We Study Billionaires - The Investor’s Podcast Network - TIP440: Beating the S&P500 since 2004 w/ Bryan Lawrence

Starting point is 00:00:00 You're listening to TIP. On today's show, I invited Brian Lawrence to join us. His company, Oak Cliff Capital, has outperformed the S&P 500 since its inception on June 1st, 2004. By December 31st, 2021, the S&P 500 had returned 392% compared to Oakcliffe Capital returning 718% after fees. So, without further ado, sit back and learn from Brian Lawrence, one of the very best at the game of stock and men. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:00:42 We keep you informed and prepared for the unexpected. Welcome to The Amsters Podcast. I'm your host, Dick Broderson, and I'm here with Brian Lawrence from Oak Cliff Cavettel. Brian, thank you so much for making time for us. Big. Thanks for having me. So, Brian, preparing for this interview, it has been a pleasure reading your letters to your shareholders. And the first that I have here is from November 30th, 2004. And it outlines your investment thesis and the five questions you want to answer before moving

Starting point is 00:01:21 from cash into an equity position. Could you please go through your process with the audience? You're happy to do that, Stig. Just before I do, I'd just like to say how much respect I have for what you and your colleagues are doing with the investors' podcast. It's really bringing a lot of good information and education to lots of people doing this important business of investing. I just commend you for it. So O'Cliff's strategy is to invest in great businesses at attractive valuations.

Starting point is 00:01:50 And how do we find those investments? We're asking ourselves five questions about each business that we look at. First question is, do we understand this business? Is it within our circle of competence? Is it a business that management makes understandable? Sometimes, management don't make their business understandable, and that's kind of a red flag for us, makes the business uninvestable. A second question is, is it a great business? And we define a great business as one that has durable cash flows. And there are examples of things that indicate that cash flows might be durable. One is, does the

Starting point is 00:02:31 business provide more value to customers than what the business is charging those customers. And an example of that is a company that we own called Guidewire that provides software without which an insurance company like an Allstate, without this software, they can't function. Guidewire software does all the policy, claims, and billing activities for the insurer and charges just 0.5% of revenues of the insurer's revenues in order to provide all that functionality. Without that 0.5%, the insurer literally cannot function. That's an example of cash flows that are durable because they're so important to the customers. A second factor is, is the business operating in an industry structure that is favorable? And examples of favorable

Starting point is 00:03:19 industry structures could be, is this a low-cost provider? So an example of that, company we own, called Interactive Brokers, allows its customers to trade stocks for a price of just one basis point, which, as best we can tell, is about a third of the cost that competitors are charging. And yet, despite charging one-third the cost, Interactive Brokers is enjoying profit margins of 60% because they've automated their operations in a way that Goldman Sachs finds a very difficult to compete with. Another favorable industry structure is either a natural monopoly or a duopoly, an example, cable networks providing us all with our internet service, have to run cable past millions of homes. And the cost of doing that means that in most markets, you find that there's

Starting point is 00:04:14 maybe one provider doing it or at most two providers doing it. And those are very interesting industries to study and invest in. And a final factor is if there are attractive cash flows in an industry, we love to see it when smart, well-resourced competitors have tried to enter but have failed. And an example would be Google attempted to enter the cable business with a big offering of fiber to compete with the cable companies. And despite all of their money, all of their intelligence, all of their resources, they failed. Walmart attempted to enter the used car business, and despite all of their money and all of their intelligence, they failed. When we see a smart, well-resourced competitor entering a business and failing, we grow very interested in want to

Starting point is 00:05:04 study that business more. So in addition to those first two questions, there are three others. Is the management team aligned with us? Are they going to treat us like we would like to be treated? Is there a valuation that is cheap relative to the cash flows? We see the business producing for shareholders. And importantly, is there a misconception in the business that is temporary and that therefore this valuation, this cheap valuation will turn into a more attractive valuation later? So in order to invest in something, we need a good answer for all five of these questions. Do we understand the business? Is it a great business? Does it have management aligned with us to shareholders? Is it cheap? And is there a temporary misconception

Starting point is 00:05:48 making it cheap. Well, it sounds like a tall order, Brian, but that's also why Buffett is talking about you're hitting within your strike zones. Like, you can just wait. You don't have to swing. But perhaps, Brian, we could illustrate your process with a case study. I know the charter has been one of your larger investments. How did you develop your conviction to invest in child in the first place? Yes, we've owned charter for several years, and it's a good example of a great business. You may know Charter as a provider of internet services under the spectrum brand name in the United States. Their network of cable connections passes 55 million U.S. homes and small businesses, and it provides Internet under the Spectrum brand to about 30 million of those homes and small businesses.

Starting point is 00:06:34 And there are two reasons really why Charter is a great business. First, people complain about their cable bill. Pretty easy to get them to do that. But the price that people are charged by a cable provider like Charter is way less than the utility that that cable provider is delivering them. And what do I mean by that? Charter delivers every month to an average household 700 gigabytes of downloaded data. And when you look at what that means, if you define it in its most data-dense form, that's a bit more than 100 hours a month of streaming 4K movies. to a big television.

Starting point is 00:07:15 If you defined it as data streamed to a smaller screen, someone watching YouTube on a tablet or something, it's a lot more than 100 hours a month. But if you just take the most data-dense form, the $65 a month price of a charter internet subscription works out to about 60 cents an hour for that streaming video. And I just questioned someone complaining about their cable bill. What other form of entertainment is cheaper than 60 cents an hour?

Starting point is 00:07:44 hour. And are you really going to turn off your internet, given how dependent we all have become on it? I think it's delivering a ton of value, despite the apparently high price. Second reason, Charter is a great business. It operates in a very favorable industry structure. So in order to get high-speed internet, in order to get those 700 gigabytes of data a month, 35% of Charter's customers have a choice, effectively of a duopoly, either Charter or a fiber provider like Verizon. And the rest of Charter's customers in the 65%, the rest of their markets, have a single choice to get high-speed internet charter. And they can, in those 65% of markets, also get internet over DSL connections, which are the old twisted copper pair wires that used

Starting point is 00:08:33 to bring us our telephone connections, or from satellite service, from geosynchronous satellites in orbit, both of those, DSL and satellite, have physical limitations we could get into, which mean they really can't provide, they don't have the physical ability to provide that 700 gigabytes a month at high enough speeds to allow all of the streaming that people need and want today. And so DSL and satellite are slowly losing market share at a charter as people realize this. They especially began to realize this in the pandemic when everyone moved home and needed to work from home. So Charter is a mix of a duopoly in 35% of its footprint and an emerging monopoly in 65% of its footprint. And so Charter is a great business, two great reasons why it is,

Starting point is 00:09:19 but that's not enough for us to figure out. We also have to be able to buy it cheaply. And that requires investors to have a misconception. Now, a misconception happened four years ago. AT&T and Verizon started talking up the idea of 5G to get us all to buy new cell phones. And a big selling point of their marketing pitch was that you could use 5G to replace internet provided over cable. You didn't need that cable connection anymore. And with all of this talk about 5G making cable unnecessary, investors worried that charter's profits would be impacted.

Starting point is 00:09:55 And so, charter's share price fell. We saw charter share price fall, and we did a lot of work on the physics and economics of internet delivered by a cellular network rather than by a cable network. And it turns out that delivering a byte of data across a cellular network is 70 times as expensive as delivering it across a cable network. And how do we know that? We know that the average Verizon or AT&T cellular customer is downloading about 10 gigabytes a month, which is 70 times less than the 700 gigabytes being downloaded by a cable customer.

Starting point is 00:10:34 But your cellular subscription costs about the same per month as your cable subscription, same price, but 70 times less data. And this fact is why people so quickly ask for the Wi-Fi password when they show up to someone's house for the first time or you check into a hotel. People immediately, very quickly, ask for the Wi-Fi password. And it's a good thing that they do ask for that Wi-Fi password. Without Wi-Fi connected to the cable network, AT&T and Verizon would be quickly overwhelmed by demand 70 times what they're currently experiencing.

Starting point is 00:11:11 No one would be able to make a phone call. So once we figured out that Verizon and AT&T were in marketing mode and that the physics and economics of cellular internet were unattractive relative to the physics and economics of cable internet, we bought a lot of charter stock. And we have done well as investors realized over time about the physics and the economics and charter share price recovered. So, Brian, I can't help but look up how is charter performed. And you picked it up at a very good time. At the same time, we can also see that the share price has declined from, say, 30%ish from the high in August last year. What are your thoughts on the business now and the stock

Starting point is 00:11:51 price performance. A really interesting point because I think there's another misconception today that's depressing at share price that make it arguably as attractive today as it was four years ago. Over the past year, there have been lots of announcements from AT&T and Verizon and other smaller players that they will be building out more fiber, wired, fiber internet connections to American homes. And if you add up the announcements from all of these players, the 35% of Charter's footprint that currently has fiber as an alternative, by five years for now or seven years for now, might be 75%. If you just take all the press releases and you add up a fiber that's going to be built, and investors, once again, are worried about charter's profits decreasing as it faces more

Starting point is 00:12:34 competition. So we've done a lot of work to understand the physics and economics of a fiber network. And the first point is there's no effective difference. If you're a cable internet subscriber or a fiber internet subscriber, you're going to get the same amount of broadband. But running fiber past homes is very expensive. Thousands of dollars of upfront investment to connect each new customer. The fiber guys are going to have to spend. And we've looked at a lot of the fiber business plants. Some of them are public, some of them are private.

Starting point is 00:13:05 We've looked at a lot of them. Every plan that we see needs $75 a month of revenue to earn an acceptable return on that investment compared to the $65 that charter is charging. And many of the plans justify their investment in their pitches to investors to raise all the capital to build all of these connections, many of the plans say not $75 a month, but $90 or even $100 a month. So what we think is if a market moves from being a monopoly to a duopoly where the new player is charging $90 a month, we don't see any reason why Charter can't raise its price

Starting point is 00:13:39 to $90 a month if that's what in fact happens. And if Charter charges $90 a month rather than $65 and it splits its footprint 50-50 with fiber, everywhere there is a fiber player, the math that we do, at least, suggests that charters cash flows as a result of this new competition will actually increase because $90 a month is a lot more than $65 a month when you have a network whose costs are largely fixed. So what investors worrying about charter's profits going forward are missing is that the fiber guys are going to have to charge more than charter $65 a month in order to actually make this, all these press releases turn into investments with acceptable returns, and that the bear case on

Starting point is 00:14:22 charter used to be, as it's 65% of its markets, became monopolies, that ultimately there would be regulation to control its pricing. But if you have a duopoly, I think regulation is much less likely. A duopoly is much better than monopoly if it's rational, less risk of a regulator imposing price controls. So it looks like a rational duopoly emerging between cable and fiber. And as icing on the cake, Stig, because Charter can deliver bytes of data 70 times cheaper than the cellular guys, it's entered the cellular business. And it's bundling cellular plans with its internet plans for one half the price. They're using the Wi-Fi routers attached to the network, either your own or your neighbors or the one at work to allow you to, for half the price, have a cell service,

Starting point is 00:15:05 just take your existing cell phone into a spectrum store. It looks to us that Charter will disrupt the cellular business with its more efficient network. So far, three and a half million of people have signed up for the service. We think about 100 million people are within Charter's footprint. Those 55 million poems probably have 100 million people plus living in them. So maybe it's three, three and a half percent share. We think it might go to 50 percent share. 15, 20 years ago, they did something with landlines. We all used to have like a phone from AT&T. 50 percent of American phones are now through the cable network and you don't pay $70 a month for it anymore. You pay $15 a month. So we're not putting any value on this happening,

Starting point is 00:15:41 but we're watching it closely. So with Charter today, we have a great business that we understand we have an attractive valuation. It's trading in an 8% free cash yield on 2022's results, which is pretty attractive with the 10-year treasury at about 2%. That free cash is likely to grow 10% a year as the network grows and as they raise prices. We have an aligned management team buying back lots of stock, what is cheap. And we think that there's a temporary misconception making it cheap. And so I'm glad you asked that question because I think Charter for a second time in four years is afflicted by misconception that we think is temporary. How do you generate your investment ideas? Well, we read a lot and we talk to other investors and as a result of the

Starting point is 00:16:21 reading and as a result of the looking at what other investors are doing and we find about 100 businesses a year that we go into in some detail. And what we're doing when we're reviewing those 100 businesses is we're trying to find great businesses that we can focus on. And why focus on great businesses? As I mentioned before, we define a great business as one that has durable cash flows. And there are two advantages, two fundamental advantages from investing in a great business. It's like that joke, you know, it's just as easy to fall in love with a rich woman, right? You know, why not fall in love with a durable business? Here are the two reasons why. The first one is if you invest in a durable business, it's likely that its cash flows

Starting point is 00:16:59 will not only persist, but if you've chosen right, they'll increase. And that allows you to hold the business for a long period of time, which from a taxable perspective is very attractive. If you hold a business for longer than a year, you get long-term capital gains. If you hold a business for way longer than a year, we have a couple of businesses, two businesses at Oak Cliff we've held for 10 years, then you never realize capital gains tax. The second reason durable cash flows are great is that durable cash flows are more predictable. And the predictability of cash flows is a big advantage to a stock picker because they make valuing those cash flows more certain. And having certainty about valuation is a big advantage given how volatile share prices are.

Starting point is 00:17:39 How volatile are share prices. This has amazed me since I started the business. When I started Oak Cliff in 2004, I was lucky enough to find myself in a room with Warren Buffett and two dozen other aspiring stock pickers. And we were very happy to ask him lots of questions, which pretty much all boiled down to how do we get to be like you, but faster. And he very nicely broke to us the bad news that stock picking was a long game. But he said, I do have a piece of good news for you. The average stock goes up and down by 80% in a year. And that's an enormous advantage. And that's an enormous advantage if you actually take the time to understand the underlying business because stock price is not reflecting the underlying value if it's going up and down by 80%. I said to myself,

Starting point is 00:18:17 80% in a year, he's got to be out of his mind. He's Warren Buffett, but he's lost his mind. I went back to New York and I did the calculations he was suggesting, which was to compare 52-week high to 52-week low for every stock in the stock market and compare the percentage difference between those two things. And when I did the calculations, maybe not surprisingly, because he is the sage of Omaha, he was right. You can use Bloomberg and a computer to crunch these numbers for the thousands of companies. It's about 4,000 companies in the U.S. stock market going back 20 years. And if you do it, we do it about once a year. The answer is as astonishing now as it was in 2004 when I started. During a calm year, like 2019, the average U.S. stock price goes up and down by 50%,

Starting point is 00:19:01 50%. And in a crisis year, like the dot com crash we had in 2000 or the 0809 financial crisis or the pandemic we just had in 2020 by up to 200%. Buffett, by saying 80% was basically averaging a comm and a comm year is also a median. In a median year, in a median year where it's 50%, you'll have many stocks that are bouncing up and down by 80%. There's no way that the intrinsic value of the average business is going up and down by so much each year. And this is a big, advantage for a stockmaker who's done the work. So what we spend all our time doing at Oak Cliff is working to understand great businesses. We own 11 right now. There's several dozen others we'd like to own. And we wait for their volatile share prices to give us an opportunity to buy at low prices.

Starting point is 00:19:47 If you stopped by our offices, if you went out, it looks like a library. It's like watching paint dry, a lot of reading going on, a lot of cross-checking. But we move very quickly, very quickly when we see a cheap price for a great business that we've done the work to understand. It happens infrequently, sometimes once a year, but we don't need it to happen often to do very well. It's interesting that whenever I ask this question, the first thing you said was, well, we read a lot. And I do hear that from very successful investors like yourself, that that is where a lot of the ideas generation come from. How about meeting up with fellow investors at Berkshire or Value X in Switzerland? is that a generator of ideas for you?

Starting point is 00:20:29 You never know where the next idea is going to come from. Some of our better ideas have come from people who have already done the work and we're able to hear what they have to say and then go back and replicate the work ourselves. That can be a big help. One thing that I will say is that the number of people in the market who are really digging into the businesses, who really are immersing is lower than you would think it would be. So what we find is that the number of people who we, you know, my partner, John and I are happy to talk to about ideas, it might be a dozen people who have really done the work.

Starting point is 00:21:03 But those people, when they call or when they come by, we're very happy to talk to them. So going back to your next step in your investment process, that is to do what you call deep research, where you review a 10 to 15 ideas annually. And this is a very interesting step as it gives you the conviction in case you decide to build a position eventually, given that the price obviously is in a good place. And you conduct a series of interviews throughout this step. Could you please elaborate on that and perhaps take us to the final step in your process? We look and we look, maybe it's 100 companies who go into in some detail. About a dozen

Starting point is 00:21:41 times a year, we find something that really seems promising. And when we find that, then we do something we call turning on the afterburners. We really accelerate. our effort to try to understand it. And it kicks off a process that I've never worked as a journalist, but I know a couple pretty well. It feels like investigative journalism. Like you immerse yourself in it. Your objective is to become best informed investor in the public markets about this particular business. And what that means is you read as much as you can about the company. It's public filings and news stories going back many years. You read what management has said in its publicly filed financial statements, what they've said on earnings calls,

Starting point is 00:22:27 what they've said conferences, and you read that for years of history, and you compare what management said was happening and was likely to happen to what actually happened. And what you're trying to gauge there is management's own grasp on their business, management's own relationship to conservatism or, you know, maybe overpromising. You want someone who's like underpromising and over delivering. And you do dozens of calls with customers, competitors, suppliers, ex-employees. And after about a month of doing all of this, we say, okay, let's try to put ourselves in management shoes. What are the good things about the business? What are the challenges facing the business? And then we approach management. We try to get as high up in the company as we can. Often,

Starting point is 00:23:12 quite often we're able to get to the CEO. And we say, look, this is what we think is happening with the business, we're a long-term investor, what are we getting wrong? Management's usually like at that step. They like that we've taken the time to understand. A lot of investors have not, and we find that those conversations with management are really informative for us. If management doesn't like talking to us, that's kind of a bad sign, which probably leads to an uninvestable outcome. But anyway, after that, if the thesis is still holding water, if we've shot as many bullets at it as we can shoot, exposed it to as much pessimism and conservatism as we can. If the thesis still holds water, if we think we have a good answer to all five of our questions,

Starting point is 00:23:52 then we project what we think is going to happen to the business operationally and financially out for the next five or ten years. And we boil that down to what is going to happen to us, the shareholders, in terms of cash flow per share, and we discount those cash flows per share back to us here at today's share price. And if the expected rate of return, if the IR, as a result of all that work, is in excess of 20%, then we're likely to buy stock. But when we buy stock, that's like a signpost in the journey. The journey's not over, especially once we own stock. We've got to keep learning. We've got to keep cross-checking. When we find something new, we've got to call up management and ask them. And what we're doing as we own the stock,

Starting point is 00:24:34 and we're going to learn more about it as we own it, is we're comparing the operating performance that we're seeing to what we projected at the time we did that initial immersion. Are the surprises good ones or bad ones? There's surprises in life, but is this a good surprise company or a bad surprise company? Have we made an analytical mistake? Is the business getting better or getting worse? And our IRA will move as we adjust those assumptions. As our assumptions increase the cash flows per share that we're expecting, our IRA will go up.

Starting point is 00:25:04 As our change in assumptions decreases the cash flow per share, our IRA will go down. And of course, the share price moving will move the IRA as well. As the share price goes up, the IRA will go up. the IRA will go down as the share price goes down, the IRA will go up. And if we get a big change in IRA, we're likely to adjust the position. If it goes up, we'll add, and if it goes down, we'll subtract. And if we conclude that we've made a mistake, if we conclude management's not credible or is misled us, if we conclude we got something really wrong, then we move very quickly to

Starting point is 00:25:35 exit. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Austin. at the height of the summer. You 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. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders

Starting point is 00:26:07 from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage talks, hands-on workshops on freedom tech, and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June.

Starting point is 00:26:55 If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference, it's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move.

Starting point is 00:27:30 With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of your choice to connect directly to your real business data.

Starting point is 00:28:04 This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, domesticifying AI at netsuite.com slash study. The guide is free to you at netsuite.com slash study. NetSuite.com slash study.

Starting point is 00:28:29 When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just getting started to household names.

Starting point is 00:28:59 It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance her product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB.

Starting point is 00:29:45 All right. Back to the show. I just want to clarify to the listeners and yours out there if you're watching this on YouTube that whenever Brian is talking about IRR, which was mentioned a few times, that's the internal rate of return or can be perceived as you expect a return on this investment whenever you make the discounting. So O'Cliffe's net return to clients have underperformed the SNP 500, 8 out of 18 years and yet your returns to clients are performed the SNP 500 over time. And I just wanted

Starting point is 00:30:13 to mention some of those numbers. I also said it in the introduction before we kicked off this interview, Brian, but I just can't help but mention because you're too polite for you to say yourself. But the SNP 500 since exception of Oakcliffe Capital was 494.2% for the SNP 500. And net of fees is 718.3%. So, I mean, this is just an amazing track record. So Bravo, you have manage that impressive track record and the same time you underperform the SP 500, 8 out of 18. Yes. I'm curious to hear your thoughts on that. Well, thank you, Stig.

Starting point is 00:30:49 But we have had periods of underperformance, and those periods of underperformance have lasted for a year or more. This is not surprising. Warren Buffett gave a speech in 1984 about the superinvestors of Graham and Dodsville, which I would encourage your listeners to go find on the internet if they haven't already. just Google super investors of Graham and Dodsville and read Buffett's speech and then the response by a professor at Columbia Business School where he gave the speech. And there are a couple of really interesting conclusions that can be drawn from that speech that basically every concentrated

Starting point is 00:31:24 value investor will underperform, underperform the market on an annual basis 30 to 40 percent of the time. It just, it jumps out of the data. And this is data as of 1984, but, you know, You can carry this data forward and you'll find it to be true. I think it's an iron rule of underperformance. Joel Greenblatt talks about it. Warren Buffett talks about it. So here's some data, which is just fascinating. If you look at Berkshire Hathaway itself, okay, which is run by the patron saint himself,

Starting point is 00:31:52 Warren Buffett, Warren has controlled Berkshire Hathaway for 57 years now, going back to 1965. And Berkshire Hathaway has underperformed the S&P 18 of those 57 years or 32% of the time. There's that iron rule, you know, 30 to 40 percent. And you could say, oh, is that a function of the fact that he's managing more and more money, making it more and more difficult for himself? And the answer would be no, because if you look at the first 25 years that he controlled Berkshire Hathaway, you know, 1965 to 1990, he underperformed nine of those 25 years or 36 percent of the time. So I think this is a reason why concentrated value investing, while it delivers

Starting point is 00:32:36 great long-term results if it's being done by people who actually have the ability and the temperament to handle it, why a lot of people kind of lose faith of it, because you will find every practitioner of it having these periods of underperformance. Brian, what do you think your competitive edge is as an investor? It's a really good question. I think if it's important for an investor to know what his or her edge is, if you don't know what your edge is. You're kind of like the guy at the poker table who does not know who the Patsy is. And I think there are three sources of competitive edge. One is analytical.

Starting point is 00:33:18 One is informational and the last one is structural. Analytical, basically, can you analyze companies better, more smartly than other people? I don't think that's a source of edge for us at least. I mean, I think we're smart, but I don't want to claim that we're smarter than there are a lot of smart people in the market.

Starting point is 00:33:41 Informational edge, I think we have a little bit of an informational edge because we have a strategy that concentrates into a small number of companies, we can, by just dint of spending more time on each business, get more informed than other investors.

Starting point is 00:33:59 If we own 11 things and we're competing with a mutual fund manager owns 185 things, we're just going to, by dint of being able to spend 10 times as much, more than 10 times as much time on each one, we're going to glean more information. So I think we do have something of an informational edge. I think our main edge is structural. What we have is patient capital. And patient capital allows us to have a long-term time horizon. And what do I mean by patient capital? We have deliberately structured our firm to make our capital, very patient. Twenty-two percent of our money is ours, meaning the people on this floor

Starting point is 00:34:38 who are making the decisions, and we have a lot of confidence in our work because it's our work. The 78 percent that is not our money, that's our client's money, we have been very intentional about saying to them, this is a long-term game. You should expect periods of underperformance. If we send you a letter showing disappointing returns, either in absolute terms or relative to the market, that's just part of the game. An investor with impatient capital might not want to own charter for fear of more news stories next month about people building more fiber. They call that headline risk.

Starting point is 00:35:14 It might drive the price of charter down as people worry about more of these news releases from the fiber overbuilders. Those news stories might drive charter's price down and the investor with impatient capital would have to explain his poor short-term performance to his impatient clients. It might cause some of them to pull their money. We, on the other hand, because we're confident in our patient capital, might take the opportunity that Charter is presenting us with the lower share price to actually buy more because we have confidence in the physics and economics that we've studied. Physics and economics may take longer to emerge than a bunch of PR from fiber overbuilders trying to raise capital. And so having patient capital is a way to ride through that.

Starting point is 00:35:52 There is much less competition waiting for the laws of economics and physics to be revealed over the long term than there is. competing with investors worrying about next month's news stories. A lot of firms claim to have a long-term focus, but they don't have the patient capital that actually allows it. But a consequence of betting on these things where we think there's short-term uncertainty and maybe share price softness and long-term share price strength is that we're likely to have periods of underperformance in the short term. I think this paradox that underperformance, you know, a bunch of the time,

Starting point is 00:36:30 is the way that you get outperformance over the long term is why an estimate I've seen, just 1% of money, 1% of money invested in the stock market is invested using concentrated value. And when you tumble through those numbers, the funny thing is 40% of that 1% is invested by Warren Buffett. I find the fact that this demonstrably superior strategy is rejected by 99% of people, despite the fact that there's so much evidence, because it isn't just Buffett. it's lots of others, whether it's Bill Miller, Eddie Lampert, or the Tishes, or Bill Ackman, you know, concentration makes a lot of sense, except for it creates some underperformance

Starting point is 00:37:09 issues that people don't want to, don't want to deal with. Shifting gears here, one thing I'm struggling with is to reduce my position once I build a full position, and to me that's 10%. And here I don't refer to not being able to hold on to the position if it's suddenly 20% or even 30%, but rather than... I tend to believe in a stock or I don't. So if the stock is near intrinsic value, I will consider selling a position. In other words, I'm naturally biased to a quite binary approach, if you like. And I'm not the person who would limit my exposure from, say, 8%. Now I have wanted to lower it

Starting point is 00:37:50 5% because let's say I still believe in the stock, but I have a lower conviction. It's to me as, if I don't have full conviction, I should be out of the stock. I'm curious to hear how you think about producing your exposure. It's decision-making with, you know, in uncertainty, right? So you think about your position size relative to the IRA, the expected return. And there's no one right answer. I guess I have a couple thoughts on it. First one, let's say you do all this work and you get conviction and you make something

Starting point is 00:38:22 a 10% position, which would be for us a very full position, a lot of conviction. and we've got an expected IRA of 20%, and we're very happy that we've made this investment. And then we're even happier because the share price goes up by 80%. And let's say that nothing's changed about our underlying assumptions. The cash flows that we expect are still the same. We now have not a 10% position with an expected IRA of 20%. We now have an 18% position with an expected IRA of 10%.

Starting point is 00:38:52 You know, there's a Julian Robertson used to say, Every day you don't sell a stock is another day you decide to buy it. So you have to ask yourself, if you did all that work and you saw a 10% IRA as your expected result, would you make it an 18% position? And the answer is, of course, you wouldn't. You might make it a 4% position, right? And so there'd be a lot of pressure, I think, barring some other factor, which I'm not quite sure. Maybe you're going to learn something more about the business. But I think if something goes up that much and has no underlying change in what you expect,

Starting point is 00:39:29 it will do for you in terms of cash flow, there's going to be enormous pressure to sell it. I think the second thought is that position size also has a psychological impact. And what do I mean by that? Let's say you have a position, you do a ton of work, and you make it a 10% position, and you've got confidence it's going to give you this great 20% return. And it goes up. You now have a dangerous situation psychologically, unless you're thoughtful about it, because when an idea has made you money after doing hard work, there's a number of psychological biases

Starting point is 00:40:03 that come into place that will make you like that idea more. It's very easy and quite dangerous to fall in love with a successful idea, especially because every day that you don't sell a stock is another day you're agreeing to buy it. It's very important in the investment business when you're investing with uncertainty and you're constantly trying to add to your information base to always be looking for for disconfirming evidence. That's the most important type of evidence there is. Very important to figure out why you might be wrong.

Starting point is 00:40:30 Come to work each day with a healthy dose of skepticism about what you believe deeply. It's harder to do this. It's harder to accept disconfirming evidence when something has made you a lot of money. There's this saying that the human mind is a lot like the human egg. Once impregnated with an idea, it's hard to get another idea in. And I think that's particularly true when it's been impregnated by an idea that's worked. It's so great to look at that name in your portfolio and think about all the happiness that it's brought you.

Starting point is 00:40:57 Charlie Munger's got this expression, a successful day for him is one in which he's learned something new, but a super successful day is one in which he's unlearned something dear to him. So I think the psychology of an increased position is such, you should subject it to extra scrutiny. And of course, there's the counter that if it's been a good surprise company and they're presenting with good surprises, then you want to keep owning it. But you have to double down on your work if something's made you a lot of money. money and re-underwrite it.

Starting point is 00:41:24 I can't help but quote Max Planck, the Nobel Prize winner, who said that science advances one funeral at a time. And he was talking about how difficult it just is to relinquish your ideas. You know, he made all his progressive work whenever he was young. And as he got older, he talked about how he was ironic that he was now one of those authorities that he always stood up to and how he had so much problem. It was so difficult for him to continue his journey as a scientist as he got older because now he, quote, unquote, knew the truth.

Starting point is 00:41:55 And he knew the truth that he didn't knew the truth, but it was so hard for him to get out of because it had worked for so long. He didn't have the open mind that he used to have. The structure of scientific revolutions is a terrific book. It talks about paradigm shifts. There'll be an area of accepted science, and then there'll be challenges, and the challengers are laughed at or not given tenure or whatever, but then suddenly there's a paradigm shift. I think that's exactly right. People don't want to give up their best loved ideas.

Starting point is 00:42:24 And I think that physicists have their best ideas before the age of 25 or 30 and then spend the rest of their lives talking about it, pounding it in. And Einstein spent the back half of his life trying to disprove all this other stuff that was coming in, questioning his theories. It's very powerful. And you have to fight against it as an investor. I think there's some clear human bugs or features in the human brain that are being demonstrated in the field of physics that I think also come to play in the field of economics. You've got to constantly challenge your assumptions. So true. Just one quick book recommendation before we go back and talk about investing here. Was Isaacson's book on Einstein? It's just a fabulous book. So I just want to leave

Starting point is 00:43:05 it at that and then move on here in the outline. So I've been very excited about asking you this question, who would you choose to manage 10 or 100% of your personal portfolio, respectively, if you couldn't choose yourself? 100%. I don't think there's anyone I would give 100% of my money to. Maybe if that were the only alternative, I'd say, I have such respect for the culture of Berkshire Hathaway, just put it all into Berkshire stock and you've got this diversified group of businesses with a great culture and a ton of cash, and that might be the answer. If Oakcliffe didn't exist, There's a short list of money managers I would trust with my family's money. It's basically those

Starting point is 00:43:44 dozen people. And I know them all. I know some of them better than others. Some of them are good friends. I don't want to name names. They're all talented and honest people with great track records. All of them practice concentrated value investing, which is obviously a strategy I believe in. So I think I'd advise that my family hold back some amount in cash for living expenses and allocate, I don't know, 10 or 15% each one of those investors. If they were actually opened a new investment at the time, which many of them are not, all of them invests in equities, some of them focus in the U.S., some of them focus in non-U.S., but they're all coming from this place where they want it.

Starting point is 00:44:23 They're sort of obsessive about businesses, and this is what they do and they enjoy it, and it seems very clear to me that they'll do it for a long time. That would be my answer. One of the reasons why I'm asking you this question is, and I don't know if you experience the same thing, Brian, but I'm often asked this whenever I'm at dinner patio or whatnot, who should I invest with? And then they say, and by the way, I want a high stable return and I don't want any downside risk. I won't ask you to answer that question because the premise is completely wrong, but rather I would like to ask you the question that comes before.

Starting point is 00:44:57 How does the individual investor identify the right as a manager for him or her? There's a lot in this question. There's a book that came out. I think it was last year, the psychology of money, which is so interesting on this. I think you've interviewed the author. I just love that book. I'm trying to get all my children to read it. I'm offering to pay them a small sum if they write me a book report on it.

Starting point is 00:45:19 I thought it was so good. And the question you're really asking, I think, is about psychology and expectations. And look, of course people want high and stable returns. Bernie Madoff managed to raise $60 billion promising that happy combination. We know how that turned out. And of course, it's impossible to achieve, at least in the stock market. And the irony is that volatility in the stock market, which we were talking about before, is actually increased by people not being able to realize this impossible dream.

Starting point is 00:45:48 When prices go up, there's something in human nature that causes people to fear missing out and people buy rising share prices. And prices fall, human nature causes people to fear more loss. and they sell stocks that are falling. And this activity, buying high and selling low, which is what it boils down to, is a bad feedback loop that magnifies volatility in the stock market. And it also, people manage these fears by not just buying stocks high and selling stocks low. They hire outperforming managers and fire underperforming managers.

Starting point is 00:46:18 And I guess one way I would answer your question is, like, people should think about that. Like, you can, if you go look at the work that a firm called Dalbar has done, on this psychologically driven, fear-driven activity of choosing, chasing the hot performing managers and firing the underperforming managers, the impact of that is a four percentage point annual reduction in the returns that most people realize. And four percentage points out over a long period of time, let's say 30 years until someone's retirement, is a big number. That's like a 70% reduction. The best thing for individual investors to do is to find a strategy that makes sense for them and then make as few changes as possible. You know, just try to

Starting point is 00:46:57 ride through the stresses. And it's hard, but I would try to ride through it. So I think, I think my answer to you is, what can your question, what can an individual investor do? Depends on their individual psychology. And I think one answer that probably works for many, if not most people, is to own a mix of index funds and cash, which will reduce volatility, because you're diversified out into owning the broad stock market, and it will drive your fees down. I think another strategy would be to pursue the only strategy that I personally think can have a chance of beating the market, which is concentrated value investing. But only 1% of money is managed this way. So you want to be very careful about

Starting point is 00:47:37 the manager you choose or the managers, multiple managers you choose. And you want to be very thoughtful about choosing that person. And I think there are some questions you should be asking. You should be asking of a manager, what is your long term performance? Are you talented or just lucky? I mean, it's a, it's an impertinent, impolite question, but it's your money, so you should ask this question. And I mean, this is the math of it. If you give 100 kindergartners coins to flip and you ask them to flip five heads in a row, three of them will flip five heads in a row. And if they're money managers, they'll tell you that great five-year track record,

Starting point is 00:48:15 but they're just coin flippers, right? They're not, I think you need to see longer and you need to get into why has this happened. What is actually happening? Second question, are they aligned? Do they have their own money up in this? Or are they just trying to raise a lot of money to charge a lot of fees? And then I think a final question is, what is their strategy for dealing with the volatility that's going to result from concentrating their portfolio?

Starting point is 00:48:39 They will deliver. Definitively, they will deliver more volatility than the market. What's their strategy to profit from that? And what's their strategy to help you, their client, deal with them? Is it communication? Is it a lockup? Is it something? So I hope that's answering your question, but that's the advice that I would give.

Starting point is 00:48:59 It is definitely answering my question. And I have self reasons to ask this because I actually invested with a fund manager here and not ongoing. This was the first time in my life. I interviewed hundreds of investors in this show, the past eight years, and one investor, you know, made it through. So I asked a bunch of questions so I couldn't help but ask you which questions you would ask. So the reason why I wanted to mention that, and please to the audience, before you bombard me who that person is, I'm going to do an episode about it here not too long from now. But I have a bunch of questions about fees, funds that comes here. So I just wanted to make that clear to people if you're like, hmm, you're never really talking too much about that on the show. It probably comes from a selfish perspective here. But going back to you here, Brian, your fund, Oakcliffe Capital, charges 1% plus 20% over a watermark.

Starting point is 00:49:53 of 6% performance. And my point of the question is not to discuss or debate in any kind of way whether the fee is correct or not, but more how you think about optimally align the interest between fund managers and clients. For example, if you are solely paid on asset management or aOM as it's often called, to some extent it incentivizes the fund manager to become more like a marketing company just focus on expanding that AOM. If you're, on the other hand, compensating on performance only, especially depending on how you

Starting point is 00:50:25 define the watermark, you have a short-term incentive to be even more concentrated because it increases portfolio volatility. So going back to the original question, how can a fund manager optimally align interests with clients? There's a lot of misaligned incentives at many investment funds. For sure, that's a problem. You're right to ask questions about it. And of course, you can dispense a lot with the misaligned incentives by owning an index fund.

Starting point is 00:50:53 And I think you might pay 10, 12, or 15 basis points in order to invest in an index fund. But, you know, that's a low price, but it's also the price that gets you average performance. And so the question is, if you're paying more than 10 or 12 or 15 basis points, are you getting better than average performance. I think one bottom line question. But I think breaking that down a bit, you want to see management fees, you know, that are charged regardless of performance. being spent on research that improves performance, right? That should be like a foundational point. And you want to see investment managers make money only when their clients make money.

Starting point is 00:51:31 So at Oak Cliff, our management fees have never been a profit center for us. Our research effort is expensive. There's a lot of talking to experts. There's a lot of research services we use. There's a fair bit of travel. there are some modest salaries to us, that's what our 1% fee has paid for over time. As we grow either through compounding or as we grow as people give us more money, we are not going to let management fees become a profit center. We're likely to reduce our 1% fee as a percentage of assets

Starting point is 00:52:02 for all of our clients in order to share the benefits of increased assets with everybody. We're not quite to that point yet, but that will come in the future. Other than modest salaries, we do not make money from a management fee. We make our money in two ways. the first one is return on our capital, and the second one is that performance fee of 20% of profits over a 6% hurdle rate. And the way the math works, given how much money we all have up personally, just taking myself as an example, we've done about 16% gross, 16% annualized returns before fees gross since inception. If we had a 15% year and you look at how my profits are derived, my profits personally from doing all of this work, 75% of those profits in a 15% year would be return on my capital. No fees charged to anyone. And so I like the alignment at Oak Cliff because we've got a lot of money up.

Starting point is 00:53:03 When our clients make money, I make money. Now, as for our fees, here's how to think about them. We think about this a lot. From inception through the end of 2021, Oakcliff has generated an annual return of about 16 percentage points annualized before fees and about 13 percentage points annualized net of all fees and expenses compared to about 10% for the U.S. stock market. Depends how you define it, big company, small companies, about 10%.

Starting point is 00:53:28 So we're very proud of this outperformance. I want to point out two things about it. Are six percentage points of outperformance before fees, 16% compared to 10% has been split between three percentage points of outperformance for our clients and three percentage points of fees to us. So 3% is 300 basis points. That's a lot more than 12 basis points for an index fund, but performance has been well above average. You could pay lower fees to an index fund, but you wouldn't have the outperformance. And the second thing I'll say is that our outperformance has been achieved while holding an average of 16% cash, as measured as the cash balance at the end

Starting point is 00:54:03 of each year. And holding so much cash, which effectively, in an age of low interest rates, that cash has been returning very little in terms of return to us, the partnership. It's reduced our risk, and it's kept powder dry for market downturns. This really is our money. We've got a lot of client money up, but the money up that's ours is a big percentage of our net worth. We are never going to put ourselves in a position where leverage gets us in trouble. And in a financial crisis, which seems to happen every so often. We have pandemics and housing crises and wars. We want to be the guys with ready cash buying things cheaply from other investors who have weaker hands. There's a great expression. Then Franklin was asked, what do you want in a financial crisis? And he said, three things. I want a loyal wife, I want a loyal dog, and I want ready cash. And so we want to be that guy. Let's take a quick break. and hear from today's sponsors. No, it's not your imagination.

Starting point is 00:55:05 Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vanta automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program,

Starting point is 00:55:26 VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, Vanta gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Riter spend 82% less time on audits with Vanta. That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at Vanta.com slash billionaires. That's Vanta.com. slash billionaires.

Starting point is 00:56:01 Ever wanted to explore the world of online trading, but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&B 500, NASDAQ, Bitcoin, gas, and much more. Explore equity indices, energy, metals, 4X, crypto, and beyond. With a simple and intuitive platform, you can train. from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast,

Starting point is 00:56:35 accessible futures trading you've been waiting for. See a trading opportunity. You'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit plus 500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.

Starting point is 00:57:12 Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested and a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8% and the average annual total return since inception is,

Starting point is 00:57:59 is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information 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 just want to mention that your wife is also a friend of the podcast that we had on Gillian. It was one of the first guest we have, I want to say, because I remember it vividly. Preston and I just decided out, and we realized after the interview that the recorder didn't work. Or I can't remember exactly what went wrong, but it's the only time in ADS that we simply ended into you like, oh, we

Starting point is 00:58:42 didn't record it right or something like that. And it's just one big button. I have a really hard time seeing how you can push one button wrong. So we actually called up, Jillian, and was like, could you please do the exact same thing again tomorrow? And she was very, very nice. It's like, yeah, you can do that, guys. So I just want to mention that. And it's such a great story. It's one of her favorite stories. She's such a big fan of yours.

Starting point is 00:59:04 And what I keep asking her, when she's told that story, and my question is always, were you better the second time? And I think Gillian would be out at the meeting together with you at the Berksie meeting. Other than being your wife, she's also a brilliant writer. Yeah, Warren does this thing every year where he asks people who have written books that he likes to be in the, in the, the stadium selling books. And so Gillian's going to be there selling books. And it's a bit competitive. She feels if she doesn't sell enough books, she'll disappoint Warren. So she'll be, just go find her. And she'll do her best to sell you a book. And I suspect she might succeed. She's very good at it. Yes. So it's good with it. We just give it a plug. Please feel free,

Starting point is 00:59:46 Brian, just to talk for a minute about one of her books. She's a wonderful writer. The things in New York that make New York, New York are the people. And she does just does a great job. at capturing some of these personalities. And then getting there is 30 people she interviewed who have risen to the top of their game, including Warren Buffett, Michael Bloomberg, Sarah Blakely, Kathy Ireland, and all of them. She photographs them, interviews them,

Starting point is 01:00:11 and asks them about the tough times they had in life. And the theme of the book is that no one who has gone up into the right, no one who has gotten there has not had tough times. And it's really how you handle the tough times and what you learn from them that is really interesting. So that's the book she'll be probably, I think. Maybe she'll be selling both books, but that's the book she'll probably be selling in the convention center. Wonderful. You can get it on Amazon. This is a good plug. She's going to be very pleased with me. Perfect. Perfect. So let's talk about one of those people who are lucky enough to be in her book, Warren Buffett.

Starting point is 01:00:43 Warren Buffett has long talked about how the sheer size of his assets is causing a drag on his performance. During the last filing, we saw that the equity portfolio is $350 billion. And as a manager, you on one hand would like to show great returns, which everything else is easier with a smaller AOM. But you also maximize your company revenue, which is, that's another thing you want to do, which is easier, everything else, equal with their bigger AOM. Because it also allows you to take some of that revenue and put it into more extensive research, which is very difficult to do if you're sitting with $10,000.

Starting point is 01:01:23 So this might be a more philosophical question more than specific math. But Brian, is there such a thing as an quote-unquote optimal fund size for an asset manager? A 1% fee on them are basically now paying for the research effort. And there is more stuff that you could add to the research effort. So I think in order to have a like a fully fledged deep research concentrated value investing operation, I think you need a couple of hundred million dollars of assets kind of as a minimum. I think you can you can find ways to do it for less, but I think that's a good solid number. I think the problem that begins to happen. So that's an economy of scale.

Starting point is 01:02:06 The dis-economy of scale that starts to happen as you go from, let's say, the hundreds of millions of dollars to the billions of dollars is this. Imagine that you have a $5 billion fund and concentrated value is your strategy. And you're trying to put out 10% positions. So you're trying to put out $500 million. And you want to invest in publicly traded companies, which has been your strategy to get to the $5 billion. And you don't want to have too much liquidity issues. And you don't want to have regulatory problems, which start to occur when you buy more than 5% of a company. We can go into what those are.

Starting point is 01:02:44 So you want to be less than 5% of each of these companies. $500 million, less than 5% position in them in each company means a $10 billion equity market capitalization for the companies that you are investing in. $500 million is 5% of $10 billion. If you look at the U.S. stock market, they're a little under 4,000 companies. And the number of companies that have more than $10 billion of equity market capitalization is about $470. So you're looking at about 12% of the companies actually are 10 billion and above.

Starting point is 01:03:18 And so for a $5 billion concentrated value investor, his opportunity set is 12% of a smaller firm. So in theory is eight times harder to find ideas. And that's why I think $5 billion is a bit of a break point for concentrated values of strategy. I think as firms have hit that, as their track record tracks more assets, as they compound the capital, I think you see a couple things start to happen. The first is returns start to decline because their opportunity set is lower. The second thing, you sometimes see strategy shift where they say, well, we're not finding enough opportunities buying 5% of publicly traded companies.

Starting point is 01:04:03 What we need to buy is 100% of companies. We need to take them private. Let's develop some way to have permanent capital. let's start an insurance business. Let's raise money in some sort of vehicle that can take companies private or whatever. And the other thing that you start to see is at $5 billion, as returns start to fall, a decision might be made by the money manager to return client capital and become a family office. And therefore, you now have enough scale as a family office to have this research effort,

Starting point is 01:04:32 but you get rid of the client capital that's reducing your returns. I think we're at about 270 million right now. I think we have the resources to do good research, and we've got a big opportunity set. I think we're well positioned for the next 20 years, but you're asking a really good question about the declining value, the declining returns to scale. I think by about $5 billion, they're very evident. Staying in the same train of thought, how can we evaluate the skill set of a fund manager and the same time factor in the size of his or her portfolio? I think there's a couple things in there. If he's a fund manager who was small and has gotten big, you have to be thoughtful about it because maybe the skills that were able to make him money

Starting point is 01:05:19 when he had a small pool of capital might not be the skills he needs when he's got a big pool of capital. Like was he a specialist in smaller companies, companies that are small now and he can't find ways to put the amount of money that he's now managing in them. And is there evidence that he or she has been able to transition the skills and change strategies now managing more money. So I guess I'm answering your question about someone who's gotten larger. Buffett's geniuses, he's, oh, okay, my partnership is so large now. I'm actually going to buy a textile company and start an insurance business and start not only picking stocks, but buying entire businesses.

Starting point is 01:05:57 And the skill set for owning, let's say, all of Burlington Northern is different than I own 2% of Burlington Northern, and if I decide that I want to, I can sell it next Tuesday. That's a different set of skills. But if someone's very small, do they have the resources to actually get the good research insights? If someone's very large, is their opportunity set too small? Or if they change their skill set to actually put that capital to work? So, Brian, in doing research for this interview, I have the privilege of reading through your letters to shareholders.

Starting point is 01:06:30 And there is one quote that I absolutely love on page two. And it says to us owning 10-year treasuries yielding 1.8% with inflation running at 7% seems like return-free risk. Absolutely love that quote. And that makes me consider how we as equity investors should factor in inflation whenever we analyze stocks. Perhaps we could go through a case study with Caravanagh, which is a vertical integrated online platform for buying selling cars that's 8% of your portfolio, or it could also be other case studies, including Transdime, Guidewire, Charters, whatever direction you want to go. But I'm curious to hear that inflation piece and how you think that into your own portfolio. Yeah, it's a great question. Everyone's got to focus on. And of course,

Starting point is 01:07:16 when we wrote that letter in January, we didn't yet have the war in Ukraine and higher energy prices. And, you know, inflation seems like it's going to be with us for a while. All of us have to get used to more inflation. And what we're doing is thinking hard about whether or not the businesses that we own will do well in an inflation. And in general terms, a business will do well in inflation if it adds value to its customers well in excess of the price that it charges them. So in other words, there's room to raise prices relative to the value that customers are experiencing or the alternatives that they have, a business will do well in an inflation if it can raise prices to customers faster than the prices that it's presented with, the costs that it's presented

Starting point is 01:08:02 with by its suppliers. You have to outrun inflation. And also, it's very favorable to already own the infrastructure that you need. Like, if you've got to reinvest in dollars that are getting ever more inflated in order to stay in business, that's much less attractive than if you already have the infrastructure and can just have prices rise and not have to reinvest. We're judging every business we have against those tests. Here are some examples. At Charter, you know, we were talking about that before. That's the kit company facing the fiber new entrance. They're charging 60 cents an hour for high-deaf television. If they said to you, it's going to be 70 cents an hour. Would you really cut your cable internet bill? I mean, I know you've got to pay a little bit extra for

Starting point is 01:08:49 Netflix and Amazon Prime, but would you really turn off your internet? Like, how is your life going to work without your internet? Especially if you have teenage children in the house, let's say you're running your business from home. If they said 70 cents rather than 60 cents, are you really going to cut it? Especially when the competitors need to charge way more than 60 cents an hour to build their competing networks. Also, the interesting thing about Charter is their network is already built. They already pass 55 million homes. The fiber guys who are coming, we're going to build tens of millions of passings, now have to compete with each other to find workers

Starting point is 01:09:24 and to find fiber and to pay diesel for all the bulldozers that are going to dig up the streets. I would much rather have charters infrastructure in place and its ability to raise prices in an inflation than the fiber guys having to invest with inflated cost inputs into building their infrastructure de novo. Another example, Transdime. This is a company we own.

Starting point is 01:09:47 It supplies parts to airplanes that fly commercially or fly militarily. And these are small dollar value parts. The average price is $2,000 or less. Like an example, they have 80% plus share of the seatbelts on jetliners. If you look down, your seatbelt will say AM safe on it. That's a trans dime company. $300 seatbelt on $100 million airline. And they are the sole supplier for 90% of what they sell.

Starting point is 01:10:16 they have FAA approval and the equivalents in Europe and Asia. So you can't if you're Delta or United Airlines put a seatbelt in place that's not an AMSA seatbelt without spending millions of dollars getting FAA approval. And in practice, they don't. And so the total cost of what Transdine charges, it's like the little valves, like when you see the flaps come down in the wings, it's a hydraulic valves delivering power to make the flaps go down, like a $1,500 part without which a $100 million airplane cannot fly. The total cost of what Transdime charges is 0.3% of airline revenues.

Starting point is 01:10:51 If they said to the airlines, it's going to be 0.33%. I mean, what are the airlines going to do? That's pricing power. Another one is Guidewire. I mentioned it before in your first question. It provides software that allows insurance companies to operate. And it's a duopoly. There's another provider called Duck Creek.

Starting point is 01:11:11 And then there's some smaller guys who really have more marginal market. presence. Every insurer is going to transition its software from this old cobalt stuff that they wrote in the 60s to either guidewire or duck creek. And they are charging 0.5% of revenues, of insurer revenues in order to allow all of the claims, all the policy formulation, all the billing systems, everything is run by these guys. Two things about that. Their contracts say, we get from you, Mr. Insurer, 0.5% of your revenues. Well, the insurer's revenues are going up with inflation. So automatically, they participate. Their prices go up. And then if they said to the insurer, you know what, I think next year it needs to be 0.55% of revenues. Like, what is the

Starting point is 01:11:58 insurer going to do? And so subjecting each one of our businesses to that kind of question, is it really a great business with the ability to price and excessive inflation? Do they already have the infrastructure that they need? Contrast it, you know, it's, you know, like, Like, invert the problem. Let's talk about the other side of it. Let's imagine that you are an automaker, and we could pick any of the auto. It could be General Motors. It could be Volkswagen.

Starting point is 01:12:20 It could be Ford. It could be Chrysler. Those guys, every time, for every car that they sell or SUV or pickup truck or whatever, you need a new model every five years. To do that new model and make it exciting, you know, so that you get customer acceptance, you've got to design it and you've got to put in new parts for it. Okay. All of that design and all of that design and all of it.

Starting point is 01:12:42 that refurbishing of the plant to make that new model has to happen in inflated cost dollars. The infrastructure needs to be renewed every five years. And then when they go to charge whatever they're going to charge, like $40,000 for this car, it's very unclear that they're going to be able to pass through the increased cost of steel, the increased cost of labor, the increased cost of energy, natural gas and electricity to use to run these factories. It's very unclear to me if you have like 8% share or 12% share of the U.S. auto market and there are seven or 10 other people you're competing with, do you really have the ability to pass

Starting point is 01:13:20 through your costs? And if you look back at how the automakers did in the 1970s when we had inflation, it was not a pretty picture at all. So you just have to be very careful with your businesses. And I think if you select the right business, it's a lot better than owning cash. And I think the idea of owning government debt yielding, let's say, two, The 10 years come up a little bit since we wrote that letter is 1.8%. It's down in excess of 2%.

Starting point is 01:13:46 But the idea of owning 10-year paper with a 2% coupon when inflation is running north of 8%. I mean, it's like a certificate of confiscation. It just doesn't make any sense. Well, said Ryan. So let's continue talking about cash. In March 2020, whenever we had this massive COVID crash in the markets, you invested 12% of your capital in businesses you already owned. was something that really impressed me. From that, you had a 132% gain. I'm just going to say that

Starting point is 01:14:16 again, 132% gain to show at the end of the year. And it really makes me think about the right level of cash to hold. Because one thing you also said in your letter, and you mentioned earlier here today, is that you had had, on average, 16% in cash since inception of the funds you're managing, I just find that fascinating. Because as investors, we know that we should hold enough cash to take advantage of big crashes as we saw with COVID. But on the other hand, we also know that it's an expensive thing to do in opportunity cost to try and quote unquote time the market and not to be fully invested.

Starting point is 01:14:55 So how do you balance that? Yes. Part of it is, the answer is the psychology of money, which I guess I'll talk about in a bit, but part of it is also, you know, the opportunity and the nature of the business that we're doing. So let me talk about, I guess, the opportunity and the nature of our business. Like, it measured at the end of each year, we've held 16% cash on average. But that's an average. And our cash balance has gone much lower at times.

Starting point is 01:15:24 So in October of 2008, we took cash to zero. Turns out the market bottomed five months later. But what was happening was, as the market was going down, The expected IRR on things that we owned and wanted to own was going up. And we said, right, we're 0% cash. We were early, but ultimately, we had a very good 2009. You can see in our numbers. In March of 2020, we went into the pandemic.

Starting point is 01:15:53 In February of 2020, the expected IRA on what we owned was in the high teens, which was consistent with our historical results. That's kind of what we've delivered over time. And 21 days later, fastest drop ever, the expected IRR on what we owned was in the mid-20s. Like, it just, wow. So we just started buying what we owned. We didn't have time to research new stuff. We were just buying what we owned.

Starting point is 01:16:21 And John and I said to each other, the market's down about 30%. The market goes down 40%. We'll get to 0% cash. We didn't know when it would stop. But if it'd gone down another 10%, we would have committed all the cash. So this question of do you own cash or do you on stock really for us depends on what's the expected IRA on what we could turn the cash into. But importantly, Stig, it's what's the expected IRL on what we might be able to find next week?

Starting point is 01:16:52 It's a little bit like you're at your high school prom and there's an auditorium filled with possible partners and you're told, find your marriage partner in this high school. school ballroom. Okay, well, what about all the other parties you'll go to? Like, do you really want to commit now? And the value of what we know about businesses, all of this work, you know, watching the paint dry, like reading, reading, you know, the 11 things we own and the several dozen other things that we would like to own, the value of what we know about those businesses goes up in a downturn. And maybe this is the psychology of money. We want to have cash to take advantage of that. We want to have the ability when everyone else is panicking to lean in.

Starting point is 01:17:37 Going back to the discussion about the right level of cash, this is something I spoke with Moniz Paparai about here on the show. And he said that he previously have considered holding a called conventional passive management index like the SEP 500 or Russell's 2000, whatever that might be. We even talked about Berksie Hathaway. She asked to mitigate the opportunity cost of being in cash. But he still found that the optionality of cash outweighed that. I'll be curious to know if you hold cash differently than just in the bank account, do you have short duration treasuries. Whenever you say cash, what are you specifically referring to? Yes, in the financial crisis, there were forms of cash that turned out not to be cash,

Starting point is 01:18:23 which was really eye-opening. And so we define cash very carefully. We say cash. We say cash. in our letters, but cash for us is one of two things. It's either money market funds at J.P. Morgan where we custody all of our assets in their private bank, which has a whole bunch of reasons we keep our money there. We think that's, you know, one of the safest places to have have money money in the United States. Jay P. Morgan has a type of money market fund that we have a lot of confidence in. It doesn't have any weird stuff in it. But if we get into, you know, there have been periods of time where, you know, the world starts to get weird. And at that point, What we do is we say, even JPMorgan money market funds is too, you know, there's the slightest risk that that won't be there when we go to get it.

Starting point is 01:19:07 And we just buy treasuries. We, you know, buy, you know, 30-day T bills under the theory that that is the most liquid thing there is. And because we're in a bank, we have direct custody of what we own and we just want to own treasuries. So it's some mix of money market funds and treasuries. Do you think differently about the quote unquote right level of cash, which of course depends on the opportunities out there, but also giving that we now see inflation coming and as you mentioned might stay here for a longer time? Yeah, I mean, obviously cash is not as good if inflation is running at 8%.

Starting point is 01:19:43 It's being agreed away. But still, you know, the value of having that cash and having the opportunity to, you know, to John and I might find something. We came very close last week to buying something. We might find something two weeks from now. Taking the 10% cash we have and putting 8% of it into a new investment or 6% of it into a new investment with an expected IRA of 20% just working all the time to find that 12th idea.

Starting point is 01:20:14 Brian, what can I say? This has been absolutely amazing having the opportunity and the privilege to speak with you here today. I would like to give the opportunity to tell the audience more about where they can learn more about you and Oak Cliff Capital. Stig, it's been a real pleasure speaking with you. It's fun to talk about these issues, and I hope it's helpful for you and for your audience. If you want to learn more about us, our website is at www. oakcliffcapital.com, and that's how to find us.

Starting point is 01:20:46 You'll find the ability to email us or send us information. Fantastic. And I think I speak for everyone in the audience when I say that there was so many, not us to take away from this interview. So thank you, Brian, so much for your time. It's really been a privilege having you on the show and I hope we can do this again. Thank you, Stig. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only,

Starting point is 01:21:23 Before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP440: Beating the S&P500 since 2004 w/ Bryan Lawrence

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.