We Study Billionaires - The Investor’s Podcast Network - TIP613: Stock Market Basics & Financial Independence w/ Clay Finck & Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. On today's episode, I'm joined by my co-host, Kyle Grieve, to discuss why we're so passionate about investing in stocks and why we utilize the stock market to work towards achieving financial independence. I first discovered the stock market when I was 18 years old after reading a Warren Buffett biography, and a couple years later, I discovered the content you're listening to on this show now, and my passion for stocks has only grown from there. During this chat, Kyle and I touch on how real-life examples of

Starting point is 00:00:30 compounding have influenced us, why we set the financial goal of becoming financially independent, how an investor might know when they're ready to start investing in individual companies, how to quickly disqualify investment opportunities, the edge that individual investors can have in picking stocks, our favorite investing books, and much more. Also, I wanted to share some announcements related to our TIP Mastermind community, which will be included at the end of this episode. There's some very exciting things coming up with the community, including a Q&A with Brett Kelly, founder and CEO of Kelly Partners Group, as well as a stock presentation by one of our members in a social hour discussing stock ideas and current market conditions later this month.

Starting point is 00:01:10 We're also nearing our limit of 150 members. To learn more, be sure to stick around until the very end of this episode. With that, I bring you today's chat with my co-host, Kyle Greve. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors' Podcast Network. Since 2014, we studied the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your hosts, Clay Fink and Kyle Greve. Welcome to the Investors Podcast. I'm your host, Clay Fink, and today I'm so happy to be joined by my co-host, Kyle Greve. It's always great to connect with you on the show.

Starting point is 00:02:07 You too. So one of the wonderful things that we do, Kyle, as host here at TIP, is help people learn how to invest, or at least hopefully help people learn how to invest. And investing is something that we're both very passionate about. And I think we both generally think it's really important to know, understand and know what sort of role it plays in our lives. And they say that there are no free lunches in life. But when I first learned about investing when I was around 18 years old, it sure felt like, one of the closest things to a free lunch I've ever found. And the reason for that really is because of the power of compounding and the freedom that investing can give us. And really the premise of this episode is to share some of the things that Kyle and I have learned over the years and why we're so passionate about this topic of investing. And I wanted to start by sharing a story of a family member that passed away a few years ago. So my grandfather, he passed away when I was very young in the 1990s, so I really never knew him. And then it was some years later, my grandmother,

Starting point is 00:03:14 she remarried to a farmer from the area where she lived and where I grew up. And for those in the audience who have read the very popular book, The Millionaire Next Door, this guy was really the classic example of the millionaires they studied in this book. He was very frugal. He worked for much of his life and he really understood the power of compounding very early as he was very interested in investing. And I think for a lot of people that knew him, they would have never guessed. You know, he became as wealthy as he did. I certainly don't know the details, but I know he certainly did well for himself. And I wanted to talk through some of the things he did throughout his life. And some of the lessons I picked up from getting to know him throughout my own life, too.

Starting point is 00:03:57 So I think of the investments he had really in these three pillars. So naturally, he was born on a farm and he just went into farming. So really, farmers, I sort of think of it as entrepreneurs at heart. So throughout his life, he grew his operations on his farm. He acquired more land, you know, worked with various other people and his family. But like a lot of other people out there in our world today, he didn't, you know, just make money from his work or make money from the farm and go out and buy nice vehicles or buy a nice house because he did so well throughout his entrepreneurial pursuits. He started investing that money elsewhere. And this is where I wanted to tie in the second pillar of his investments, which was his private businesses. And him and some other people that were active in

Starting point is 00:04:42 the community, they started a local bank in a small town that he lived in. And he wasn't active in the day-to-day operations of this bank. He oversaw what was happening. I'm sure he helped getting people lawn boarded hiring people. And he had an equity stake in the bank. So he was one of nine people that helped get it going back in 1984. And then over the years, the banks just had substantial growth and it's opened new branches. And last year, I actually attended their annual meeting, which was quite interesting in itself. And, you know, it's the type of situation where you see the managers, you know, they're people you can trust. And you see, you know, their type of capital allocation decisions. You see their earnings just march up year after year at around that 10% mark. And

Starting point is 00:05:25 they produce substantial free cash flow for a community bank. It was very conservatively run. And then if those two pillars weren't enough, the third pillar was that he was also very, very interested in the stock market. And I remember throughout my college years when I sort of started to gain an interest in it about every time I saw him, he always had some story of a stock he owned or how his portfolio was doing at the time. and I believe he bought into Berkshire around the great financial crisis. He was a huge fan of Buffett, and I believe he also cloned Buffett's purchase of Apple. And then he passed away in 2020, and it was time to distribute his assets. And he ended up donating a lot of what he accumulated over the years and just donated to charities locally. And that also reminded me of Buffett, just like, you know,

Starting point is 00:06:09 living this very frugal lifestyle and ending up just giving a lot of it all back to society. And one thing that really stuck out to me and where I'm going with the story is just how well he did financially and how just like starstruck some people were when they saw like kind of his end result. And again, I don't know the exact numbers. And it's not like he was a billionaire, like a lot of the people we talk about on the show. But when someone who doesn't understand compounding sees the results of it, you can just see how in awe they are. And you know, you can just see in their mind that they're thinking, how is this possible? Like, did he get lucky? Like, what, what am I missing? Like, is essentially what they're asking themselves. Like, it's like, why can't I, you know, be in that sort of position?

Starting point is 00:06:52 And then it was just such a great case study for me in my actual life of what compounding can do for us. You know, we always hear the story of Buffett and he got 99% of his wealth after he was 50 or 60 and he's one of the richest people on the planet because he's fully utilized compounding. But to see that in your actual life, I think, just really made a big impact on me. And what's also, very interesting and sort of funny about the story. I sort of saw him like as the local Buffett. He lived his frugal lifestyle. He gave a lot of his wealth away. And like I mentioned, the millionaire next door, he didn't try and flash his wealth. He lived by an inner scorecard rather than an outer scorecard. And he really couldn't care. He could care less what other people

Starting point is 00:07:34 thought about him. And just had a lot of these Midwestern values that I think Buffett sort of embodies. So yeah, that's the story I really wanted to share. And one of the things I've picked up over the years with regards to compounding. Yeah, and I can relate somewhat to this story because my grandfather was similar in some ways. He passed away in his 90s, so he was around for a long time, but he was a very, very avid saver for most of his life. And not only did he save, but like you said, he compounded it by investing it and, you know, putting money into the compounding engine.

Starting point is 00:08:05 And so he never really discussed investing much with me because unfortunately he passed away when I was still a teenager. But from talking with my mom, I got a chance to learn about some of the the different investments that he made. So I know he had boring government bonds, which, you know, paid just a nice little coupon, but that worked for him. He was a child of the Depression era and obviously, you know, he was very risk-averse. I know that he was very risk-averse. So bonds made a lot of sense for him. And I know he also owns some Canadian blue chip stocks, things like banks, railroads that paid a nice secure dividend and had very, very strong moats and most likely weren't

Starting point is 00:08:37 going to be going anywhere. So the thing that really stood out to me about my grandfather was that he helped use his savings to provide me with a great life when he was still around, not even after he passed away. So, you know, while I was in elementary school and high school, he paid for tons of things like my hockey equipment, back to school shopping, clothes, shoes, tons of activities. So he managed to enhance my life with all the savings that he did from his working days and his frugality, which I'll get into as well. So in regards to compounding, I never ever got a chance to talk to him about it. But my grandfather was pretty smart. I wouldn't be surprised if he understood it to some degree. But, you know, he definitely compounded.

Starting point is 00:09:11 did his money over a long period of time and it grew to a nice little chunk. And same thing. He gave away a lot of it while he was alive as well. So a funny story just to illustrate my grandfather's frugality was in the beer he bought. I remember going to a store with him when I was in my teens and he asked me to go grab some beer. This was before I started drinking me. He gave me money and said, just go buy whatever the cheapest one is. And I think it was like old Milwaukee or something. And I didn't really give it much time with the thought because I didn't drink beer. But he told me, I don't even know why it came up, but he told me he's like, all beer tastes the same, you know, just buy the one that's cheaper, does the exact same thing. And I was like,

Starting point is 00:09:45 yeah, you know what? That makes some sense. So this is a lesson that I still really continue to live by. It to some degree, you know, obviously I enjoy some things that are quality, but, you know, being frugal and things where quality maybe isn't as important to you is, is a way to increase your savings rate. And that's something that he really instilled on me and that I still use to this day. Yeah, that's a really great point. I had, uh, Remeet Satie. He always made the point in his book. that you should cut ruthlessly in things that aren't as important to you, but then, you know, spin lavishly in the things that are very important to you. So it's like, you know, finding those things that you find value in. And obviously, you and I highly value compounding our investments.

Starting point is 00:10:25 And we want to make sure we're allocating some chunk of our income towards that. And compounding, it's really one of those things that amazes you when you first discover it. You pull up the compound interest calculator that everyone checks out the first time. And you're just in awe of like, the power it holds and then you wonder why in the world you weren't taught this at an earlier age. And another thing I've noticed is that you really either get it or you don't. Just the other day I was playing basketball and I was meeting some guys that, you know, just kind of telling us a little bit about ourselves. And I mentioned to them, you know, what I do, what I'm invested in.

Starting point is 00:11:00 And right away, they just want to talk about like Dogecoin and all these other things. And it's like, yeah, if they were shown the compound interest calculator, I just don't see it registering in the way that it would for you or me or all the people we talk with in the audience. And, you know, there's just something in terms of a personality trait of, you know, the way we're wired and to be able to see that power and see the value that it can add to our lives. And I had mentioned that, you know, many people that were surrounded by him were in awe of the gentleman I talked about. And I think the reason for this partially is that, you know, we're not wired to think in these

Starting point is 00:11:39 exponential sort of frameworks. You know, we're pretty much wired to think linearly. And I don't want to bore people with, you know, these compound interest numbers, but I do want to share an example of compounding using the story I had sort of as a template. You know, as much as we cover investing on the show, it's not very often we talk about, you know, this true long-term power of, you know, why in the world we're so passionate about this. So that family member I talked about, he finished his active duty work. I went back and looked at his history. He finished his active duty work for the U.S. Army in 1956, and he was 26 years old at the time. So just running the math, he was around 90 when he passed away in 2020. And let's just say he managed to get $1,000 when he was 26 years old.

Starting point is 00:12:23 I'm sure many people would say that's ridiculous. There's no way you could save that amount, but this is just for illustration's purposes. And it's just a one-time investment is something he could have certainly built up over time. So if he started with $1,000 in 9,000, 1956, that's equivalent based on just a CPI calculator, equivalent to around 11,400 today. And let's say he invested that in the S&P 500 and reinvested all the dividends over time. So this is what that journey would look like from 1956 through 2020 when he passed away. By 1970, that $1,000 investment would be worth $3,200. You know, it's not bad. It's over 14 years. You've tripled your money. I mean, not life-changing money, but seriously, not bad return.

Starting point is 00:13:06 So fast forward to 1980, he'd be up to $5,900, so almost a 6x in 24 years. 1990, it'd be over $27,000. And the nominal return at this point would be 10.2%. That's over 34 years. Fast forward to 2000, the 90s was quite a great decade for stocks. The 27,000 increased now to 147,000. So now from 1956 through 2000, 44 years, you're up 147x, and that's a 207. 12% average annual return. And then due to that really good decade in the 90s, we had a slower

Starting point is 00:13:43 decade in the 2000s. So it actually shrunk. It shrunk to 138,000 because the stock market was down over that 10-year time period. And then as stocks do, they rose again the following decade. So the year he passed away in 2020, that one time initial $1,000 investment would be worth $492,000. of 492x, like just mind-blowing numbers. And people love Chris Mayer's book on 100-baggers, but this investor didn't analyze a company. He didn't, you know, look at an individual stock or understand a balance sheet or anything. You just bought the overall index, and he's up nearly 500x over 64 years. And just to just share the average return on that, it's 10.2%. And, you know, we often, quote, an average return of 8 to 10% in the U.S. markets at least. And it's,

Starting point is 00:14:36 It's no wonder that Buffett and Munger, they've preached for years, that the key to success in life is deferred gratification. And in reflecting on this example, I wanted to share a few points that I think worth highlighting here before I throw it over to you, Kyle. Again, this is just for illustration purposes and not what he actually did. So the first is that we have to consider the impact of inflation when looking at such long time periods. Just due to math, stocks are likely to go up over time just because the currency. is losing value. So it should be no surprise that stocks continue to hit new highs, eventually at least, over 10, 15, 20 year time periods. And then the first 14 years, I had mentioned it went from 1,000 to 3,200. So in the first 14 years, he gained $2,200 on his investment. In the last 10 years,

Starting point is 00:15:26 he gained $354,000. And I think there's just no way you can shortcut this process. You have to put in the time, put in the patience, you have to kind of wait through that grind of the initial slow early years to get those massive gains down the road. And Morgan Housel in his book, Psychology and Money, he highlights that much of the power of compounding comes from simply giving it enough time to work. And for most people, investing success is not going to be from achieving above average or high returns, but it's just simply staying in the game for long periods of time. And we regard Buffett as the greatest investor of all time and really obviously did, generate high returns, but the most important part of the equation in him becoming the best and

Starting point is 00:16:11 the wealthiest and known as the goat is he compounded his money much longer than the vast majority of other people. And then the third point here is in 1956, the S&P was trading around $45, and in 2020, it was around $3,200. So while the S&P 500 was up 71x over that period, his investment was up 492x. So it's like, okay, what? What's happening here? The reason he got such a much higher return than the index itself, what he was invested in, is because he reinvested dividends. And that's something that people sometimes ignore or exclude from this type of analysis. And it's common practice to just, you know, nowadays, especially just with our whatever account you use, just to automatically

Starting point is 00:16:55 reinvest dividends. You don't even have to do it yourself. You can just make it simply just click and automate it. So just by making that one decision of reinvesting dividends, this increased his ending amount that he ended up with by nearly 7x. And again, it just points to, you know, people think that'll just be a linear change adding dividends. Like, oh, he gets a slightly higher return. But, you know, again, this is an exponential problem. And it really helps illustrate the power of continuous contributions to your accounts, reinvesting dividends, and obviously sticking with the long run. Yeah. Those are great examples, Clay. And like you said, the concept of compounding just really, really is not intuitive.

Starting point is 00:17:36 There's a great question that I believe I read from Thinking Fast and Slow by Kahneman and Tversky that I've read that I thought about a lot. And it illustrates this really well. So in a lake, there's a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days to cover the entire lake, how long does it take for the patch to cover half of the lake? So intuitively, I remember the first time I heard this, my brain just wanted to half 48 and say

Starting point is 00:17:57 24 is my answer. And it's completely wrong. So the simple way to look at the, this a quick. is basically, if the patch is full on day 48, then the day earlier 47, it's half full. That's it. So if you looked at that lake, it takes 47 days or 98% of the time for the lake to fill up halfway, then it takes one day or 2% of the time for the lake to fill up with lilies entirely. So that just kind of goes to what Clay was talking about with, you know, you have to wait

Starting point is 00:18:23 a long period. And the longer you wait at the end, that's when compounding really, really kicks in. And that's when you can really grow your wealth. So Albert Einstein famously said, quote, compound interest is the eighth wonder of the world. He who understands it earns it and he who doesn't pays it, unquote. If you don't want to unlock the ability to compound money, you must try and understand how it works. And I don't know about you, but I never learned how compound interest works in school. But I think one of the most underrated parts about compounding interest that Einstein alludes to in that quote is that if you don't

Starting point is 00:18:54 understand it, you end up paying it. So there is a story about a king, a chess board in the stage. and, you know, I'm sure there's, you've heard, there's many different ways of saying it, but essentially there was a king and he liked playing chess. So he would go around and challenge people to play games of chess. So one day, there was a traveling sage, and the king challenged him to a game of chess. So the sage, having played chess all his life, was obviously good and probably knew he could beat the king. But the king offered him a reward for beating him.

Starting point is 00:19:20 So the sage said, okay, well, you know what? Here's what I want. I want you to put a single grain of rice on the first chess square and double it on every consecutive square thereafter. The king, you know, didn't understand compounding. So he said, that's nothing easy. Sure, let's do it. So they played the game. The sage wins.

Starting point is 00:19:36 And being a man of the word, the king gets a bag of rice and starts putting one grain on, two grains on, four grains on, eight grains on, and keeps going doubling on each subsequent square. But of course, the sage understanding compounding knew that there's no way that the king had even close to enough rice to pay him. So after the king got to the 20th square of the chessboard, he would have had to put about a million grains of rice on. By the 40th square, that would increase to a billion grains of rice. And by the 64th square, that would have been 18 quintillion, which is 18, followed by 18 zeros,

Starting point is 00:20:09 grains of rice, which is equal to about 210 billion tons. So this story illustrates just how much of a benefit understanding compounding is versus how much of a detriment ignoring it really is for you. Those are both also wonderful examples. And one of my favorite quotes on compounding is one from Godham Bade, one he shared in his book, The Joy's of Compounding is from Anshol Carr, probably butchering that name. He writes, in the initial years, compounding tests your patience. In the later years, you're bewilderment. And I just absolutely love that quote. And without talking too much about compounding and all the wealth and money it can give us down the line, some people might be listening and thinking that we're totally obsessed with money. That isn't

Starting point is 00:20:54 necessarily what I want to communicate with this or it's not because it's not necessarily the case. And I know it isn't for me and I can only speak for myself and I'm sure it is for you, Kyle. I really see money as a tool that enables us to help us live the lives we want and do the things we want to do. Really at the end of the day, money can give us the freedom to live the type of life that we truly want to live. Munger has long talked about how he didn't just want to get rich. He wanted to enough money to have the freedom to live life on his own terms. And Kyle, it reminds me of the presentation you did for our mastermind community where you shared your portfolio results for 2023. And during that presentation, one thing that stuck out to me is that you have the financial

Starting point is 00:21:41 goal of becoming financially independent. So talk about what this means to you and why you ended up setting that as your goal. So to me, financial dependence is quite simple. I can't remember I don't remember exactly who said it, but it's basically to do whatever I want with whoever I want, whenever I want. And so to me, like you said, you know, obviously money is important, but it's more of an unlock to unlock these three characteristics that I hope to achieve one day. So to me, being able to manage my own money while doing nothing else would mean financial independence. And I know some people think that if you have to do any type of work, they're still saying that I would be working by managing my own money. And, you know, in their defense, I guess if they use that as their

Starting point is 00:22:25 definition, then I wouldn't be financially independent. But to me, I love investing so much. So if I could just manage my own money and live off of that, you know, I would basically be doing a something I really love to do and not having to do anything else. I could set my own schedule. Like I said, do whatever I want, whenever I want with whoever I want. So to me, that would be financial freedom. And, you know, essentially I would have to build a portfolio up to cover all my family's expenses for a long period time. And then with the effects of compounding, you know, that just grows, which is great. And then I can do whatever I want with with that money. And then just kind of getting into, you know, the nitty-gritty of how that works, you know, your income and your savings rate have a lot to do with how quickly

Starting point is 00:23:02 you can reach financial independence. But it's important to define in whatever light makes most sense to you. Another interesting point about finances is just the lifestyle you choose. There, you know, there are tons and tons of people like Clay mentioned, you know, the millionaire next door. They have tons of examples of people there just, you know, working blue-collar jobs who retire with a lot of money. And then you got people making six, seven plus figures, and you hear about them going bankrupt after their career is over and they have nothing. So, you know, no matter how much money you're making, it's all about decisions in life and figuring out what you want to allocate your money towards. You're either allocating it towards things that are, you know, shiny toys right now,

Starting point is 00:23:38 which a lot of people do. And if you do that, perfectly fine. I'm not judging you. But me personally, I like to allocate a certain percentage of it, basically to buying my freedom in the future. So That's kind of how I look at it. And obviously, that means I do have to sacrifice some splurges that I could make if I didn't save money, but I'm okay with that. So anyways, I just wanted to bring that up because it's why people with, you know, lower paying jobs can retire with, you know, these ungodly sums of money, whereas people who have these really, really high paying jobs, you know, just kind of fade off or have to end up working for the rest of their life. A couple things stand out to me there. So first is you mentioned, and I

Starting point is 00:24:18 ideal life for you is like analyzing companies, managing your portfolio, and keeping up with all those things. So, you know, it's finding what you value in your life. And second, it's recognizing that while a lot of people find value or find, believe that happiness for them lies in the next big purchase, the bigger house, the nicer car or whatever else. It's recognizing that, hey, I don't have to allocate my money, you know, or show that I value those things. I can use my money to buy freedom. That's just a realization that I don't think many people believe is even an option for them. Like money can be used as a tool to, you know, buy back our time because our time is finite. And, you know, have that freedom to chase things that you value most.

Starting point is 00:25:04 You know, for you, it's managing your portfolio, spending more time with your family. And generally just having like free time to explore other things as well. And it's funny looking back when I go back to when I was in high school, considering what sort of career I wanted to pursue. One of the most important things for me, whether it was consciously or unconsciously, was having, you know, a pretty good income. And this wasn't because I wanted to become financially independent when I'm 35 or whatever else. Really, it was the lifestyle that that income could give me because I didn't realize that you could use money to buy freedom because so few people, I think, you know, talk about it or just sort of live that out in their lives. You just don't really realize, like, growing up, that that's even an option. You can go and do other things.

Starting point is 00:25:50 You can buy back freedom or work on things you really enjoy. And there's that saying that true wealth is measured in terms of personal liberty and freedom or essentially the ability to control your time. And it reminds me that someone could have all the money in the world. But if you're selling your time, like 14 hours of your day and then you're sleeping eight hours, then you have like one or two hours to yourself to like, cook, clean, do laundry, all that. And if you also have expenses that exceed your income, one has to question if that person is actually wealthy, even if they have the car, the house,

Starting point is 00:26:25 whatnot. And one of my favorite books on financial independence, it's J.L. Collins's book, The Simple Path to Wealth. And he explains why having, you know, it's a general rule of thumb, 25 times annual expenses is enough to be considered financially independent and never work again. He goes into way more detail in the book that I'd rather not cover here. So just for simplistic sake, say you're living in New York City, your expenses are just say 100,000 a year for your family, 25 times that is 2.5 million. So one might say that's a lot of money. Another person might say that's like much less than they think they would need for to be

Starting point is 00:27:03 financially free. And to me, really, when I try and implement this into my own life, I see the holy grail not so much as hitting that your number, but finding something that pays you a reasonable or decent income, but it's also something you've really enjoyed doing. And you see many people in the financial independence retire early community. They work jobs they don't like. They're making crazy good money, but they're thinking five or 10 years out. They just want to work this job. They really don't like so they can hit their number, go to the beach, and live a totally different life. But everyone values something different and everyone has to figure out, you know,

Starting point is 00:27:41 what it is they want their life to look like. And, you know, I'm not really in a position to say what's right, what's wrong. You know, you have to, you know, look at your options and educate yourself on what opportunities are available. In Charlie Munger, I mentioned him. He was a huge fan of Benjamin Franklin. And he was well aware that it's not money that's scarce. It's our time that's scarce. Franklin knew that once you're financially independent, you have the ability to buy back your time. And then he started doing things like giving back to society, you know, just do things that he thought was beneficial for society and fulfilling to him. He wrote about how he wanted to live a useful life rather than simply die rich. And it reminds me again of the story.

Starting point is 00:28:21 I mentioned at the start where, you know, he just had a tremendous impact on society just because of the decisions he made and the contributions and, you know, the investments he made in himself and understanding investing, compounding and such. And again, one of my favorite chapters or favorite books overall is The Joy's at Compounding. And he has a chapter in that book on Financial Independence that I just loved. He tells the story of Munger going through some really tough periods early on in his life. He was broke, divorced, lost his kid when he was 29 and persevered through that. And yeah, I end up making just like an amazing life at the end. And I just really wanted to mention that chapter. I wanted to transition here to talk about the ways we can.

Starting point is 00:29:04 can achieve financial independence or hit that 25 times number that I mentioned. And that's also referred to as the 4% rule. There's, I believe it's called the Trinity study they put together. And there's so much research out there online if anyone wants to dive in deeper on the 4% rule. But in terms of hitting our number, there's a number of ways to get there. There's plenty of asset classes. You know, there's stocks, there's bonds, real estate. One could use their own business to build their wealth. Someone else's private business, invest in someone. else's business or, you know, I mentioned stocks, which is just public equities. And then there's things like precious metals and Bitcoin, which Preston covers on the feed here. So instead of

Starting point is 00:29:44 diving into the ends and outs of each asset class, how about Kyle, you talk about why you're dedicating the vast majority of your time and energy towards the stock market. Yeah. So like you said, you know, all those options are really good. But me personally, I have a very large percentage of my family's wealth in the stock market. And essentially the simple reason for that is that if you look at long-term charts, stocks are the best performing financial asset over like 150 years. But that's not everything. I think I've educated myself enough that I feel like I have the most amount of knowledge of businesses as compared to the other assets that you named on that list. So, you know, things that I've learned about to understand stocks better are things

Starting point is 00:30:21 like financial statements, moats, management, capital allocation, investor psychology, case studies of successes and failures, you know, biographies are really good source. And just learning about business models in general. So all these areas that I've really just educated myself on because I'm passionate about it really, really support me investing in public companies. And if I had to go outside of the public company realms, the next bucket would, that would make the most sense for me based on what I know would be private businesses because, you know, there's not much difference. It's just one has a stock price and one doesn't. So I've had some experience investing in crypto in the past and I made a lot of mistakes. So I feel I proved to myself that that wasn't an arena

Starting point is 00:31:02 that I had much proficiency in. And, you know, I know many of others have succeeded and my hats off to them. But when it comes to figuring out what to allocate your own savings to, you should take into account what you're already good at. If you have spent, you know, decades in the real estate market, but don't know the difference between a stock and a mutual fund, well, then you're probably better off investing in real estate. This is why investing is such an exciting endeavor because there's multiple roads that lead to Rome. You just have to find which road is optimized for you before you make the trek. Let's take a quick break and hear from today sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of

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Starting point is 00:35:40 Yeah, you make a really good point on picking the game that we're equipped to win. And part of that is how we're wired. Part of it also is just the skills we've developed over time. Like some people are just sort of born into a real estate family where their parents have always invested in real estate. And that's what, you know, they taught their kids. and same thing with the stock market. And I do know a number of people that are deeply involved in real estate and that's the game

Starting point is 00:36:06 they know. And I think that's generally kind of the sentiment with real estate is that you lose a lot of the control when you invest in stocks because you're outsourcing the management of the companies that you own when you buy stocks. You know, some see that as a benefit. Others see that as a, you know, a drawback. And to a large extent, that's true. Like, I don't want to manage all the companies I'm investing in.

Starting point is 00:36:28 I want someone else to do it. And you also might be someone that's a day trader. And for whatever reason, that might just be the game that they're equipped to win. And that's okay. And it also just might be how they're wired. They don't want to just sit back and not look at their investments for the next year. So, you know, and you might talk with a day trader and be like, hey, you could compound your money in whatever stock or index fund and watch it grow over 10 years. But they just want to focus on surviving that day. They love sort of that game and that's the game they're equipped to win and just the way they're wired. And again, that's just the way it is. And it's common advice in the world of the stock market and what J.L. Collins talks about in his book is for the vast majority of people to just invest in an index fund or a basket of index funds and take the guesswork out of choosing individual stocks. And for the vast majority of people, I think they may get better results just buying an index rather than picking stocks. That's not only because of the returns, but also the time that must be invested in researching companies, doing the due diligence, keeping up with their quarterly earnings, looking at the company's competitors, the list goes on. And when you're buying an index fund, if you're not familiar, a couple of very common ones here in the U.S. at least is Vanguard's S&P 500, the tickers VOO, and the total stock market index fund is VTSAX, both very popular.

Starting point is 00:37:56 I believe they both have similar return prospects. And I mentioned the time that's needed to manage a portfolio. Kyle, you and I talk a lot about this. My question is, when does someone really get a feel for picking individual companies? Is the game they're equipped to play and a game they're equipped to win? Because there's just so much more that goes into it when you're picking individual stocks. And you're super passionate about this. And you're quite certain that that's the past.

Starting point is 00:38:26 for you. So certainly you have some insights on what we need to think through in deciding, yeah, individual stocks is something, a game that we should be playing. I get asked us a lot. And, you know, looking back at what I did, I probably took the incorrect path, which is fine. But for people who don't understand businesses or don't really understand stocks, you're probably better off, like you said. And what I suggest to people, if they ask me, is just buy an index one first and then go from there. So I didn't take that route. I just went right into stocks. But, you know, the thing that's cool about index funds is it's very forgiving. You don't, you don't need to know how to read a balance sheet. You don't need to know about financial statements.

Starting point is 00:39:03 You don't even need to know the CEO's name or what the business sells. And, you know, because there's 500 companies in the SP 500. There's no chance that you're going to have, you know, you might have in-depth knowledge about a couple companies and that's cool. But there's no way you're going to know a lot about all the companies in an index fund. So to me, if you have an index fund and you find yourself spending time learning about some of the businesses inside of that index fund, well, that might be a trigger that maybe stocks or maybe a portion of your portfolio might be invested in stocks. Again, not financial advice is just kind of what I kind of foresee. So like I previously mentioned, I love individual businesses. So for me, to make that synergized kind of with my investing strategy,

Starting point is 00:39:40 it makes more sense to me just to own a few businesses that I feel I understand really well. Like I said, you know, I can't understand 500 businesses. I can understand 10 to 15 businesses. So to me, that makes more sense to me. And I'm willing and able to put in the work to understand. those businesses. But, you know, it is a lengthy analysis period. You know, like I said, if I was financially independent, I could manage my own portfolio or I could just own an index one and do absolutely nothing. But part of the joy for me of investing is I actually enjoy it. I enjoy it. I enjoy spending my time doing it. So, you know, that's just kind of a personal thing. But because the process is so lengthy, it requires a few things in order to make sure that you

Starting point is 00:40:16 only have a few ideas. So, you know, you have to make sure that you have conviction in your ideas and kind of know what you have. You have to understand that you are going to be spending a lot of time. It allows me, when I know only a few ideas to put more money into certain ideas that I think will have really, really good returns or certain ideas that I think I have a lot of conviction in. And then, you know, it gives me the ability to leave a business if I don't think I like the direction that it's going in. And so because I've learned all these things and I feel confident in using that as part of my strategy, it just makes more sense to own a few businesses and let the thesis that I find play out and see what happens. So, you know, just getting into strategy a little bit more,

Starting point is 00:40:53 I know that my thesis will be wrong at times. And when I'm wrong, I have to determine if my thesis can get back on track or not. Sometimes it can get back on and sometimes it's permanently derailed. So if it is permanently derailed, that means I have to sell. And so, you know, we'll be getting over some mistakes and stuff that people make. But for me, if I find something that isn't working out, then I just sell it and reallocate it to a different position. But the goal for me is to try and make it hard to find bad businesses or bad investments in my portfolio. I think that most people, should go the way of index funds simply because you get that nice 8 to 10% return. And you literally have to don't, you don't have to do any of the work that I just mentioned above because, you know, you can easily spend 40, 60. There's people probably spending 80 hours a week doing all this. I don't personally because I have a life and a job and a family. But my goal is to hopefully get above those rates of return by utilizing my behavioral edge. And so, yeah, this is my journey and looking forward to how it ends.

Starting point is 00:41:50 Yeah, and what's really interesting and somewhat puzzling to some people is the enjoyment of it. I think I know a lot of people who would be happy to manage their portfolio. And even if they knew their returns were going to be slightly lower than the index, they would probably still do it because it's like a, it's their way of interacting with the world and their way of learning more about that. So is that something you resonate with? Absolutely. Yeah, I mean, ever since I started learning about investing, I learn all sorts of things that

Starting point is 00:42:23 might not even have to do with investing because, you know, obviously I'm trying to learn, kind of be trying to be in a generalist, right? So I'm learning, you know, all sorts of things of different mental models, different sciences, psychology, all sorts of cool things. And 100% you nailed it. It really helps me understand the world better. It helps me keep up with things that I find important and interesting. And yeah, I agree. I think there's a lot of people that probably know that they'll underperform an index, but that little fee, that little change in return is worth it just because they get to partake in investing in individual stocks. Yeah, and I say the knowing they had underperform kind of tongue in cheek, because we never really

Starting point is 00:43:01 know what our returns are going to be. And we can always find reasons for why we underperformed in recent years and the mistakes we made. And hopefully we improve on those mistakes and get better over time. And investing, it's also a process of compounding knowledge. I'm reminded of the Buffett quote that he's a better businessman because he's an investor. He's a better investor because he's a businessman. And I feel that that's definitely applied to my life as well in thinking about business in general and what we do here at TIP. I think that feedback also goes back to being an investor.

Starting point is 00:43:34 And I think of companies like Costco and the tremendous value they're adding to society, like I know it's not a company I'd ever own, but like learning about that company is like so cool to me. and the tremendous value they're adding to society, like why no one else can do what they do, what's their edge in the markets. And just like studying all these things is so fascinating and it's just a rabbit hole that feels like it really never ends. Absolutely. And I agree with you on Costco. I've spent some time researching them and learning about sole price. And yeah, it's an incredible case study and definitely worth it just to understand business better. So again, one of the things I think

Starting point is 00:44:10 people have trouble with is the time commitment that it takes for managing a portfolio. So say someone wants to own 15 or 20 companies, they might end up analyzing 40 names and, you know, it takes quite a bit of time to dive into a name, read their reports, listen to some of their earnings calls and all the research that goes into that. And a year or two ago, you wrote an ebook. It was called Five Minutes to know. And it explains how you quickly say no to new ideas. And Sigoy says to me that, saying no is the best productivity hack. And it's really good advice with all the things that can grab our attention nowadays. And I think before you go out and pick stocks, you need to figure out what you're looking for. Ian Castle mentioned it just to me on the show that everyone, when they

Starting point is 00:44:56 first start out, it's like they show up to a restaurant the first time of their lives. And you don't know what you want. You see the menu and you just start trying things. And oftentimes people do the same thing in the stock market. They see Apple in the headlines. They go buy Apple. They shop on Amazon, so they go buy Amazon stock. And it's pretty well in line with Peter Lynch's advice of getting exposure to the market is just buying companies you interact with in your day-to-day life. So talk more about some of the things you covered in your e-book, five minutes and know and how we can quickly figure out what we're looking for and filter out the rest.

Starting point is 00:45:32 Yeah, great point. I mean, when I first started investing, I remember making the, I still have these, you know, Google spreadsheets of like 100 businesses. and I'd be looking in them and, you know, I don't think I bought any of them. And I literally spent all this time making that list and it was a waste of time, right? So as I've gotten more and more experience, I've realized, okay, well, I want to have a system where I could, you know, not do that and hopefully spend most of my time finding ideas that I actually want to invest in and make sense for me and my financial goals.

Starting point is 00:46:04 So I wrote the book specifically because I wanted to refine my own system and I thought it was pretty repeatable so that other people could hopefully use it as well. It's super simple in my opinion, but basically it allows you to easily find out of a business has some degree of quality and also finding the growth that I see personally. So the beauty of the system is that you can pick and choose to have numbers to whatever specifications you want. I'm trying to find investments that are growing at pretty high rates, hopefully around 15%. And that's kind of what I want my returns to be as well. So I have numbers optimized specifically for finding that kind of of investment. So other people might have different things are optimized it for. Maybe they want

Starting point is 00:46:42 10%. Maybe they want dividends. And that's cool. And you can, you know, kind of pick and choose and change it however you want. But this was kind of my system. So the way I do it, I literally just, I go over in the book, but I can literally just put a ticker symbol in FinChat and just I click a couple buttons of things that I think are interesting. And then it gives me those numbers in compound annual growth rates. So it might do things like checking revenues, net income, earnings per share. The share is outstanding. Checking their debt. Checking cash flows. I can see the capital efficiency. I can see all this just on Finchat. So it takes me really, really short period time. And then there's other sources you can check to see insider ownership, as I do like having

Starting point is 00:47:19 pretty high insider ownership. And it basically just lets me see really quickly if a business meets the benchmarks that I'm looking for. And, you know, will it remove a lot of great investments? I know I've gotten a lot of flack on on X from people, being like, oh, well, like, you would never have found Amazon. And yeah, for sure, it definitely removes tons of good investments. But the point of it is it just removes, it just adds an additional guardrail and simplifies things. So, you know, now that I understand the system really well, I can easily make modifications to the system that work for me. And I, I break my own rules all the time because I understand it and I know what I'm looking for and there might be certain situations that, you know, might not necessarily

Starting point is 00:47:56 fit right away, but I feel like at its ground base, the system still runs what I'm trying to do. It's just, like I said, there's a lot of little nuance to how I use it. You mentioned all those metrics, revenue, net income, all these financial metrics. And one really important one is return on invested capital. And you wrote about that in the ebook as well. I think a lot of retail investors don't really understand what this means. And it's actually one of the most important metrics to know. And I've been recently reading the book you covered on the show, what I learned about investing from Darwin by Poulac Prasad. And man, it is definitely one of the best invests. books I've read in the past year or two. So Prasad, he uses return on capital employed instead of return on invested capital. That's his most important metric for filtering on business quality, because really it takes into account the profits that a company produces, as well as the amount of capital it took to produce that level of profit. And when you filter on this, it's quite interesting because you obviously narrow down your opportunity set of the companies you're looking at,

Starting point is 00:49:07 and then you have a good number of high-quality businesses once you filter on, say, 15% return on capital employed, for example. But when you don't filter on that, of course, you might be filtering out Amazon or Netflix, and he makes such the great point that, you know, just considering like the base rates of success, there's a host of tech companies in 1999. And obviously, Amazon was the right one to invest in. But what's not in the headlines is the countless others who maybe had a leader just as brilliant as Jeff Bezos, but things just didn't work out the way it did with Amazon.

Starting point is 00:49:42 And, you know, again, the base rates of success. That's something that's really important. One thing that I've been thinking a lot about lately in reading this book is just minimizing the chance of luck playing a role in investment success. Obviously, luck plays some role in a lot of companies, but you want to try and minimize that and maximize. I always think back to in my interview with Morgan Housel. He tied in a quote from Naval, where Naval is like, if you lived a thousand lives,

Starting point is 00:50:13 you want to make sure you're wealthy in 99 of them. You know, there's plenty of alternative histories out there where maybe Amazon doesn't do quite near as well as they did. Or maybe there's a scenario where, you know, the retail business does well. The stock is average at best, but Amazon AWS was never a thing. You know, just simple things like that. You know, luck certainly plays a role. And again, we're not here to say there's a right or wrong way to invest, but what we can do is share how we sort of think about things.

Starting point is 00:50:42 So turning back to return on capital employed here, it's calculated simply as the operating profit of a business or the EBIT divided by the total capital employed. And the total capital employed is simply the total assets minus total liabilities. So again, how much profit does a company produce relative to the amount of. capital it took to produce those profits. So it's really bringing in two financial metrics into one. Since we mentioned Costco, I've pulled their numbers. Their return on capital employed is around 23%. And you'll find that most other retailers have a much lower return on capital employed. And that's also why Costco trades at a higher valuation relative to their earnings. So really, if you put a dollar into Costco, it's really a metric of how much earnings would that dollar give you back. So if you put one

Starting point is 00:51:30 in and they go out and reinvest it back into the business, you'll get 23 cents in profits. And Prasad, I just loved the way he explained why this metric is so useful. We're told to look for so many things when selecting businesses. And he talks about how just this one thing is such a great filter for filtering on quality. You know, many businesses have managers that are impressive. They create amazing products. They're very charismatic. But that doesn't mean they're great capital allocators or the business has great

Starting point is 00:52:00 economics. And he explains that many companies look to have great managers, but they either overlook or don't understand capital allocation. And it's sort of just a filter. Like instead of going, looking at a company and looking at the management, before you look, dive in deeper into the company, what's the return on capital employed? Because a high return on capital employed tells you that management's doing something right. So a consistently high return on capital employed, say it's greater than 15%. It's also an indicator of a strong moat. And it's just a really great starting point for what sort of return you can expect going forward. And of course, it's not a magic bullet. Like just because you filter on this one metric, it's just like the secret that no one's talking

Starting point is 00:52:44 about. But it tends to be a good place to start in your analysis. And I wanted to also mention a point that Prasad made I hadn't considered too much. She explained that a high return on capital employed business, it allows a company to take business risk without taking financial risk. So it really increases the chances of business success as they weather through, you know, weather through this very intense capitalistic world. And companies with a high return on capital employed and a strong balance sheet, they can go out and invest in new opportunities and afford for them not to work out because they're in a strong financial position.

Starting point is 00:53:20 Whereas if you have another business, they have low returns on capital, weaker balance sheet. And if that project fails, you know, it really could hurt the business because it, you know, could weaken their position. They need to issue equity, issue debt just to weather through that. And this is why you find in some industries that some one, two or three players just sort dominate. And then just the weak continues to get weaker. And you just see that divide in terms of the great businesses and the poor businesses.

Starting point is 00:53:48 So again, such an amazing book. It truly was, I agree with you, probably one of the best books I've read in in the last couple of years. So Fulac did a great job like you already outlined about why he likes returns on capital employed and why I bring so many additional benefits to a business that has a number like a REOCE over say 15%. So I personally use R-O-I-C, which has many similarities. But honestly, you know, if you have a high R-O-C business, there's a pretty good chance it also has a high R-O-I-C. So, you know, you're just kind of nitpicking here. But just kind of digging in a little more into the weeds, if you do decide to use these numbers, I would highly recommend

Starting point is 00:54:24 recommend kind of breaking them down and finding out, you know, which numbers belong in there and which, which don't. So, you know, so for instance, with returns on capital employee, you're using earnings before interest and taxes. With returns on invested capital, you're using net operating profit after taxes. So these are just minor differences. The numbers are going to be a little bit different. But if you look at each line item and that you're accounting for using those equations, you can take a look and maybe make a more accurate number by making certain adjustments. So an example here might be like for me, when I'm looking at, you know, that returns on invested capital, I remove cash from the invested capital equation. So the reasoning

Starting point is 00:55:00 for me is that, you know, cash isn't invested in the business. So it's not generating a return. So removing it makes sense. But, you know, and this gets into really understanding a business, there are some businesses where they use their cash in their business to operate it. So in that sense, you know, you would actually keep a little bit of cash maybe in that invested capital number to get a more accurate return on invested capital number. So this is just saying that, you know, look more into how you're doing these calculations such as return on capital employed or return on invested capital and look at the adjustments that can and should be made to make a more accurate number because there's a lot of data out there and you can make some really, really big blunders by just

Starting point is 00:55:38 kind of defaulting and putting every company into one bucket. So just a resource I would highly recommend. Just look up Michael, Michael Mobison's papers on return on invested capital. They're like incredibly well done. I've learned so much from them. So just look at that if you really want to get into the weeds. If you want to keep things super simple, just, you know, stick with whatever you learn on the data aggregators. But if you want to really understand a company really well, I would highly recommend digging into the weeds. Another point that comes to mind here is the reinvestment rate. I'm reminded of Dino Polska because the formula just seems so simple. And we did an episode on it. So many of the audience are going to be aware as well. So if their

Starting point is 00:56:17 return on investing capital is in the 20 to 25 percent range and they reinvesting. And they reinvesting $100% of cash flows, do you sort of assume that that's going to imply to, you know, that level of earnings growth in the future? Maybe talk more about that reinvestment rate, because you might have a company with a high return on capital employed, but their reinvestment rate might be zero. So talk more about that sort of dynamic of how that ends up playing into how the business develops and maybe it's stock performance too. So yeah, like you said, I think returns on invested capital, reinvestment rates are highly impactful, obviously, on the share price of a specific business. So let's go over a quick example to show the audience why that would be. So let's say we have two businesses. Let's say they're both earning 20% returns on invested capital. But the difference, let's call them A and B, A is retaining 100% of its earnings and B is retaining 50% of its earnings. So by retaining, that basically just means that all of the money that they're creating, all the profits are being reinvested into the business.

Starting point is 00:57:22 So A is reinvesting all of that money back into the business, whereas B is only reinvesting 50% of that. And then the other 50% is just being paid out as a dividend to shareholders. So let's just go over some of what happens over a 10 year time period. So let's assume both these businesses have a constant valuation. So I know that this is kind of not possible in the stock market. We don't have constant valuation, but just for simplicity sake, for the sake that we're doing this on a podcast, we're just going to say that the valuation just stays at a price or earnings value of 20 for both businesses. So let's start with B, which is retaining about 50% of their earnings. So we're going to start them both off at per share earnings of just a dollar.

Starting point is 00:58:01 So after 10 years, B is going to have an EPS of about $2.85 and they are going to have a total return, including the dividends. We're not reinvest in dividends just for the simplicity sake of about 330% and a compound annual gain of 12.7%. So that's why. That's really good, right? But you can see there that 12.7% obviously isn't 20%. It's good and that's nice. But let's see now what happens with business A that retains all of its, all of its earnings. So in business A, same thing. Earnings per share starts at $1, but after 10 years, that jumps all the way up to $7.43. So that gives you a total return of 743% and a compound annual gain of 20%. So you can see now that, you know, that high return on invest in capital number

Starting point is 00:58:50 is going to be much more accurate over a long period of time if you assume that 100% of profits are reinvested into the business. If you're not doing that, then that number is going to be significantly lower. And obviously, you know, if you have a higher return on investing capital business, you're still probably going to do really, really well, even if that business is distributing a lot of the money to shareholders by dividends or buybacks. But the point is, is, you know, if you can find these compounders, these businesses that can put all of their profits back into the business and then just keep on compounding at historical rates, that's where you're going to make the most amount of, the most amount of returns just because, you know, it's just a math

Starting point is 00:59:28 equation. I mean, I'm just plugging in some numbers into Excel and getting these numbers that I just described to you. But yeah, so that's really powerful. So it's really, really, really important that you look not only at returns on invested capital, but also at the reinvestment rates. So one just kind of simple thing you can do to, find out reinvestment rates is to look at retained earnings. So retained earnings are a portion of the balance sheet that you'll find under equity. Basically, retained earnings is just like, like I just said, it's basically the amount of money that the company retains. So if retained earnings goes up, you know, $100 million, that means that the company retained $100 million

Starting point is 01:00:09 of profits and placed it back into the business. If you saw that that same company earned $100 million dollars in profits, then you can deduce that, you know, they put 100% of that money back into the business. But if that company, let's say they earn $200 million and they only put $100 million back into the company, then that means they have a 50% retained earnings rate. So you want to be really careful that. Obviously, you can still do well, a business that Clay and I both own, that does have a pretty high dividend payout ratio would be evolution, which is paying out about 50% of its profits. You know, as shareholders, yeah, of course, we would love to see that business be able to put all of its money back into the business and, you know, continue compounding

Starting point is 01:00:50 that capital at really high rates. But the fact is just, you know, with certain businesses and evolution is definitely included. There's just not places to put money. Evolution has done a couple of acquisitions where they've tried to put that money to work. But I would say the returns on invest in capital on those acquisitions definitely is not anywhere close to their historical rates. So yeah, it's just, you kind of have to weigh the pros and cons. For me, in a perfect scenario, I would just be looking at businesses that can have a 100% retained earnings rate and hopefully just keep on pumping money into the business into really high return on investment capital opportunities and then, you know, just keep that compounding

Starting point is 01:01:30 engine going. It also kind of comes into the life cycle of businesses. More mature businesses, they run out of places to spend money, whereas a younger business might have a bunch of different places to have to spend their money. So you kind of have to be the judge of where our business is in this life cycle and understand it really well. And then the other thing also to look into is that, you know, with Dino Polska, they're reinvesting all their money into one thing, which is just new stores and they have a long track record of doing that really, really well. Whereas some other, you know, look at Google, they have a whole other bets part to their

Starting point is 01:02:01 balance sheet of other bets that they put money into. And a lot of them, you know, probably were zero. But, you know, they have their own way of doing it, kind of like the Amazon model where they're just throwing some little things at the wall, not spending a lot of money and hoping one works. So in Amazon's case, Amazon Web Services worked well. But there's just something to be said with if you have a business that can clearly reinvest its money into something that it's already really, really good in. You know, that's like, that's where the magic comes from. So that's why Dino Polska, in my view, is priced where it is.

Starting point is 01:02:28 It's just an incredible business. They can keep reinvesting their profits for quite a long period of time. And they probably are still going to earn the same returns on investing. the capital. So, yeah, I hope that's helpful. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. Vanta 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 two or running an enterprise GRC program, Vanta keeps you

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Starting point is 01:05:49 risks, charges, and expenses. This and other information can be found in the income Funds Perspectus at Fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Yeah. And another thing that you mentioned there that's really interesting is each company has its own life cycle. So when a company is in its first few years of operations, they found their niche. They found what they can do differently and what sort of value they can provide. They have a small part of a large market generally. In a case where they found a formula that works and they have something they could copy and paste time and time again. I'm reminded I just picked up Williams book this morning and I was reading through Will Danoff, I believe his

Starting point is 01:06:34 name was. He was at Fidelity and he has a very, very good track record. He interviewed Howard Schultz one week before they went public Starbucks and they had, I believe it was a 192 stores. And Will Danoff saw that it costed $250,000 to build a Starbucks location. And then it in year three, that store would earn 150,000 in profits. So that's a 60% return in year three. And then hopefully that's stable over time and competitors don't come in and eat their lunch. But 192 stores and, you know, there's hundreds of thousands, if not millions of coffee shops globally that they could, you know, try and steal some share from. And that's a case where it's very early on in 1992 as the year it was when they went public. I think for you and me, we want to find companies that

Starting point is 01:07:22 are earlier on in their cycle. There's enough history to where we can see the formula works. It's predictable. We have a sense of management knowing what they're doing and the market opportunity that's there. But say, you know, there's someone that's listening to the show and they have a nest egg that they need to protect and they're in their 60s or 70s or whatnot, then they might want companies that are later in their life cycle where they can start collecting dividends from companies and they don't need a lot of growth. And obviously, there's execution risk in terms of going and continuing to build and expand the business. So I think there's sort of an alignment of as an investor matures in ages, the companies they're looking for changes as well. And that's

Starting point is 01:08:06 totally okay. And obviously there is some execution risk with the company like Dino Polska. Over time, we're hoping eventually they have double the size of their business. And that's not going to be easy. I don't care who you are. And Technion as well, they're going to have to learn a lot of new things and growing and expanding their operations. And yeah. And that's perfectly fine. You know, you don't have to, if you're someone who's averse to risk or is someone who's going to be in need of your money in a very short period of time, well, then your investing strategy is going to be a lot different probably than Clay and I, because we still have probably decades until we're going to use our money. So, and that's perfectly fine. You don't have to get into everything. Definitely make sure you

Starting point is 01:08:44 know where you are in your life cycle and how soon you're going to need the money. Because if you need the money really soon, then it might make sense to have a large portion of your investments in bonds because, you know, they tend to be very reliable and don't go down very much. But not something that interests me. What's also interesting with regards to stocks is so many people talk about, you know, the statistics that show that it's very unlikely that a retail investor is going to beat the market. And obviously, I'm somewhat biased because I'm a stock picker, just like you. And, and And maybe I'm way overconfident in my abilities to do well in the markets. But I'm led to believe that individual investors actually have some edges that either institutions

Starting point is 01:09:25 or other market participants just generally don't have. I'm going to highlight a few edges here just to share some of the things I've found in the research on, you know, why should I be picking stocks? Why not just park it in an index and just call it a day? So the first one I wanted to mention here is that I think the biggest edge that individual investors can harness is patience. It sounds so simple that it just like can't be true. But I truly believe it's the case. And Bill Miller, he's well known for saying that there are three edges an investor can have that's informational, analytical, and behavioral. So in terms of information, everyone

Starting point is 01:10:02 nowadays has access to the company's filings and the internet made that accessible to everyone. So Ben Graham might be able to have a informational edge, but I don't think I'm going to ever have one. The second one is analytical. So I don't believe I necessarily have an analytical edge. There's a lot of people out there that are a lot smarter than me and a lot of people that build complex programs that I'll never be able to understand. So that leaves us with behavioral. So there's plenty of data out there that shows that the average holding period of stocks

Starting point is 01:10:32 continues to decline. One of the more recent studies is in the 1970s, the average holding period was five years. And in 2023, it was just 10 months. So the average participant is holding a stock for 10 months. And I generally think that humans are really just biologically hardwired to be impatient. And it makes sense if you're out in the African Savannah, like you don't care about the compounding that can happen 20 years down the line. You're just wanting to figure out where your next meal is going to come from.

Starting point is 01:11:02 And I'm led to believe that most market participants aren't willing to look out five years or more in holding a great business that might have a PE that's optically. high. So I'm also happy to see meta stock recently cross $450. And that's not because I own shares, but I think it's a perfect example of the market largely being inefficient. So in less than 18 months, this stock is up over 400%. And I'm nearly 100% confident that the fundamentals of this business have not changed that much in that short period of time. And then the second point I wanted to mentioned here is God on Facebook, it just really influenced me and led me to believe that quality and companies have the potential to be underappreciated by the market. The best businesses

Starting point is 01:11:50 tend to have earning surprises to the upside. It's quite funny where as value investors, we're sort of taught to have like conservative assumptions and that can keep a lot of people out of quality businesses because they're conservatively doing 10% growth rates for three years and maybe you're not willing to look out further when in reality the business has consistently grown at over 20% a year and you just never buy it because you don't realize the quality that's there. And then investors also just underestimate the duration of how long a quality business can grow. So the difficult part with this is that it takes time to realize whether you were right in your initial assessment. So you might buy a business today in 2024. The stock price might not go anywhere for a few years and maybe the business continues to

Starting point is 01:12:35 execute, but, you know, it just takes time to recognize whether you made a mistake or whether you were right in your assessment. So that's really the difficult part with thinking long-term and being patient is it might take years to recognize whether you're any good at it or not. And the third point I wanted to mention here is not every business is as well covered as every other business. So many people pay close attention to the magnificent seven. But there are loads of quality businesses out there that 99.9% of an investors have never heard of and don't even know it exists. This really can create significant mispricings. And it's funny, I mentioned the informational edge earlier, how, you know, information's available

Starting point is 01:13:14 to everyone. That still doesn't mean everyone's looked at every single business out there. And there's a lot of what we believe are great businesses that we've found and discussed with our mastermind community, where there's little analyst coverage, few institutions have probably looked at it. You know, you and I have talked about how we're finding more opportunities internationally as of internationally, meaning outside the U.S. at least. There are still great opportunities in the U.S., but there seems to be even more compelling opportunities for us, in our view, at least, when looking at these other markets on a risk-adjusted basis.

Starting point is 01:13:49 It'll take time to find out if we're right or if, you know, the U.S. is still a better place to look. And another example is smaller companies tend to be more illiquid, you know, just because there's so few market participants that move the price that can. also create mispricings and it also keeps a lot of institutions out from even investing in it or again even looking at it. With that said, the beauty of index funds is that it still takes all the worry of even having to consider all these factors of company size, the country it's in and whatnot. And, you know, index funds allow anyone to harness the power of compounding. And you don't need to understand

Starting point is 01:14:25 balance sheets and return on capital employed. So again, like you mentioned, you can know next and nothing and still be able to harness it. I really think you nailed it with the three buckets on the edges that investors can have that were outlined by Bill Miller. So you had a recent interview with Scott Phillips of Templeton and Phillips Capital Management and Scott was talking about these edges. And he said, quote, am I going to go out and compete with a multi-billion dollar hedge fund that has satellite imagery and unstructured data to get the edge on customer accounts

Starting point is 01:14:53 at shopping malls in Walmart or oil fields or cargo? You get the idea, unquote. So retail investor with limited resources. is there's just no chance you're going to be able to compete with a billion dollar hedge fund that has access to these types of information and analytical edges. But like you said, the behavioral department is where the individual investor really, really does have an edge. So I've written about this. I call it the retail investor's edge. And so I just wanted to share some key findings from from what I wrote about it. So the first thing is, is if you put yourself in the shoes of a professional

Starting point is 01:15:24 investor, you have to understand there's a whole bunch of different things that you have to worry about, whereas when you're an individual investor, you don't have to worry about it. You have to worry about your partners. You have to keep them happy. And so this usually means that you're trying to basically match the index each quarter so that you can have similar results to other managers out there. So I personally, I don't care about that. I don't care.

Starting point is 01:15:45 I might underperform sometimes. I might be the same. I don't care. I'm looking out like Clay has been mentioning a lot is we're looking out 10, 20, 30 years. So what happens in one quarter is completely irrelevant to me. So when you look at being an individual investor, you don't have partners and it opens up a lot of strategies that institutions just simply can't do. So I'll just list off a whole bunch of them here. So like I just said, you don't have to track your performance on short term fluctuations of stock prices. You know, prices go up and down. And a lot of times when they go down, I see as an opportunity, whereas an institution might see that as I need to sell it. You can look at the process. So, you know, your process is more important than your outcome. So whereas an institution might have to be worried about that outcome, I don't. I can just make sure I have a process where over the long term, hopefully, my outcome is going to be very, very good.

Starting point is 01:16:32 And so I'm okay with short-term losses, as I mentioned as well. So another one is that, you know, you can use longer timeframes to make great investments. So maybe a company is going through some short-term headwinds, but let's say in the next year, they're going to be out of those headwinds. You can buy these stocks, but if Wall Street thinks the stock price isn't going to move, they're not going to buy it. They're going to probably wait. So that gives the individual investor these huge advantages where it's like, okay, well,

Starting point is 01:16:56 I'm going to buy the stock that's gone down. Let's say it's gone down 50%. Maybe it goes down a little bit more. But, you know, I'm going to hold it for five years. Whereas an institution might be like, okay, well, it's at 50% is cheap, but it could go down another 10% this quarter and, you know, not provide any return for our partners. So they'll skip it. So another one is that you don't need to try to time the market.

Starting point is 01:17:17 Institutions, you know, like I said, they want to try to match the market. And so if they think the market's going to go down, they're probably going to sell, which is, you know, it's not the right way to invest as as we talk about all the time. And if you, you know, read all the grades that that's not what you want to be doing. So, you know, we as individual investors don't have to fear short-term losses. And you should in fact live with them because if you're a long-term investor, you should understand that sometimes the market won't love your stock and the price will go down. And as long as the fundamentals of your business are improving as you kind of envisioned, then you're good just holding on to it regardless of what happens with the stock price.

Starting point is 01:17:52 Another one is that you can buy anything in any industry or geography. So Clay already brought this up that, you know, we both look a lot outside of the United States. I still think the United States is probably the best market in the world. But, you know, everyone knows that it's the best market in the world, right? So that means that there's a lot of investors looking at companies in the U.S. and because of that, the prices are simply high. Whereas if you look at other markets, there's just prices that are not so high and a lot of very attractive opportunities and high quality businesses. And then, you know, it also matters that the geography you're looking at. There might be. even countries, whole countries that are unloved or that people don't understand. So like Turkey, I know obviously Monich Pabriah loves Turkey. I personally don't understand Turkey at all. So I wouldn't invest in it. But, you know, if you have proficiency in other countries that other people don't, that's a huge edge that you can have. Another edge that individual investors have that Clay also mentioned was market cap size. So let's say you're managing a billion dollars. Are you going to buy a little nano cap that's $20 million and has a $1 million dollar float that, you know, that's not going to move the needle for you. So you're not going to spend a

Starting point is 01:18:56 second even thinking about investing in that business, even not nanocaps, even like a small cap, that's like $500 million. You're probably still not going to spend much time on that. So because of that, there's not a lot of professional investors looking at a lot of these businesses that are smaller. And a lot of them are really high quality. And that's a huge, huge, huge advantage, especially when you're an individual investor with obviously, you probably don't have $100 million to invest. You might just have a whatever, a couple hundred thousand or a thousand. $1,000, whatever. In that case, you can literally buy anything and that will move the needle for you. So, you don't have to worry about that and you don't have to worry about liquidity as well. Another thing that

Starting point is 01:19:31 individual investors can do is concentrate positions based on their conviction. So a lot of institutional investors have all sorts of restrictions that, like for instance, the SEC will say, you know, you can't put more than, I don't know, 5% into a position. So for me, I have positions like evolution that are 20% and I have no problem with that. I sleep very, very well at night. But that's, that's an advantage for me because I think that it's a position I have a lot of conviction in. And that's something that institutions can't do because if that were to go down a lot, they'd get a lot in trouble with their partners, but they'd also get in trouble with the SEC. And then lastly, is that obviously as an individual investor, we can live with a lot of volatility. I kind of

Starting point is 01:20:09 already hammered that point home. But just because your portfolio is down doesn't necessarily even mean you're a bad investor. This kind of goes into the process over outcome thing. You know, you can have the best process in the world. And sometimes over the short term, the outcome won't be what you want it to be. But if your process is really good over the long term, your outcome should be really good. And so you can take advantage of that by just kind of shrugging off some of the short-term losses that your portfolio makes as long as you understand the businesses that you have in them. I have a few points I'd like to add here. So I was on a call with a new member of our master buying community. And he manages a family office. Well, I asked him if he managed, you know,

Starting point is 01:20:47 other people's money, you know, friends or any other partners. And he said, no, It's just a family's money. And he mentioned one of the advantages of that is permanent capital. It reminds me of Bill Miller. And I don't know the exact numbers, but the great financial crisis was a very, very tough time for him. And part of the reason for that was not only was his portfolio dropping like crazy because he had a heavy allocation to Amazon and the overall market was just getting hammered, but investors were just pulling their money out of the fund at the exact wrong time.

Starting point is 01:21:19 So, I mean, at the end of the day, he really couldn't control it. I mean, obviously he let them invest in the first place. And Nick Sleep has talked about being careful who you partner with and ensure I think Sleep had people sign off that they should be investing for at least the next five years. And it's quite an interesting dynamic because you and I, Kyle, like, when our portfolios go down, no one's calling us trying to get us to sell our positions. You know, as we earn income from what we do, hopefully we're taking some of those free cash flows and buying better bargains when they're at great prices.

Starting point is 01:21:52 And I was on a call with Chris Mayer for an interview the other day. And he mentioned to me that his funds closed. He's mentioned multiple times that when his portfolio goes down, he has a lot of investors calling him adding money so he can go and buy. I mean, that's sort of the ideal situation for a fund manager. And it also creates a sort of paradox where if you're a really, really good investment manager and you have a track record about performing, naturally, I mean, just due to incentives, like naturally you're going to bring on more investors and your fund's going to grow. It's going to

Starting point is 01:22:25 grow from 10 million to 100 million to likely much larger as long as you continue to do really, really well. Size becomes sort of a disadvantage where Chris, for example, is an invested in a company that's sub one billion dollars. And once he gets to a certain size, you know, companies with less than a billion dollars, he just can't really touch either just due to liquidity issues or just isn't going to move the needle. It might be, you know, even if he makes it a 1% position, it's just not really going to be worth the time for him in the way he manages a fund. So there's all these interesting aspects at play of how these incentives within how people manage funds and the downstream effects of bargains, where those bargains are to be found. And again, you know,

Starting point is 01:23:09 once you're aware of all these inefficiencies of how money sort of flows within different capital markets, you and I have a chance to hopefully capitalize on those. And there's, there's so much to do with how institutional money works that I've been learning a lot now. And it's a really interesting realm to try to educate yourself on. Before we wrap it up here, Kyle, I know you've read a ton of investing books. And I know there's a lot of people in our audience who are readers and they're always looking for new books to read. And you found one that's probably going to be one of the best reads for me this year, what I learned about investing from Darwin by Poulac Prasad. So maybe you can mention a few of some of the

Starting point is 01:23:48 most impactful books that helped you develop as an investor and maybe one or two of the high, high level takeaways of what you learned from reading them. Yeah, absolutely. So the first one is probably one that's going to be surprised to a lot of people. And that's invested by Phil and Daniel Town. And the reason I think this book is so good. You know, if you've been investing for 10 years, yeah, probably it's not the best. But as an introduction to investing, it's hard to find a book, I think that's better just because it does such a good job of making, investing really, really simple and kind of covering the whole gamut of what you need to know in a very simplified way. So I personally, it's funny, because he has a couple of valuation methods that he uses

Starting point is 01:24:29 to evaluate business. I still use them to this day. I still, they're all really simple and I love simplicity. So that's kind of, that was probably one of my biggest takeaway is his evaluation methods. And then, you know, he talks a lot about moats and just simplifying what they are, what they mean, and labeling them, which was really helpful. So if you're a lot newer to investing, I think Invest is a great book. I'm lucky. That was honestly, I think it was like maybe the second or third book I read about investing back in 2020 when I really started getting interested. And I still refer to it because it has some really, really good points. And it's really simple. So I highly recommend that, especially if you're newer. Then probably the one that has the most impact on me was the most important thing by Howard Marks.

Starting point is 01:25:08 There's a lot of things that I learned from this, but I really, really think it's probably the best book on risk in relation to investing that I've read. He does such a good job of showing you, you know, how market cycles work and where risk is off and where risk is on inside of that market cycle. And it's really, really important, I think, to understand that. One thing I really like to do is when the markets are up and everyone's euphoric and maybe me too, I'm happy is I'll go back and look at risk and read about, you know, he talks about things that happen in the great financial crisis and the tech bubble. Just to kind of get a reminder that, you know, when everyone's really, really happy is the time when you actually should start being kind of scared because that

Starting point is 01:25:49 usually means that the cycle is going to turn. Who knows when? Again, he makes a really, really good point that you shouldn't be trying to try to time the cycles, but you should understand where you are in them. So I think that was really important. And then another book that had a really big impact on me was the Warren Buffett portfolio by Robert Hagstrom. That one man, like I learned a lot about how I invest now, which was, you know, things to do with conviction, concentrating your portfolio, being long-term oriented. He uses tons and tons of different case studies from, you know, investors that everyone knows, such as Warren Buffett, of course, and Charlie Munger, John Maynard Keynes, and all sorts of just really concentrated investors who had these really good

Starting point is 01:26:27 track records and talks about the similarities and their strategies and how it works. And Another thing also that I really liked was that he talked about being long term oriented in that book. And especially how if you're long term oriented, you don't necessarily have to look at the stock prices to determine how good you're doing. So he talks a little bit about Buffett and look through earnings and how Buffett, he doesn't, I don't think he's talked about it for quite a long time. But he has in previous letters. And that's a really good way of just measuring your performance without even necessarily having a ticker price. So, you know, you just, for instance, you can look at add up the EPS of the businesses that you have and look. at how that goes up over time. And, you know, that's just a really easy way. Because if your businesses are all growing at 15% per year, then generally speaking, your portfolio should probably

Starting point is 01:27:11 grow at about 15%. Obviously, it won't because the stock market is fickle. And over the short term, it likes things and it hates other things. But the point being that if you want to be long term oriented using metrics that maybe don't have to do with stock price are really smart idea to track your own performance. So yeah, those are three books that definitely had a lot of impact on me. Obviously, we could spend a lot of time digging into specific things in there. But yeah, those were the three for me. All right. I'll be sure to get all three of those linked in the show notes. I'll also add a couple of comments on the invested one. For anyone in the audience, it's like pretty new to investing or they don't really know where to start. I think one of the

Starting point is 01:27:48 most important things is just like find the right resources to help get you going. Because, you know, so much of the learning comes in that early part of the phase. And now, Kyle, when you and I read an investing book, like, we're just happy to get, like, just a few insights that we sort of add to our investing toolkit. But initially, it's just like information overload. And, you know, when you find the right book, it can just be immensely, immensely helpful. So I'm glad you mentioned invested by Phil and Danielle Town. And then regarding the Warren Buffett portfolio, you talked about look through earnings and looking at the business performance rather than the stock performance. And I'm reminded of 2022. I just chatted about this with Chris Mayer where that was a year

Starting point is 01:28:30 where many great businesses, it was really just business as usual. They continue to increase earnings. They continue to reinvest. They continue to do what they've always done. But there's so much noise. Markets overall went down. So a lot of these share prices went down. But if you just, I'm also reminded of Chris Mayer's book, Hunterbaggers. If you look at Monster beverage, if you just look at their financials and that's all you knew about the business, you probably never would. have sold that stock because earnings just went up year after year after year. And any of the noise you took in would have just been detrimental to potentially trimming your position or selling when the share price is down and such. But I don't want to keep you too long here, Kyle. Really appreciate

Starting point is 01:29:10 you joining me. And that wraps up our discussion on stock market basics and financial independence. We're actually going to be releasing a second episode here in a couple days on Saturday, March 9th. We're going to be talking about what we've learned about investing in stocks over the years and some of the mistakes we've made. And hopefully we can share some of those mistakes and you can learn from them and not make the same mistakes we did. So be sure to follow the show and get notified of our episode's next release. And Kyle, thanks so much for recording with me. It's always a pleasure to have a chance to connect on the show. Had a blast.

Starting point is 01:29:47 All right. So as promised, I wanted to include some announcements related to our TIP. Mastermind Community? We've been quite surprised by the level of interest in such a community, and after launching the group in April of 2023, we've had an amazing inflow of high-quality members, and we're soon going to be capping the group at 150. For those not familiar, the TIP Mastermind Community is our paid community to network with like-minded value investors. One member described the group as a place to surround yourself with high-frequency people, and I just absolutely loved that. We have weekly live Zoom calls to talk about various topics from the stock market to life.

Starting point is 01:30:25 We also bring in special guests every month. Previous guests we've had with the group include Pooleuk Prasad, Chris Mayer, Godham Bade, and Ian Castle. We have an online forum to connect with others, get to know each other, and share ideas. And we have two live events each year, the first one being in Omaha and May during the Berkshire weekend, and the second being in the fall in New York City. Another cool thing about the community is that after you join, it only gets better and better over time, as we attract to the right members, continue to share new ideas, and build a growing library of content as we record all of our calls, which is now over 55 videos. We've recently decided to double down on our mastermind community as well.

Starting point is 01:31:05 My co-host, Kyle Greve, will be spending more time with the group, and we're going to be a bit more stringent on the type of people we allow to join in, and we're working to have one more very special member of the TIP team get more involved, but more details are to come on that front. Some of the upcoming Zoom events we have planned over the next month include a Q&A with Brett Kelly, the founder and CEO of Kelly Partners Group, a stock presentation on TextSSA by one of our members, a book club discussion on Nassim Teleb's book fooled by randomness, and a social hour discussing new stock ideas and what we're seeing in the markets. We've also recently hiked the price due to the demand we've seen.

Starting point is 01:31:44 also mention that we'd love to have more members that come from the investment industry. So if this is you, remember that we even have members that have their employers pay for their membership because of the value it adds to the work they do. To apply to join the community, you can go to theinvestorspodcast.com slash mastermind or simply click the link in the show notes. That's the investorspodcast.com slash mastermind. So if you're interested in joining, I encourage you to not wait because we're We're going to be capping the group at 150 members and not go above that amount. Hope to see you there.

Starting point is 01:32:21 Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by The Investors Podcasts. broadcast network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP613: Stock Market Basics & Financial Independence w/ Clay Finck & Kyle Grieve

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