We Study Billionaires - The Investor’s Podcast Network - TIP 027 : Value Investing Traps (Investing Podcast)

Starting point is 00:00:00 This is episode 27 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is The Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish and Sting Broderson. All right, how's everybody doing out there?

Starting point is 00:00:29 This is Preston Pish, and I'm your host for The Investors Podcast. and with me is always Stig Broderson from Denmark. And today we've got a fantastic guest for you. His name is Andrew Sather, and he comes from us from eInvestersfor Beginners.com and the MoneyTree podcast. And so, Andrew, I've got an appreciation for what you do because I think Stig and I have a very similar background as you. And that's that we're out there trying to make investing very simple for people to understand. And if you've ever gone to Andrew's site, this e-investing for beginners.com, you're going to find that that's exactly what Andrew's trying to do is to help people understand the art of investing by

Starting point is 00:01:11 making the financial terminology, the basics to it, more understandable for the general population. And we got a deep appreciation for what you're trying to do, Andrew. So we found it very pertinent and you is the perfect guest to come on our show to talk about what it is that you do. And the thing that Andrew really specializes in is he specializes in the art of detecting value traps. So Andrew's going to be talking. That's what this whole episode today is all about is the idea of trying to detect value traps

Starting point is 00:01:43 and how it's important to not get sucked into thinking that you're only seeing maybe one variable that has a really good characteristic to it and that you're not considering all the other variables that kind of go along with it. And I just want to throw something out real fast because Monich Pabry, who's stigin, I follow very closely. He's just a fantastic investor. He says that investing, when you're looking at all these different variables to investing, that it's like flying an aircraft. You can't just look at the altimeter of the aircraft and think that you are in good shape because you might be flying up on a mountain. So you've got all these different variables that you're looking at simultaneously. And when you piece those together, that gives you the full picture. And that's what

Starting point is 00:02:22 Andrew's going to be talking to us about today, is that ability to piece things together and detect a value trap. So, and one other thing that I really like about Andrew is that he has a background on electrical engineering. So I automatically like you, Andrew, because my background, I have a background in engineering as well. So I just wanted to throw that out there. Hey, well, thanks for having me on. It's really an honor and I really like what both you guys are doing, Stig and Preston. You know, Warren Buffett had the thing where he read every book in the finance section of his library by the time he was 11. And so what you guys are doing with the show, all the executive notes and everything, I definitely follow along, and it helps me to try to

Starting point is 00:03:01 make it towards that goals. I want to appreciate you guys for everything you do. Thanks, Andrew. Really appreciate it. All right. So with that, let's go ahead and kick it over to Stig, and he's got the first question. Okay, so Andrew, say that I look at a bundle of stocks where the stock prices moved nowhere for years while the rest of the stock market has soared. I might think that these stocks are bargains now, but how do I know if there are value traps or indeed bargains. Well, that's kind of the million dollar question right there. The way investing works is you want to try to buy low. That's kind of the general mantra everybody follows, buy low, sell high. The problem with that, and when you're trying to become a value investor

Starting point is 00:03:43 and you're trying to buy assets at a discount to their intrinsic value, you get, you have to sift through the garbage. There's a lot of junk that comes down that way. And so when you're buying low, what you're really doing is you're buying these companies when they're out of favor. And a lot of times there is a good reason why they're out of favor. Companies just naturally go down and don't succeed like they should. And so you see companies that the phrase is trying to catch a falling knife. And so what you got to do when you're value investing is you got to be careful about these falling knives and you got to know what they look like. And if you can identify them, then you'll be in a lot better place. So the biggest value trap is a bankruptcy. And knowing that, you want to be able to understand the symptoms of

Starting point is 00:04:30 a bankruptcy so that you can avoid it before it hits you. So that's what that's kind of what I do, and that's what I've been focusing on lately. I did some research and I established what I call the value trap indicator. And what I did is I examined the 30 biggest bankruptcies of the last century, so we're in the 21st century. If you look at the 30 biggest bankruptcies, a lot of these companies were in the S&P 500. They were well respected, well followed. and people really looked at these companies and a lot of them seem profitable and then the next day they're gone.

Starting point is 00:05:00 So what the value trap indicator did was take all of the companies that went bankrupt, looked at what happened and then tried to basically make a number based indicator to prevent from this happening again. So of the 30 bankruptcies, 29 of them would have been prevented with the value chip indicator. So for a 96% success rate, the value tripped indicator did a good job

Starting point is 00:05:23 as far as that. Okay, so I've got the next question, and this one has to do with an interview that we recently had with a person on our show two weeks ago, Toby Carlisle, and he was talking to us about deep value investing, which involves the purchase of a company that typically has some value trap indicators to it. So what makes your approach different than his as you're talking about value traps? Because one of the things that Toby was saying was that he wants one of the ugliest companies that he can find in order to get the biggest gain out of it in a short duration after he would purchase it. Yeah. So I definitely did.

Starting point is 00:05:59 I listened to that episode. I think it was great. There were a lot of great ideas and opinions. And definitely, you know, when you get into things like deep value, there's a lot of risks that can come with it. But again, that's where the reward comes from. So you got high risk, high reward. Have either of you heard of Ted Williams?

Starting point is 00:06:18 He's a baseball player. he was one of the best hitters of all time. Have you heard about Ted Williams? I've heard about him, but I don't know that much about him. So Ted Williams played baseball. So the way that batting average works is that you try to, not only do you have to make contact with the ball, but you have to make contact with the ball and get on base,

Starting point is 00:06:41 and that's so you get a high batting average. So back when Ted Williams used to play, a good batting average was like 300. So Ted Williams was able to get a batting average of 400, in a season. So he is outperforming the average by more than more than like 10%. And his secret to successful hitting was not, how am I going to focus on what's the best ball to hit? He said, I'm going to focus on whether the best balls not to hit. And so by reducing the strike zone and segregating it, he figured out which balls have the greatest percentage of him getting on base.

Starting point is 00:07:18 And as a result, he became, he set many records. He became. one of the best greatest hitters of all time. And when people think about great baseball hitters, I think of Ted Williams. And so I tried to take that approach with investing as well. You know, the value trap indicator is a quant-based metric. So there are a lot of similarities to a lot of the other quant-based metrics. You have, everybody has their own valuation. They like to use.

Starting point is 00:07:40 Buffett had his owner's earnings. O'Shaughnessy had his, what works on Wall Street. He had the price to sales. He had the price to book. And he incorporated momentum as well. You had Benjamin Graham with the cigarette butts and the PB. So these are the different metrics that people like to rely on. The thing that makes the value chart indicator different is instead of optimizing for how much overperformance can we get with one or two metrics,

Starting point is 00:08:08 instead it provides a fail safe for when one or two metrics are not good, then that's when we're going to stay away. So we're not optimizing for what's the best opportunity. We're looking at what's, what are the pitches that? they're coming our way that might look great, but in reality, there's not as high of a percentage, and we're just going to avoid those. And so by taking a lot of various valuations, we try to cover our bases and avoid those situations that might lead us into bankruptcy. And so, you know, the saying goes, the only thing you have to fear is fear itself. Well, if you can understand how a bankruptcy works, you'll never have to fear bankruptcy, so you'll never have fear in the market.

Starting point is 00:08:46 I love it. That is fantastic. And I really like your point about Ted Williams. So good points, Andrew. That's awesome. Stick, go ahead with the next one. So, Andrew, would you care to provide a few historic examples of great companies that investors might have been thinking there was profitable stock picks at a great price, but proved to be value traps? Yeah, sure. So I think the obvious one is Lehman Brothers. Everybody kind of thinks about that when they think about these crazy bankruptcies that made everybody just get so surprised. You had Lehman Brothers, by every metric of profitability, they seem to be just the perfect company. They get their income statement. It's flawless. They have growth.

Starting point is 00:09:27 They have a low PE ratio, low price to book ratio. All of these things look great. And then even the cash flow, I mean, discounted cash flow, free cash flow, they were superb in all metrics except the debt to equity. So they had a debt to equity of 29. And to put that into perspective. a company with debt to equity usually is around one. When you have a company, it's a financial like Lehman Brothers, it's usually around 10. So even in financial terms, they were three times more leverage than the average financial.

Starting point is 00:10:03 You talk about 29 times more leverage than the normal company. You have a crisis like 08, and of course they're going to go under. So that's one example of really a company that it looked great on the surface. But if you look at everything, then you'll understand the, the debt to equity was really too high. And then another one I actually wrote about on my blog, and it was this company, I was doing the screen, and I was looking for some great value. I wanted a high dividend, among other things. And I found this company called Atlantic Power. They had a dividend over 10% at the time. Even the debt to equity was great. It was like 0.23. If you know Graham,

Starting point is 00:10:40 you know that he likes high current ratio. So you're looking at over 4 at the current ratio. I mean, that's the kind of thing that Graham would like. The price to both. was very low. But one little metric, the earnings were negative for the year. So I wrote about and I warned on my blog that this is a value trap, stay away. It looks really juicy, but you just got to stay away from it. And luckily, for people who follow my advice, that stock tanked from like the eight or ten range down to like the two range and it's hovering around two dollars a share now. And so those are the type of things that can really hurt your returns as a value investor. Because to be honest, I mean, when you're searching for value, you do get a lot of high returns.

Starting point is 00:11:24 But the problem, your returns, your average return will lower if you're getting these big drawbacks as well. And so that's what I try to prevent. So, Andrew, I can't help with thinking. Now you're talking about bankrupt, which of course is like the ultimate value trap. But what about time? Could you share your thoughts on that? Because I guess that time is a major cost too for you as a. the vesta. Well, definitely, you know, when you're looking at something like the value trap indicator,

Starting point is 00:11:50 it's a very conservative metric. So like you say, you have the opportunity cost and there is a good chance that you might miss out on some great returns. So, I mean, the way the value trap indicator works, I really look down strongly on things like leverage. So a lot of times, that keeps you out of the financials and those type of stocks. But if you turn around enough stones, I mean, there's over 6,000 stocks just in the U.S. market. And, you know, there's so many opportunities out there. When you're looking at like the financials, yes, you might miss out on the big returns when they recover. But at the same time, you miss out on a lot of the downfall and a lot of the drawdowns that come along with that.

Starting point is 00:12:34 So I think it is a strict balance. And you do have to, you do have to consider what's my opportunity cost that I'm losing. but at the same time, what's the opportunity cost of a stock that rises 300% but out of the P.E. of a thousand. That's something you have to consider as well. So it's really just a person's like preference for risk. It's really what you're comfortable with and it's really what are you trying to avoid. Doing this research on the bankruptcies, I know exactly because I've been so immersed with the bankruptcies, I try to share about all that research with the book. I have coming out soon called Value Trap Indicator.

Starting point is 00:13:14 So knowing all those things, I'm able to be very strict on my valuations. If it doesn't meet one in valuation, it's because there's a reason. And it's because these are the type of symptoms that a company has experienced before. So, Andrew, it's funny because one of the big things that I pulled out of security analysis with Ben Graham was he talks about this idea of whenever you're assessing a business and, something that you're getting ready to invest in. He always starts with the mitigation of your potential risks first, where he's talking about, hey, look at the debt to equity, look at the current ratio, look at on your income statement, your coverage ratio. All these ideas really revolve around how much debt is the company taken on versus how much are they earning and how much are they

Starting point is 00:13:57 going to have to pay back. And he starts always there. That way he can make sure that he doesn't get into a value trap situation like you're referring to. And then after he's basically, made that determination that he feels that the company is safe and then the earnings in the future will continue to produce enough income to pay those debts, that's when he goes in and figures out what he thinks the intrinsic value of the company is. He won't even go to that second step until he figures out whether he feels like it's a safe investment. And so it just, it totally sinks with what you're telling our audience here and how important it is in order to make sure you mitigate those risks first. So that with all that said, it kind of leads into my next

Starting point is 00:14:37 question in that I think a lot of people out there, a lot of investors do not have this strong background that you might have or like Stig in accounting where they understand all this terminology like current ratio and coverage ratio and things like that. And so I guess the question that I have is for a person that might not have that strong background in accounting or a firm understanding of these indicators, do you think it would be more beneficial for them to focus on index funds to lower their exposure to risk? Believe it or not, I actually don't have a background in accounting whatsoever. I'm just a guy who really likes diving into the books and I kind of picked all this up as I went along. So don't think that you have to get four years at a university with an

Starting point is 00:15:19 accounting degree in order to make this stuff work. You can do this all on your own, but it's not easy at the same time. You do have to put in the time and the study. That being said, with the Vallecharp indicator, as I mentioned in my book, even though we are looking at these bankruptcy cases, yes, if you follow these methods, you will stay away from 96% of the bankruptcies, whatever the number may be. But there's always that small chance of a company who, for whatever reason, I mean, this is the stock market, this is real life. Things happen that just nobody can predict for, nobody's models can predict. And so this is why you have to diversify your risk. You have to be diversified.

Starting point is 00:16:00 You need to spread your investments over many different types. I mean, even looking back at the previous bankruptcies, there was a company called Monaco RV, and they were a very cyclical company in the sense that they depended on consumer demand to make their earnings. They had a very strong balance sheet. Everything checked out. I mean, the Valleatory Indicator said it was a strong buy. Everything looked great. Even the CEO at the time.

Starting point is 00:16:28 So they interviewed him afterwards, and he said, we should have stayed liquid and we should have stayed open. but the banks wouldn't give us money. So for whatever reason, you know, they hit a rough patch where they have one bad quarter. And then all of a sudden, 3,000 people lost their jobs, the company went under. So you have these situations where even if a company is well run, like I said, 96% of the bankersies I looked at, they were predictable. And there were big red flags that say, okay, these companies are in trouble. But there's always the off case that a company could go bankrupt just because of the, of a crisis or because of the banks or whatever it may be. And we don't know what the future holds.

Starting point is 00:17:08 So this is why if you have a diversified portfolio of a group of stocks, you are lowering your downside risk and you are making sure that one little freak accident doesn't screw up your financial future. And so if you don't want to, I mean, I don't think you have to be an expert to really profit from these concepts. You could literally just pick up a book or two, apply what you learn. and you'll be fine. But for the people who maybe want something that's a little bit less involved, definitely an index fund is something, you know, that you should go for. But at the same time, these are concepts you need to understand.

Starting point is 00:17:46 If you're holding an index fund and it goes down 50% during the bare market and you sell out, well, you're just in as bad of a situation as if you hadn't even gotten an index fund at all. So you need to not only understand these concepts, but process them and use them and make sure you're doing a long-term strategy, and index funds are also a great way to do that. 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 height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord,

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Starting point is 00:22:17 Back to the show. I really like that last point because I think a lot of people, think that, oh, yeah, I'm just going to buy an index fund because all that stuff's really hard to understand. And I don't really, you know, I just don't know what they're even talking about. So I'm just going to buy this index fund. And then, like you say, it goes down 50%. And because they don't understand the inherent nature of what it is that they own and they don't understand what it's all about, they sell out because they're scared. And the fear is induced because they lack the knowledge.

Starting point is 00:22:45 So I really like that point. And I think that's a very strong point. Even if you just educate yourself a little bit, you're going to, you're going to, you're going to understand markets move in cycles. And if it goes down, you have an opportunity to purchase more equity, those basic things. Even if you don't go down the rabbit hole as far as some of us have, I think just understanding some pieces of it are going to help educate you so that you stay strong during that and you increase your position.

Starting point is 00:23:10 So, yeah, go ahead, Stig. And Preston, I think that's a really good point because often you hear a really brilliant business people that do understand everything there is about accounting and actually how to select individual stocks, they still invest in index funds, simply because it's easier for them. They don't need to manage other companies as they have to if it's individual stockpicks. But still, they make really good returns because they understand the process. And they're, for instance, as Preston was saying, they do not sell, as you were saying, to, they do not sell if the index fund lose 50% price.

Starting point is 00:23:44 So even for really, really smart people, you know, don't think that because you are selecting individual topics, you know, you need to be really, really smart. All the opposite, you can actually do both. And that actually leads me to the next question, Andrew, because I was thinking, if I really want to copy what you were doing, more or less at least, but what is your own investment process for avoiding these value traps? Could you just take us through the process, you know, perhaps step by step. Yeah, yeah, definitely. So there's three financial statements that every company is required to file by the SEC. You have the income statement, the balance sheet, and the cash flow statement. If you look at those statements, they actually tell you a different picture. And if you can understand

Starting point is 00:24:28 what that picture is, you'll understand the process a little bit better. So the income statement really tells you, how is the company doing right now? What's their health right now? The balance sheet is what's the company look like long term? Are they a good company? Are they strong financially? Do they look like they have a great future? And then the cash flow statement's a really great place to look at what's the performance going to look like in the next few years. So a lot of value investors like to jump onto the cash flow statement. It's a great place to go because you have the free cash flow, the discounted cash flow. By looking at what these cash flows are doing now, oftentimes that formulates what happens in the next few years coming up ahead. So if you look at the,

Starting point is 00:25:09 look at it, look at it in those three ways. You really have to understand that you need, you need parts of each statement in your analysis or else you're missing the whole picture. And so what the value chart indicator does is it takes seven categories and we have some from the income statement, some from the balance sheet, some from the cash flow statement. And if any one of those metrics look out of whack, if any one of those metrics trigger a red flag, then automatically it's either going to be a strong sell or we're just not even going to get. get involved with that stock. That does preclude us, and there is some opportunity cost lost there, but the value of

Starting point is 00:25:48 being able to sleep at night knowing that I've done everything I possibly can, and I've looked at every situation that could possibly be negative, and I've accounted for that, really, to me, that's priceless. And so that's kind of what the value sharp indicator does. Obviously, I break it down in the book, and we look at every single category, but those are the main things that we look at. And if anything, I mean, it just takes one. Like I said, Lehman Brothers, debt equity over, over 29.

Starting point is 00:26:14 Just that one metric, okay, we're not going to buy it. Even though for years and years and years, it looked great. It was one of Fortune 500's top companies, you know, everybody saying praises of it. But it just takes one metric. And so that's why we avoid those type of situations. And I think that you use in Lehman's a very good example because most of the time when you see a really ugly company, like let's go back. to 2007, 2008, and you look at GM, like, their numbers were horrible. Like, you, you could see it across multiple variables, but his, his discussion about Lehman is really important because Lehman had a lot of good

Starting point is 00:26:50 indicators across the board, and they had one sore thumb that was really sticking out. And that should be enough for investors to really say, you know, there's just something not adding up here. There's something that's being pushed into this corner over here, and it's not making sense. And that needs to be kind of your, you know, if you find a fantastic business, you are not going to see something like that. If you pull up Berkshire Hathaway today, you're not going to see anything on there that shows a value trap indicator like you might see in some other businesses. So you need to be very picky. And it goes back to Andrew's original example with Ted Williams in hitting. He was making sure that he wasn't swinging at any of the pitches that had a low probability of not getting a hit.

Starting point is 00:27:32 So I really like the fact that you keep coming back to Lehman because you know, a lot of companies when they start looking ugly, it's ugly across the board, but you need to be very choosy in what you select. So with that said, Andrew, if you can narrow down your value trap to two major indicators, what would you say that those two indicators are? That's a really great question because it's simpler than you might think. We use all these big terms and all this jargon, and it sounds like, oh my gosh, It must be this crazy secret that I don't even know.

Starting point is 00:28:08 I can't comprehend. But really, the answer is quite simple. I'm going to give you one last story just because I like to work in stories. So there's Vince Lombardi. Have you heard of him? Oh, yeah. So every time there's a Super Bowl, you know, they're holding Vince Lombardi up. He was such a great coach back in the day that they named the championship trophy after him.

Starting point is 00:28:30 He had a really great team one year. And they went to the playoffs. They were expected to win it all. heavy favorites and they they got just absolutely destroyed it was it was completely a let down and you know he was very embarrassed so the next year in training camp the very first day of training camp he made a speech to all the players and he said we're going to get down to the fundamentals we're going to learn every single fundamental and if you don't understand the fundamentals you know you have no choice like we're going to go through each little one so the very first day they

Starting point is 00:29:02 just practiced tackling. The sort of stuff that you learned in peewee football as a little kid. And they went through every single fundamental to the point where the players were getting annoyed and they would make fun of the coach. Like, oh, stop, coach. You're going way too fast for us, you know. But they meticulously went through and this is how they did their training camp. And sure enough, that team went on to win the Super Bowl.

Starting point is 00:29:26 They won multiple Super Bowls. I think he had like five championships or something like that. And now the trophy is named after him. So what I'm really stressing with everything with the value trap indicator is let's learn the fundamentals. The number one way that you can measure if a company is successful or not is if it is making a profit. The number one goal of a company is to turn a profit. So if it's not able to do that, I don't care if you call it lost leader. I don't care if you think there's going to be a comeback.

Starting point is 00:29:54 I'm telling you right now, I analyze every single bankruptcy in the past 21st century, whatever we've seen up to now. And the number one thing that every company that most companies had in common was they had negative earnings. So this is a huge red flag. If you're going to invest in a company that has negative earnings, you're gambling with your money. You know, you're taking a big chance. Yes, there's the chance that they do recover. But a lot of times these companies don't. And when they're saying that they are bleeding cash and they're in the red, they are warning you that there is trouble on the home front.

Starting point is 00:30:25 So you need to be careful of those situations. And then the second one, we kind of already touched on. And that's the debt to equity with Lehman Brothers. Just like when a person, you see an individual person and they're having trouble financially, what finally takes them to bankruptcy court in the personal finance world is too much debt, too much leverage. And it's the exact same thing with companies. A company with too much debt is really walking, they're towing the line and they're really hoping that nothing bad happens. And so for a bull market, which may last five, six, seven years, things can be perfectly fine and they can have great profitability.

Starting point is 00:31:04 Oftentimes, this leverage leads to more profitability because they're able to maximize their profits and they're able to do things that companies that don't lever up aren't able to do. But it does catch up with them. And a lot of these companies do end up bankrupt because of too much debt. So you want to look out for negative earnings and you want to look out for debt to equity. Stick, go ahead. Yeah, Andrew, I just want to say it was. you know, a fantastic point because, you know, we hear all these stories about how one investor was able to find a company that was rebounding.

Starting point is 00:31:36 But everyone thought, you know, go broke. But then, you know, it just skyrocketed. The share price just skyrocketed. But basically, these companies that has two months debt and had negative earnings, they're just too hard to figure out. I mean, even if you spend countless hours, I mean, at least in my opinion, it's just too hard to figure out whether or not they will be profitable over the time. time. So, yeah, Preston, I see you have a point too. Yeah, it's just a, it's a probability thing. So you can

Starting point is 00:32:02 have success by picking one of these companies that has, you know, bad earnings for multiple years. But the problem is, is your probability drastically decreases. You're down in like the less than 5% range that it's going to come back and you're going to have a lot of, you know, success with it. So I think that's the thing that a lot of people lose sight of is, yeah, you can invest in it. You can have success, but you just, you're, you're making it very hard for yourself. And I think one other thing, and I'm going to throw it over to Andrew because I see he has a follow-up. But when you're talking about earnings, that's the lifeblood of the company itself. Think of it almost like blood flowing through your body.

Starting point is 00:32:37 Without that flow of the blood, you're not going to live much longer. And that's where a company has to be profitable because that's what's generating their ability to grow and to sustain their operations. But go ahead, Andrew. Yeah, I was just going to say, I mean, when I was talking about Atlantic Power and the blog post I wrote about them, they actually, if you were looking, at the stock screeners, they showed positive earnings for that time period because a lot of these stock screeners will update quarterly. And, you know, just because you have a one quarter that's profitable,

Starting point is 00:33:08 doesn't mean you're profitable over the year. So I want to make sure you're looking at yearly earnings. And I know Ben Graham said he looks at yearly earnings. He looks at even like three year, five year averages, whatever it is, you want to look at the annual report because that's like the main, this is the thesis that we're all basing our valuations on. And so if you see a company might look profitable in the quarterly earnings, but if they're not profitable in the annual earnings, then that's something you need to consider. And that was the case with Atlantic Power. They had negative earnings in the annual report, but positive earnings in their quarterly report. And sure enough, their stock tanked. So let's take a quick break and hear from today's sponsors.

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Starting point is 00:37:04 slash income. This is a paid advertisement. All right. Back to the show. Okay. Andrew, for sure, I think it's really interesting to hear about value straps. If you would like to give any recommendation, books or resource to our audience, what should that be? And as a continuation of that, I would also like to hear if you have any investors that you have heavily modeled your approach after.

Starting point is 00:37:32 Yeah, that's a good question as well. I would say for people, obviously, there's the obvious books, right? There's Intelligent Investor, some of Warren Buffett's books. Everybody knows about those. one that I really liked that helped me during this process was J.M. O'Shaughnessy's what works on Wall Street. I know there's a lot of people who don't like him because he went through a time where he was very popular on Wall Street and everyone used his ideas and then suddenly his ideas were not profitable anymore. Yes, that did happen. Yes, his back tests don't work as well as they did before. But the information he presents in the book and just the lessons you can learn about why. certain metrics and why certain valuations are are important is really a great is really great thing to look at. So I think that's that's one book that's people should check out if they're interested in this topic. As far as the second part of, of course, you have my book too, which you can check

Starting point is 00:38:30 out, value trap indicator where I look at the 30 biggest bankruptcies. We break down what the value check indicator means and we break down what were the similarities between these bankruptcies. And then to answer the second part of your question, I actually did not model it. I did not model it based on one investor. I think what makes this indicator so different from everything else you see on Wall Street and with the value investing community and everything, it's unique. And it looks at the big picture. What's the big picture? Let's not get so focused on little optimizations and little details that it's really easy to get stuck in that rabbit hole.

Starting point is 00:39:11 Instead, what's the big picture? What are these financial statements telling me? What's the picture that they're painting and what's the overall picture of the company? And let's use that to profit. And by limiting your drawdowns, limiting how much you lose on a position, that's really how you'll outperform. And if you want to outperform the market and even help boost your returns. I love that point personally. I find that I know Stig and I interact a lot with some of the people on our forum.

Starting point is 00:39:40 and that's the common thing that you see is a lot of people are just so quickly pulled into the weeds of investing and they focus on things that are not big picture. And I think for somebody who's starting out, I think that is some fantastic advice, Andrew, is start really big picture. Understand what the profit of a company is. Understand what the debt of a company is. Understand how could the company potentially fail, which is your value trap indicator discussion. when you start with those really big chunks, and think of it like you're almost sculpting something, you've got to first knock off the big chunks whenever you're sculpting something, and then you slowly and fine-tune what it is that you're trying to create.

Starting point is 00:40:22 And I think that's what people really need to do that are new to investing, is they've got to knock those big chunks off and understand the really big picture first, and then eventually mold themselves down so that they understand the finer elements of investing. So really great point. I love that. So, Andrew, if anyone wants to find you or learn more about you, and I also want to throw out there, Andrew is being very generous. He briefly mentioned that he's writing a new book, and the book is going to be coming out soon.

Starting point is 00:40:51 It's not released yet. He'll tell you what the street date is, but he's also going to throw in a special thing for all of our listeners. So, Andrew, go ahead and tell people about your book. Thanks, Preston. Yeah, I'm going to, so the book is called Value Trip Indicator, examining the biggest bankrupties of the 21st century, to formulate a proven by low, sell high approach. It's everything we talked about today. It comes out on April 2nd.

Starting point is 00:41:15 I'm going to open up a early release for your listeners, because I know this is coming out next week. And what I'm going to do is give you guys a special promos. So you can get 25% off on the checkout if you put in the promo code TIP for the Investors podcast. So not only will you get first access to the book, which I haven't even released to the public or my subscribers yet,

Starting point is 00:41:36 but you also get the special discount. So you can find that at value trapindicator.com. It'll send you right to the landing page and you can find out more information about the book and then TIP for the promo code. Perfect. And we'll have a link in our show notes as well. If you pull up our show notes,

Starting point is 00:41:53 we'll have a link at the bottom for you guys to go ahead and check out Andrew's book. That was awesome. Really excited to have you on, Andrew. The information that you're imparting to our audience is very useful and invaluable for them. And I think that it's a great, fit. So thanks for coming on the show. We really appreciate it. And that's all we got, Andrew.

Starting point is 00:42:12 Hey, thank you, Preston. Thank you, Stig. I had a great time. And thanks for letting me ramble today. All right. So this is the time in the show when we go to a question from a member of our audience. And this question comes from Eli Ponticos. And here's this question. Hi, Preston and Stig. Greetings from the UK. I just wanted to start off by thanking you both for providing all this invaluable information on your podcasts and on the Buffett's books website. My question has to do with a comment Preston made in his recent video, expressing his concerns about the health of the economy and what we might expect in the next couple of years.

Starting point is 00:42:50 If I decided to cash out for my current investments, what do I do with the cash until the right buying opportunity reappears? Do I just hold on to the cash, or are there any other short-term, low-risk instruments that can use. Many thanks, Eli. All right, Eli. So that's the magic question here. And I think for anybody that can answer that one and look back in the next five years and see how they performed, I think that is going to be the true test of how good you are. But to tell you a definitive path of what the right solution is, that is really difficult to do. I think that a lot of people get in a position where they

Starting point is 00:43:30 know that there's a crash that could potentially happen in the next year or two. And they start moving into a cash position. And they feel like they've got to be doing something. And that's whenever they, a true test of your patience kind of comes out. And I think for, you know, most people, they'll sit there for maybe a month or two and say, I can't do this. I can't keep holding cash. I've got to put it into something. And so then maybe they enter back into the stock market or they enter back into something because they feel like they're doing nothing and that they're falling behind. But I'll tell you, I think that your patience is probably the most important thing, the most important asset that you're going to possess during the next year or a year or two until you see

Starting point is 00:44:14 some major changes in the market. Now, what you can do with your money in the meantime, I think the key here is if you do invest your money, it needs to be something that is going to protect your principle so that you keep that principle in place. and here's the key, it's got to be able to quickly be turned back into cash or be liquid. And so that's the key because that's going to give you the ability to enter back into the market and to go back and buy stocks whenever that opportunity persists. So obviously the best thing, or I shouldn't say the best thing, but the thing that's going

Starting point is 00:44:46 to give you that liquidity is cash. You're going to have no problems being able to transfer that into what you want. Another option is bonds. Now, when you invest in an individual bond, you might be. be handicapped in the ability that you want to try to resell it at the right time. There might not be a real high demand for that bond that you're trying to sell. So you might run into a liquidity issue. Now, if you're investing in some type of index, that's going to a bond index.

Starting point is 00:45:14 You're going to be able to liquidate that a lot faster. Now, here's my word of caution for anybody that's looking at a bond as an investment during these next coming years. With a bond, especially with the interest rates the way that they are, which they're at all time lows. If interest rates creep up, even in the smallest amount, that value of that bond index or bond, individual bond itself is going to decrease in value. And that's where your risk really lies with owning a bond. So the key is, if you do invest in a bond index, which is what I would recommend because you can liquidate it a lot faster, I would recommend that the duration

Starting point is 00:45:48 of that bond is very small. So like something less than five years, because the smaller the duration on the bond, the less that it's going to be impacted with the change in interest rates. And that's the key point if you do move into bonds. But Stig, go ahead. Let's hear your opinion. Yeah, so, Eli, I think this is really a tricky question. And as Preston is saying, I don't think that anyone really knows the answer to that one. You had to remember that the situation is very different from it was in 2007 and 8.

Starting point is 00:46:19 And I also think the Preston mentioned that. So back then, the interest rate was, what, like 5%, at least if it was a long-term. bonds. So you could put your money into bonds and since the Fed had the opportunity to decrease interest rate, you will actually make a profit and not only protecting your principal, but making a profit on bonds back then. Now, the situation is very different today. As the president was saying before, you really can't make any profit on the Fed lowering the interest rate, which will make your bonds more valuable. So what to do? You know, I've been going back and forth in this and I kind of agree with the president in terms of cash.

Starting point is 00:47:01 It might not be the best, but perhaps the least bad option to some extent. One reason is that inflation is not really high at the moment. We almost close to deflation. So it's not like your cash will lose a lot of value. But then you will probably hear people saying, well, could we at least protect against inflation? And I think you can. Tips, that would be one idea. So that would be simply a bond that defaults inflation.

Starting point is 00:47:32 And then you will probably hear other people talking about gold. Now, we can probably have a whole long podcast just about gold. And I'm sure that if you look at gold, you can see that the fall in inflation, at least in the long run. But I think what I'm really cautious about at the moment is the volatility. So as Preston was saying before, you really need to have access to the cash really, really fast. And if you see a crash, I have no clue where the goal price will, you know, which direction will go. So yes, it might, you know, increase 20% or might decrease 20%. But if your goal is really to protect your principle, I would not go into something that has volatility.

Starting point is 00:48:12 Because I think if you see a crash, then you can really make a, you know, high profit. And you shouldn't be thinking about making one or two percent return in the meantime. it's really not where the profit is made. I've got a point that I want to add because Stig's exactly right. This is much different than 2007 to 2008, simply because interest rates are different than where they're at. And so as we look to the next crash, and whenever that happens, like we said, we don't know. We think it's going to be in a year or two years, but we really don't know. But when that happens, I do know that the Federal Reserve is going to have to do something to stimulate the economy.

Starting point is 00:48:49 and them lowering interest rates isn't an option because it's already at zero. Okay? So where they're going to have to induce and to spark the economy is they're going to have to print more money. They're going to have to do more quantitative easing. And the difference between this time and that time is on the last one, they changed the reserve ratio in order to offset that printing of more money. This time, they can't really change the reserve ratio. So what I think you're going to see is I think that you are going to see an inflation in the currency. how much it's really kind of hard to say. But whenever the market does crash,

Starting point is 00:49:25 I think that that's going to be a very short window where a cash position is advantageous just because of the threat of inflation because that's the only way the Fed's going to be able to get out of it. I don't think that that's going to happen necessarily immediately after the crash, but I think that it might happen within the year of the crash where whenever they start printing more money through the quantitative easing, that's where you've got a concern with continuing to hold your cash position.

Starting point is 00:49:48 So then the next question is, is where do you go after that? And we'll have many more conversations where we can get into that. But I think people need to be aware of that. And you've got to realize that there's a risk holding cash after the crash for a long period of time because of the instruments and the tools that the Fed has at their disposal to fix this is very limited. It's not like the last crash. They have to start inflating the currency. And it really comes down to how much are they going to inflate it. Fantastic question.

Starting point is 00:50:16 I think that that's probably the hardest question we could possibly answer. and really try to provide guidance to everyone out there. And I really think everyone has to start thinking for themselves and really start making sure that you're comfortable with the position that you're in. And the most important thing to me every night is to make sure I sleep well and to make sure that I'm not worrying about this kind of stuff. And I think for where we're at right now, if you're trying to protect your principle,

Starting point is 00:50:39 whether you keep that in cash or you keep that in a low-duration bond or something like that, I think that that's going to help you achieve that goal and also to make sure that you don't get hurt or harmed by this potentially brewing economic issue that we're facing. So long response. We really like the question, though. We'd really like to thank Andrew for coming on the show. He gave a fantastic interview. And I think that he brings up some really important things that people need to be thinking about as we go into this high valuation in the market and these interesting times, I guess.

Starting point is 00:51:13 And so, Eli, we're going to send you a free sign copy of our book, The Warren. and Buffett Accounting book, and we just really appreciate your question. And for anybody else out there that has a question, make sure that you go to AsktheInvesters.com, and you can record your question there, and we'll potentially play it on the air and send you a free book. So we really appreciate everybody joining us this week. Thank you so much for being in our audience. We really do value everyone's input, and it's really fun interacting with everybody on our forum and all the other places. So we'll see everybody next week. Thanks for listening to The Investors Podcast.

Starting point is 00:51:45 To listen to more shows or access to the tools discussed on the show, be sure to visit www.com. Submit your questions or request a guest appearance to the Investors Podcast by going to www.com. If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network.

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