We Study Billionaires - The Investor’s Podcast Network - TIP614: Investing Guardrails: Avoiding Common Mistakes w/ Kyle Grieve and Clay Finck

Starting point is 00:00:00 You're listening to TIP. In today's episode, my co-host Clay Fink and I dive deep into how human psychology impacts your investment decisions, why even the best investors fall victim to their own biases, strategies to mitigate common mistakes, how to deal with market timing, leverage, and speculation, why you should focus your time on improving patients, simplifying things, and understanding value, how you can recognize the biases of the market by understanding market cycles, why you should prioritize temperament over intellect, the importance of long-term results over quick gains, and a whole lot more. Clay and I already discussed the simple reasons we like to invest in

Starting point is 00:00:39 the stock market and why we invest in stocks rather than other assets in episode 613 from Thursday. We also discussed some of our goals and investing strategy. If you haven't listened to that episode, I checked that out first as it's a good precursor for this episode. I wanted to discuss more about mistakes today. As I think identifying mistakes is one of the simplest ways to excel. at investing. Everyone focuses on what the next best investment is going to be. And while that's important, what I think is even more important is surviving the market for long periods. And to do that, you must focus on avoiding as many common mistakes and biases as possible. Today's episode is an overview of some of the most common mistakes that Clay and I have observed during our times in the

Starting point is 00:01:19 market. Additionally, since we spent so much time researching for our interviews, we have picked up many interesting case studies and experiences of others that we can't wait to share with you. Lastly, we both draw on our own personal mistakes and discuss them in detail so we can hope to avoid making the same one twice. If you plan on being in the market for the long haul and want to better understand the mistakes that we all make, you're going to love this episode. Now, without further delay, let's get right into this week's episode with Clay Fink. 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

Starting point is 00:02:02 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 We Study Billionaires Podcast. I'm your host, Kyle Greve, and today, I'm happy to be joined by my co-host, Clay Fink. Clay, happy to have you on the show. Always great to be on the show with you, Kyle. So investing is not easy. How many people do you know who have made 100 times their money on the stock? What about just a 10x or even a double?

Starting point is 00:02:41 My guess is very, very few. And I don't think investors are necessarily getting better. And it's easy to see why. We have so much information now at our fingertips that we can react to each and every day. And while this may be a benefit in other realms in the realm of investing, I think information overload is rarely a positive. So today, Clay and I are going to discuss some of the biggest mistakes that we've observed in the market, learned about from our research and interviews, or are guilty of making ourselves.

Starting point is 00:03:06 So we're going to start with the most powerful two emotions in investing. Greed and fear. Greed causes investors to make mistakes of incorrectly assigning a rosy narrative into infinity. So you can think about the tech bubble where businesses were just adding a dot-com to their name and seeing their stock prices shoot up as a result. The internet was supposed to change the world, and it did, but not so much in 2000. But back in 2000, investors greedily piled money into these internet companies with zero concern for the underlying fundamentals of the business. Did the business have zero revenues in a multi-billion

Starting point is 00:03:35 dollar evaluation? Who cares? Someone else will pay double what I paid for it. That was kind of the essence of what investors were doing back then. So greed is so powerful because it can sweep you off your feet and make you feel really invincible and very, very smart. There was a great case study from Lauren Templeton and Scott Phillips book, The Templeton Way, that shows how powerful Greed can be. A social worker in Redondo Beach, California, had never bought a single share of a stock. She didn't think the market was for her. I didn't understand it, she confesses. Then, while driving one day, she heard on the radio that a local company had signed a contract with Russia that sounded interesting. After calling for more information, she set up her first brokerage account and bought 100 shares at $12 each.

Starting point is 00:04:15 Today, that company is MCI WorldCom Inc. Her original $1,200 is now worth $16,000, part of a mid-six-figure digit portfolio, unquote. So greed makes us feel really, really smart and a lot of times smarter than we actually are. And since we're the easiest people to fool, it's really easy for us to have confirming evidence that a narrative is going in the direction that we think it is. So when it comes to investing, all the confirming evidence we really need is increasing stock prices. But on the other end of the spectrum is fear. Fear makes us do silly things as well, like selling because of a short-term headwind or selling a holding exclusively because the stock price went down. And the scary part about fear is that it forces us to action where inaction is usually going to be the best course.

Starting point is 00:05:01 Let's say that you have a business growing its earnings at 15% per year like clockwork, but the market takes a nosedive. The price drops, say, 20% over a few days. If the business is continuing to produce, then there isn't really a reason to sell. But that is exactly what investors do because fear causes them to think irrationally. Yeah, you said greed makes us feel smarter than we are. And I think that's a great way to put it. And what is so fascinating to me about investing is that the market has a way of causing the most amount of pain to investors and the maximum amount of frustration.

Starting point is 00:05:39 And I think that goes for both bull and bear markets. While the overall market, it tends to go up, say, 8 to 10% per year during our last episode, I said 10% over a very long period of time. But that happened to be just a very good period for stocks, especially in the U.S. But when you look at the year-to-year returns, it's very unlikely that the returns are going to be in that 8 or 10% range. And this is where the mood swings and the market sort of play into things. And when you average it out, it ends up being that 8 to 10%. And this is why human psychology is such an important part of investing. When you type in the compound interest calculator that we talked about during the previous episode,

Starting point is 00:06:21 it doesn't show the bumps along the way. It doesn't show the giant crashes that are inevitable that we, We don't know when they're going to happen. Most years are either really good or pretty mediocre. And just to give you a real-life case study, if you look at 2022, stocks were down. The S&P 500 at least was down 19%. And the broad stock market overall, about any stock you look at, it was down, maybe except energy. And then 2023 was the opposite.

Starting point is 00:06:48 Stocks were way up. The S&P 500 was up 24%. I had a recent interview with Chris Mayer. his portfolio was up 45%. And, you know, some of his stocks went up, one of them went up 80%, and the lowest performer was 16%. So the market just swings between this pendulum that Howard Marks talks about that we're going to discuss today. So in the good years, investors get excited. They pile in. They have that confirmation bias of thinking market conditions are really good. It's the time to invest. And then when stocks start to fall, that's when people start bailing. They look for

Starting point is 00:07:25 reasons to sell and they start selling at the wrong time. And it's this feedback loop of both the positive and negative side that is really important to understand. And it's not just the newbie retail investors that can get sucked into this greed and fear cycle. I'm not sure if you've studied the background of Stanley Druck and Miller. We don't talk about him too much on the show. But when you look at his track record, he has one of the best track records I've ever seen. Over a 30-year time period, he had an average annual return of 30% per year. And that's despite him being a macro-based investor that invests on these big themes that I definitely can't understand or fully comprehend.

Starting point is 00:08:06 But he definitely has one of the best track records I've ever seen. And he was well known for shorting the Japanese stock market in 1989. That's like one of the biggest overall big bubbles we've seen in markets. Great case study. And then him and George Soros, they also work together in shorting the British pound and they both made a billion dollars in that one trade. It's funny that even you and I, we have these rules that, you know, we're just never going to short, just not a game we want to play. And after someone thinks they might be really good at shorting, after shorting the Japanese

Starting point is 00:08:38 stock bubble or shorting the British pound and think they have it all figure out. But I think eventually short sellers end up getting burned. And Druck and Miller, I think, is a good case study here. He recognized the bubble in 1998, 1999. He knew all these stocks. were at least he thought they were overvalued for some period. And he shorted the dot-com bubble and ended up costing his fund $600 million as tech stocks continued to become more irrationally priced. And to add to this, he was this veteran on Wall Street, this stellar track record he had.

Starting point is 00:09:12 And he was surrounded by a lot of these younger guys that are newer to Wall Street. And the younger guys got sucked into the tech scene and as a lot of investors did. And Druck and Miller just could not handle these other guys showing them, you know, just outdoing them in terms of performance. And like tech was what was working and shorting tech was not working. So he was the veteran losing money and all these rookies were doing exceptionally well. So rather than sticking with what he knew best, he ended up joining the tech party. He bought Veracine at $50 a share.

Starting point is 00:09:48 And then just months later, it's up to $240 per share. And then he ended up doubling down, adding $300 million to his bet. And again, he still thought like a correction was coming. But he thought, based on his research, he assumed that Veracine would be immune to such a crash. And amazingly enough, this stock fell by 98% to under $5 per share. I mean, one of the best investors in terms of a track record that you could find out there, you know, got sucked into the greed cycle of the tech bubble. And it's just a good case study of even the smartest people can be duped by,

Starting point is 00:10:26 just sucked in by our emotions and tricked. You know, the easiest person to fool is ourselves. And there was actually one point where he bought $6 billion worth of tech stocks and he lost $3 billion in the crash. And it's just such an interesting case study of, you know, just makes you humble again. Like, I'm never going to be as smart as this guy or likely I have a track record that he has. And I'm just as susceptible to these sort of greed and fear biases of someone like him. And I think many people a lot in the audience just need to recognize that you never know what sort of things could peak your interest and maybe sway away from the principles that you might have today.

Starting point is 00:11:08 Yeah. So I've read about that Druck and Miller case study. And it's such a powerful example of greed. And just thinking about it, it's kind of scary, right? because if an investing legend like Druck and Miller, with such good results over multiple decades can fall victim to greed after decades of success, I think it's very, very safe to say, as you pointed out, that we are literally all susceptible of making that exact same mistake and getting swept by greed. So for me, the key here is to really try to track where our emotions are.

Starting point is 00:11:38 So I've spoken a little bit to the TIP Mastermind community about how I journal. And part of what I journal about is tracking my emotions and kind of. of, you know, how am I feeling? Am I feeling sad one day? Am I feeling happy? And how I'm feeling about very specific positions that I own in my portfolio. And so this, I think it has a lot of good effects on me, but it really shows me where my head is at. And it also allows me, one thing I've really focused on is trying to slow down and make sure that I'm not making tons and tons of actions in a very, very short time span, because I think that's where you make a lot of your mistakes. So it's really important to really slow down, try to get a gauge of where your

Starting point is 00:12:14 minds at, where your emotions are, and just give it some thought before you try to make a decision because in my experience, doing nothing should be probably the default action. And when fear kicks in and greed kicks in, though, that's where that kind of just goes out the window. But I think it's really important to always default to inaction. And then when the right opportunity comes knocking the door, that's when you spring into action. And then, you know, on the downside, a lot of people just sell because their stock prices go down. But in reality, you should be focusing on the fundamentally of your business. So, you know, if your business is doing really, really well and the stock price goes down, well, in my opinion, it doesn't matter. But, you know, where fear actually

Starting point is 00:12:52 would maybe make sense is if you have a business that comes out with, let's say, a really bad news item that you know means that maybe there's a secular decline happening in the business. And that, in that case, then yeah, maybe being fearful and knowing that it's time to sell is the right move. you make a good point there of just slowing down. When you make quick decisions, oftentimes you're making that decision based on some sort of emotional response you have. So slowing down, journaling, great ways to help counter that. And during periods of FOMO, I think some people, they can see that one thing is working

Starting point is 00:13:29 really, really well. And how that can get you into trouble is if you decide to over concentrate into that one thing. So maybe you're holding something and the multiple is just really getting out of hand and the price is just really going crazy. Just setting rules for yourself, I'm reminded of Chris Mayer. He said on our call that if a position gets over 10% of his portfolio, he just isn't adding to it, but he'll let it run. You know, that's kind of his way to keep his emotions in check, not let himself get out of hand. No matter how much conviction he has in something, he's not going to push it further than that 10% mark. And, you know, that has a lot of benefits in that he's letting it run and he's letting it

Starting point is 00:14:10 letting the business run its fate. But he's also not getting overly greedy and, you know, making a massive portion of his portfolio. And then there's a flip side to that where if the valuation gets out of hand, then he might miss out on the opportunity to trim it to allocate to something better. And, you know, that's just some sort of tradeoff or you have to draw the line somewhere of how you're going to manage that risk and prevent yourself from becoming over concentrated and yeah, just all sort of good things to think about and things to consider. So the next mistake we see is investors that are trying to time the market. So you may know the feeling.

Starting point is 00:14:47 Your position has just gone up, say, 20% on some sort of news item and you're ready to hit the trigger and sell for a profit. You end up selling, say, the whole position and are proud of yourself for making a quick 20%. Fast forward a few years. And if you hadn't touched your investment at all and never sold, it would have gone up by, say, 500%. So these are kind of the hard parts of investing that aren't talked about that much, but this is a prime example of trying to time the market, in my opinion. So I define trying to time the market as attempting to time your buys and sales depending on the moves of the market.

Starting point is 00:15:19 But there's a huge problem with doing that. Our ability to try to time the market correctly has the same, if not lower odds than blindly throwing darts at a dartboard. To succeed in investing, we should not be relying on luck to help us build the market. wealth. Yes, there's a little bit of luck involved and that's perfectly fine, but you shouldn't be relying solely on luck to generate returns. So another attribute of market timing is when investors withdraw their capital from the market, usually at a loss because they're anticipating a market downturn. You saw this in 2020. When everyone in their cat was horrified by the pandemic, prices bottomed out and investors preferred the safety of cash over the potential pain of additional

Starting point is 00:15:59 losses. Nobody would have anticipated that the S&P 500 would have done 16% during a global pandemic, and yet it did. So investors pulled money out of the market and then reentered often at prices above what they had initially paid for. So this mistake causes quite a few outcomes that aren't particularly fun to experience. So one, you miss out on stocks that have multi-bagger characteristics because you never hold stocks long enough to capture a lot of upside. Two, you sell stocks at a loss when the market goes down, assuming the market will continue declining and you can buy it for even cheaper at a later date. So, Clay, since many of your listeners are investing in things like stocks and index funds, what do you think are some of the best ways to create an environment where you minimize your ability to self-sabotage via market timing? This reminds me a lot of the question I asked Morgan Howsell during our interview.

Starting point is 00:16:50 During that chat, he was talking about how most of the time, the market overall is not trading at what many would consider fair value. So the market can spend years at overvalued levels and years at undervalued levels. But over time, as Benjamin Graham says, the market is a weighing machine and ends up overriding any of these short-term headwinds. during my conversation with him, this inevitably brought up the question of whether Morgan thought today's market was overvalued or whether he thought it was undervalued. And you hear from a lot of people nowadays that the market's crazy overvalued based on all these different metrics. And you know, a lot of people have been saying that for the past 10 years and they've watched the market just overall go up pretty much almost every single year. And Morgan's response to my question

Starting point is 00:17:43 to him is that he doesn't even think about if the market is, if the market is, you know, is overvalued or if it's undervalued because his goal as an investor is to be invested over the next 50 years. So if you were to fast forward 50 years into the future, the probability of him regretting, staying invested and not trying to time the market in 2024 is practically zero because over that length of time, he's going to do really well as an investor. And even if we do have a major crash this year or next year, history has historically shown that eventually recovers and hits new highs. And it also reminds me that I've noticed that people like to complain or talk about the Fed a lot.

Starting point is 00:18:21 Some say that they control the markets or they've overdone it with the zero interest rate period and whatnot. And I'm not disagreeing with any of that. I do think that the Fed does have some control of the economy. Of course they do. But that doesn't mean we should try and predict what they're going to do and how their actions are going to impact markets. So similar to market timing, playing the game of predicting the macro,

Starting point is 00:18:44 predicting the Fed is really a fool's errand more generally. We're going to see occasional market corrections. We're going to see an occasional market crash every major market crash every 10 years or so, but we shouldn't be playing the game of trying to guess when that's going to happen. Because again, like you mentioned, we want to take out the luck out of this equation. You might get right on the next market crash, but being right on every single one is honestly next to impossible. Like, show me one person who's done that. A lot of these macro people sort of forecasted a major recession in 2023, and we saw the opposite. You know, the economy rebounded and markets ripped. There's much more to lose and being wrong about the market timing than being correct because the market just generally

Starting point is 00:19:31 tends to go up over time and we can be blinded by these narratives. And it's also important to remember that what the incentives are of a lot of these media organizations and, um, whether it be major TV outlets or various publications that what drives clicks for them tends to be negative headlines. So they're sort of incentivized to keep posting negative type headlines where a crash is coming. And there's a lot of books out there that talk about how markets, people really feel the downward swings because they tend to be surprises and sudden. But the progress is really hard to make headlines because the progress is so gradual.

Starting point is 00:20:10 but it ends up just outweighing any of the downsides over time. And COVID's a prime example where you had this swift down swing and then all these consequences that causes markets to go up and rebound. And Warren Buffett also mentioned arguably the greatest investor to ever live. He said that if he knew what the Fed was going to do over the next 12 months, then that wouldn't have any effect at all on how he would invest. And that tells you how much emphasis he puts on predicting the macro, how much he pays attention to the Fed and predicting short-term prices

Starting point is 00:20:45 and how the Fed's going to affect prices in the short term. He has this quote that I really like, we believe that forecasts of stock and bond prices are useless. The forecasts may tell you a great deal about the forecaster. They tell you nothing about the future, end quote. So one of the tricky things about macro forecasting too is that a lot of the people that do it sound really, really smart, and they usually are really smart. And biologically, since we don't like uncertainty, we want to feel like we know what's going to happen in the future. So we tune into the experts and have this authority bias that plays in as well.

Starting point is 00:21:20 And as investors, we just have to accept that the immediate future is always going to be uncertain. It always has and it always will be. But I think investing in high quality businesses or even investing in index funds and hanging on to them is a game that is heavily stacked in the investors' favor. And that's because businesses over time, they improve, they reinvest, they become more efficient, they find new and better ways of doing things, and they grow their businesses, grow their earnings. And these types of businesses, or just the market overall, tends to increase over time and reward long-term investors handsomely. So when you try and add market timing to the equation, I view it really as lowering your

Starting point is 00:22:03 odds of success and being a, you're lowering your odds of success over the long term. And you're adding more luck and sort of speculation to the equation. So I think dollar cost averaging is really a great way to diversify your bets across time and sort of take the pressure off of what's going to happen in the near term. And in many ways, I sort of view it as a win-win. I don't know if markets are going to go up or down this year, but if they go down, I'll be happy because I can start finding some good opportunities. And if they go up, then that's good. That's the reason I'm invested in the markets is to have my investments go up. So sort of framing it that way of not trying to worry about what's going to happen, just sort of embrace what does end up happening and keep your emotions in check.

Starting point is 00:22:46 Like Kyle mentioned with journaling and tools like that and kind of be mindful of how you feel when you're checking your portfolios. And at the end of the day, I think it's so, so important to just accept that uncertainty is just part of the game. And over the long run, things tend to turn out pretty well. So the next mistake we're going to discuss is leverage. So unlocking the ability to increase your returns by simply borrowing money does sound like an intriguing option, you know, at the very surface level. But using leverage is one of the easiest ways to destroy your capital.

Starting point is 00:23:18 Charlie Munger liked to say that there are three ways investors can go broke, liquor, ladies, and leverage. I think he was completely right here that it's easy to abuse leverage and end up going broke as a result. So what exactly is leverage? The simplest way to think of leverage is something like your credit card. Whenever you use your credit card, you're borrowing money from the issuer to pay for your products. This allows you to buy things that might be more expensive than you can afford, such as a car. In investing, leverage works very

Starting point is 00:23:44 similarly. It allows an investor to buy more of a stock than they can afford. The problem is that in investing, the people lending you the money don't want to lose their money. So if your investment moves in the wrong direction, they will force you to sell it and keep the money they lent you for themselves. So I had some really bad experiences in this back when I was trading cryptocurrencies, when I very first started making investments. And I would use Bitmex, which I'm sure a lot of people are familiar with. And I would do crazy things like use 100 times leverage. And that basically means if the price moved 1% in the wrong direction, I lost my entire investment. And it was stupid. It was literally just gambling. And I didn't really realize that at the time, but it was completely

Starting point is 00:24:26 gambling. So a lot of stock platforms won't allow you to use 100 times leverage, which I think is great because it's too speculative. And even using 10 times leverage is pretty scary. But some will let you use double or triple or whatever. And I personally just try to stay away from that as much as possible because in investing, we want to maximize our ability to survive. So Morgan Hausel in the psychology of money wrote, quote, effectively all of Warren Buffett's financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time, unquote. So we don't have the luxury of being able to invest when we are kids, but we do have the ability to reduce

Starting point is 00:25:08 the chances of an investment going to zero. And avoiding leverage is going to be one of the simplest ways I can think of to decrease the chances of an investment being completely destroyed. Yeah, to tie in another legendary investor, Benjamin Graham, he's well known for being one of the most conservative investors ever who put an extremely strict emphasis on the price he paid. But I think a lot of listeners would be surprised to know that when the market started to fall during the Great Depression at the start of, actually he's after 1929, he started to use leverage to juice his returns because he thought the worst of the bear market. was over. And part of the reason he did use leverage is he's not dumb. He's a really smart guy. He knows how to calculate the value of a business. The reason he used leverage is because he was really, really certain that the businesses he was buying were trading well below their intrinsic value. But the problem is that the cheap things he owned in his portfolio started to get a heck of a lot

Starting point is 00:26:10 cheaper. And some businesses, believe it or not, they even traded below the level of cash they had in the bank. It's a good reminder that you shouldn't ever take leverage with the expectation that the market is going to become more rational, you know, in the coming months. Just because it's irrational today, it doesn't mean it can't become more irrational. So with that said, I think there are still ways we can sort of implement leverage, but do so in a responsible way. One great example is just buying a house. Here in the U.S., for example, a lot of people will tell you that a mortgage with a 3% fixed 30-year interest rate is an asset because, you know, if inflation's 3% or more, then the value of your debt's going down. And really, that's sort of an anomaly throughout history

Starting point is 00:26:57 to be able to get such long-term debt for an asset like a house. And one of the reasons that that can be such an asset is because you can't get margin called if your home value goes down. As long as you're making your payments month to month and, you know, you're responsibly spending within your income and such, then that can be very advantageous, especially if you're using a lot of your cash flow and buying things like stocks. Using leverage with stocks can be actually quite a bit different because of margin calls, like you mentioned. When stock prices fall and you're using margin through your broker, then you risk getting margin calls and being forced to sell at the exact wrong time of when you want to be selling. And Bill Miller, he's actually talked on

Starting point is 00:27:42 the show with William Green about how he had to sell some of his Amazon shares to cover some of his margin calls in 2022. And in my opinion, leverage in this manner, you know, using it in the margin account, to me, it really just adds unnecessary stress to your life. There's another Buffett quote that ties in well here. Rational people don't risk what they have and need for what they don't have and don't need. So part of it is also understanding what is, uh, also understanding what enough for you. So you can figure out what sort of your savings rate is going to be over the next five or ten years and get a look at, you know, in 20, 30 years time, what sort of, what might your portfolio look like? And is that going to be enough for you, you know, based on what your

Starting point is 00:28:26 projected returns are going to be and what you conservatively can expect investing? And in the case of leverage, I think oftentimes people are simply trying to compress the time it takes to get the money they want. You know, say if you want to become a millionaire, it can happen in 15 or or 20 years or whatever. They don't want it in 15 years. They want it in five years. And that's when leverage can be used and it can really get you into trouble. And then you discover why so many value investors say you shouldn't use leverage.

Starting point is 00:28:53 And it's also greed, which we talked about at the start of the show. So being free of leverage, I think it really can make you anti-fragile financially. Like I said, eventually market corrections and market crashes are going to happen. And when they do, not having leverage really puts you in a position. of strength because it frees up your cash flow. You're not paying interest on your accounts. And having no debt means you have more cash flow. So it's easier to weather through those tough times. Then you're able to really take advantage of the opportunities that that sort of drawdowns bring to you as an investor. After I've studied enough businesses, you see that many great businesses

Starting point is 00:29:36 have like amazing balance sheets. They have minimal to no debt. And these are some of the best performing stocks in the market. So why can't I implement that myself for my own personal finances and try and adopt that as well and invest opportunistically to some degree without doing too much market timing and sleeping better at night being more anti-fragile? Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo. Fjord, and every conversation you have is with people who are actually shaping the future.

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Starting point is 00:33:45 Start your business today with the industry's best business partner, Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify. be. All right, back to the show. So Robert Hags from wrote, quote, speculators are obsessed with guessing future prices while investors focusing on the underlying asset, knowing that future prices are tied closely to the economic performance of the asset. If they are correct, it would appear

Starting point is 00:34:24 that much of the activity that dominates the financial markets today is speculation and not investing, unquote. This is a great example of how the market works speculatively. But as value investors, we should be trying to avoid this line of thinking. The problem with always trying to guess what the price of the stock will do is that nobody has ability to do it successfully over a long period of time, which we discussed a lot in the market timing section. But many investors have had the feeling of buying a stock seeing it skyrocketed in price and then patting themselves in the back for making a great choice that was so obvious

Starting point is 00:34:58 to them at the time. So they feel like this is a repeatable strategy and try it again. but the next time, speculation fails miserably, and they end up losing a ton of money trying to speculate on the direction of the market. So unfortunately, this is the path that many investors end up taking. There's a great IMF graph out there, and Clay actually referenced this on our previous episode, but it shows how the average holding period of U.S. equities from 1975 to the present. So in 1975, the average holding period was about five years, which seems very good and nice and long.

Starting point is 00:35:30 And today we're sitting around 10 months. So obviously, that holding period is shortened drastically. So this tells me that investors are buying stocks and hoping to generate immediate returns than selling them and then trying to repeat that process over and over again. But unfortunately, the results of doing that have been very, very poor. So I recently read a Forbes article and it said, quote, according to the latest 2014 release of Dow Barr's quantitative analysis of investing behavior, the average investor in a blend of equities and fixed income mutual funds has garnered only

Starting point is 00:36:02 2.6% net annualized rate of return for the 10-year time period ending December 31st, 2013. The same average investor hasn't fared any better over longer time frames. The 20-year annualized return comes in at 2.5% while the 30-year annualized return is just 1.9%. So I know this is an apples to apples because it's a blended fund and it does have some other fixed income. But to me, it still holds true. and it shows you that this strategy of basically keeping your stocks for a very short time period, it doesn't work.

Starting point is 00:36:34 And a lot of people are speculating on where to put their money and trying to just time the market and try to ride momentum. And it doesn't work over the long period of time. So Clay and I can only speculate on all of the reasons why this is, the numbers are the way they are. But I think that we can both agree that speculation is probably a big part of the equation. So when you're trying to time the market, you will have. a lot of money losing investments. And to me, trying to time the market goes hand in hand with

Starting point is 00:37:01 speculation. If you're trying to speculate over a long period of time, like I said, you're going to have a lot of money losing investments. And if you want to actually make money over a long period time, you're going to have to have a lot of successful investments to offset all the negatives and all the losses that you're going to go through. Otherwise, your results are going to be like this 2.6% over 10 years or probably even lower or maybe even going to zero. So when I first invested as previously mentioned in my crypto experiences, I was a short-term speculator. I've completely switched to being fundamentals-focused investor who looks at businesses that will hopefully continue to perform fundamentally at a very high level for hopefully long periods of times. So I understand that the

Starting point is 00:37:42 market may take some time to understand this fact, and I'm willing to wait for the market to catch on. And so what this means is that obviously I might have a stock that I think is going to go up over time, but sometimes the market might not see it that way and might punish the share price and put that share price down over time. But if I have the conviction in my investment and I feel I understand the underlying fundamental of the business and that earnings and cash flow are going to continue to go up, well, I'm okay waiting for the market to understand that exact same thing. And that's basically how value investors seek to make returns in the market. So I know the market might take a year to see that. And obviously sometimes it's kind of painful to wait out when a sock you have has gone down 50% or

Starting point is 00:38:21 whatever. But, you know, if you have the conviction and you've, you've done your work and you feel like you understand the business, you can make a lot of really good choices by just holding. And like we just mentioned with leverage, if you have cash flow and savings and money to deploy, when those prices get punished, it just means that you can buy more out of cheap price. That's kind of how I view speculation. And, you know, I'm okay with holding for long periods of time and I'm okay that with my stock prices going down and price, that's just part of the long-term game of value investing. One of my favorite things about investing is that the market really has a way of testing

Starting point is 00:39:01 who you are as an investor and what you really know. Kyle, you and I, we generally talk about individual stocks, index funds. I also have Bitcoin as a part of my portfolio and have had it for the last four to five years. And in terms of the market testing you, of everything I've held in my portfolio, that has tested me more than anything else, just due to the volatility. You know, in 2021, it got up to around $69,000. 2022, it got to a near low of $16,000. And everyone around me is calling me crazy for hanging onto it. And some people are calling me in panic selling.

Starting point is 00:39:36 And that sort of sent a signal to me of what the sentiment was in the market. And today, this morning, we just crossed $51,000. So just quite a roller coaster ride. And I talked with Patrick on millennial investing about how despite the majority of market participants in this asset, it hasn't shifted hands over time. Just a few players in the market can really drive it. And FTX just really sort of seem to have a big impact on it. I think it's just a good example of the market generally testing you whenever you buy an investment. So with individual stocks, the market overall is individual stocks.

Starting point is 00:40:13 or broader index funds, it really is eventually going to give you a time where it's going to be down and it's going to test what it is you really know about the company. And to point to that study you mentioned on, you know, the average return being so low, it's only around the inflation rate. I think a lot of that is people chasing momentum, you know, buying when things are hot and selling it when it's down. That's obviously not a good strategy over time, but it can work over short periods of, very short periods of time, such as the tech bubble, when everything seemed to be rising related to

Starting point is 00:40:47 tech. And I'm reminded of chapter one of Poulac Prasad's book where it essentially is just sharing the lesson of don't lose money. When you're trading in and out, the odds of just one or two trades can really hurt you and make really make you lose a lot of money. And coming back from that, it's just so difficult. So that's why you really need to understand what it is you know and have a good assessment of the value of what it is you bought. And the discussion on speculation and investing is quite interesting because even with the fundamental approach that you mentioned, we still have to do some level of forecasting

Starting point is 00:41:22 or some level of speculation on what the earnings are going to be in the future based on the fundamental approach. And you just simply don't know what earnings are going to be, but you can try and make an educated guess. And at the end of the day, we really want to try and stack the odds in our favor to achieve, you know, a sufficient return on our investments. So part of stacking the odds in our favor is using filters to help protect us from losing

Starting point is 00:41:50 money. You know, this includes things like investing in businesses with strong balance sheets. They have a strong history of revenue and earnings growth, consistently high returns on capital, verifiably strong moats, and then sticking with businesses you understand, all these things we talk about on the show. And I think another key hurdle is having a good understanding on valuation. If you don't know how to accurately assess what a business is worth, then you probably have no business investing in that business.

Starting point is 00:42:22 I look back at times when, you know, I speculated early on in my, before my value investing journey and I just shake my head at how little I understood valuation. You don't buy a business because it's in a hot sector. you like the company or product, you think the CEO is brilliant. It sounds so obvious to say now, but you should only be buying a business that you think is trading below what you think it's conservatively worth based on those fundamental reasons and not buying it based on emotions, how you feel about the company, what the sentiment is.

Starting point is 00:42:58 And this is just me speaking from a value investor's point of view. Morgan Housel has this great quote in his book, Same as Ever, GameStop at $400 a share makes no sense if you're a long-term investor. But if you're a day trader, betting it's going to go to 401 in the next hour, then it might be a great buy. A lot of financial debates don't reflect people actually disagreeing with each other, but people playing different games talking over each other, end quote. And when you talk with people that might be friends,

Starting point is 00:43:31 you know, they're just oftentimes they're playing a different game when they disagree with you. And I also think back to when I was speculating too, I would check my portfolios daily and just get worried about when prices fall. Because if the prices fall, that means I might have made a bad investment decision. Well, I still check my portfolio pretty much every day. But I'm not near as worried when prices inevitably do fall because I have some sense of what I think the value is. If you're worried about the price is falling, then you have to consider, one, how well do you know, know what you own. And two, how well do you understand its intrinsic value? And maybe the intrinsic value goes down over time. You know, the business's growth isn't as high as you originally

Starting point is 00:44:16 expected it to be and whatnot. So maybe you need to continually assess, you know, the underlying value as well. And another thing I do to try and sort of anchor myself in reality and invest rationally is to invest based on this principle that stocks follow earnings. So, So one of the investors, Will Danoff outlined this in Williams' book, and I just love the idea. The idea is simply that as earnings of a stock go up over time, the intrinsic value goes up as well, and hopefully the stock price is going to follow. And sometimes that takes quite a few years, but generally, it's a pretty good rule of thumb. And one example I recently came across on Twitter was the share price of Alphabet or Google.

Starting point is 00:45:01 Over the past five years, Google's earnings per share, increased 164%. The stock over that time increased by 160%. And I certainly don't think that's any coincidence at all. Like you said, Clay, with earnings, I agree. You know, there is a degree of speculating on where earnings are going to be over the future. But I guess part of being a fundamentals focus investor is that we're focused more on

Starting point is 00:45:28 trying to figure out why a company can continue keeping those earnings, growing at a high rate and what characteristics of the business, what competitive advantages it has to protect its ability to continue doing that. And so, you know, obviously if a business can't protect that and that's what most businesses are, then those earnings are going to decrease or eventually go to zero and the company fades away off into existence or gets bought out. So that's kind of, I guess, where, you know, you can look at it as value investing. Some part has a, does have a speculative component to it, but at least with all the work we're doing, And we can try, like you said, to put the probabilities into our favor.

Starting point is 00:46:06 So the next mistake that I wanted to cover was this is along the same lines that we've been talking about with greed and, you know, time frames. But it's trying to get rich today rather than over decades. So as we previously have mentioned, investors today are trying to buy investments for a very short time, 10 months is the average holding period, and then are selling them in just a few more quarters later. So since we know that holding periods are so short, we also know that investors are reallocating their capital into other opportunities at alarmingly high rates.

Starting point is 00:46:38 So I would guess a major reason for this is that they're seeing an investment that they think can go up very rapidly in price. So one of my favorite examples of this was during the tech bubble. Berkshire Hathaway hit a multi-year low in 2000. And this was because investors who owned it were selling their shares and chasing the latest dot-com business because they saw those businesses going on. up hundreds of percent in literally just a few days and were attracted to those types of returns that people were getting from speculating on dot-com businesses rather than holding, you know,

Starting point is 00:47:07 boring old Berkshire Hathaway. So in other words, they were trying to get rich quickly. And while getting rich quickly sounds good when risk is off, as Howard Marks would say, people forget about the downsides of getting rich quickly. The media loves covering the get rich quick lottery winners. That's who they highlight in the news and that's what, you know, movies and Hollywood are all about. But they fail to show the thousands, hundreds of thousands, these probably millions of failures of people running nearly identical strategies. So this is why I try to concern myself with failing and mistakes a lot. And I know Clay does as well. It's okay for me if I can build up my wealth over decades. I'm perfectly fine waiting.

Starting point is 00:47:48 I know the effects of compounding that we discussed about in our previous episode. And I know that if I just keep on slowly going up over a nice period of time, I'll have very nice, outsized gains in my wealth in a couple decades. So one of my favorite strategies for making sure that I'm not taking too much risk is to get a sense check of where the market is today. So a simple tool that you can use, for instance, is CNN's Fear and Greed Index. It does a pretty good job of showing how greedy or how fearful the market is. When the market is greedy, it's often best to stay on the sidelines and let your investments do the work for you. So another great sense check is to follow Howard Mark's framework on understanding market cycles. So here's what he said from his book,

Starting point is 00:48:28 the most important thing. Quote, the longer I'm involved in investing, the more impressed I am by the power of the credit cycle. It takes only a small fluctuation in the economy to produce a large fluctuation in the availability of credit with great impact on asset prices and back on the economy itself. The process is simple. The economy moves into a period of prosperity. Providers of capital thrive, increase in their capital base. Because bad news is scarce, the risks entailed in lending and investing seem to have shrunk. Risk-averseness disappears. Financial institutions move to expand their business, that is, to provide more capital. They compete for market share by lowering demand of returns, e.g. cutting interest rates, lowering credit standards, providing more capital

Starting point is 00:49:14 for a given transaction, and easing covenants. So now once everything looks nice and rosy, the cycle can reverse its course. So here's what he said. Losses cause lenders to become discouraged and shy away. Risk averseness rises and along with it interest rates, credit restrictions, and covenant requirements. Less capital is made available and at the trough of the cycle only to the most qualified borrowers, if anyone. Companies become starved for capital. Borrowers are unable to roll over their debts leading to defaults and bankruptcies. This process contributes to and reinforces the economic contraction, unquote. So the important part of understanding the cycles is that it helps you make better decisions. So it's really important here to understand that looking at market

Starting point is 00:50:00 cycles does not necessarily mean you need to be able to forecast the direction of the market cycle. That, again, just kind of goes into market timing. But I think what's really important in the way we can use market cycles is to understand just where we are and understand how the market is feeling. So generally speaking during upmarket cycles when money is really easy to come by, that tends to correlate, not always, but tends to correlate with stock prices being really expensive. And then on the other hand, when the market cycles are down, that tends to correlate with stock prices being lower because businesses have decreased abilities to find lending, and then that can oftentimes lead to lower earnings increases or decreased earnings. If you know that,

Starting point is 00:50:43 that can help you, really help you guide your decision making and understanding, you know, okay, well, now might be a really good time to deploy money. Now might be a really good time to, you know, maybe I don't really take money off the table. But if that's what you do, then, you know, at the top of a credit cycle, that might be time to take money off the table. Or, you know, one thing I think, if you know you're in a bull market and, you know, money's easy to come by, that might be a time where you just don't do anything. You know, you just let the market do what it does and just hang back and enjoy the show. I'm glad you mentioned Howard Marks and some of his thoughts on market cycles because it's just

Starting point is 00:51:16 amazing how we're all prone to making these mistakes of getting caught up in the cycles. And I also like in his book how he talks about why cycles even exists in the first place. And it really just comes down to human psychology. And it's just so fascinating how these cycles, you know, it's nothing new. It just repeats over and over again. And once we learn about these cycles, hopefully we learn to not get caught up in the peak media or peak fear again after experiencing it ourselves. And there are plenty of telltale signs of being in a frothy market, but 2021 was just a time I'll never forget. I had friends who

Starting point is 00:51:53 have never studied investing or really understood investing. All of a sudden, seemingly overnight, they want to quit their jobs to become day traders. That's their dream. Or all of a sudden, they've five X their money and some meme stock and people who have never invested all their lives all of a sudden look like they're investing geniuses. And that right there is a good sign that maybe you should be a little bit more cautious with your investments or maybe build a slightly higher cash position or even just incorporating a stronger margin of safety in your purchases or in your research process and not trying to chase things that are going up. And with that said, I'll also say that we shouldn't try and time things too much.

Starting point is 00:52:38 You know, it's not a black or white sort of thing. It's, I think Marx uses the analogy of like the temperature of the market. You know, sometimes the temperature heats up quite high and then, you know, sometimes it eventually just cools off and trying to time that is really difficult. And there are a lot of great businesses whose share prices have gained significantly ever since 2021. So trying to add too much timing to it can also hurt us. So if you waited, you just watched, again, great opportunities pass us by. So that's, you know, again, anchoring ourselves in these principles of, you know, what types of businesses we want to own, how we determine the intrinsic value of that business and going from there.

Starting point is 00:53:18 And talking more broadly about the really big shifts in market cycles, managing risk can be quite counterintuitive. Because naturally, when something goes up in price, your gut and your instinct is telling you, to buy it and not miss out on other people getting rich. At that time, risk actually feels like it's low because all you see is green candles going up. But ironically, that is the point in which risk is the highest. And again, I'm just speaking from a broad, big picture overall perspective here. So when prices are high, risk is generally the highest. And on the flip side, when everyone's panic selling, people are calling you and they're getting

Starting point is 00:53:59 margin calls and they're freaking out and saying the world's going to end. Everyone's heading out the door. Your gut is telling you to follow their lead because things now feel really risky. And all sorts of media headlines and narratives are going to be just blaring in your face and blaring in your headphones of whatever radio station or whatever you're listening to. But when prices are low is when your margin of safety counterintuitively is the highest. And thus, your risk is also the lowest. assuming you have an accurate assessment of the intrinsic value and such, and you have that longer-term time horizon, say, three years plus to let the cycle play out. And Howard Marks, I'll never forget

Starting point is 00:54:40 in mastering the market cycle, I did an episode on that book. And he tells a story of the great financial crisis how just some of the smartest people in markets just thought the economy is done for. There's no way we can recover from this. And they may have been right. But, you know, it really, what he's pointing to is just the sentiment. Like the sentiment, cannot have gotten any worse at that period. And another point I'll make is that it's important to remember that most things are cyclical. So when you find a stock that is just crushing it, it's gone way up, their recent growth is insane. And if you don't understand cycles and how most things are cyclical, then it's easy to just extrapolate that forward.

Starting point is 00:55:24 We just need to be mindful that it's very difficult for a business to not only grow at above average rates, But it's very difficult to do that over a long period of time. And in 2021, there were so many businesses that had these insane growth rates. And investors naturally just extrapolated that forward. But a lot of these companies, their growth slowed down to like near zero, sometimes even negative growth in 2022. And credit dried up. You know, they didn't have easy money to fund their operations and fund their growth and these businesses actually ended up being very fragile. So they grew too fast, they got ahead of themselves, and they weren't prepared for the economic slowdown. That was inevitable. So a bunch of key critical lessons that I've, some of these lessons I've learned

Starting point is 00:56:09 the hard way, but hopefully they can be helpful to somebody out there. One thing, one add on to what you were just talking about the end there, about cycles, is that Howard Mark said most businesses and most sectors, even though the cyclicality might not be as rough, you know, if you compare cycles of, you know, mining companies, obviously those are going to be super, super volatile, whereas, you know, maybe discretionary retail is going to be less cyclical. But it still definitely does have a degree of cyclicality. So it's really important to understand that because like Clay just mentioned in 2021, when investors were seeing these insane growth rates, it's really important to understand that

Starting point is 00:56:46 there's a very, very good chance that it's going to be unsustainable. And so if you're using those unsustainable growth rates in your modeling, you're putting yourself at a lot of risk simply because it's not sustainable. So it kind of just goes back to making sure that you're understanding where we are in the cycle. You're not trying to get really rich really quickly. And you're trying to be conservative when you're making assumptions. I'll also mention a lot of value investors do get into energy. I know a number of really smart people that invested in energy.

Starting point is 00:57:18 And some people get burned in energy just because of the really high cyclicality. And when an energy name is in an up cycle, the PE looks cheap and it looks really low. But what they don't see is the cycle reversing and the earnings reverting back to the mean. So I personally, I know there's so much to learn in that space. And it's not something I've dove into really deep. I don't really feel like I need to add it to my portfolio. I think a lot of people see that there's much higher perspective returns, say, you know, some sort of oil or energy thesis where the oil demand continues an increase. We've had a massive underinvestment over the past decade and playing this broader theme. But the cyclicality of it can be really tricky. And it's another case where the market can really test you where valuations might look low for a really long period of time. And you really have to know your stuff in that space. I'm not sure what your thoughts are on energy. I completely agree with you.

Starting point is 00:58:15 It seems like energy is an area where definitely there's people who are going to succeed at a very high level in it. But just like you, it's not something I've spent much time on and definitely at this point don't feel comfortable investing in. But with that said, I do like the picks and shovels pay based around energy. I have a couple businesses that deal in that realm. So I understand it to some degree, but yeah, like a pure play, energy play doesn't interest me at this point in time.

Starting point is 00:58:42 Maybe it will in the future. I have no idea, but yeah, no, I'm, I'm there with you. So the next mistake that we want to cover could be discussed for probably multiple, multiple hours. So we're going to go over this very briefly, but this is just biases. Obviously, there's so many different biases that humans express and that also impact investing very, very directly. A few biases that I think are worth understanding are, and I'm going to be using the

Starting point is 00:59:11 word in that Charlie uses, just because I like how he's. words. So loving tendency is one. This tendency makes us judge favorably with symbols that we like and we love. So in examples of this right now would be like looking at Nvidia. So it's viewed super favorably due to its large involvement in AI and everyone's seeing all this AI explosion and they like it and they love it. So doing that, whether that's a mistake or not, I don't know enough about it. We'll see how that works out in the future. The opposite of the liking tendency or loving tendency is a hating tendency. So this is a tendency that makes us judge less favorably with symbols that we dislike and we hate. In our previous episode, Clay mentioned meta and how he was very

Starting point is 00:59:51 impressed with how the stock price has gone up. I think it was 400% in the last 18 months or so. But there was a reason why it's gone up so much. It was because it also went down a crap done. So meta, when it announced that it spent to think about $10 billion in the multiverse investments, The market did not like that at all because these were seen as more speculative. And Zuckerberg seemed to be going in the whole new direction for the business and they just didn't like it because the core business of Facebook is really, really good and there's not really a reason to change it. But regardless, basically the stock price was at 380 and in one year after this investment

Starting point is 01:00:28 into the multiverse was announced, it went down to $93. That just can show you how Facebook was a market darling. Everyone loved it. and then this new piece of information came out and everyone hated it and that completely changed the narrative of the stock. Another one, then this might be, you know, one of the biggest problems and biases that everyone has is confirmation bias. So this is where we basically cherry-picked data and information that supports our current view

Starting point is 01:00:53 while ignoring disconfirming evidence. So an example of this that I've gone through many, many times is when investors hold a stock, they obviously have a thesis for it. And that thesis seems to be breaking down and it's supported by facts and information. But the investor just chooses to ignore that and hold on to it, just trying to make sure that their original thesis was right and they're allowing their kind of their ego to be fed by the original thesis. And they don't want to interrupt that thesis from happening because it would show that they

Starting point is 01:01:26 were wrong. And unfortunately, in investing, you have to accept that you're going to be wrong a lot of time. So another bias that I really like is anchoring bias. So this is a bias that keeps us focused on the first piece of information that we obtain, whether that's on a stock or an idea or whatever. So an example of this that I see in investing is when an investor buys a business and is anchored to the original price that they paid.

Starting point is 01:01:49 So this was a problem that I went into with a Ritzie actually, which is a business that I've held the longest in my portfolio. But I originally bought it at around $16.5. It shot up to, I think, early mid-50s in very high. short period time, like a year. And then I always was like, man, like I really want to add to this position because it was one of the first positions I bought. So I had very small amounts of capital. But it felt like, okay, well, I don't want to add until it gets back down to $16.5. And that was a mistake on my part completely because obviously the intrinsic value of a business

Starting point is 01:02:21 goes up over time. Luckily, in 2023, the business again got hit with some bad short term news. And the stock price went down to low 20s. And I was lucky enough. to add a lot to my position. And I got a lot of flack and people saying I was crazy for doing that, but it's paid out for me well so far. So, but you know, the thing that's interesting about that is I think when I re-bought in, I think I re-bought it somewhere in the mid-20s, I actually was getting it for cheaper than when I was buying it for $16.5. It's really important to understand that anchoring bias and how powerful it can be. The next bias I want to go over is recency bias, which is a bias that overweights recent events over historical ones. So an example of this might be new.

Starting point is 01:03:03 that might have very little impact on a specific business and spook investors and punish many adjacent business because of that news item. So, you know, like the example here that I gave is Warren Buffett when he first bought American Express. So the market was super spooked because Amex was on the hook for some loans and there was a huge scam that they were basically, they weren't a part of the scam, but they were on the hook for some of the loans that this fraudulent company performed. But Buffett saw this and he saw the stock price cratered, but he literally went went out to different stores and restaurants and would watch people come paying with their American Express cards.

Starting point is 01:03:40 I think at this point they might have been called something else, diners or something else, but, and he literally would see someone come up with an American Express card and ask them like, oh, hey, you're still using your card. Do you have any fear about what's happening in the news? And he noticed, no, no one cared. I mean, the fact that American Express owed some money on loans, it freaked out investors, but the actual people who are using their products and services were still using it. So he understood that, okay, I can still, I can make a lot of money on this because no one,

Starting point is 01:04:09 all investors have recency bias and they're punishing the stock price, but because I can look out further, I get a great opportunity. So obviously, you know, in Charlie Munger's, in Port Charlie's Almanac, he talks about, I don't know, I think it's like between 45 and 50-ish tendencies, so I'm not going to cover them all because I'll take forever. But the point is, is that I would really understand what these biases are. And obviously it's easy to apply them to other people, but it's probably more powerful to apply them to yourself and see where you make mistakes because I guarantee you everybody make mistakes.

Starting point is 01:04:44 Buffett makes mistakes. Munger used to make mistakes. Everyone that we follow makes tons and tons of mistakes. And it's really important to try to figure out what your mistakes are because you're going to be able to hopefully try to make it so that these biases aren't affecting you negatively. You'll never be able to fully get rid of them. but you should be able to try to figure out what biases maybe are affecting you the most so that you can spend some time trying to game plan and strategize with the best way to avoid them.

Starting point is 01:05:12 I have a few comments on some of the ones you mentioned. Confirmation bias is quite important, especially in today's age, because social media platforms, the algorithms are designed to feed you the information you want to see. What this leads to is you're just getting into an eco chamber of you see the information you want to see. And we need to actively look out for people and find people that have viewpoints that are different and hear out those viewpoints and whether you believe they're valid or not. Regarding anchoring bias, in picking winning stocks, I think it can be difficult for people

Starting point is 01:05:53 to average up into their winners. So when you buy a stock, it goes up. after executing, we view the price differently than someone who has a fresh set of eyes of that they've never seen the company before. And they might see it as a great deal. They see the execution. They see the stock performance, the fundamentals. But if you bought it and it's gone up 50%, you're probably naturally more reluctant to be interested in buying anymore just because your previous price is so much lower than the current price. And it's just a good reminder that the best businesses tend to hit a new all-time high about every year. And it's a good problem

Starting point is 01:06:34 to have if you find yourself with some of those businesses. But it's also a good bias to keep in mind regarding anchoring. Anchoring is so, so strong, especially with losers too. If you buy a stock at 100, it goes down to 75 because the thesis has changed. You have to be willing to part ways if the thesis, your thesis is busted. You shouldn't be like, yeah, I need to sell when it gets back to even. I think that's another natural bias we have of we don't want to, you know, hit the sell button when we realize we've been wrong. Another bias, I think, is really important that I've come to appreciate is related to impatience. And I've thought a lot about why quality businesses tend to do well over time. Our friend compounding quality from Twitter, he came in for a

Starting point is 01:07:23 presentation with the community that was just really good. And he shared how quality businesses over 10, 20 year time frames, there's studies out there that show that they outperform the market by 3, 4% per year, which is substantial. And it's like, why is that? And I think for some of the businesses we own Kyle, I think that some people can get too anchored into a price multiple. And they're used to paying low multiples for businesses. And as a result, sometimes they might be sacrificing on the quality spectrum. But I think even if you look out just a few years on a lot of these businesses, and if you're right on the business, that's the hard part. Then a lot of these businesses, their multiples are going to look cheap in hindsight. So again, if you're right on

Starting point is 01:08:09 the business, that's the hard part. I think quality investing is a great strategy for people that have that patience. Impatience definitely plays a role in the stock market. You mentioned that study again where the average holding period is 10 months. And I truly believe that most people are a lot of market participants simply aren't willing to hold on to great stocks for more than a few years. And instead, I think we want to try and develop that bias towards patients to kind of create that bias ourselves, hopefully. And one of the reasons that patients can be so difficult is just with all the noise that's out there, information overload, when a stock runs up, it's easy. to take gains and chase some other next shiny object or maybe when the stock just goes nowhere for a

Starting point is 01:08:56 year, which is also inevitable with most businesses, it's easy to try and chase something else that is going up. In 100-baggers, Chris Mayer has a chapter on the coffee can portfolio and just shares these examples of irregular everyday people that just bought into these blue chip companies. They set it aside and just didn't even check their portfolio for decades and just like were amazed by the results that compounding paid them. And I think it can be a useful mental model to try and sort of adopt that sort of approach and not tinkering too much with things. And at least maybe having some segment of your portfolio where you see it as something that you don't want to touch unless you know you're obviously wrong. And figuring out if you're right or wrong is extremely difficult because it's not a black and white type thing.

Starting point is 01:09:40 And developing this bias towards patience is something I'm generally trying to implement into my own approach. And I'm never going to forget that in the 100-bagger study that Chris did, the best-performing stock at the time, it was an 18,000 bagger. It's much higher now. That was Berkshire Hathaway. It was the best-performing company in a study of 365, 100-baggers. In Berkshire Hathaway, I believe since Buffett took over, it's had three drawdowns of 50% or more. I believe it was during the 1973 or 74 that time frame, the 2010.

Starting point is 01:10:17 bubble and then the great financial crisis. So that's a 50% drawdown for each of those times. And then there are multiple periods where the stock went nowhere for five or six years. And hanging onto that is not easy to do. And when you look at that history of that stock, you have to believe there's so many investors that did not fare well in the best performing stock in the study. So they either got spooked or chased the tech bubble in the 1999, or they just got bored of it. If the stock goes nowhere for three years, they probably just assume it's a dud.

Starting point is 01:10:52 Like, people are making money elsewhere, so why don't I chase that? So the Berkshire Hathaway example is another one that I'll never forget and just reinforces that emphasis on patients and focusing more on how the actual business is performing and put less emphasis on the stock price. Let's take a quick break and hear from today's sponsors.

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Starting point is 01:13:51 a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest in the Fundrise income fund in just minutes. The fund's total return in 2025 was 8% and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund fundrise.com slash income. This is a paid advertisement. All right. Back to the show. Yeah, and that's a great kind of segue into the next mistake, which is like you just said with people during the tech bubble selling Berkshire,

Starting point is 01:14:40 trying to out be smart by reallocating their money from Berkshire into these other more speculative positions. So the next thing I wanted to go over was basically overcomplicating things and making things more complicated than they need to be. So there's tons and tons of people that invests. And a lot of people have very high IQs that also invest. But the problem is that having a high IQ doesn't necessarily mean you're a good investor. So Charlie Munger's quote is something that I think about very often.

Starting point is 01:15:08 So here it is. Quote, it is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid instead of trying to be very intelligent, unquote. And then another one, just another quote, great quote, quote, quote, investing is not a game where the guy with 160 IQ beats the guy with 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges, that get other people into trouble in investing, unquote. Investing at its core is about finding undervalued assets and holding them until price and value converge.

Starting point is 01:15:44 And it's a very simple concept, but people love making it more difficult and complicated than it really needs to be. I think maybe if you look at the professional industry, it might have to do with people trying to look smart in front of their clients or even for retail investors, people trying to prop up their own ego. That's why they try to do all these smart things. There's not really a clear answer, but what is clear is that focusing your efforts on reducing stupid decisions and making sure to control your temperament is much more important. So Clay just had an interview with Ian Castle where Ian discussed one of the most boring businesses that I've ever heard of, which

Starting point is 01:16:20 was Arminino, which I'm sure no one has ever heard of unless you heard that episode. So they make pesto sauce. So this was a business that went from a share price of 30 cents in 2009 to about $5.2 and $2 as of a few days ago. Obviously, no crazy tech was involved in the business. It just grew its revenues and profits at a really nice, steady rate. So sales went from $21 million to $60 million. Earnings went from $1 million to $7 million, and they diluted shareholders by a total of only 8% over that entire period. And with all that, you got a 14 beggar. And to me, this just shows how powerful a simple business can be. You don't need to find some high-flying, highly speculative of AI play to succeed in investing. A boring business with just a great product that can grow at a

Starting point is 01:17:05 nice and steady rate with a great capital structure is really all you need. So if you were to spend all of your time looking for businesses with just those qualities while ignoring everything else, you'll succeed. But once you start trying to get smart and cute, that's when a lot of these mistakes come into play. One of my favorite examples of intelligence and lack of investing acumen comes in the form of Isaac Newton. So, Isaac Newton obviously is one of the most famous scientists of all time, but he lost a fortune buying near the top of the South Sea China bubble. So here, you have one of the smartest people to ever walk the face of the earth.

Starting point is 01:17:42 And his most impactful investing-related quote is, quote, I can predict the movement of heavenly bodies, but not the madness of crowds, unquote. So no matter how intelligent you are, I think making sure you focus on simplicity is going to keep you in the investing game for as long as possible. So Clay, I'd love to know what your thoughts are on overcomplicated investing and how you personally try to make sure you're keeping things simple. That's really well said there, Kyle. And this is such a tough issue because with investing, there's just so much nuance. Hardly any rules can be black and white. I can pull up plenty of

Starting point is 01:18:19 examples. There's no hard roles to successful investing generally. Again, there's no there's no black or white. And that company you mentioned that did the three things that Ian talked about during that interview, it grew revenue, grew earnings, and didn't have excessive dilution. So I think that's a really helpful mental model of, you know, what were the key things that led to the success of this business? I sifted through William Green's book prior to this because I was reminded of a very simple, like even simpler mental model that he shared during it.

Starting point is 01:18:55 And I couldn't remember the investor, but it was Will Danoff. He managed a massive fund of Fidelity, is extremely successful. And I just love the phrase that he shared with William during the interview for the book. And it's that stocks follow earnings. I already mentioned this, but I just think it's worth repeating because I've revisited it and really enjoyed reading through that piece. And obviously, there are exceptions. Like sometimes a company can increase their earnings, but they dilute more.

Starting point is 01:19:25 than what the earnings increase and that can lead to a weaker business. So there is some nuance, but maybe you could just adjust it and say stocks follow earnings per share. But again, it's not easy. Sometimes numbers can be manipulated, but it's a good sort of mental model and rule of thumb. Because first, it filters out businesses that aren't profitable. So if you want businesses that are going or earnings that are going up over time, naturally you want that to be a positive number. So that can save investors a lot of time and headache. And then the second piece that I think ties into this mental model is that over time, there's a Ben Graham principle that the market's a weighing machine over the long run and a

Starting point is 01:20:06 voting machine over the short run. And the market tends to reward companies that succeed over time. So a lot of times I'll ask myself, when I'm analyzing a company, how likely is this business to have earnings that are, say, two times? or three times higher in five years than what the earnings are today. So a double in five years is actually a 15% kegger, which is around what Kyle and I are targeting for the returns of what we are investing in. So what is the likelihood that earnings will be two, maybe three times higher? And in Will Danoff's case, he had met with Howard Schultz one week before Starbucks went public

Starting point is 01:20:47 in 1992. And this was shared in Williams' book. Starbucks at the time had 139 locations. and they were aggressively expanding. And Danoff, he just looked at the economics of the business. It costed $250,000 to build a cafe. And then by year three, that one store is earning $150,000. And it didn't take a genius to see that the model worked. And Howard Schultz had figured something out here. And they just needed to rinse and repeat the process all over again.

Starting point is 01:21:16 And then obviously make sure, you know, you have some sort of economic moat there, of course, too. But Danoff shared with William the earnings growth and the stock performance of Starbucks over a two-decade time period. It wasn't detailed what time period it was, but it must have been around since they went public. So earnings grew by 27% per year, and the stock grew by 21% per year. And then he compares that to the S&P 500. S&P 500, earnings grew by 8% per year. Then the returns were also around 8% per year. Generally, I like businesses I can understand.

Starting point is 01:21:52 I can get a good estimate of what earnings are going to look like in the future. And in many ways, fall back on that principle that over time, eventually stocks follow earnings and alphabet earlier I shared that example as well. And ideally, a business has a formula for growth that's repeatable. It's easy to understand. Starbucks, great example. They don't have to create new business segments. They don't have to invest in the metaverse.

Starting point is 01:22:18 or create a cloud business like Amazon did. They just need to repeat what they've been doing since day one. William writes in that chapter, I quote, his mantra doesn't sound particularly profound, but Danoff's edge lies partly in his consistent refusal to overcomplicate. His friend Bill Miller, one of the most insightful thinkers in investing, says Danoff consciously focuses on the questions that matter most instead of getting tangled up and distracting details, end quote.

Starting point is 01:22:50 And then to wrap up that section, William Riley points out that we each need a simple and consistent investment strategy that works well over time, one that we understand and believe in strongly enough that we'll adhere to faithfully through both good times and bad. And to tie back to a company we talk about often, Kyle, we discussed Dino Polska back on episode 587, we both owned the stock. And if you look at their store counts, earnings and their stock price and just charted it out over time, I think you would see a pretty dang high correlation where each of these metrics is just up and to the right. And I want to own a business where the situation only seems to improve year after year.

Starting point is 01:23:33 But Kyle, you know as well as anyone that simplifying things can also be what can kill us as investors. There's just these simple lines or narratives people throw around. For example, with meta, people might have just said, Zucks just throwing all the profits down the drain with these investments in the metaverse, just these simple things that people can say. So there's still a fine line, I think, between keeping things simple, but not to an extent where you end up hurting yourself. Yeah, I completely agree.

Starting point is 01:24:04 I mean, like you said, in investing, there's very rarely, is it black and white? It's a lot of gray areas. and that's why investing is so difficult, right? Because you have to determine what news items or what event is happening to a business and what's material versus what is immaterial. And there's so much news out there that it's really hard to assign a news item and say that it's material when in reality it's immaterial. And you can make one little mistake and maybe you thought something was immaterial

Starting point is 01:24:32 and it turns out to be material and you get punished for it. So yeah, investing, you know, like I said at the beginning of the episode, it's not easy. And I think that's just one really good example of why it's not so easy. So Clay just discussed earnings and how that creates value over time, which is a really good segue into the last mistake that we're going to be covering today, which might also be the most powerful mistake, which is misunderstanding price and value. So Warren Buffett famously said, quote, price is what you pay and value is what you get, unquote. So this quote is so simple and elegantly put, yet its message is so powerful.

Starting point is 01:25:13 There is a massive, massive difference between what you pay and what you get. I would say most investors have a very difficult time understanding the difference between the two. A simple example might be, let's say here shopping for a household good. Let's say it's a laundry detergent. You might go to three places. Let's say you go to Costco, Safeway, or 7-Eleven to look at it. Look for it. And you'll notice that the price for the same item is going to be different at each store.

Starting point is 01:25:40 But the product is the exact same. So 7-Eleven might sell the exact item that you're looking for, same brand, same volume amount for $15. Safeway for $13. Costco for $11. Yes, Costco's going to win that battle. But the important thing to remember there is that you're paying a different price at each store, but you're getting the exact same value. This happens in the market all the time that there's these discrepancies.

Starting point is 01:26:06 So a stock like Amazon has traded in the last 52 weeks between $88 and $12.75. So you can't tell me that the value of Amazon has been that volatile. And if you look at Amazon's last four quarters, revenue has grown from $127 billion to $169 billion. Net income is grown from $3.1 billion to $10.6 billion. and cash from operations has grown from $4.7 billion to $42.4 billion. Now, I'm not an Amazon expert. That last number sounds crazy to me. But the point is, is that their growth has been, for all intents of purposes, linear.

Starting point is 01:26:42 And yet the stock price has this massive, massive whipsawes. But the point is that the business is growing in the direction, like Clay just said, up and to the right. And the stock price over the long period, obviously with Amazon, has been going in that exact same direction. This means that as Amazon's value has increased, the price is fluctuated between times when the business was undervalued and times when the business was overvalued. So you can do this exercise for literally any single business and you're going to see a massive fluctuation and share price versus fluctuations and the actual value of what you're getting.

Starting point is 01:27:16 So the point is that the stock market is a public market where many people are setting the price of stocks. And while they're very efficient a lot of the time, they're not efficient 100% of the time. So that's very important to fact to remember. So savvy investors understand this at a very, very deep level. So if you're following a business like Amazon, you should be, you know, really happy when it has a double-digit drawdown because it means that you can either initiate a position or add to your position that you already have. So another mistake that I've observed is people assigning expensive or cheap label to a stock based on the absolute value of the business. So this is a really kind of newbie mistake, but I've seen it for multiple people. So I just want to

Starting point is 01:27:57 share it with you guys. For instance, let's say a stock is a dollar. Someone might consider it's cheap because it's a dollar, whatever. But if a stock is $100, they'll consider that one to be expensive. But obviously, if you know the difference between price and value, it doesn't work that way. Let's say you're getting 50 cents of value on a stock that's priced at a dollar. Then in that case, the stock's overvalued. And in the same token, if you're getting $200 of value on a stock that's priced at $100, then the stock is undervalued. So the absolute value of a stock It doesn't matter. Whenever you look at its stock, it's important to look at both the price and the value and try to search for areas of time where it's disconnected because that's where you're going to get

Starting point is 01:28:35 really good opportunities to get entry points. So if you understand this and you understand how to value a business, then you can use this to your advantage, especially to buy shares that are unloved by the market. And also, if you also want to sell things, if things are starting to get too scary and too overpriced, it also helps you understand when to exit an investment. The essential strategy that Clay and I are both trying to do is buy shares that are unloved, which usually means undervalued by the market. Hold on to them as the market realizes some snakes and brings up the price in line with intrinsic value or sometimes even above. And you know, you just do that for a really long period of time. And with high quality businesses, they tend to just keep on increasing the intrinsic value over hopefully, you know, 10, 20, 30 years and you just hold on to it and enjoy the ride. This also reminds me of like Buffett's transition from, you know, cigar butt deep value to quality. And if you're going to pay like a higher multiple for quality business, I love how Godinbate in his book, The Joy's a Compounding, he talked about how quality in itself can produce a margin of safety. So say if you have one business, you think it's trading 50% discount to intrinsic value, but the business isn't growing.

Starting point is 01:29:47 that can put you in a tough predicament if, you know, the convergence of price and value takes quite a long time, or maybe it just never happens, or maybe it's just a different sort of situation for me than if I'm buying something. It's a P.E. of 30. Earnings are growing by, I think they're going to grow by 20% a year. Maybe earnings only end up growing 15% a year. But eventually, the intrinsic value is going to keep going up over time and I'm going to be rewarded given a long holding period, and I'm still right about the business being high quality. So I like with quality businesses that your intrinsic value just goes up year after year. And I see a lot of cases where value investors, they talk about this company is trading at

Starting point is 01:30:30 $5 billion, and a very similar company just sold to private equity for $8 billion. And it's, you know, discount appears essentially. And personally, it's just not my flavor. Like, it might work for some people, but I just think it's still a difficult, game to play because what's going to be the catalyst that ends up unlocking that value. And I had a comment here on Amazon. If you look at some of Bezos's early comments in the past, you'd probably think he's studied value investing. During the tech crash in 99, Amazon stock, I believe, went down over 90%. And during that time, he talked about, like, in the public,

Starting point is 01:31:11 that even though the stock was down 90%, if you looked at their financials, like, you'd think Amazon was just becoming a way better business year after a year, because all of their metrics that mattered to their success were just going up over time. And of course, there were some things related to their access to financial, access to debt and equity markets and being able to raise more funding. But putting that aside, obviously that is important for the business. But if you look at the fundamentals, the revenues, the gross, margins, their net income, you probably needed to make some adjustments for that business.

Starting point is 01:31:45 But everything Jeff Bezos cared about was heading in the right direction. And I believe he said that even in public. So you didn't have to be an insider to kind of realize that things are heading in the right direction. So another, I believe it was a Bezos quote. He has a quote that a rising stock price doesn't make you a genius and a falling stock price doesn't make you an idiot. And I think he told that to Amazon employees that, hey, even though our stock's down 90%, we just got to keep doing what we're doing. And, This discussion on price and value, one mistake I see people making is assuming that a business with a high, optically high PE is overvalued and a business with an optically low PE is

Starting point is 01:32:25 undervalued. So a PE doesn't determine a business's valuation, whether it's over or undervalued. It's the intrinsic value in the price that determines whether it's under or overvalued. So there's some second level thinking that you need to do and not just look at a multiple and just dismiss a company right away because oftentimes there are some adjustments that need to be made to the earnings. And if there's an amazing business, it's growing at extremely high rates and as an insane mo, it could be at a multiple of 50 and still be drastically undervalue. Like, that's the reality of it. That's the way the market works. And you might have an energy company like ExxonMobil,

Starting point is 01:33:00 for example. It says it's a P.E. of five, but they need to reinvest all those earnings back into maintenance cap-x. It's like, okay, what are they really earning? Maybe a normalized PE is much, much higher than five. That's something I, it took some time for me to realize that and come around to that idea. And again, price and value don't necessarily have to be connected in the short run. And that's where opportunities can arise for opportunistic investors. And Chris Mayer during my chat with him, he loves to say that at the end of each year for his holdings, he likes to look at the high and low point like you did with Amazon. And what you'll see with so many great companies is that every year, every two years, they give you opportunities to add to them. Even if it's not just like a bargain, it's just like just a relatively good price to what it's been at historically.

Starting point is 01:33:54 Oftentimes 10 or 20% drops or even bigger drops are very common. And the last company we covered on the show, Kyle, Evolution AB, it's had two 50% drawdowns just in the last three years, I want to say. There was the 2022 drop and then the most recent drop were both, I believe, over 50%, definitely over 40%. You know, another example of it. If you look at the fundamentals of the business, it's just up into the right, but the stock price is quite volatile and tests investors' patience.

Starting point is 01:34:25 So I know you've recorded an episode on the book, Big Mistakes by Microw. I think Michael Batnik on We Study Billionaires 579. Are there any other good books that have helped you better understand the mistakes of the market that you'd like to share with the audience? So the best way to learn for mistakes is to look at your own. I'll say that the mistakes you make yourself are the ones that really stick with you and tend to be ones you hopefully learn from because they tend to be quite expensive as well relative to a $20 price tag of a book. I did like that Michael Battenick book, big mistakes. That was really a great one because each chapter covers like a legendary investor and the mistakes they made. There's a chapter on Buffett, Drucken Miller, John Meeter Keynes.

Starting point is 01:35:06 There's a great chapter on him where he was a big macro economist and he tried to make these macro bets. And he found out it was just so, so difficult. And then he transformed into a fundamental investor. And then just he went down as like one of the great, great investors of that time period. other books, none specifically on mistakes in particular, but right now I'm reading what I learned about investing from Darwin. And Poulac Prasad, this guy is just brilliant. So he shares his approach, but he also shares why he's developed the approach he has and why he

Starting point is 01:35:43 doesn't do other things. So he essentially is pointing out the mistakes that other people are making. Just the other day I read how some people like to invest based on like the Tam, that a company has. So you have an early stage growth company, say it's a Nikola. Nikola, I'm not sure how I pronounce it, but it's this EV startup. They have no revenue. And, you know, there's all this buzz around EVs. And, you know, kind of the pitch for someone that invests in that is like the EV market in 10 years is going to be just massive. Like, it's going to be so big. There's going to be so much money to be made in this market.

Starting point is 01:36:17 But the problem with that is, first you don't know if any, Tam doesn't, tell you whether any profits are going to be made. There's plenty of industries today where the Tam is just massive, but most companies don't make any profits, if any. And there might be one or two huge winners and predicting the winners is so tough. So that's the second issue is you don't know of the profits who's going to be making any of them. Yeah, Pooleck's book really has opened my eyes to new other mistakes that people make. You know, I've sort of added some filters to my own process and part of it is cloning what other people do. And Poolock kind of exposes, okay, why are we using some of these filters or why are we investing in this sort of manner? And it's been really helpful

Starting point is 01:37:00 for me and honing my process and finding more of these red flags because his average returns have been 20% per year. And he definitely understands the disconnect between price and value. He called up his shareholders like crazy during the great financial crisis and just went on a buying frenzy and that's taking advantage of that sort of opportunity just really seem to make a really great career for him and juice his returns like crazy. Those are probably great books to learn from, I think. Sometimes it's better to find just one or two of these amazing reads rather than sift through other books that maybe aren't near as good. Yeah, I agree. Both those books are incredible. And one thing also that stood out to me from Pulaq Prasad was how he

Starting point is 01:37:45 tries to basically put as little emphasis as possible on stock prices. And he's essentially engineered his day and, you know, the fund around it. You know, they don't talk about stock prices and, you know, minor news articles during their meetings. You know, they don't have, their Bloomberg terminal is somewhere like stuck in a corner, I think, in their, in their kitchen. So, you know, they're, they're really trying to do everything that they can to stay focused on the long term and, and try to reduce noise as much as possible. And so I really liked his point. And so, I really liked his points in his book about how he went about going on doing that. So anyways, that wraps up today's discussion on investing mistakes. Clay, thanks so much for recording me. It's always a

Starting point is 01:38:25 pleasure. Always enjoy it, Kyle. Thanks for inviting me. Okay, folks, that's it for today's episode. I hope you enjoyed the show and I'll see you back here very soon. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. 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 Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP614: Investing Guardrails: Avoiding Common Mistakes w/ Kyle Grieve and Clay Finck

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