware of it, there's some interesting things happening here. And we're not saying it's going to replace or become the world reserve currency. It's something that I think people need to be aware of. And I think, Antonio, if your question is more in the direction of will countries use, call

Starting point is 00:58:31 a Bitcoin or another cryptocurrency to sell transaction, I think that is highly unlikely because all nations really have a incentive to use their own currency, at least not use a cryptocurrency. So that's probably not it. Right now you see a lot of individuals settling transactions with cryptocurrencies. You will probably also see companies starting to do that, but you will probably not see government institutions doing that for a very long time. But if you ask in a sense that what will happen if the market loses faith in the US dollar, whether it's gradually, it's just slightly or if it's more significant, yes, it will have an impact

Starting point is 00:59:09 on other currencies. So remember, what is one dollar worth? One way you can price that would be in another currency. I can tell you what it's worth in euros or I can tell you what it's worth in yen. And if people start to lose faith in the US dollar, for whatever reason, less money will be flowing into the US dollar. And basically, you know, a currency is no different than the price of a stock. You know, you have demand, you have supply.

Starting point is 00:59:32 And if you have less demand for the US dollar and that money is going elsewhere, you will see a sore in that type of currency instead. Now, whether or not that would be Bitcoin, which is what you're saying, I don't know. I mean, I think a lot of money that would potential flow out of the U.S. dollar, I think it will go to the other major currencies, definitely first. But you're right in the sense that you don't need a lot's percentage of funds, call it from fixed income or whatever it might be, to pump up something that's only $137 billion and thinly traded.

Starting point is 01:00:03 So this is where Stig and I see things a little differently. So he said that if money flows out of the U.S. dollar into other currencies, he thinks that they're going to go into other currencies before cryptocurrencies. I would agree with that up until probably the next year. And then I think that that's going to start to change. I think when you look at the price action of Bitcoin specifically, it is following Metcalf's law, almost to a T. And Metcalf's law is how when you look at the growth of Bitcoin specifically, it is following Metcalfe's law, almost to a T. And Metcalf's law is how when you look at the growth of Facebook, you look at the growth of Google, Alibaba, 100% correlated the Metcalf's law. Since the start of Bitcoin, it has been following Metcalf's law almost to a T. Could you elaborate more on the law and what it means? Yeah, so the law is, if you've ever taken a business class or you've seen a chart that shows a network effect where the pricing of something looks like a hockey stick, where it starts off slow, then all of a sudden it's almost completely parabolic and it goes almost like a rock

Starting point is 01:01:06 straight up. When you look at the pricing, you need a logarithmic scale to plot something on a chart to do this. That's what's happening with Bitcoin today. So I think once you start getting past a market cap of $100 billion, you got some people really raising their eyes saying, what the hell is this thing over here? And then if that continues, if that trend continues, which it is. This has not subsided at all. If this trend continues and we see this go for another year, guess what? You're not talking $100 billion. You're talking like $500 billion. You're talking some real numbers here. And then once it hits a trillion dollars, watch out. Because I mean, the network effect of this is going to only compound on itself. So I really think there's

Starting point is 01:01:53 something here. And I think that it's something that people need to pay attention to. I'm not saying that I guess I'm not saying anything. I'm just describing what has happened over the last seven years. And I think the trend, you know, the perfect example I saw, and we're here in November of 2017, Coinbase, which is the exchange that does cryptocurrencies here in the United States. Coinbase had something like, I want to say, 12 million users from the last seven years. In the month of November alone, they had something like 1.2 million people sign up for Coinbase just this month. in just a month. So when you have that many influx of buyers versus sellers, there's some

Starting point is 01:02:36 interesting things happening. And I think it should really grab a person's attention. And I think they need to study what the heck's happening. I'm glad that we disagree. Unfortunately, it's not about stocks, but primarily about Bitcoin, I guess. I guess we can live with that. I think what I see now whenever you bring up numbers like that, yes, there are definitely a lot of individuals. They're signing up going into Bitcoins. Perhaps they're buying for a thousand bucks or five 100 bucks or whatever it is. I'm really curious to see what happens with institutions. And we talked about, I think we talked about CME before and what they're doing with futures was this. To me, a lot more breakthrough in many ways than, for instance, Japan saying that now you can start

Starting point is 01:03:13 paying for things with Bitcoin, even though it sounds a lot bigger. The market for Bitcoin, it's very thinly traded compared to many other markets. And that also means that if you take out 10 trillion from the US dollar, and then you put 9.8 trillion dollars worth in other currencies, and only is like 0.2 trillion, which will be $200 billion. You don't see a market cap going from 137 to 337. That's not what you're seeing. You're seeing the number of Bitcoin multiplied with the last traded price. So the market price might go to trillions of dollars suddenly. And also what you see now is that the circulation of Bitcoin, it's not that much in the sense that you have a lot of people who are using it as an investment or storing value or whatever

Starting point is 01:04:00 you want to say. So you have a lot of buyers going in, not too many sellers going in. So if you see a huge influx of money, you would see a very interesting pattern in price setting. Yeah, meaning that it would go up more. Yeah, no, interesting, interesting stuff. I think that when we look back at this in 20 years from now, we're going to be quite amazed maybe what transpired, what happened, what didn't happen. This is just, this stuff is crazy. This is absolutely crazy. It's very exciting.

Starting point is 01:04:28 I guess that's probably why I have so much emotion in some of this is because it's really exciting stuff to see what's happening here through the technology and what people are coming up with to try to peg all these global currencies, domestic currencies. It's quite fascinating. All right. Fantastic question. So, Antonio, we went way longer than we had ever expected on that question. But because you submitted this, we're going to give you a free course on our website on the TIP Academy website.

Starting point is 01:04:56 It's our intrinsic value course. And for anybody else out there, if you want to get a free course on our academy webpage, go to Asktheinvestors.com. You can record your question. If it gets played on the show, you get a free course. And we just really appreciate everything our community does for us and offering up these questions. So thanks for doing that. All right, guys, that was all that press on I had for this week's episode of The Investors podcast. We see each other again next week.

Starting point is 01:05:21 Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to Asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or resuscation or resists.

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