We Study Billionaires - The Investor’s Podcast Network - TIP243: Tobias Carlisle - Creating an ETF (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. How's everyone doing out there? On today's show, we bring back our close friend Toby Carlisle to talk about all sorts of investing topics. For example, we talk about value spreads. We talk about what it's like to set up your own exchange traded fund or ETF. And the underperformance and value picks, just to name a few of the topics. Toby is the best-selling author of multiple books, and he's got an expertise in back testing and mixing value and momentum strategies. He's the founder of the Acquires multiple and always a crowd favorite on our show. So without further delay, we bring you the always thoughtful Tobias Carlisle.

Starting point is 00:00:40 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. Hey, everyone, welcome to The Investors Podcast. I'm your host, Preston Pish. And as always, I'm accompanied by my co-host, Stig Broderson. And, And we got our good friend here with us, Toby Carlisle from the Acquires Multiple. He's part of our mastermind group. Toby, welcome back onto the show. Hey, thanks so much, guys. I love being on this show. And this is a special one for me, so I'm excited to be on. I'm very glad to be talking to you today. Dude, we're always so pumped to have you

Starting point is 00:01:28 on here. And we always just have so much fun chatting with you. So you're doing something really cool here. And Stig and I just, we're excited to just kind of pick your brain on it because we don't know a lot about what it takes to kind of set up your own ETF. And that's what you're working on right now. So I'm kind of curious through some of the mechanics. I'm sure this is going to be really interesting for people to hear what it's like to go about doing this. But before we go into some of that stuff, I want to talk to you because there's people that are joining us and they might not know you from our past episodes or whatever. So let's just quickly go over some of your fundamental core beliefs, which are all rooted in value investing, Warren Buffett style value investing.

Starting point is 00:02:10 If you had to describe deep value to a person in elementary school, how would you describe it to somebody in fifth grade? The way I always like to describe it, so Buffett looks for wonderful companies at fair prices. So he's looking for a good business and he has a special definition of a good business, which is one that earns a very high return on invested capital. So invested capital is basically the capital in the business that it needs to run its business. So they often have some excess. They might have a little bit of cash that they don't need that they could pay it as a dividend or they might have some capital that they can grow with. But you can perform an analysis and there are several different ways of doing it to really get down to the core of the business and find out

Starting point is 00:02:51 what sort of capital it needs and then how much income it's generating from that. And that's your return and invested capital. The higher it is, the better. That's sort of a company that's much more profitable per dollar invested in it. That's better than another company that doesn't earn as much. That's what makes it wonderful. And then what makes it a value investment is you have to sort of see if the earnings and the assets and the cash flow is something that you can get for a reasonable price. And so what's a reasonable price? Well, it depends on lots of different things, interest rates and the risk of the business. But basically cheaper is better. So you want to pay less for the income than otherwise. And that's what Buffett's trying to do. What I try to do

Starting point is 00:03:27 and what makes it deep value is the businesses that I'm trying to buy aren't good businesses. They tend to be their okay businesses, they're fair businesses, but they're available very cheaply. And the reason that I like to do that is I have done some testing. I've done some quantitative testing. And in my estimation for somebody with my skill, so Buffett is an incredible genius and he's been doing this for a very long time, photographic memory. I don't have those things. So I do it in a different way. And when I test it, I find that my way does at least as well.

Starting point is 00:03:59 Joel Greenblatt very famously wrote this book called The Little Book that Beats the Market. It's one of the most successful value investing books ever written. He describes in there his magic formula, which is this sort of quantitative version of what Buffett does, wonderful companies at fair prices. So when I wrote a book in 2012 called Quantitative Value, we tested that idea and we found that that did, in fact, beat the market. And we do all these things to it to make it hard for it to work. When we tested it, we found that it did in fact work.

Starting point is 00:04:27 I have my own version of that, which is called the Acquire is multiple. And basically, I just took away the quality metric, the return and invested capital. And when we test that, we find that that does even better again than the magic formula. And the reasons are because most businesses aren't this sort of very high quality businesses. Most businesses have a cycle to them. And so what you want to do is you want to buy them at the bottom of their cycle when they're cheap. And then you get the improvement in the business and you get a closing between the discount to the intrinsic value and the price.

Starting point is 00:04:57 And so you get both of those things you do a little bit better. If you're in the magic formula, sometimes you're buying stocks at the top of their business cycle that look cheap, even though what's going to happen is that the business is going to start doing progressively worse over time and then you may have paid too much. So that's essentially the difference that I'm trying to buy fair companies at wonderful prices where Buffett buys wonderful companies at fair prices. Thank you for explanation, Toby.

Starting point is 00:05:22 So keeping that in mind, please tell us about your new company. and your new ETF. The new firm is called Acquirers Funds, and it's going to be focused on the Acquireers Multiple. And I wanted to start a firm specifically tailored to the individual investor. And so the first thing that we're doing, but the only thing that we're doing,

Starting point is 00:05:42 is this deep value strategy that's based on my Acquirers Multiple, and we're putting it into an ETF. The ETF is called the Acquirers Fund. The tick is going to be Zig, ZIG, as in you should ZIG when the market zags, The idea basically is to take, you have the website, acquire is multiple and it puts up these stock screens all the time. People can come and subscribe and get the ones that cover the entire market or there's a free version of it that's just the largest thousand stocks. So the fund, I found people using it over time and they have, it is hard to rebalance. It's hard to use the

Starting point is 00:06:14 fund. It's hard to use the screeners and you've got tax issues to worry about and you've got rebalancing. And all those things are quite difficult to do. So I've often had people ask if I could put the strategy into an ETF. I've finally got around to doing. I've waited until now because I've had this view that the market is very expensive. You and I often talk about that. We're of the same mind about the market itself being very expensive. I look at the market, but I'm a value investor. So I'm mostly concerned about undervalued stocks. And I'm trying to put those sort of positions into my portfolio. But one thing that I don't often talk about on the show, but one thing that I do do is to short, I think in a market like this, where value,

Starting point is 00:06:52 Spreads are very wide, and we can talk about what that means in a little while. Basically, the overvalued stocks are unprecedentedly overvalued. They've reached this level of, and they're all the sort of the techy kind of businesses that you would expect. They're losing lots of cash. They're issuing stock to stay afloat. They're raising debt. They're not the kind of stocks that, as a value investor that I would buy.

Starting point is 00:07:14 In fact, they're the kind of stocks that I want to be short. You're not talking about Tesla, are you? That is one of my shorts. I kind of like Elon Musk. I think that he's a great entrepreneur, great businessman. I've got this quantitative approach to value, though. I've got to look at the financial statements. When I look at the financial statements, it's a short for me.

Starting point is 00:07:32 And we can talk about why in a little bit. I think we're at this unique or this very rare point in the markets where the spread is so wide between the overvalued stocks and the undervalued stocks. Just because undervalued stocks have been completely left behind, values underperform now for coming up on 10 years, the money's been flowing to growth. So because I'm a value guy and I'm a contrarian, and I want to bet on mean reversion, my feeling is that over the next decade, over the next five years, the next three years, it's more likely that that spread starts closing. And often the way that that happens is the overvalued stock is going to become less overvalued,

Starting point is 00:08:07 and that's going to happen probably in a dramatic fashion. And the undervalued stocks are probably going to become a little bit more undervalued too, but less so. Once that sort of market has cleared, it's going to take off. Do you think the rise of ETFs are the primary reason for the disparity that really is seen here for value stocks that's been underperforming for quite a few years? Because so much capital are being pumped in the ETFs and many of these ETFs, they're following an index or whatnot, and that's just not the value companies that would then be popped up in price.

Starting point is 00:08:39 It's not so much ETFs in and of themselves. It's not the wrapper. It's the fact that they're tracking these indexes. So the passive indexing means that once a company gets big, if it's in the S&P 500 or the Russell 1000 or whatever the case may be, as it gets bigger, it attracts more capital. And so they ignore the price. They ignore the valuation. And so the money flows into those kind of positions. It's not the ETF itself because the ETF could be like my ETF where I'm aiming for a huge active share in the ETF.

Starting point is 00:09:08 I'm trying to make a bet that is very different from what the passive index looks like. What that means is that it's going to behave differently to those passive indexes like the S&P 500. For many of the last years over the last decade, that would have been a bad thing. It would have underperformed in any given year and it would have underperformed over that full period. But when the market gets as dislocated as it is now with overvalued stocks, very overvalued and undervalued stocks, much cheaper relative to those overvalued stocks, it's much more likely that that gap closed and you get some good performance out of that if you're a value investor. I'm kind of curious to hear your thoughts on this one because what I'm seeing in a lot of the filters that I use is that financials are extremely undervalued right now. In fact, they're just all through the filters that I'm looking at from a value investing standpoint. Couldn't agree more. So my portfolio is, we're recording this before the ETF actually launches, but I don't anticipate that there'll be my portfolio just doesn't change very much because it's pretty boring stocks. But I can tell you right now, there's a lot of commercial banks in there. There's a lot of insurance, capital. market is represented in there. It's all the sort of things that they just haven't really kept

Starting point is 00:10:14 up with the market over the last 10 years. It's been a bad decade for those stocks because the decade before then was a very good decade for them. And they got smack in the financial crisis 2007 to 2009. And I think people are very wary of them now. But what has happened is they've become pretty good value. Now, I think they're sort of deep value names. So I agree with you 100%. You mentioned the value spread before Toby. What is that and how do you think through finding a value spread? The traditional way of doing it was this academic way of looking at price to book. You have the most overvalued companies which have the very highest price to book so they could be, you know, they might trade at many multiples of their book value, which is basically their assets. Once you back

Starting point is 00:10:54 out the liabilities, it's the accounting equity value of the company. And then the very cheapest to sort of trade at some fraction of their own book value. The way that I do it is because book values become a less useful metric over time. There have been changes to the accounting standards, which means it's not as good. It's also, it's the traditional kind of quantitative approach to measuring value. So it's the value factor. But I don't really think that it's a great representation of value. What I prefer to use are these.

Starting point is 00:11:19 The acquires multiple primarily, but I also use all of these other composite of these value metrics, which give you a better understanding of whether a company is overvalued or undervalued. And so we look at a spread of those. So we can take a universe and I can look at, say, the S&P,500, which is the largest 1500 stocks. covers about 90% of the stocks by market capitalization. That's the universe that I draw my picks from or the ETF. And I can rank them in sort of 10 different groups. And I have the most expensive group is the most expensive 150,

Starting point is 00:11:52 according to a variety of these metrics. And the cheapest ones are the cheapest 150. And I've been able to track the relative valuations of those two groups over time. And they've got wider and wider and wider apart as the value stocks just get left behind and all of the love goes to those really overvalued. There's a lot of biotech in there. There's a lot of tech. There's sort of stocks that there's story names.

Starting point is 00:12:13 They make good headlines. People love to be in them because they're hot and they can pop. But as a group over time, they don't do as well as the undervalued stocks. We've been through this unusual period where it looks like value investing doesn't work and it looks like the overvalued stocks is where you want to be. These unusual periods happen every now and again. They happen in the run up to the dot-com bubble. It happened regularly before then, including in the run-up to the great time.

Starting point is 00:12:35 depression and the stock market crash of 1929. So we're at this point in the market where there's only two times when the spread has been wider and that was in the last legs of the runup in 1929 and the last 1999, the last year of the dot com boom before the bust. So I think that basically we're in this market, which looks a lot like those without any sort of, it's hard to point to what is really driving it. There are tech names in there, but there's a lot of stuff that's just overvalued that you don't want to own. You probably ideally want to be a little bit short because it gives you a little bit of a cushion if the market comes off. It's better than just being long only. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in

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Starting point is 00:17:19 I think a lot of people in our audience understand what an easy. ETF is. I'm kind of curious because you have some experience with mutual funds. Talk to us about the difference between a mutual fund and an ETF, why one's more superior than the other and whatnot. I'm just kind of curious to hear your pitch. We launched and shut down a mutual fund pretty quickly in 2016, I think it was. And the reason was it's very hard for an independent manager like me to get a mutual fund onto a brokerage account that somebody else can buy. It's just the bigger players have sort of created these rules that make it very difficult for small independent shops like mine to get their products in there. Whereas an ETF circumvents that problem because it's traded like

Starting point is 00:18:00 a stock. You can go to your brokerage account. You can pull up the ticker and then you can buy some like you're buying a company, like you're buying any sort of stock that you want to buy out there. That's one thing that makes them a better product is that they're easier to invest in. The other thing is this tax. So if you own a mutual fund and the manager does some buying and selling inside the mutual fund that can create capital gains tax for you as a holder, even though you haven't traded the mutual fund. In an ETF, provided that the ETF is managed in the right way, those capital gains are leaked out through this special process called the custom basket create redeem. Basically, it's not that complicated, but it's sort of a little bit beside the point.

Starting point is 00:18:40 Basically, all you have to know is that the capital gains don't get put out to you through that structure. So you just have, you buy it at $10 and you sell it at $15 and your capital. capital gain, it's the difference between the two. You don't have to worry about what the manager's doing inside the ETF. So, Toby, I guess what we're all thinking is, how do you expect your new ETF to perform? We talked about multiple times here on the show also with you that the market is overvalued. What's a good balanced view on the expected performance of the ETF?

Starting point is 00:19:11 That would be the question that I would ask. How can you have these two thoughts in your mind? One is that the market is very overvalued, particularly for US equities. And the other is that I think that value is going to do well relative to the market, but I think that long, short value, which is what I'm going to do, which is what the fund does, is going to do very well. And the reason for that is that one of the things that I've learned over a long period of time in the markets is that value investing strategies are idiosyncratic. They do things that the market doesn't do. So if you were a value investor in the late 1990s, that was a terrible time to be a value

Starting point is 00:19:42 investor because you underperformed while the market was taking off. Warren Buffett and a lot of other value investors were down over that period while the market was up many times. And then there was this catch up period through the early 2000s where value, just being long, just owning undervalued names, you actually went up while the market was falling. I don't necessarily expect that to happen this time around. I think more likely what happens is that the undervalued stocks get a little bit more undervalued. But I think that the overvalued stuff is going to crash hard. And I think that the market is probably going to crash along with it. So basically, you want to have some sort of short protection in there somehow. You

Starting point is 00:20:19 You could do it. If I was to run just a long only fund, you could go and then short something yourself. Like you could short an index that was a representative of was drawn from the same universe as the stocks that I'm trying to buy long. That would be a perfectly valid way of doing it. But I think that if I can find individual shorts that are worse than the average stock, and I think that they will go down more than the average stock, then I think that you can get more cushioning from the shorts that I put in there.

Starting point is 00:20:45 For things like, you know, so my shorts are no secret that it's Tesla because I think that I've talked about Tesla in the past. That's one of them. It's one of those stocks that, you know, it brings out a lot of emotions and people. Like, I think the cars are beautiful. I think Elon Musk is a very good entrepreneur. The financial statements are the way that they are. And I just sort of ignore both. I ignore the longs and the shorts. And I look at the financial statements and the financial statements say to me, this is a better bet as a short. And there's a little bit of time to go before this podcast comes out. So it's possible that I'm out of it because I'm very risk averse with the shorts. They come into the portfolio. They're very small. They're 1% at insolent.

Starting point is 00:21:19 and then we rebalance them regularly because we don't want them getting too big because that's a risk. But as a portfolio, those shorts provide a little bit of ballast for the rest of the longs in the event that the market goes down. So the other stuff that I've had in there for a long time is Snapchat. Snap's just one of those, I think, sort of emblematic of what has occurred. It's not as good as Instagram. It's listed by itself. It's one of those things that I think it has been a better short than it's been along and it's been going down for the most part. So, Toby, I'm kind of curious how when a person would look at the ETF, because you're doing some shorts inside of your ETF.

Starting point is 00:21:54 So how much of a percentage if a person would get involved with your ETF, how much of that is being short, how much of its long value? Talk to us a little bit about that. Basically, there's two portfolios there. There's a portfolio that's 100% long undervalued stocks. And that's the process that I often talk about when I'm on the show with you guys. I look for deeply undervalued stuff. And in fact, the longs are likely to be names that I've discussed on this show over a long period of time. So Micron, I've discussed lots of times.

Starting point is 00:22:23 Fiat Chrysler, I've discussed AGO, a short guarantee was when I discussed a long time ago. And I've discussed, I think Tesla was a short before. So I don't think that anybody who's been listening to your show for a long time and heard me appear, and it will recognize all of the names. Like, I'm loyal to the names that I really like. And so they're likely to be in there. Basically, what we've done is we've created two portfolios. there's one that's just 100% long, those sort of names.

Starting point is 00:22:45 And if you use the Acquire as multiple website, and even if you're a free user, you're going to recognize some of the names that I put in there. That's exactly how my process is. I use that screen. That's sort of my candidates for the portfolio. And I do a valuation on them and try to find things that are undervalued the way that I like to look at the valuation,

Starting point is 00:23:03 which is as a deep value guy. And then I also do this forensic accounting diligence, I call it. So there are just things that the numbers in the financial statements, don't capture. And it's necessary to go and have a look at the management discussion, take a look through the notes, see if there are things like underfunded pension liabilities that I think that they're transitioning into the financial statements, but they're not there yet. Various other things that should be included in evaluation. So that process is partially done with some machine learning, which is very buzzy right now, but that's a good way of just picking out the issues using a

Starting point is 00:23:34 computer to do that. And then I look at it. And for people who don't know, I was a merger an acquisitions attorney for a decade in Australia and in California, in San Francisco. Part of doing that, if you're a junior, you start out, you do a lot of due diligence. That means they send you to a data room. You sit there and you look through a whole lot of documents. And so that's sort of what I spent a lot of my junior lawyer doing. And I still do it to this day to look through the stocks to make sure there's sort of nothing hiding in there.

Starting point is 00:23:58 No landmines in the positions. We use a service that pulls these out for us. So the process in its entirety is sort of quantum. It's not quantitative, which. So, again, a quantitative process, you might have a very large portfolio. It might have hundreds of different names in it. No human being interferes with the process from start to finish. The computer picks the stocks and they appear in the portfolio.

Starting point is 00:24:21 That's not what I do. I have a quantitative screening process that pulls out the names and those screens you can see on the Acquirers Multiple website. That's where that process starts. Then there's a valuation and then there's this diligence that's, I use an off-the-shelf service pulls out all of these little interesting tidbits if I put in the ticket tells me about the company and then that has to be put into the valuations. Basically what we're trying to work out is are the financial statements a fair representation of what's happening? Does

Starting point is 00:24:50 that describe the economic reality of this business? And often you find that the financial statements are misleading. They may paint a very pretty picture but the underlying business isn't doing that well and the way that you would, so for example, the way that you would find out something like that. Accounting profits are going very well and they're increasing every year, but the cash flow is negative and growing worse every year. So that's not uncommon. Like that's Tesla that I'm describing there. If you look at Tesla's cash flow, every time Tesla sells more cars, it loses more money. Tesla, I think you see that in the financial statements. You don't actually have to dig into the management discussion to sort of see that one. But that's the idea. I want the economic reality of the business. And I need to understand

Starting point is 00:25:28 that before I can do a valuation. And so once that is understood or it's understandable, then that becomes a position that is either long or short. And sometimes you'll find these things that they're very overvalued. They've got a misleading trend in their earnings relative to their cash flows. They're issuing stock to stay alive or they're borrowing to stay alive. And insiders are selling. All of these sort of things are signals that you don't want to be long. So just to summarize, if you put in $100 into your ETF, how much is long and how much is short? It's $130 long and then it's $30 short. Gotcha. And the reason for that, So that you could construct a market neutral version of this where you have $100 long and $100 short or $190

Starting point is 00:26:10 long and $190 short. The reason I don't like to do that is I do think that over time, the stock market tends to make money from even at very overvalued points. If we look forward 10 years, we're still likely to be slightly up from where we are now. Where the market is now, it's not predicting negative returns. It's predicting very low positive returns. But you don't want to be short, low positive returns from here. You want to be long, though. So that's the 100% portion.

Starting point is 00:26:37 And then there's a 30-30 long short in there. And that's the arbitrage between the spread. So you've obviously done a lot of back testing on various strategies. Have you found that when you implement this long by 130, short by 30, that you get the best or most optimal results? Is that why you kind of gravitated towards that ratio? Well, it's a balance between being aggressive and wanting to, generate as much performance as I possibly can. And at the same time, I'm a reasonably conservative guy. I don't. 1.30 would be regarded, I think, by most people. So it's largely, it's like being

Starting point is 00:27:13 long the market with this 30, 30 long short portion attached to it. It's probably a little bit more aggressive than being long only, but it's not a super aggressive. You can find two times, three times levered versions of most strategies out there. And I don't like getting that long, even in a market neutral position because lots of things can happen. The spreads can blow out further. The market is always about to do something that you've never seen before. And I try to run it as conservatively as possible so that if we're talking about this in 25 years time, and I hope we are, I hope investors podcast is its own channel on my TV. And I get to come on occasionally. And I'm hoping we get to talk about it then. And I'm hoping that it's still going and it's survived because that's

Starting point is 00:27:52 really the name of the game, particularly in value investing, is survival. Because the rough periods can be very rough, but you need to be there for those very, I have been very brief, but for the good times when they come along. And I can't really ever predict when they're going to come. Well, you know, when we did our thing in New York with West Gray, I distinctly remember West saying, you know, the reason value investing continues to work over time is because there's periods where it doesn't work. That's exactly right. And people give up on it. I thought that was such a great way of saying it. I think that's exactly right. There are two things that value does. It's this tracking error. The tracking error is it doesn't follow the market.

Starting point is 00:28:28 And I have people ask me all the time, like, what happened in 2011? Like, why was that such a bad year? Like, if I knew, I wish I'd knew it. Like, I'd be a multi-billionaire now if I knew when this thing was going to work and when it wasn't going to work. Nobody's sort of figured out how to time it. Toby, I can help but think, why don't we see more ETFs like this? The problem is that the short portion is hard to implement. It's a pain to track it and rebalance it all the time.

Starting point is 00:28:51 The reason that I do it is because I love it. I love fun. these junkie overvalued companies and holding them through a little portion of the justice that is served out to them. Because it's so hard buying the deeply undervalued stuff and seeing really good businesses struggle when at the same time there are these businesses that are undeserving and extremely overvalued and prepared to put up with it just because I enjoy that process so much. I love the kind of the carnage of shorting. So it's very high touch. You need someone who knows what they're doing in there all the time doing it, which for the low

Starting point is 00:29:27 fees that ETFs attract, people often don't want to do. The other thing is that it's just been such a tough period for value. People are scared to kind of do these things long short, using only value. They sort of want to try to put in some momentum or some other things, which is fine. I think those strategies do work, but sometimes if you want a concentrated bet on value, which I really want a concentrated bet on value right now, this is the way to do it. You need to be long, short value and you need to be short in a way that captures that overvalued. I need to be long in a way that captures the undervalue. A lot of the other implementations of these tend to be sort of, they use the value factor to implement it, which might be relying heavily on book value or something like that. For me, value is not a

Starting point is 00:30:11 factor. It's more, it's value is a philosophy. What I mean by that is I'm looking for something that is undervalued across a variety of different metrics the way that I look at it. And is the balance sheet robust enough to survive this rough period that it's going through? Is it generating enough free cash flow to sort of survive and grow? Is management doing the right stuff? Are they buying back stock or are they paying down debt or doing something appropriate when they're undervalued? And I think that if you approach it as the philosophy of value, looking for something that is undervalued, rather than just an implementation of the factor, which is sometimes it's a little bit agnostic. Buffett has said it, He said like a low price to book value is not necessarily indicative of something that is

Starting point is 00:30:52 undervalued. You can be a low price to book value and be overvalied. And the converse can be true. It can be a high price to book value and be undervalied. So I don't want to use it as a factor. I try to implement the philosophy, which is not something that is easy to reduce to the numbers for one of the biggest shops to bring out some sort of factor-based portfolio and they tend to trade pretty poorly.

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Starting point is 00:34:35 All right. Back to the show. So talk to us about the shorting. If I put on a short position, it's typically through an ETF because it's distributing like the whole, you know, the whole piece of it is distributed across the whole market. But doing like an individual company, I've just found that Tesla is probably not a great example because it's so big. And the buyout side of it is maybe not so much of a concern, but with a lot of companies that don't have such a huge market cap, there's the prospect that they could be bought out. And then you just absolutely get crushed in that short position. And so I guess my question for you is, how do you set a stop on a short position? How do you think through that piece of it where you put it on? It's moved in the opposite direction of what you

Starting point is 00:35:23 thought. And where is your breaking point? How do you know where that's out? How do you know when to get out of it by saying I was just wrong. This last decade has been very good for me as a shorter because it's been, so the decade before then was an easy period for a value guy to do shorting. If you short it on valuation, basically it worked. If you were long on valuation, basically that worked too. So we're at this different point in the market over the last decade where the intuition for value guys was wrong.

Starting point is 00:35:53 Stuff that you were short tended to keep on going up, stuff that you were long tended to keep on going down. That's why guys like David Einhorn, who I think is a very good investor, his performance hasn't looked very good over the last few years because he's been in these wrong positions. That really made me sit down and think hard. And I did that about five years ago because I had, I'd been suffering for about five years to sort of think about my, the way that I shorted, the way I went about that. And I did add something extra in. So these are my general rules for shorting. I only short up an individual name. I would never short more than one percent of the portfolio at a time. My long position is a four point.

Starting point is 00:36:27 3%, 1% for my shorts. And the reason for that is for the reasons that you've just discussed, somebody can come in and buy them. If they get 100% premium or more, then that hurts me to the extent of 1% in the portfolio, which is something that I'm prepared to put up with because the whole portfolio, I think, delivers these better returns. This is the short portfolio I'm talking about, delivers these better returns. And the other thing that I have done, and this is one that I've sort of learned over the last

Starting point is 00:36:51 five years, this is the thing that stands out for me is I don't short companies that have an enormous amount of momentum. Netflix is a good example. Netflix doesn't look great from a financial statement perspective, but clearly it's a very good business. They have a good subscription model business, and the stock has been very, very strong. So if you had thought, well, Netflix is overvalued

Starting point is 00:37:13 and the balance sheet doesn't look great, I might get short. That's been a terrible decision for a really long period of time. Because I have this approach now where I don't short things that are going up a lot, then I don't make those sort of mistakes anymore. I still make lots of other different mistakes, but I don't make that particular mistake anymore. I think this is kind of an interesting

Starting point is 00:37:30 because I have two automobile stocks in the portfolio and I have one long and one short. And I just think it's interesting to compare. So the long is Fiat Chrysler and the short is Tesla. And it's entirely possible that there's been a rebalancing before this airs. But at the time that we're talking about, this is the portfolio. The market cap on Fiat is $25 billion. The market cap on Tesla is almost double that at $46 billion.

Starting point is 00:37:56 So I like to look at the enterprise value, which includes all of the debt, hold on. So Fiat, total enterprise value, $27 billion. Tesla, total enterprise value, $56 billion. So it's more than double. So if you're paying twice as much for Tesla versus Fiat, what do you get? More debt. You get more debt. But the operating income from Tesla over the last 12 months has been about $252 million in the red,

Starting point is 00:38:23 whereas Fiat Chrysler has generated $6.5 billion in the black. So when you look at Tesla, and in addition to the $6.5 billion in operating income that Fiat has generated, it's also generated more than $5 billion in free cash flow, whereas Tesla's been negative free cash flow to the tune of $220 million. And I appreciate Tesla's sort of a tech-type stock and Fiat's like an old. I get all of those sort of arguments, but at some stage it has to sort of turn into profitability and free cash flow. And I know that Tesla's a beautiful car, all those sort of things. The reason that it has to happen eventually is that car company, that's an asset intensive business. It's a capital

Starting point is 00:39:04 intensive business. And the capital has to be funded. The assets have to be funded. How do you figure out how they're funded? You go and look at the balance sheet. Balance sheet for Tesla has a lot of debt on it. There's a little bit of debt in there for Fiat as well, but Fiat's generating multiples of operating income to its debt, whereas Tesla doesn't have any operating income. It's got negative operating income. My hat's off to Elon Musk. He's done an incredible job running this business to this point, but it's still run like a startup. And at some stage, it has to start making money. Otherwise, it's got to raise capital. Well, Toby, this was an awesome, awesome discussion. I really enjoyed learning about this. For people that are listening, the ticker is Z-I-G. That's he wants the ZIG when

Starting point is 00:39:46 everyone else zags, which I think is brilliant. I love it. So go ahead and check it out. We'll have the prospectus for his ETF in the show notes here. If people want to check that out. Toby, anything else you want to highlight or tell people about? Yeah, it's called the Acquirers Fund, custodians U.S. Bank, listed on the NYSC. It's the only thing that I'm doing at the moment all of my money is going into it. All of my family money is going into it. I'm a believer. So, of course, I'm biased and you can back out my bias from this, but I think that the data really does support the position. So I'm extremely excited. The management fee is 0.79 percent because of the way that shorts are treated, that I have to, the dividends from the shorts are reflected in the expense ratio.

Starting point is 00:40:31 So the expense ratio is likely to be a little bit higher than that. I think it's a modest fee for what is really a hedge fund type strategy. It's super excited to be getting it out there and running. It's something that I've been trying to do since I moved to the States a little bit over eight years ago. I hope that we're talking about it in 10, 20, 30 years time. Well, I'm excited for you, man. And it's really fun to have you on here. So thank you so much for your time, Toby.

Starting point is 00:40:57 Thanks, Preston. I love you guys. And I'm so happy that I was able to come on and launch it here with you. You are always more than welcome here on the show, Toby. All right, guys. So at this point in time, the show, we will play a question from the audience. and this question comes from Michael. Hi, Preston, Stig.

Starting point is 00:41:14 My name is Michael. I'm from Washington, D.C. I just want to thank you guys both so much for your effort with the podcast. I've been listening for about a year, and it has truly transformed my investing knowledge. My question relates to my beginning, because I was a complete newbie. And as I looked up books to kind of build a foundation, I was inundated with a myriad of reading list and recommendations from Buffett to Munger to Pabri. and it was easy for me to get overwhelmed. So my question for you is if you two were to build a value investor curriculum for a brand

Starting point is 00:41:48 new investor, what books would it contain and in what order should one read them? Thanks again, guys, and I look forward to hearing the answer to this question. All right, Michael, I love that question, and it's very relevant for anyone who is starting to invest. I for sure also asked myself that very same question whenever I started out. I mean, there are so many resources, but it's not grouped into a curriculum. And I definitely did not read the books in the right order. For example, it didn't take long before I started reading security analysis because that's just what I heard.

Starting point is 00:42:25 Like, you're supposed to read security analysis if you want to analyze stocks. Don't get me wrong, it's a great book, but it's not something I would put into a curriculum at all for a new investor. If you're completely new and you would like to take an education in value investing, I've come up with the following four steps. So the first step is reading the book The Education of a Value Investor, and that is a book by our good friend, Guy Speer. This is a book that I absolutely love. It's not really only a good foundation to understand how to think about investing, but also more how to live your life as a value investor. Being successful in value investing is as much a choice of lifestyle, which is not for everyone.

Starting point is 00:43:12 The second step is the course, the Warren Buffett Investment Strategy course, which is the free course that you can find here on TAP Academy. And this is a course pressing created to explain the principles behind Warren Buffett's investing method. because as much as I'm an average reader, I also like to recommend courses, as it illustrates many of the points about investing a lot better and easier than you can in a book. The third book is actually a book, Monish Paprai, just recommended here on the previous episode.

Starting point is 00:43:48 It's called the Essus of Warren Buffett. Instead of recommending Warren Buffett cheery letter, which are absolutely amazing and something that I think all the value investors should read. What Larnikonham did really, really well is that he neatly grouped all of Buffett's teachings into topics in his book like corporate finance, investing, valuation, and much more. And I just looked it up on Amazon and the paper bag is 13 bucks. So even though you can find the latest for free, I think it's well worth your money to save the time and get a better overview of the different topics. Just one thing to can. Just one thing to keep in mind is that currently the newest one is the fourth edition. So remember to get the most

Starting point is 00:44:34 updated edition to ensure that you cover as many of the letters as possible. The last step is really about accounting. And I'm all for thinking about stocks the right way, living your life the right way, you know, understanding Mr. Market and concepts like margin of safety. However, soon or later, you need to be able to understand how. how to refinance the statements before it can value a stock. Even though it would be easy for me to recommend Warren Buffett accounting book that Preston and I wrote about this very topic, to really understand the nuts and balls about financial statements

Starting point is 00:45:11 and how to use it as a business person as much as an investor. You know, the book Financial Statements, a step-by-step guide to understanding and creating financial report. It's just such a wonderful and simple book that gives you a really good foundation. And if you do pick it up, I would highly recommend that you have a set of real financial statement next to you. Make sure you're not analyzing banks or insurance companies. Those financial statements are a bit harder to understand. But choose a company with more conventional financial statements, for instance, a production company for simplicity,

Starting point is 00:45:49 because that's really what is all about right now and you can always advance from that step. We're going to include all the links and the show notes to these four steps. But Michael, very hard to come up with recommendations for a curriculum. But I hope that these four steps in that order will help you in your journey to becoming a value investor. Michael, I really love this question. In fact, I believe this was the most important question I asked myself when I first started out. Like most people, when Warren Buffett says a couple books are the most important books that he's ever read. I immediately tried to read those books.

Starting point is 00:46:26 But the problem that I ran into was I didn't understand the terminology when I first started reading books like the intelligent investor and security analysis. And the terminology is all about accounting. So like anyone else, I quickly realized I needed to understand the basics in accounting before I could follow on and read these books. So my recommendation for you. And one other point is Ben Graham is not the most entertaining. author. In fact, his writing style is very academic. So this is what I tell you. Find a way to learn accounting that will keep it fun. And so you might not get that knowledge from reading a book. I'm obviously biased by the content at Buffett'sbooks.com because I created that website.

Starting point is 00:47:13 And the whole intent behind that was to teach the terminology of accounting in an easy and fun manner for people. So you can check that out. It's completely free. Just go to buffetsbooks.com. But there's other sources out there to learn this language of accounting. And so I would just challenge you to try to find whatever that source is. I don't care if it's a four dummies book or whatever, but find a book that is easy for you to understand. And at the end of it, you need to understand how the three financial statements, your income statement, the balance sheet, and the cash flow statement, how those statements are tied together and how, They work because once you understand that, everything is then going to start making sense.

Starting point is 00:47:54 So after you get that knowledge of accounting, I would tell you you can try to tackle some of the books that Buffett and Munger are recommending. Additionally, I would tell you that I personally like the book, Seth Clarmann's book, Margin of Safety, way better than I liked the intelligent investor or security analysis. I'm sure that's very arguable amongst many people in the investing community, but that's just my personal opinion. So without reiterating a lot of the recommendations that Stig had, because we have very similar recommendations in very similar ways of viewing this, I'll just leave you with that. All right, Michael, as a token of our appreciation for leaving your question, we're going to give you access to one of our free courses on the TIP Academy page on our website. The course that we're going to give you is our intrinsic value course.

Starting point is 00:48:42 And our intrinsic value course teaches people how to determine the value of an individual stock. It also teaches you how to think about the market cycle and when you're buying your stock. And it also teaches you some stuff about options trading. So we're really excited to give you this course. If anybody else out there wants to check out the course, you can go to tip intrinsic value.com. Or you can just go to our website and click on Academy link at the top of the page and courses right there. So if anyone else wants to leave a question on the show, go to Ask theInvesters.com. And if your question gets played on the show, you'll get a free course. All right, guys. That was all the Preston that I had for this week.

Starting point is 00:49:17 episode of The Investors Podcast. We see each other again next week. 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 rebroadcasting.

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