We Study Billionaires - The Investor’s Podcast Network - TIP329: Value Investing - w/ John Huber, Tobias Carlisle, and Wes Gray (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. In this episode, I speak to three faint favorites of the investors podcast, John Hoover from Saber Capital Management, Tobias Kail, Quiris Fund, and Dr. West Gray from Alpha Architect. All three of them are highly successful asset managers. We discuss value investing concepts that all investors should know, ranging from a deep understanding of risk to secalty, position sizing, and much more. So without further delay, here's our discussion with John Hoover, Tobias Carlisle and West Gray. 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.

Starting point is 00:00:54 Welcome to The Investors Podcast. I'm your host, Dick Broterson, and I'm not here today with any of my co-hosts. However, I'm here with no less than three guests, and it's safe to say that we have a superior lineup for you. We have John Hubert, Tobolson. Kyle and West Gray with us. Jens, thank you so much for making time to join the group here today. Thanks, Sig. Yeah, thank you, Sig. So I was speaking with John the other day, and he suggested that we tried out a different format here for the show. So instead of a typical interview-style episode, we would invite a group and talk about

Starting point is 00:01:28 value-investing concepts, and I absolutely love the idea. So you guys can think of this a bit more like a master-man group meeting, but we won't be pitching particular stocks or find the intrinsic value of a stock. Rather, we'll be talking about our successes and failures, and most importantly, what we learn all the years in the market. And we have four main topics for today. And they are knowing what you don't know, signality, risk, and advice to your younger self. I wanted to start up the first topic knowing what you don't know with a few quotes.

Starting point is 00:02:01 The first is from John Kenne Goldbright, who said, we have two classes of forecasters, those who don't know, and those who don't know that don't know. The next quote is from Henry Kaufman. He's saying that there are two kinds of people who lose money, those who know nothing and those who know everything. So with that bleak kind of kickoff, I wanted to kick it over to you guys. Perhaps, John, you could start out. It's a really interesting topic, Stig.

Starting point is 00:02:26 I think the way I think I would think about that question is to, I guess, first, like, accept the reality that the world is uncertain. And so I think the implicit logic in your comment is that we don't know the future, right? So the way to the best defense against ignorance, I guess, or not knowing the future is to, when you're thinking about investments, is to position your portfolio in companies, at least the type of investing that I do, position your portfolio in companies that are, I think, best adaptable to change. So for me, I think the world, and I've talked about this, I think Toby. I talked about this on a podcast one time, but I've been thinking about this concept for a few years. I think the world is changing to a degree where the rate of change is much faster than it used to be in previous decades.

Starting point is 00:03:18 And so companies, what that means is companies are changing much faster. And so I don't think you have companies that will be able to exist on these static competitive advantages that they enjoyed for decades. Companies like Procter & Gamble had shelf space advantage that they lived off of for for years and years and years and years. And the nature of business now is that barriers to entry are so much lower. And so you have upstart companies in all different industries that are able to take on, you know, incumbents that would have been unthinkable 20 years ago. So I think you have a situation where the rate of change is faster, incumbent advantages are no longer, in many,

Starting point is 00:03:59 there are some exceptions, but incumbent advantages I don't think are as strong as they used to to be. And so you have to just come to grips with the reality that change is a constant. And so I think the best way to defend against that is to invest in companies that have the ability to change. And that means thinking about management teams that are adaptable, companies that can quickly shift. And I think those are the investments, those are the companies that will be best positioned to fight against the unknown, which is the future. So that's, It's kind of my thought on that. That's very interesting, John.

Starting point is 00:04:37 Thank you for sharing that. And, you know, the issue I had with one of those quotes, you know, those two kinds of people lose money, those who know nothing and those who know everything, whenever I think about guys who know everything, I think of you guys. I could say, you know, hey, talk to me about a really, real smart guy. And I would say, talk to Wes, if anyone, he would know his stuff and not trying to paint you into a corner here, Wes. So how do you not know everything?

Starting point is 00:05:01 I guess that's a more my question going into this. Well, I think the more you know, the more you kind of realize you don't know anything else. And so I kind of boiled this question down to what do I actually think I know and just I'll assume I don't know anything else, right? That's a much easier question to ask than how do you know what you don't know? I'm just going to invert it and say, what do I think I actually know? And for me, I wrote down three notes here. The first one is that incentives matter.

Starting point is 00:05:29 And to John's point, Mark is competitive. So I do think, you know, no pain, no gain is a pretty good mantra to live by in investing. And if you can't identify where there's pain to get your gains, you're probably wrong. Or you probably don't know something that you don't know. So that's a good rule of thumb. And then the other one is I got another note here. It says humans matter. So sentiment matters, fear and greed do affect prices.

Starting point is 00:05:56 And so that's just to say that, you know, market probably isn't perfectly efficient. and there are maniacs out there. I know that. The problem is I don't know how to time these maniacs, so got to be ready for being patient. And then the third one, which is kind of living too close to Vanguard, is that fees and taxes matter a lot because I can identify perfectly how much those are going to cost me. And so to the extent I can minimize those, that's really important, especially on the tax side where I think a lot of people forget that, you know, 50% Uncle Sam carried interest is the biggest fee you'll ever pay. So those are things I know. Incentives matter, humans matter, and we should avoid fees and taxes. I don't know anything else

Starting point is 00:06:40 beyond that. I think there was a good way of responding to that question, Wes. So actually, let me follow up on the third part you said there about fees. You know, we are in a new environment right now. I don't know if I could say new normal. It's going to be such a cliche if I said that. It's just crazy what we're seeing right now. And we're all paying taxes. on nominal gains. We all like to look at nominal numbers, not real numbers. So knowing that, how do you think about fees and taxes now? What has changed, giving the low interest rate environment that we're in? The problem with being an asset manager in a world where expect to returns on everything are really low is it's one thing to charge 1% when you have

Starting point is 00:07:24 fixed income or just brain dead money paying you 5, 6%. Now that you literally haven't sent have to put your money in a pillow because if you have a bond that a 10 year bond that pays 1% well half of that goes to taxes you're down to 50 bips then you pay 50 bips and fee you got zero with a lot of brain damage why did I even hire this person to do anything with my money so that obviously extends a little bit into people that do more risk you know like toby myself and john but but even for us that matters right because you know maybe we had a high expect return of 15 20% now that all got chopped in half Like, you know, our fees, our infrastructure costs as a percentage of your potential gains are still relevant.

Starting point is 00:08:07 But I feel really bad. And it's going to be very interesting to see how advisors, fixed income managers, and a lot of other people deal with this reality of why am I paying anyone in financial services anything right now? Because they're not going to deliver anything after all their cost and lack of transparency, liquidity constraints, etc. It's going to be a tough business going forward, I would say. Toby, you're looking at me right down like, oh my God, I feel the same pain as Wes. It's a tough world to be in and say, you know, I do know more than the market. Or what do you know? I know it sounds a bit provocative, but we're friends.

Starting point is 00:08:45 So I guess I can throw it over to you like that. The first time you confront the market, none of it makes any sense. And then you find some guys who succeeded. And the way that I did it is I found Buffett and I found Graham. And so their value guys. So what their idea is, there's a quantity that you can calculate that's different from the market price. And if you put together, you know, you look at the yield, you look at the rate of reinvestment

Starting point is 00:09:11 in a stock that gives you a value for that stock. And you can reverse that process and get some expectations about it. So rather than working out what I think it's worth, just look at what the market thinks it's worth. And then I can ask, is that reasonable? And where there are instances where I think the market is so. far wrong that it's worth sort of betting on the market being wrong. And, you know, I could take Wes's advice and say, well, are they wrong because there's a lot of pain here? Are they wrong

Starting point is 00:09:38 because the market just doesn't understand? Is that, you know, there are many events where, in option pricing, for example, there are many events where there's some binary event going to occur. And the option is priced as if it's like shoals, which is assuming that all possible outcomes close to the central tendency are more likely, further away or less likely. I think that there are very small pockets of miscalculation in the market. And I do think that if you know a little bit, you can get comfortable with them. The risk that you run into and every single one of those is that you've missed something that the market knows more than you do. And so the way around that is just to diversify across enough positions so that if you're wrong in any given one,

Starting point is 00:10:15 and you would hope that over time you would generate a little bit more return potentially than the market, or at least your process is a little bit more sensible than the markets, which is just sizing into float-adjusted market cap, which really that doesn't make a great deal of sense to me. As competitive as it is, as an index to be, it really doesn't make a great deal of sense to sort of allocate money. So that's how I do it. I just kind of think about it. If I was a business guy sticking money into the market and I only regarded the stock market sort of incidentally stock market investing that gave me these opportunities, how would I approach the problem? I'd approach it like a business guy. I wouldn't really care what the index does.

Starting point is 00:10:51 I try and come up with evaluation. I know that I'm probably going to be missing. some stuff and wrong on some stuff, so I'll just size down my positions and try and hold a basket of them. I still think that over the very long term, that's a pretty good approach. So let's talk about having the right sizing in our portfolio. So right now I'm going through this amazing CNBC resource with Warren Buffett and Chalamonger, and it's all of the old Berlid's annual shareholders meeting back to 1994. And in the 2008 morning session, this gentleman asked Buffett and Munger, how aggressive can you build your positions in your portfolio, you're giving that you have a maximum conviction. And Buffett talks about how he multiple times

Starting point is 00:11:27 had 70 to 75% of his net worth in one investment. Now, Jens, what are your thoughts on that? Can we do that and should we do that knowing that we're not Warren Buffett? Is that a correct statement for Warren Buffett? That probably is a correct statement for Warren Buffett. Is that a correct statement for me? No way in the world is that correct for me? I would never size something up like that. There's a point where I don't have enough interest to keep on digging in And I think that Buffett, clearly when you listen to Buffett talk, he's on a different level. There's no point in my timeline of development as an investor where I get to where Buffett has been at any stage. So I'm never going to size like Buffett does.

Starting point is 00:12:05 I'm just going to keep them smaller. I think that really the hardest thing about investing is just working out who you are. And as soon as you figure out who you are and you stop trying to do it like everybody else does it and just do it in a way that the only thing you have to do really to succeed is to stick with your conviction when something goes against you. And if you can do that, you're going to be okay. If you can't do that, then you're doing the wrong thing. It's too big. You've got the wrong method. Like, you know, where's this got some momentum?

Starting point is 00:12:29 It doesn't quantitatively, but he's got some. Momentum just doesn't appeal to me as an investment style. So I just can't do it. If it goes against me, I just wouldn't be able to hold the position. And that's exactly when you need to be holding it. True of value, when it goes against you, you need to hold it. If you're confident in the underlying and you can hold it, you're going to do okay because that's when you get the better performance.

Starting point is 00:12:47 So, I wouldn't size like that, but I think it's a price. appropriate for Buffett to do it. I would still say 70% pretty big for Buffett if you're Buffett. But then again, he would probably say, well, I got like 99% of my money in Berkshire and that's one stock. When you think about slugging percentage to use a baseball term, you know, I think regardless of the type of investment approach you use, you can have a very, this thing about like George Soros has this quote where he says something to the effect of, or maybe it was Drucken Miller, which is obviously a completely different investment approach than I think any of us used, but said something like, You know, Soros is right, 30% of the time, but he just wins so much more on the ones on those 30% hits.

Starting point is 00:13:28 His winning, I guess the size of his wins are so much larger than the size of his losses, so he can compensate for that. And that's really the same with Buffett. Buffett had a much higher batting average, but if you look at Buffett's performance over the last 50 years, you'll see that a large percentage of his gains, even after the partnership years into Burnton, I mean, some of the biggest gains in Berkshire's book value have come from a relatively few successful big investments like GEICO is one, Washington Post is one, Coca-Cola's one. So some of them were public securities, some of them are wholly owned businesses, but that slugging percentage, it's the same, I think Buffett is the same, Soros, the VCs in Silicon Valley, that that is, I think, a common denominator to a lot of successful approaches. And then in terms of

Starting point is 00:14:22 sizing, I was just going to, I was thinking about what West said in taxes and the frictional costs that go along with investment management. And you have to think of it like a barbell. You have to have one of two extremes. You either have to be extremely diversified and do what I think Wes and Toby do more of, which is a quantitative approach. And you're looking for almost like an insurance style bet where you have, you're taking advantage of the law of large numbers. You have a large sample space and value investing works over time. And so if you have a large enough sample space, you can gain a small edge and you can replicate that over and over, knowing that on average, low price to earnings, low price to book, maybe, although that maybe isn't as relevant anymore, but a basket of

Starting point is 00:15:07 value stocks will outperform over time. And then at the other extreme, it's more of the concentrated approach, which is just the approach that I feel more comfortable with because I'm picking stocks. I think you have to be very selective and very patient. And then you just have to wait for something that makes sense to you. And to Toby's point, I've discovered this long ago, you can't invest like Buffett. You can't invest like Peter Lynch. You have to figure out your own style, your own circle of competence. And then you just have to wait for things that you understand. And once in a while, for me, it's very rarely. But once in a while, I understand something. And then I can take a swing at it. And so I think you can improve your hit rate by being overly patient

Starting point is 00:15:51 and just waiting for something that shows up that makes sense to you. But I think it has to be one of those extremes. You either have to be very concentrated and very selective or you have to run some sort of a diversified approach that has a proven edge over a large sample space. Anything in the middle is just not going to work, especially when you layer on fees. Well said, John. 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, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:20:25 So, guys, let's move to the second top here of today and talk about cyclicality. We did have the pleasure of speaking with Howard Marx about his book mastering the market cycle here on the show, and he emphasized the two rules of cyclicality. Rule number one, most things will prove to be cyclical, and rule number two, some of the greatest opportunities for gains and losses come when other people forget about rule number one. So, starting with you, Wes, how have you made or lost money in the market because of neglecting them, or perhaps from having a deep understanding of cyclicality? I would first question the premise a little bit in the sense that you're going to have a lot of

Starting point is 00:21:03 survivor bias in claiming their cycles because that implies something came back. But what about like all the other things that literally went to zero and blew up and you don't read about anymore, right? So cycles clearly didn't work there. But you know, if you're a survivor cycle is always going to be amazing because just keep buying the U.S. equity market, you know, you're a genius. You get earned the 7, 8% equity return premium. But, you know, go ask all the other countries. where on average you earn like 2% and you get your face ripped off most of the time. So I would say I just question the premise of that in the first place. And then obviously all my wins go exactly in line with what he's talking about in the value

Starting point is 00:21:42 realm where you buy something that's totally out of favor, total piece of junk and it makes money. But who cares about that? I would say the cycles that I screwed up the most are actually the opposite of that, momentum cycles where I can think of three examples, a recent memory. One is in real estate. So my brother lives in Eagle, Colorado, where I grew up, it's in the mountains. And probably 2012, we had all these opportunities to buy, you know, different real estate properties out there. But of course, being value cheap bastard, we're like, nah, it's too high, man, don't want to get in.

Starting point is 00:22:19 Of course, you know, we didn't realize that's a momentum trade. And, you know, it's only quadrupled with leverage and we'd be millionaires right now. And of course, most recently here, March 2020, me being a genius, I'm like, ah, this is the greatest time ever to buy value. I'm going to do that. And yeah, that kind of work, but guess what? Should have bought momentum because it would have worked 10 times better, right? So for me, all the cycles that I look back that I missed, everyone always value guys always talk about cycles and point the value wins, but they're not highlighting that the big wins or the momentum cycle. that we all mess. I think that's an important thing for kind of value people to think about it,

Starting point is 00:23:00 is momentum cycles, not mean reversion cycles. What do you guys think? Yeah, I mean, I think that's a great point, Wes, when you think about like that real estate example you used in Colorado, you know, that local market might have been at some inflection point where the true value was dramatically understated for whatever reason. And whether it's people moving to the area or, you know, prices are appreciating or whatever it was. But I think about like Google as an example in the stock market, you could look back and I think Google did 20 billion in revenue in 2008 when the last real lengthy recession occurred before this past one. But, you know, the advertising market that year contracted 10%. Google's revenue slowed. It was growing at 50% before the recession. It still grew

Starting point is 00:23:53 through that period, I think their revenue grew 8 or 10% in 2009, which was a significant advertising downturn. And it was just the fact that Google was such a small piece of the advertising pie at that point. They had $21 billion of revenue or something. The advertising market was $400 billion. So they had a 5% share of a big market. And they had a value proposition that was very clear cut. And it was clear that they were going to be much, much bigger. And so, you know, those are businesses that are able to withstand the cyclical nature of the economy. And I think all businesses are cyclical to a certain extent, some more than others. But the other way to think about cyclical businesses or the risk that you're talking about,

Starting point is 00:24:39 the risk of investing in something that's cyclical is to think about how, think about the business itself within that industry. So I'll use homebuilding as an example. most homebuilders, all home builders are cyclical because the nature of real estate is cyclical. And so that implies some sort of risk to a typical home builder because most home builders have an enormous amount of inventory on their books. And what happens in a downturn is home sales slow. Land prices often decline.

Starting point is 00:25:15 And so home builders are left with a huge amount of inventory on their balance sheets that have to be marked down. And a lot of that inventory is financed with debt. And so the balance sheets are often very risky. But within that industry, there's a company called NVR. And I've spoken about this company before. And it's a, it's a stock that my fund owns. But it's a, it's a very cyclical business, just like all the other homebuilders, but with one key difference. And that's that the balance sheet is much lighter. They carry far less inventory than most of the other homebuilders. And so what that means is their inventory turnover is much faster. They have about $1.5 billion in inventory, and they turn that inventory about every two and a half months.

Starting point is 00:25:57 Lenar is the biggest builder in the country. They did about $22 billion in revenue last year. They have $18 billion in inventory, and they turn that inventory about once every year. So NVR's turning its inventory five times faster. Lenard did about 3 billion in profits on 18 billion in inventory and NBR did a billion in profits on 1.5 billion in inventory. So basically what that's telling you is NVR's return on capital is about five times higher. And so it's just a better business is another way of saying it. But it's got a variable cost structure and it's much less risky when the downturn comes.

Starting point is 00:26:36 They tie up their land using options, which is how that's how they're able to do it. they don't put as much capital into the ground. They put it down payment on the, on the land. And if trouble comes, then they're able to walk away and just lose the option premium, just like a call option on a stock. John, just push back. Because I was talking about more like sentiment cycles. I mean, arguably, these guys are positioned extremely poorly for a sentiment cycle. They may be missing, right? Because wouldn't you want to own the like the super operating leverage, maxed out, whoop it on, home, builder versus the nimble low inventory, you know, super 51. Yeah.

Starting point is 00:27:15 Because if you can borrow for negative rates and there's a sentiment cycle, like I would argue, you actually take a huge cycle risk betting against sentiment, the sentiment cycle, by not buying the other one you mentioned. That's the problem. Yeah, exactly. And so the problem for most builders is they can't get away from exactly the situation you're talking about. So it's two things. One is the inflation in land prices that happens over time. So in theory, you're much better off owning land if land prices are appreciating at 2% a year

Starting point is 00:27:49 because the nature of your slow turnover, the one benefit of slow turnover is that land as it's on your books is going to be worth more when it leaves your books than the price that you paid for it a year ago. So that is true. The problem is, and again, this is why builders can't seem to replicate NBR's model. The problem is one of it is incentives. All the builders, if you read the proxy statements, almost all the management teams are incentivized to produce absolute profits. And so the best way to produce absolute profits,

Starting point is 00:28:22 not necessarily return on capital, just make more money. The easiest way to do that, just like Buffett says, the easiest way to make a savings account earn more money is just add more money to the savings account. So builders are incentivized to just go out and buy more land, regardless of the returns that they can generate on that land because they'll know that if they can, even if they earn 15% gross margins instead of 20, they're going to be compensated for that at the end of the year because they can use other people's money, the bank's money, to go out and

Starting point is 00:28:48 buy more land. So it's the inflation aspect of it and the incentive structure makes it very difficult for any other builder to copy NVR. But you're exactly right that NVR is on the losing end of it in an inflationary environment or in a big boom. We're sort of experiencing that right now in housing, which housing is in a boom right now. Part of its COVID-fueled and part of it, I mean, the housing market's been in a bull market for a number of years now. But yes, NBR earns smaller profits relative to what it could if it put the land on its balance sheet.

Starting point is 00:29:21 But the benefit is when the next downturn comes and it's inevitable in housing, NVR is just going to be much safer. They're much better position to survive any sort of downturn. And most of these builders are going to be fine. They're going to survive fine. A lot of the builders have tried to slowly try to work towards a more asset light model. But again, none of them have been able to replicate what NBR has in terms of returns on capital. But they're all trying to go that direction to de-risk their balance sheets.

Starting point is 00:29:52 It's just a slight philosophical difference, right? There's one approach to investing where you say, I'm going to try and maximize the amount of return that I can take per unit of risk that I take. which I think there's only two sort of sensible ways of doing this. I'm going to maximise amount of return I can take per amount of risk that I can take, or I'm going to try to not take any risk at all. And I know that there's no way in the world you're investing in the markets at all, not taking any risk. I'm going to look for situations where there is some returns still available there,

Starting point is 00:30:21 and I'm going to try and only hit on those things. I think John's sort of more in that. He'd just rather not take any of the known risks that if there's a way that you can lose money, it's just not going to do it. You have to be careful because, like we said at the top of this call, you know, knowing what you don't know, there's all kinds of uncertainty out there. But I do believe that when you think about surprises, it just seems in my, this is just an empirical observation. I don't have data on this, but good surprises tend to happen more often to good companies and bad surprises just tend to happen more often to bad companies. And so I'm not in the game of trying to predict these cycles.

Starting point is 00:30:57 I understand that business is cyclical. And so for me, I just kind of, I think Charlie Munger has this quote, you know, sometimes it ties with you, sometimes it's against you. And we just focused on trying to keep swimming forward. And that's kind of my view on it is sometimes the wind's going to be at my back and sometimes it's going to be a headwind. But I'm going to try to focus on investing in companies for the long run that I think, you know, have staying power and that are good businesses that I have a feeling that earning power is going to be higher in five years than it is now, for example. I want to invest in those types of companies. versus the real cyclical companies that have a huge amount of risk and much more volatility to their business. So I tend to avoid those types of companies. It's not that you're not taking risk because all companies have certain amounts of risk and things can change, which goes to my point earlier on you want to invest in companies that are adaptable to change.

Starting point is 00:31:52 Stig and I talked about Facebook once. I mean, that's a company that I think has proven its ability to adapt to changing environments. That's a business that's very difficult to predict 10 years out. It's hard to know what that world is going to look like in 10 years, but the management team, to this point, and this is not guaranteed, you know, there's no guarantee that this will be the case forever, but to this point, I think they've done a good job at shifting and recognizing business risks that they faced as opposed to just putting their head in the sand and ignoring it. I think they've been very genuine about their desire to fix issues. I think they've been

Starting point is 00:32:29 they've had a lot of foresight in risk that their businesses face and maybe it's facing right now and they've adapted to those changes. So that's the other thing to think about is you want to, again, for my style of stock picking, I want to invest in companies that I think can adapt to those changes and can, you know, have some sort of staying power through these cycles that will inevitably occur from time to time. So I think that's a great segue into the third topic here of today, which is all about risk. So, typically, whenever value investors talk about risk, they often refer to Warren Buffett's comments on risk being a permanent loss of capital.

Starting point is 00:33:04 That's one. And the second one would be obtuned to cost of not being invested in the best investment at the time. And Howard Marx makes the obvious but yet profound observation that viewing risk as higher risk implies high return is just wrong by default. I mean, if a return is certain, it's by definition not risky. So kicking back over to you, Toby, how do you define risk? And how is that reflected in your own portfolio and investment strategy?

Starting point is 00:33:30 I subscribe to the buffer definition of risk that you've got. The risk is that you lose such a material amount of money that you can't recover from it. That's the risk of ruin and not so much the volatility on the path to getting there. It didn't answer the last question, but I would have just said the big cycle that has hurt me in particular, where it's partly too by virtue of the fact that he's got some value funds out there. It's just been, this has been an extraordinarily long, bad run for value. And there's, you know, Mikhail Samanov, who runs two centuries, he's got that research that stitches together, three data sets, including the Cal's Commission and the family of the French

Starting point is 00:34:06 data with this other sort of crazy thing where they've gone and looked at annual reports from like 1825 onwards, looking at dividend yields plus Cal's Commission, which was priced a book, plus French data, which is price to book and other things. It's the longest, worst down cycle for value in 200 years. So that's been difficult to sort of invest through, particularly because it would have been so much easier just to go and pick a sexy tech company and let it run. And I can see which ones are like they're very good businesses there. I just think they're very expensive in many instances. And if I didn't care about risk, I was only trying to capture the return.

Starting point is 00:34:42 I'd just go and light up on those things. And I would make me feel good for several years until it gets to the end of the cycle. And then it would feel terrible. and it would be like a betrayal of my own code, so I couldn't possibly do it, but it would take away the pain in the interim. So the risk, that's the way I define risk. Like, I just don't want to get, there's two things. One of them is, I don't want to invest in something I think is massively overvalued because I think that at some point it's going to meet its value. And I also don't want to, I want to follow the rules that I've established because I know that those rules will keep me safe.

Starting point is 00:35:17 So part of it is the sort of intellectual, psychological part. Like I, if, If I keep on following the rules, then I haven't betrayed the code. And at some point, when it comes back, then assuming that it does, if it doesn't, then I won't be on the next one of these next year. It'll be somebody else. I think you bring up a good point, Toby. I mean, you have to be true to yourself, and you probably couldn't sleep at night if you loaded up on those tech companies.

Starting point is 00:35:40 And then there are other investors that probably can't sleep at night if they don't have tech companies in their portfolio. Yeah, that's fair. Right. I'm not talking about Facebook in there, by the way. I don't want to be thought over that to sound like I just came straight on John's heels criticism. Because I think that those big old FAMGy, like the Fang or whatever the current things are like. So, funnily enough, I think they're reasonably, they're not egregious as companies.

Starting point is 00:36:03 Like, I can see how people are buying them here. It's the other stuff in the middle that's not yet proven that has the big hockey stick in the revenue line and then the hockey stick magnified in the price line that are the ones that I'm kind of talking about here. If you're a momo guy, you might be, you might be writing those. you might know where to get off, so it can't be too critical. Yeah, that's a really good point, Toby. And when talking about risk, I would say that personally, with the amount of money printing that we see right now, I found very risky to hold cash, partly due to opportunity costs due to asset classes competing with each other, but also partly due to inflation concerns.

Starting point is 00:36:40 But let me throw it over to US. How do you define risk and how is that reflected in your portfolio? I think Toby did a good job saying that basically, the main risk to any portfolio is really behavioral in some sense, because obviously there's always fundamental risk where if you buy some that has a high chance of cash flow destruction, that's kind of more well understood, I think. But it's this behavioral stuff that kills people. So it's like either FOMO, like you're saying, like, got to have cash, and I should have bought Tesla, and then you may go take an action that, you know, ends up putting it in the wrong place.

Starting point is 00:37:15 And there's chasing returns. And so the solution to that risk, is to form a religion. But the problem with the religion is now you get a lot of conviction. So I'm now of the stance that we should believe in multiple religions and be religious about that because that seems to be the only reasonable solution to solve a behavioral problem. That's kind of my latest stance and theory on the situation. Well said, Wes. You know, I remember once thinking, it's definitely in my religion that I should always have bonds. And to be fair, you would have made a killing in long-term bonds for this cycle. That's not what I'm saying, but I don't know how many good arguments I can find for buying

Starting point is 00:37:57 a 30-year bond, giving me a negative interest rate or whatnot or close to at least here in Europe. John, let me throw it over to you. How do you see risk? Yeah, I think, first of all, I agree with Wes's point. I don't think you can be dogmatic about anything in investing. And so my view on risk is really simple. It's just the risk of losing money is how I think about it. And it's I don't think about volatility. I don't worry about volatility. I define risk as the chance that I make a wrong decision or that you can think about risk in the portfolio or you can think about business risk.

Starting point is 00:38:34 And we talked about, you know, some specific companies that I was talking about before. I think I look at risk when I'm thinking about investments by trying to analyze the risks of change or the risk that the business I'm looking at might suffer some catastrophic change to their future free cash flow. And therefore, the intrinsic value of that asset would be significantly changed. So, yeah, that's how I think about risk. I think most investors would benefit from worrying less about sentiment shifts, less about volatility, less about what's working right now or what's not working right now, and just think

Starting point is 00:39:14 about individual companies and think about the risk to those businesses and just think more, just like Buffett says, I think thinking like a businessman, thinking like a part owner of whatever company that you're going to buy stock in is the best way to think about investing. And then that will lead you to think critically about the business itself, not just the price you're going to pay, but the risk, like I said, the risk to the business, what might cause it, what might cause a change in that business, what other companies could attack this business's competitive advantage if it has one, things like that? I'll just add one thing just because I understand what John's saying explicitly is there is a

Starting point is 00:39:55 risk that the market doesn't agree with you at some level. Like, you need, and fortunately as a value investor, there's an assumption that gravity matters and that fundamentals, you know, wag the market tail. But it could be the case that actually it doesn't. And what drives fundamentals is actually prices. Go talk to some like great, fundamental, amazing business with huge return on capital, with a guy who's been running or gal for 30 years. And his cost capital is going to probably be 10 times more than Tesla.

Starting point is 00:40:26 So you tell me what matters, the momentum or the fundamentals. And it gets confusing when you start really thinking about it, much, which is what I unfortunately have been doing. So I, like I said, I like value with the great religion, but I also like momentum as a great religion too. And I just believe in both of them now. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:43:58 can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. I've spent a little bit of time. Because values work so badly for so long, I've spent a lot of time thinking about what are the drivers of value. And I think that the more I've sort of spent time thinking about it,

Starting point is 00:44:17 the more I think that Buffett is right, that when you buy something, you lock in a return, and you get the yield and you get the underlying growth. And it really then doesn't matter how the market treats it. in the interim. I mean, you got, that's not entirely true. If you're managing money, you've got other considerations, then you've got this sort of asset liability issue where you do have to perform otherwise. You lose your assets. So it's not necessarily applicable to professional investors. This is more for individual investors. You really have locked in the

Starting point is 00:44:45 return that you get in the market. Now, one of the risks to that is that you have a competitor who's not economically rational or who the market treats in a not economically rational way. And so this is a specific Tesla point. Musk's cost of capital is virtually zero. and he's competing with guys who have expensive costs of capital. And so that makes that a different dynamic. But I think that that's an unusual dynamic too. Most of the time what it is is the kind of businesses that you want to find are the ones that us are competitively advantaged, that are going to sort of chug along regardless of what everybody else does.

Starting point is 00:45:18 And then if you buy those and you get the purchase price right, it doesn't matter if they spend the next five years trading at a discount to value. If anything, that's the best thing we can possibly happen to you. if you're right and you're confident that you got the valuation right, you just keep on buying. And then, you know, I know the son of a guy who, and his son is a little bit older than me. So the father who did this buying, he worked in not a particularly well-paying job, but he worked out that there was this brewery in Australia. It was just perpetually cheap and it was a safe investment that was going to be around forever.

Starting point is 00:45:49 He just put all his money at this brewery in there, an incredibly wealthy family by virtue of the fact that they bought one stock and kept on buying it. and it was mostly pretty cheap for most of its life. So it can work, and it's not necessarily, no point did you really get the great stock price performance, if anything, you benefited from the lower prices from the discount. Yeah, because in the end, if you believe intrinsic value, if you believe stock prices correspond to intrinsic value over the long run, then which I believe,

Starting point is 00:46:17 and sometimes that can take quite some time longer than we might like. But over the long run, I do think those two things converge. So the price will meet the intrinsic value. Either intrinsic value will come down to the price or the price will come up to the intrinsic value. If you're truly trying to estimate Tesla's intrinsic value, you would spend a lot of time thinking about how likely it is that Elon Musk's salesmanship is going to continue to allow him to keep that cost of capital long enough to where Tesla can actually start producing free cash flow. And so I think the bearish arguments on Tesla for so long have been, well, that's not going to happen. The business is not profitable. It's going to run out of cash.

Starting point is 00:47:05 They won't be able to access the capital markets in a downturn. And that probably would have been true if that would have happened. If they wouldn't have been able to access cash at certain periods of time, they might not have made it. But they were able to make it. So I think in that case, it's such a unique situation. It's, you know, Thomas Edison in 1880, I think got J.P. Morgan to four. finance his operation. And J.P. Morgan had his house wired, his own primary residence. And the thing burned to the ground, or it didn't burn to the ground, but it started on fire. And he didn't even lose

Starting point is 00:47:36 faith after the electrician came in. I guess the electrician was so, so scared. J.P. Morgan, because he was such an intimidating figure. You know, he stayed up all night the night before he was going to go back and meet with him. And he thought he was going to get fired, lose his job, and who knows what else. And Morgan told him, hey, do it again, rewire it. And so he rewired it and Edison kept his access to Morgan's capital and the rest is history. So it's a different type of investing again, but sometimes you have to factor in those types of reflex, I guess I'll call them reflexive components to the intrinsic value because those can, in fact, influence the future free cash flow generation. But for me, in the end, the value of any asset is the amount of future

Starting point is 00:48:19 cash that it will produce. And that end can be a long time into the future. But at some point, the market will come around to the price. All right, guys, I think it's time to go to the fourth and last point here of today's discussion. And the topic is advice to your younger self. And the three of you all accomplished investors, you paid your dues making, I want to say plenty of mistakes. I don't know if I'm getting ahead of myself whenever I say that.

Starting point is 00:48:45 But most investors with a long track had also made mistakes. And you also calibrated your strategy accordingly. So knowing that, which type of advice? would you give to your younger self when forming your investment strategy? And I was just about to say something goofy about not buying value stocks. And because I said that going into it, I think that Toby should have the first go. Yeah, I think that's a fair. Look, I haven't had any of the success yet.

Starting point is 00:49:10 So I don't really feel like I can go back and say, give that younger self some advice. The advice that I would give to my younger self is figure out how to value growth properly. And then I think you'll do a little bit better rather than being so wedded to value. I think that the mistake that I have made has been trying to not pay for growth, trying to get growth for free. But I think that there are instances where being better able to value growth would have led to better returns and probably does work out for the best over the very long run. So I think that that would be the advice that I would give to my younger self. And actually, I'm going to try to take that advice as my youngest self now, because hopefully I've still got another several four or five decades left on the planet. I can still correct that error.

Starting point is 00:49:50 Yeah, I was kind of echo Toby's point. I have a note here, if I was going to give advice to my younger self, I would just say experiment heavily in hopes that you have a wide bell curve outcomes, and mainly so you can get humility and stop being so conviction-oriented in your decision-making. Because it seems to me like overconfidence is the number one driver of great results, but more often not results that you didn't understand why you got them. John. I guess for me, yeah, trying to focus on getting, kind of focus on getting.

Starting point is 00:50:22 better every day. So trying to learn something new every day has been some of the best advice that I've received over the years. And so that's something that I'm not just telling my younger self. I'm trying to do that now, always trying to improve at this game and always trying to be open-minded. I think investing, and this goes to West's point West made a few minutes ago, but not being dogmatic about something. I don't think you can clone another investor. I don't think You can be, like I said before, you know, no one's going to be Warren Buffett. You can't be Peter Lynch. Every investor has their own unique set of understanding their own lens through which they view the world.

Starting point is 00:51:02 And I think just the way we're wired as humans, we're going to all view things slightly differently. And so we're all going to be, we're all going to have to find our own way in business or in life in general, but certainly in investing. There's no one way to skin the cat. And so I think that's really helpful to keep in mind is to be open-minded and to be willing to learn new things and to not get, you know, not sort of get stuck or to be dogmatic about certain things when it comes to investing. Because I think there's a lot of that, for some reason, there's a lot of that in the investing world. And then for me, I think that the most critical thing that I've learned, and again, this is, I still consider this to be quite early, hopefully in my career, just like. like Toby said, hopefully there's a long runway ahead for all of us. But I think my empirical observation has been that the best investments in the stock market over time come from the best

Starting point is 00:52:00 companies. And so if you're trying to be a long-term investor, if you're truly thinking of yourself as a part owner in a business, you want to own quality businesses that can compound value over the long run, especially when you factor in things like taxes and other frictional costs that go along with turnover. If you're a long-term investor, you want to own good companies. I had an intern this summer who put together a list of the top performing stocks over the last 15 years. And I chose 2005 because I wanted to see sort of the middle of the last cycle. You see a lot of things like what's the best performing stocks in this bull market. And that will, as we were talking about earlier, that's going to catch a lot of these survivors that just didn't barely hung on, did not go bankrupt,

Starting point is 00:52:43 but survived. And you're going to see a bunch of those types of winners if you start in 2009 or 2010. But in 2005, it's sort of like the middle of the last cycle. And when you look at that list of the top 100 performers, they're all really high quality companies that have, you know, survived over now two different recessionary periods. And so if you're a long-term investor, if you're thinking of sort of the coffee can approach to investing, which is sort of how I think about investing, then you want to own quality companies. And so my mistakes have always come from when I've, when I purchased a stock that looked very cheap on the surface, but in reality, you know, it might have been 10 times earnings, but it might have only been worth seven times earnings.

Starting point is 00:53:24 So I've made that mistake numerous times. And conversely, some of the some of the best investments I've made, and this is something that is not just 2020, 2020 is sort of in vogue when it comes to this because there's so much momentum, but where I was very convicted on the business, but other investors questioned, I guess, the valuation at that time. And so some of those investments have turned out to work very well. And so I think a business is not worth what it earned last year. It's what it's going to earn over the course of the life of that business.

Starting point is 00:53:56 And so I think that's something to keep in mind as well. So just buy good businesses. Obviously, you have to pay a price that is discounted in order to achieve alpha in the stock market. But I think focusing on quality companies is, in my experience, the better approach. I think far more investment mistakes are made from picking the wrong business than paying too much for a great business. And you can make mistakes in both those categories, but I think the more catastrophic mistakes are from selecting the wrong business.

Starting point is 00:54:26 Yeah, that's definitely true. I mean, if I could give advice to a younger self, it would be listen more to Toby. I always take up the two examples of buying GameStop and BethBeth. Beyond, we have that on record, and both times Toby said, don't do it and hear all the reasons why, and both times I didn't listen. And look what happened. Did they work out? Didn't they work really well?

Starting point is 00:54:45 No, they really didn't. I definitely called it at the wrong time. So we had you on there with Jesse Felder and he made a fortune in Beth Bath Beyond because he's much smarter than me. So I bought it on the way down. Apparently I misunderstood Wes's this momentum strategy. So I bought it on the way down. Jesse bought it on the way up, lo and behold.

Starting point is 00:55:03 So he absolutely made a killing in that. So I just wanted to say that. If I can give my two sense to really a younger self and not just a few years, I'm just a few years back and, you know, listen to Toby, if I could give myself another advice, it would probably be to. Buffett said that he bought his first target date to 11, and then, you know, up to that age, he's just wasting his time. I kind of like that quote, because, you know, Buffett talks about being a learning machine, and that's definitely something that I haven't practiced. Definitely not since 11, that's for sure. But I always understood the intention of, you know, compound interest and, you know,

Starting point is 00:55:38 why we need to accumulate capital investing that. But I never really understood, because, you know, concept of compounding knowledge before I got into my middle or late 20s. And I think that's one of the things I would like to change. And the other thing, this is just something I'd like to convey to our listeners too, is really to read more. I think one of the mistakes that I've made as an investor is, you know, I speak to people and they're smart people. They're not necessarily as smart as you. But whenever you primarily speak to people, especially if you're not too selective, they tell you things you already know or they talk to you about things you're not interested in or you don't understand, they're speaking too fast, they're speaking too slow.

Starting point is 00:56:12 Reading is just, you get it in just the right tempo, and you get just what you're interested in, and it's a lifetime of knowledge put into 200 pages or whatnot. That I haven't done that before is just, I don't know, I definitely wasted my time until then. Guys, it's been unbelievable talking to you about, you know, not just these topics, but really having the chance to have the conversation going any type of direction that we want. Before we let you go, we would definitely like to give you the opportunity to, tell the audience where they can learn more about you and your companies. Wes comes out with you?

Starting point is 00:56:47 Alpharchitect.com. It just follow the blog and you can hit us on Twitter as well at AlphArchitect. John? Yeah, my firm is called Sabre Capital and you can find the website at sabercapitalmgatcom. And I have a lot of the archives up there, publish a number of blog posts. And so you can follow me there and you can find me on Twitter as well. Toby? Yeah, I've got a question.

Starting point is 00:57:12 Acquireasfunds.com, Acquireasmultable.com. We've got the interview. John is up at the moment because it's one of the most popular podcasts of the year. All that name recognition he got from the... How is that? How did that happen? Nice word, John. That's the best way to get in contact with me.

Starting point is 00:57:31 Or through Twitter, I'm greenbacked. It's a funny spelling. G-R-E-N-B-A-C-K-D. I spent too much time there. Amazing. Guys, thank you so much for taking time out of your business schedule to join the Investors podcast yesterday. I really hope we can do it again.

Starting point is 00:57:46 Thank you so much. That was fun. Thanks, Dave. All right, that was all that I had for you for this week's episode of The Amasters Podcast. Trey and I will be back next weekend with her interview with Lawrence Cunningham. Thank you for listening to TIP. To access our show notes, courses or forums,

Starting point is 00:58:03 go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP329: Value Investing - w/ John Huber, Tobias Carlisle, and Wes Gray (Business Podcast)

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