We Study Billionaires - The Investor’s Podcast Network - TIP666: Compounding Beyond Wealth: Unlocking Life’s Hidden Potential w/ Clay Finck & Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. God and Bade wrote one of the best books on compounding that's ever been written, The Joys of Compounding. Now, while it's based on the concept of compounding through the lens of investing, you realize just how deep and wide the concept goes once you read the book. Now, whether you want to compound your wealth, relationship with others, wisdom and knowledge, or even your own health, the joys of compounding provides insights that can help you compound your life for the better.

Starting point is 00:00:25 It's one of Clay's favorite books, and I completely understand why. Today, Clay and I will cover some of the key learnings that Clay took from his in-depth research into this book. We'll cover things like why self-education is just so important to continue even after you've completed a formal education. How humility plays such a prominent role in identifying where our strengths and weaknesses lay. Why the inner scorecard is such a profound concept, how Buffett has successfully utilized it through his life, and how you can implement it into your own life. Why good investing is sometimes as simple as attaching your sidecar to an outstanding manager, critical insights into how quality businesses can have a place in your portfolio, even if you despise paying optically high prices, how to utilize base rates in your investing to observe

Starting point is 00:01:09 the realities of investing, and a whole lot more. But one of my favorite talking points that Clay helped prompt me to think about was my own circle of confidence. How was one company that I started researching over a year ago led me down a rabbit hole, of which I'm still only scratching the surface. And where will that journey take me over the next year? Thinking in this light has shown me how compounding wisdom works. It's also given me some foresight into how much deeper the circle of competence concept goes. I find it amusing that it took me multiple years to understand my circle of competence, but it's also given me an appreciation of

Starting point is 00:01:43 how far I've come and it's excited me about how much more I can learn into the future. If you enjoy compounding wealth, you'll be ecstatic to learn how many, other valuable areas of life compounding can be found. So if you want to learn more about these areas where combining can provide value, please listen on. Now, let's get right into this week's episode. 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 influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your hosts, Clay Fink and Kyle Greve.

Starting point is 00:02:30 Welcome to the Investors podcast. I'm your host Kyle Greve and today, Clay and I will continue our discussion on our favorite investing books. So during the previous episode, we covered one of my personal favorite investing books, which was the most important thing by Howard Marks. And today, we're going to cover the book that Clay selected, which was the joys of compounding by Godham Bade. Both are excellent books to discuss on the show, so I think you're going to enjoy this chat and reading the book. So, Clay, let's start with why you selected this book to cover on the show. Yeah, so I'm reminded of that saying that we're all the average of the five people that we spend the most time with.

Starting point is 00:03:14 So if you spend time with people who are above you in some way or more competent than you in some areas of life, then you can't help but better yourself. And the joys of compounding by God and Bade, it really reminds me of that saying because I'm not sure how someone could read this book and not walk away. a better person in some way. So I read this book at the beginning of 2023, and I pretty quickly realized that it was something I wanted to cover on the podcast. But the problem I had was just, there was just so much good content in the book. And I knew I couldn't just do one 60 or 90-minute episode and just call it a day. There was just so much important content that I felt I had to cover. So I actually ended up doing five episodes covering the book, which sounds ridiculous. But if you read this, you'll realize just how much good contents in it.

Starting point is 00:04:03 And no book I've covered on the show has really even come close to this. And very thankful that Gottem, let me do such a comprehensive overview of the book on the show. So the series starts on the feed back on episode 534 and progresses from there. And it gives a pretty good summary of the book. So really what Gottem did in writing this book was capture all of the really important content as it relates to value investing. And he just packed it all into this one.

Starting point is 00:04:30 book and one resource, and I found it to just be so incredibly insightful, but also really inspiring. So I think it's worth mentioning a bit about Godham's story and his background here to help set the scene for the discussion. Goddham was born and raised in India, and he got his CFA designation, and then he moved to the U.S. with the dream of one day launching his own fund. So instead of taking an investment banking job that would pay just a ton of money and essentially take all of his free time, he ended up just covering his living expenses by working a minimum wage job at a hotel in San Francisco. And this sounds crazy, and to me, it is pretty crazy.

Starting point is 00:05:11 So he worked the night shift at this hotel, and this really allowed him to just read and learn and just consume all of this information as it relates to value investing with his side set on one day being a fund manager. So while he was reading and learning everything, he could get his hands-on. He applied to at least three stock market jobs online per day. And over time, when you run the numbers, he applied to over 1,300 jobs, which just shows a ridiculous level of dedication that he had. And given that he had his CFA, I think he moved to the U.S. sort of assuming that it was going to be easygoing to get into the industry, but it ended up being just a tough time for him. So eventually, this passion for investing, it did land him a role as a portfolio manager,

Starting point is 00:06:00 which is a role he held for four years during which he ended up writing this book. And then he ended up launching his own fund in 2022. So I think in the interview I had with him on the show, he also discussed how he expected to have to work his way up to being a portfolio manager. So that role that he got was just a portfolio manager role. So he really, that reading and learning really paid off for him. Eventually, it just took a number of years to get there. So with the book, I love that it not only covers a lot within the value investing space, but also just as it relates to life. So for example, chapter one covers why the best investment one can make is in themselves. And chapter 11 covers the key to success in life is delayed gratification.

Starting point is 00:06:44 He also just did such a wonderful job sharing so many relevant quotes in the book. So the first one, I have to mention here every time I talk about this book is from Charlie Munger. The best thing a human being can do is to help another human being no more. It's just so simple yet so profound. The Mugger quote at the start of chapter two is that those who keep learning will keep rising in life. And that's really what TIP to me is all about. And it really makes it an extra special book for me to cover on the show here. That's right, Clay.

Starting point is 00:07:15 And I really share your love in this book. So I got to read this book back in the 2020. to you and I hadn't actually gotten much of a chance to revisit it since then. So it was really nice to revisit it and take a look at all the quotes that I highlighted. But even back then, similar to you, I'm just blown away by the quality content and just the amount of content that he fit. And it's not a super long book, but you know, it's just jam packed. And, you know, I really agree with your point that, uh, how hard it would be to make a single podcast into the book. Obviously, we're doing that now, but by no means is it complete because there's only so much time

Starting point is 00:07:46 that we have. The book has just so many great teachings, lessons, and insights that I think should be explored very deeply. And I think hopefully we're going to go through some of those deeper ones that we think are very important. My copy, like I mentioned, is fully dog-eared and has been well read, got writing all over it. So yeah, I've taken a lot from it. A few of my most significant insights were from his really good chapter on just becoming a learning machine. So he mentions the excellent book, How to Read a Book by Mortimer J. Adler, which is a book that I highly recommend and I've mentioned on other podcast episodes as well. He also mentions the importance of attempting to find the truth when trying to learn, not just confirming what you already know. So

Starting point is 00:08:22 this is a distinction that's very important and it really makes me think of the importance that Ray Dalio has stressed on this exact point in his book, Principles. Another area of the book that really resonated with me was his points on developing staying power as an investor. So he breaks down a few fundamental maxims to survive long term. Their passion for the investing discipline, a constant learning mindset, a long runway for your investing time horizon, low or no personal debt, making sure to be frugal, discipline, understanding of human behavior and biases, learning the major lessons from market history, owning a patient long-term investing mindset, and the importance of having a supportive family to get through rough patches of the market.

Starting point is 00:09:03 So these are all areas on which Clay and I place a significant emphasis in our own learning. And I'm just fascinated with how the best long-term investors have survived such long periods of time. mastering the specific maxims can only help increase the odds of you surviving the markets for decades and hopefully reaping the returns of decades of compounding. So my view on the book is that compounding can obviously be seen in many areas of life. It's important not to make the mistake that compounding is strictly for accumulating wealth. There are just so many ways that compounding can benefit us and Godham did such a superb job in this book of showing how compounding is visible in all these sorts of different areas of life. Yeah, so many of these lessons can really be

Starting point is 00:09:42 applied to anyone. And I actually gifted this book to one of my brothers. And I was just like, hey, if you want to skip some of these chapters on stock picking or whatnot, go ahead and do it, because each chapter, to some degrees, largely standalone. But there's just so much in the book that can really apply to all of us, as you mentioned there. And I wanted to expand on that a little bit here. So as I mentioned, chapter one is on why the best investment you can make is in yourself. Many of us get attracted to value investing because of the prospects of making money, achieving financial independence. But I think what keeps most people in this circle is the community of like-minded people.

Starting point is 00:10:21 And because the community embraces lifelong learning and becoming a better version of ourselves, and it's likely that we can't get to where we want to go in life based on what we already know. So we need to seek out that information from others to really help us level up ourselves. Got them explained that acquiring wisdom is simple, but certainly not easy. We need to read, read, and read. And if I were to add one more thing here, it'd be listened to some podcasts as well. All of this wisdom is really out there, just ready to be seized by us. And all we really need to do is take action and go and get it and try and acquire some of that

Starting point is 00:10:58 wisdom for ourselves. So if we look at Warren Buffett, his typical day is just sitting. in his office and reading. In the world of instant gratification and in this world of everyone having a desire to get a payoff now, I would argue that there's never been more upside to investing in ourselves and becoming a learning machine. And it could also be argued that the stakes have never been higher. Another great quote that Goddum shares from Jim Rhone is that formal education will make you a living, but self-education will make you a fortune. I mean, what a statement I just find it so true because I think for the most successful people, the real learning isn't in a classroom.

Starting point is 00:11:42 It's typically after they're done with school. So many of us are done with school around 18, 20, or 25 or whatnot. And when people are finished with school, a lot of times their time reading and learning ends there. And for a lot of the people we study here on the show, that's really when the learning is just beginning. So David Ogilvy, he described reading and learning as a priceless opportunity to furnish our mind and enrich our quality of life. I also think that many people see reading as something that can be pretty intimidating, which I can totally understand and totally get. Most books are, say, 300 pages long and there's just so much content to take in. And then there's the time that you need to invest to actually implement some of these learnings and just organize all this information you're taking in.

Starting point is 00:12:30 So the way Munger approached this was that early in his life, he decided that he just wanted to commit at least one hour in the morning to self-improvement and investing in himself. He asked himself, who was his most important client? And he said, his most important client is him. So one hour, it's really just a fraction of the day. But over time, it really compounds significantly with consistency and the desire to just get a little bit better each day. And if you do believe that the best investment one can make is in themselves, then I think you'll set aside some part of your day to make that investment in knowledge. Yeah, great point, Clay, about how learning can often stop for people after they finish school. I think about this a lot. And, you know, probably 99.99% of what I know and use today was learned outside of my formal education. So I expect that number to probably grow as I get older and more wise. And like you said, you know, much of that learning has come from reading and a lot from just thinking. So Charlie Munger would definitely support this notion.

Starting point is 00:13:29 After all, he is definitely one of the masters of multidisciplinary thinking and is criticized traditional education institutions for their lack of thinking outside of just the specialized areas in which they're teaching. So to Charlie, you know, I think using these thinking tools from different disciplines is how you get to the best possible answer. If you just stick with one discipline to answer all of your problems that come across you in your life, you'll come across with just lower quality answers and you might come to the complete wrong conclusion. So Bade has several great thinking tools that he covers in this book. He writes about the importance of vicariously learning from others, and he mentions how vital

Starting point is 00:14:06 biographies and history is to improve your understanding of the world around you. He also mentions first principles thinking, which is really just boiling things down to their fundamental truths. And as I mentioned previously, getting to the truth should really be the goal of everyone, even outside of investing. We kind of default to just hammering things in that we already know to be true, but that often leads to suboptimal thinking because we cut off. off the possibility that we could be wrong. So this concept goes into some really good details that

Starting point is 00:14:32 Godin Bade shares about James Clear. So the first principles is definitely embedded in another one of James Clear's concept, which is thinking in scientist mode. So a few of the key concepts of thinking in a scientist mode are favoring humility over pride and curiosity over conviction, looking for reasons that you might be wrong and not just reasons why you might be right. The last one here is viewing opinions as a hypothesis that are in need of confirmation or, more importantly, rebuttal. So I also liked the concept that Bade shared here about the Feynman technique, which is just a way to simplify a concept that you want to learn by imagine that you're teaching it to a 10 year old. So you must do this exercise without reference to material and use language

Starting point is 00:15:12 that a 10 year old would understand. So once you're done writing it, you can then compare it to the original source material to kind of better understand where maybe you're misunderstanding specific concepts. So I haven't used this myself in a formal way, but I like to think that I probably use it to a certain degree, especially with our mastermind community. So a recent example was that I recently had a one-pager on this royalty-type business that I've started adding to my portfolio. And so as a result of sharing this one-pager, I got a wave of just really, really good questions from our community members. And some of them I didn't necessarily know the answer to right away. So I had to go out and read and learn and then come back and answer the questions that I was asked. So writing the

Starting point is 00:15:50 answers in my own words really helps me cement a lot of those learnings into my brain that might not have stuck in my brain if I just copy-pasted source data or quotes from others. Yeah, I like that point on how teaching others can really help cement those insights that make you a better investor. And having other people hold us accountable can be extremely helpful in our learning process. And it's a good segue here to my next piece on lifelong learning. So Godham outlines the importance of reading and lifelong learning because really it's the foundation to being a great value investor. Before getting to value investing specifically, I think once

Starting point is 00:16:28 we start learning about any subject, we can start by understanding the fundamentals. So there's millions of different things that we can learn from just the topic of value investing itself. But Charlie Munger shared with us that it's just a few big key ideas that really move the needle and are absolutely critical to understand in any field. So Goddham writes in his book here, five words separate the good from the great. Flawless execution of the fundamentals. Boiling things down to their most fundamental truths, that is, to first principles and then reasoning up from there. This type of reasoning removes complexity from the decision-making process so that we can focus on the most important aspects that pertain to the decision at hand, end quote. And we've mentioned Amazon countless times on the

Starting point is 00:17:19 podcast here. There's just such a great example of first principles thinking. And when you think about just from the very beginning, Bezos had this maniacal focus on the fundamentals. He focused on thinking long term and providing value to customers rather than putting focus on his competitors. So based on first principles thinking, Bezos knew that customers would always want wide selection, they'd always want low prices, and they would always want fast delivery times. So if Amazon delivered on just those three things, then for the most part, the rest would really take care of itself over the long term. So first principles can really help us, you know, just keep us anchored into what doesn't change fundamentally, just keep us anchored in those core principles.

Starting point is 00:18:04 And another part, I think, is also important to first principles thinking is that they can help simplify how we make decisions over time. The world is just infinitely complex. There's so many things to consider when making a decision. And I think really being anchored in sort of those core principles, whether it be really any decision in life, whether it be investing related or not, and can really be helpful in decision making, I think, too. So there was another area that he shared, which was his core principles, kind of his first principles of investing. So he mentioned kind of two that really, really stuck out to me, which were thinking probabilistically and underestimating the power of incentives. So if you listen to our previous episode,

Starting point is 00:18:46 episode on the most important thing, you can probably tell that I'm very passionate about trying to think probabilistically. It's a key tenet of successful investing, and I think it's a requirement to really optimize your decision making. You know, we're never going to know the future, and thinking otherwise is most definitely going to do us to making many of the common investing mistakes. So I think it's very important to imagine what all your investments will do in multiple scenarios. One aspect of this that I've been thinking about is how I should heavily weigh the bear scenario compared to maybe the way I do it now, I probably need to wait even higher, which will put more emphasis on downside protection. It can just be so easy to get caught up in the

Starting point is 00:19:24 market's bullishness and forget that a bear market will always be around the corner. You know, the economy is never smooth and it oscillates between these up cycles and down cycles. So it's just very important to build your investment portfolio to deal with these inevitable cycles. And then on to the point about incentives, Bade mentions a really good Charlie Munger quote, perhaps the most important rule in management is to get the incentives right. So the best ways that I've learned to make sure management is incentivized in line with shareholders is to look at a couple key things here. So, you know, how many shares do they own? Is it a lot? Is it a little? Were those shares purchased on the open market or were they accumulated just through options through the business

Starting point is 00:20:01 essentially just giving it to them? And, you know, what percentage of company ownerships make up their net worth? You know, maybe they only own 0.5% of shares outstanding, which seems negligible. But if that makes up, you know, 99% of their net worth, well, that's probably a pretty good signal. Other things might be, you know, what is management incentivized to do inside of the business? Are they incentivized to increase a KPI that is aligned with adding shareholder value? Or is it some sort of typical things such as increasing revenue, which, you know, is probably not something that's necessarily aligned with creating shareholder value? And then the last one here is just, can a manager earn its incentives without adding

Starting point is 00:20:40 shareholder value. So Bade gives a perfect example of how Warren Buffett structured the incentives for GEICO executives. The bonuses received by dozens of top executives, started with Tony, are based upon only two key variables. One, growth in voluntary auto policies, and two, underwriting profitability on seasoned auto business. So once you know a business very well, I think you should probably know which KPIs are going to hopefully enhance shareholder value the most. Then I would just look for businesses that highlight that KPI for their executive to hit. If they are similar and management has a lot of their personal wealth inside of a company, then I think you have a pretty good chance of having a well-incentivized manager. A critical point on the incentives is a third point

Starting point is 00:21:23 that I made there, which is that too many incentive programs are essentially just guarantees of future payments to the management. You most definitely want to avoid these. If a manager can destroy shareholder value and still earn their incentive, then you want to run, not walk to the exit, because that's an easy business to just skip. And chances are that management just won't care that much about what happens to shareholders. Absolutely. And one of the other important lessons for me, both personally and as an investor, is the importance of humility.

Starting point is 00:21:55 And this also ties into the principle on thinking probabilistically that you outlined. I believe that having an appreciation for humility has a ton of benefits. Most of our listeners have probably read about the Dunning Krueger effect, which essentially shares that the more one dives into a field, the more one realizes how little they know. And by recognizing how little we know, we can have the humility to know that we need to learn more. And it's sort of a catch-22. But initially, you think you know a lot. I've run into a lot of people who probably haven't read a single investing book or probably

Starting point is 00:22:36 haven't read a single 10K, but they're some of the most confident investors I've ever met. I'm sure that you could also relate to this, Kyle. So first, humility can help us appreciate the need to continuously learn. And then Goddham shares a couple of examples of people who displayed humility in their own lives. First is, of course, Charlie Munger, who by any measure is incredibly intelligent. Most people just couldn't believe that Charlie chose to be a subordinate partner to Warren. But Charlie has said that there are some people who are okay with accepting being a subordinate partner to. And there are always going to be some people who are just better than us in some way. And Charlie accepted that

Starting point is 00:23:19 in the case of Berkshire Hathaway. He should be a follower to some extent instead of the leader of that organization. And then the other story Goddum shares is that of Frank Wells. He was the president of Walt Disney from 1984 to 1994. He didn't share too much about him in the book, but I liked the story of how when Wells passed away, his son had found a piece of paper in his wallet that read, Humility is the essence of life. And it was later discovered that Wells had carried this in his wallet for more than 30 years. And pretty early in all of our investing journey, we all realize just how often we can be wrong. And the market humbles us and makes us realize just how difficult the game of investing can be and how complex our world can be. And when it comes to

Starting point is 00:24:06 the world of investing, absolute certainty just never exists. Yet you see people all over the news displaying overconfidence on a grand scale and they continue to be largely proven wrong. And they seem to only become more confident in their next predictions when they're on television and whatnot. And understanding and accepting uncertainty is just essential to being a good investor. Buffett grapples with this issue by really being very picky when it comes to picking stocks. I've noticed that our co-host Stig Bratterson also takes a similar approach. Both of them are looking for reasons to say no to a stock idea and setting that bar really high. So for Buffett, he's defined his circle of competence and most stocks can really be placed into three categories as it relates to this.

Starting point is 00:24:56 So the first category is just the simple and easy to understand businesses. The second category is the difficult to understand businesses, and then the third is just the too hard pile. Given that Buffett is just the greatest investor of all time, I think that most people would be surprised to learn that he puts 99% of his stock ideas in the too hard pile. If that doesn't make you humble and what you think you know, then I'm just not sure what will. So, Kyle, I'm curious, how do you approach this concept of the circle of competence and how that ties into humility here? Let's take a quick break and hear from today's sponsors. All right, I want

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Starting point is 00:29:48 Bade does such a superb job defying the circle of confidence in the book, which he just says is when you are unsure and doubtful about what you want to do, do not do it. I think this concept ties perfectly into humility as well. To admit that you have a circle of commonwealth requires that you admit what you do know and what you do not know. And if that isn't humility, then I don't know what is. So the more I learn, the more I understand just how small my circle of competence is, you know, talking a little bit about my own journey when I started investing.

Starting point is 00:30:15 I didn't know much about business. So I had to go out, I had to read books, I had to listen to podcasts, you know, read books on specific topics that I needed to learn about, maybe even ones on adjacent topics as well. And I just had to continue learning about a variety of different things. So early on in my investing journey, I wanted to learn about China. I read books, articles, listen to podcasts, you know, read substacks, did everything I could to really kind of deepen my knowledge. And regarding China, I still don't feel like I know very much.

Starting point is 00:30:43 But it took me a while to learn that. also took me losing money to reach that conclusion. So I think this is obviously an event that most investors would like to avoid. I've noticed now that I'm a few years into this investing rabbit hole. I'm starting to just better understand the concept of the circle competent. It's funny that it took me this long to kind of understand it when there's so much good writing out there for it. But, you know, just generally thinking about what I know, I still don't think that I know very much. But, you know, I have spent, you know, thousands of hours researching, investing, and business. and I'm starting to delineate kind of better what I maybe know to a higher degree,

Starting point is 00:31:18 what's easier for me to learn versus things that maybe won't be easy for me to learn or things that will be very, very time consuming. So for instance, in 2023, I started learning about improving thermal energy efficiency while researching a microcat business. And that just led me down this huge rabbit hole. So that led me to learn more about renewable energy. And then through learning about renewable energy, I learned more about mineral producing mines and feed water as part of my learning.

Starting point is 00:31:45 This led me to learn more about mines that created this wastewater and what they were mining for. And then all this has been just a year-long journey. And I still feel like I'm just scratching the surface. I feel like I can continue going a lot deeper. So Albert Einstein said one of the best quotes I think on Circle of Competence that I've ever read. As our circle of knowledge expands, so does the circumference of the darkness surrounding it. I think this just perfectly encapsulates what the Dunning Kruger effect is, that you mentioned there, Clay.

Starting point is 00:32:12 So just a couple of industries that I feel I have some degree of knowledge and this would include retail with a specific focus on kind of mid-level brands, eye gaming, trust manufacturing, mobile surveillance, vertical market software, renewables, and fossil fuels. However, I know that I can continue expanding my knowledge in all of these fields. Luckily, I'm pretty curious about all of them. So each week, I try to spend some time thinking about my businesses, their industries, and their competitors and just do a deep dive into a variety of different subjects. It's probably an imperfect strategy, but I'm not sure that there's a blueprint for widening one circle of competence

Starting point is 00:32:48 that exists. So when I think my own circle of competence, I'm just trying to find areas where I might have some sort of edge on the average person. It reminds me of a good riddle that John Train, the author of Money Masters of Our Time, proposed to Warren Buffett regarding beating a chess grandmaster. So he asked Buffett, how can you beat Bobby Fisher, who was a chess grandmaster at the time? Buffett gave up trying to figure out what the answer was, and John Train told him, get him to play you in any game except for chess. So I think this is just a great way to consider where your strength lie and avoid playing games where you are at an obvious disadvantage.

Starting point is 00:33:22 It's definitely challenging problem to solve, but I think over time with humility, it's a puzzle that can be completed. Yeah, circle of competence can just be so tough because not only do you need to have a good understanding of the industry and the business, but the market also needs to give you the opportunity to buy at a good price. So the stars to some degree you need to align. And it can also be a tricky line to walk when we say that there's only a few key things that drive the success or the failure of the business, but there's so many things you need

Starting point is 00:33:50 to understand to sort of get to those few key things and understand a good opportunity from a bad opportunity. So next year, I wanted to tie in Chapter 10, which is titled Living Life According to an Inner Scorecard. For those who might not be familiar, this is a lesson that Buffett. shared that he learned from his father. So his father taught him to live a life by his own values and not by the values that other people would set for him. So if anyone has lived a life that's true to themselves and practically never compromised on their values, it's probably Buffett.

Starting point is 00:34:26 He never cared for luxurious possessions. He's always lived in the house he bought since 1958. And he's always stuck to his own personal investment philosophy, whether he's doing well or not doing as well. So during the 1999 bubble, many of our listeners are aware that Buffett was just being humiliated in the press as Berkshire stock was falling and the overall markets were just skyrocketing. Rather than judging his performance by what the stock price was doing that day, that quarter, that year, or what the news headlines were saying about him, he continued to monitor his performance based on what he believed was most important, not what other people believed was most important. And I think this is just such a important lesson, both for life and investing.

Starting point is 00:35:09 I think the key insight is that most people just can't help themselves, but to follow the crowd, essentially all times. And Buffett is a great example of someone who's able to think independently in a reason from first principles. And I mentioned this applies to both investing in life, you know, in markets when markets are rising. People just can't help but pile in and get in on the action and then there's just so many things in life where people just sort of follow whatever other people are doing in so many areas that I'm sure all of us can come up with different situations. Godham wrote here that if in your heart you know who you really are and that the choice you made was absolutely right, then the criticism of others should be considered and analyzed to see

Starting point is 00:35:52 whether it truly has any merit, but it should not be given permission to belittle what you're trying to achieve. Let your life be guided by internal principles, not external validation. We're not perfect, nor should we pretend to be, but we always should endeavor to be the best version of ourselves, end quote. And then another great example from Buffett is from his early partnership years. He launched his partnership in 1956 at the age of 25. And over the 13 years that followed, he compounded the fund's capital at 24%. And that was versus just seven percent for the broader market. And then in 1968, he achieved a 58 percent return, while the market also grew again by just 7 percent. What he decided to do at that point surprised most of his

Starting point is 00:36:40 investors, and that was that he shut down the partnership. He said that the results of the years prior have absolutely no chance of being replicated in the years that followed. Now, think about all the money that Buffett could have made had he just kept going. He likely could have just continue to beat the market, maybe not by the same degree, but he certainly would have beat it. And he also set his fee structure to a point where he only made money if he had a return over 6%. So if his performance had a negative year, then he wouldn't make any money. So that's another topic of discussion as well on living by one's values. But Buffett wasn't just doing it for the money. He had these closely held values like honesty, sincerity, integrity, and authenticity. So these

Starting point is 00:37:27 closely held values are what won out over that desire to earn more money for himself. And instead of telling investors to hang tight so they can invest with them later when the market looked more attractive, he recommended that they invest with Bill Ruyn, because Bill was not only smart, but he was someone with a high level of integrity and a moral character. Buffett and many other successful people we can look up to, they strived to live a life full of happiness and fulfillment, as well as the desire to genuinely want to help other people achieve that as well. And we can contrast this with, you know, the opposite extreme example of someone like Bernie Madoff. Bernie for many years had a perfect external scorecard. So he built

Starting point is 00:38:12 up this Ponzi scheme of billions of dollars. He was a very successful entrepreneur living the high life. And he was very successful by essentially all measures externally. But based on on his internal scorecard, he was living through what really he referred to as a nightmare, because he was living a life full of lies that he constantly had to try and cover up. So Goddham also discovered this inner scorecard line of thinking in Adam Smith's book. That was titled The Theory of Moral Sentiments, which was written over 200 years ago. Smith wrote, even though we desire to be loved by others, at the end of the day, we experience happiness only when we're successful according to our own internal scorecard. We derive true joy

Starting point is 00:38:54 from our achievements only when we feel we truly deserve it. We can't just receive praise. We must be praiseworthy. We can't just be loved. We must be lovable, end quote. And of course, this ties in perfectly with the munger quote, that in order to get what we want in life, we must deserve what we want in life. It's just such a simple mantra, but again, it's just so powerful. It also reminds me of the Jeffersonian dinner that TIP and William Green hosted that I helped organized at the Berkshire meeting this year in 2024. There were some people who attended the dinner from the TIP audience and they wanted to make the trip to Omaha, attend the event, join our social events and whatnot.

Starting point is 00:39:37 And after getting to know them, I've realized that they really weren't that into investing. And it just sort of threw me off because I wanted to figure out why they came to Omaha and why they, you know, wanted to surround themselves with all these investors. And I think this idea of living a life true to yourself and living by those values that you truly believe in is really what it's all about. It's really not about the money. It's about making an impact, helping others, living a life full of integrity. And I think that doing something like attending the Berkshire event, for example, and surrounding yourself with those types of people can, really help us embrace, you know, that type of life more fully. Yeah, so I'm so happy that you brought up this chapter, Clay, because I think that it's one of the

Starting point is 00:40:22 most powerful chapters in the book. The concept of the inner scorecard is just vital to living a happy life as you outlined there with Buffett and Madoff. So when I read Warren Buffett inside the ultimate money mind by Robert Hagstrom, I started to really gain an interest on some of who Warren Buffett's biggest influences are. And the less obvious ones were the ones that interested me the most. So the one that actually stood out to me was Ralph Waldo Emerson. Warren's father, Howard Buffett, passed along many, many of Emerson's principles that Warren exhibits today and throughout his entire investing career. So I want to share a few of these Buffett traits that have Emerson just written all over it. So after finding out about Emerson, I went out and bought his

Starting point is 00:40:59 selected essays and just focused my time, especially reading his essay on self-reliance. So one of the attributes that you discuss regarding Buffett is Buffett's self-reliance. Emerson wrote, It is easy in the world to live after the world's opinion. It is easy in solitude to live after our own. But the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude, unquote. So Warren's inner scorecard concept perfectly aligns with Emerson's quote here, I think. In terms of investing, I think it's a significant reason why Warren Buffett has been so successful over all these years. Despite all the noise in the market, the media repeatedly telling him that he's lost his step,

Starting point is 00:41:36 or his history of underperforming and raging bull markets, Warren has just stuck to a strategy, and it's because he can think independently and isn't easily distracted by all the noise out there. Another great Emerson quote, Buffett lives by is, men imagine that they can communicate their virtue or vice only by overt actions, and do not see that virtue or vice emit a breath every moment. I think that many lessons can be learned from Warren, not just by what he does, but what he doesn't do. You know, examples are he doesn't use excessive leverage. He doesn't try and screw over investors for his own well-being.

Starting point is 00:42:08 He doesn't do hostile takeovers. And, you know, he just, he can't compound his wealth without increasing value for Berkshire Hathaway. And he was very intentional in doing that. So examining Buffett through the lens of what he doesn't do is just a very fulfilling activity because, you know, if we can avoid these major blunters in life, I think that we can lead a very fulfilling life. So the last point on Emerson I wanted to mention is his emphasis on principles. Emerson wrote, nothing can bring you peace but yourself.

Starting point is 00:42:34 nothing can bring you peace but the triumph of principles unquote. So Warren has lived his life through a set of principles such as the inner scorecard and he just doesn't waver when it could benefit only him. I think this is just such an admirable trade and it's one I think that's very rare. So as for me and my own inner scorecard, I'm just very fortunate, I think, to be part of the TIP team. The TIP brand aligns very well with the principles that I personally stand for. Principles like transparency, responsibility, excellence, creating value and building

Starting point is 00:43:02 wisdoms are all principles that TIP and I hold very dear. Very well said. So I think this is a good point to turn to chat more about stock investing, which starts around chapter 12 in the book, since that is what much of the book is about. Godham explains a number of benefits of stock investing that might not appear obvious to a lot of people. A lot of books say that the best way to build a substantial amount of wealth is to own equity in a business. But not everyone has the knowledge, the perseverance, the capital, or the will

Starting point is 00:43:36 to start a business of their own. But the stock market allows anyone in a developed economy to participate in the benefits of owning a business. Benjamin Graham stated that investing is most intelligent when it's most business-like. And that's exactly how investors like Buffett and Munger treat buying stocks. They treat each purchase into a company as if they were purchasing the whole thing. So they truly want to understand the business well and not treated as something that they might potentially sell tomorrow if they don't feel like owning it anymore. That isn't how a business owner thinks about the business that they run and they operate. They're in it for the long run. What is also really appealing about stock investing is that since there's just thousands of companies

Starting point is 00:44:19 were potentially able to purchase, you get access to some of the best business people in the world. people you would never meet in person or in your town or in your city or whatnot. And you really don't get charged anything for that privilege. And despite us being charged nothing for that privilege, the benefits of being able to buy shares in their company are potentially just enormous. So to use Amazon as another example here, Bill Miller recognized talent when he met Jeff Bezos 25 years ago. And he's made 50 to 100 X's money since his original investment since then. Bezos and the rest of the management team were essentially all the brains that implemented their businesses strategy.

Starting point is 00:44:59 And Bill Miller continued to just sit in his office, reading their annual reports, keeping touch with management and just tuning it to the conference calls. But he benefited just as much as them. I believe at one point he was the second or third biggest shareholder in Amazon that, or I guess another way to put it is that he was a biggest shareholder not named Bezos. I think this is just an amazing opportunity worth highlighting because I think a lot of of people in the developed world can just take it for granted because it's just always been out there in the open and too many people actually take advantage of it. So Goddum has a short piece on what it refers to as sidecar investing as well, which is an analogy that I just love. And this analogy refers to an investor riding along in a side car pulled by a powerful motorcycle driven by an individual

Starting point is 00:45:45 who has complementary skill sets. So these managers just bring things to the table that we just can't bring to the table. They get access to deals we can't. And it also ties into the point that starting and scaling a business is just so difficult. And the stock market offers just so many amazing businesses that have incredible and competitive advantages and they're likely to grow for many, many years ahead. And it also reminds me of when I first started getting into stock investing in college, it felt like one of those fields where you can make money simply by out thinking, other people. So if you recognize talent or you recognize a big opportunity that the market is appreciating, then we're able to take advantage of that. And it just sounds so simple and obvious,

Starting point is 00:46:32 but in a world where stocks are largely treated like a casino or a slot machine to many people, I think it's definitely worth mentioning here. And then the other thing that's unique about stocks is just how liquid they can be. So you can sell a stock with the click of a button, have the money in your bank account that week. You likely can't say that with a business, own, you likely can't say that with the house you live in, or maybe the funds that have these lockup periods, or essentially a lot of funds that people are invested in. So if you happen to change your mind on a business, which is bound to happen eventually for all of us, it's nice to have that level of selection and optionality in the stock market. Let's take a quick break

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Starting point is 00:50:22 This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. So an additional point from this chapter, Clay, that I found intriguing was how Godham pointed out that Buffett also uses this equity bond mental model when he thinks about stocks. So I've enjoyed using this model to think about stocks as well. And the benefit about stocks as

Starting point is 00:50:47 compared to a bond is that a good business will grow the coupon over time, unlike a bond. Additionally, you can reinvest all of your company's coupons into owning more stock. And the company can choose to reinvest excess profits into itself. So if you have the right kind of business that can reinvest at high rates of return, you can get businesses that compound intrinsic value for very, very long periods of time. And as a result, the coupon increases at some just astronomical rates and these are the exact type of investments that Warren Buffett looks for. So I just wanted to point that out. So Goddham writes extensively in the book about investing in high quality businesses. So I'm just curious, what were some of the major takeaways that you had from this topic in particular?

Starting point is 00:51:26 Yeah. So this book really impacted how I think about investing in the types of business I want to invest in personally. So when I first started investing, I always believed that a business with a high PE was probably too expensive to buy. And I should focus my attention on the low PE or high dividend stocks that appear to be bargains. And the irony of the stock market is that a lot of the best investments over the long run are those that were previously trading at an optically high PE multiple and they just continue to hit new all-time highs. So stock investing in a lot of ways can be pretty counterintuitive for those first getting into it. And at the end of the day, a stock is worth the present value of the future free cash flows. So

Starting point is 00:52:08 PE ratio is only a small part of the equation and looking at what is a company really worth. So earnings typically need to be adjusted to what Buffett calls owner's earnings, which is the cash one would receive if they were 100% owner of the business. So it ties into the point earlier of looking at the business as if you actually owned it and not just looking at the metrics that are shown in some stock screener. And what matters most is trying to only purchase stocks when price is below value and not trying to target some sort of PE ratio that's in your desired to range. And another key insight that Goddham shared is that the market tends to underappreciate companies with a durable mo in a long competitive advantage period. So for example, Shri and I just

Starting point is 00:52:52 did a stock deep dive on Hermes. In 2015, the stock traded at a PE of 40. So many investors likely would have said, hey, that's an earnings yield of two and a half percent. It's way too expensive. Since 2015, the stock is up over 5x, and the company's earnings are up over 4x. So these high PE stocks can definitely surprise us in how long they're able to grow and how much they're able to grow. I had mentioned Buffett's owners' earnings figure earlier. So another key insight that Gottem highlights is understanding how capital expenditures play into a company's valuation.

Starting point is 00:53:28 So for example, let's say a business has a market capitalization of $5 billion, so it's trading on the market for $5 billion. They produce gap net income of $1 billion, so the company trades at a P.E. of 5. But if most of the earnings are needed to just maintain the business, which is what I think you would find in a surprising number of cases, then the P.E. of 5 is just totally irrelevant. It doesn't really matter. This is why you see some companies trade at a low P.E. and their stock chart is essentially flat over 10 or maybe even 20 years. There's just zero value creation taking place within that business. So Ford Motor Company, I think, is a great example that comes to mind for me. Their stock price is lower than what it traded at 20 years ago.

Starting point is 00:54:12 And I think if you factored in the dividends, you know, you probably wouldn't be up that much, but it trades at a low PE. So that alone can get some investors interested, unfortunately. And that's why the owner's earnings figure is just so critical to understand because it factors in other considerations for what you would earn as a true owner of that business. And then Gottem also shares some interesting insights on value traps. He believes that most of the time switching from a high PE or high quality stock to a low PE, lower quality stock tends to be a mistake. So this sort of goes to the point of respecting where the market is pricing each company.

Starting point is 00:54:50 so expensive-looking stocks are expensive for a reason and cheap-looking stocks are oftentimes cheap for a reason. He writes, in the stock market, prices usually move first, and the reported fundamentals follow. A plummeting stock price in an otherwise steady market often turns out to be an accurate harbinger of deteriorating fundamentals for a company. Think about this before you jump in and buy. What appears to be cheap or relatively inexpensive oftentimes turns out to be value traps and destroys wealth. So then he has a number of value trap examples that he lists here that I think are worth highlighting. So cyclical earnings, oftentimes cyclicals can be attractive because of where they're at in their earning cycle. Disruption risk, a retailer might look really cheap if it's

Starting point is 00:55:33 in the midst of being disrupted by the shift to e-commerce, for example. Poor capital allocation, this is the third one here. If management is investing in bad projects, then the earnings are essentially being just thrown down the drain. And then the fourth one is governance. issues. So the business is run by crooks that are siphoning the cash from the business for themselves. That's not something you want to get yourself involved with. And I think you and I, Kyle, we both set a pretty high bar for the businesses that do enter our portfolio. So if anything, we're falling for quality traps instead of value traps where the business, you know, the quality of the business isn't as high as we expected it to be. And he also dives into detail

Starting point is 00:56:12 and why focusing on business quality is great for long-term oriented investors. So in the short run, lower-quality businesses have the potential to outperform, say, over a year or two. But over five or 10 years, usually it's business quality that becomes much more important. And then finally, he has a study I've referenced many, many times. It's from Credit Suisse. The study broke down businesses essentially into four quartiles. And the four core tiles are based on their return on investment metrics, which can be essentially referred to as a quality metric. So over time, your traditional value investor would expect that most companies are going to

Starting point is 00:56:56 revert to the mean return on investment. So a great company with high returns is essentially going to see competition come in and then drive down those returns over time. But what the study found was almost the opposite to some degree. Over half of the top quartile of businesses remained among the best performing firms over successive five-year periods. And over half of the bottom quartile businesses remained as the poorest performers. So great businesses, in a lot of cases, tend to remain great. And poor businesses, in a lot of cases, tend to remain poor. So intuitively, this is what I would have expected over a five-year time period, but there's a lot of nuance when looking at each company you're looking into here.

Starting point is 00:57:42 Yeah, so that study that you mentioned there is pretty provocative. I mean, quality businesses tend to be the stocks that deliver the highest returns over long time frames. However, you know, if the markets were efficient, then you'd expect that the best stocks would get bid up to a point where there's just no returns going forward, such as what happened with business like Microsoft in 99 or many of the tech stocks in 2021. So I also love the chapter titled The Holy Grail of Long-Term Value Investing. So Buffett said that leaving the question of price aside, the best business to own is one

Starting point is 00:58:13 that over an extended period can employ larger amounts of incremental capital at very high rates of return. The worst business continually requires more capital to be injected into it at low rates of return. So there's a business here that I'm not going to mention by name, but it fits many of the qualities that Buffett listed above as a high quality business. So this is a business that just has some awe-inspiring numbers, in my opinion. So pro forma free cash flow margin of 94% on average since 2007.

Starting point is 00:58:41 Got zero capex spent since 2017. It has very little debt on the books. It does have a little bit, but it should be paid off here by their free cash flow in the next one to two years, which will end up leaving it debt-free. And the business does not require more debt or much capital injection into the future. And then the returns on invested capital are 39%. So the best part of this business is that once the debt is paid off, it should be able to shrink the shareholders' equity via buybacks, which should also increase returns on invested capital.

Starting point is 00:59:11 So this business, which is, I'd say somewhat similar to C's Candies, can't invest incremental capital at high rates of return, but it doesn't need to in order to create shareholder value. And then to top it all off, the business trades at a ridiculously high free cash flow yield of 24%, which you wouldn't expect from a business of, I think, this high quality. So, you know, while the business might not meet a lot of the standard quality characteristics due to the lack of reinvestment opportunities and, you know, the fact that it's just going to have volatile cash flow streams due to the cyclicality of some of their key customers, I think it's still a quality business and an incredible investment. So I'm going to be pitching this investment to our TIP Mastermind community here in the next couple of months. So I'm really excited for that. Yeah, I definitely can't wait for that presentation of this company. I'm really intrigued. learn more about it. So you mentioned how, or we discussed how many of the best businesses can be pretty difficult to get at attractive valuations. And it's also difficult to judge the extent to

Starting point is 01:00:12 which the market has priced in the quality into the market valuation. I think one of the more difficult moats to identify is the culture as a moat. So Godham explains how businesses with a strong culture focus on delivering a great customer value proposition and communicating the proposition more effectively than their competitors do. So he writes here, as investors, we look for those companies that are fanatically obsessed with the well-being of their customers and that empathize with them more than their competitors do. Culture matters to long-term investors because it empowers the company's employees to do their day-to-day tasks slightly better than the company's competitors do theirs. Over time, these little advantages compound into much larger advantages, which can

Starting point is 01:00:59 persist far longer than conventional wisdom expects, end quote. And this reminds me of the episode we did on Old Dominion. So to me, Old Dominion's a great example of a company that just puts a maniacal focus on exceptional service. And this is why they've won the award for top service in the industry for 14 years in a row. And then they also have the top ranking in 25 out of 28 categories currently for service. And in the age of the internet, it's qualitative. information that tends to be less efficiently priced in the market, whereas these quantitative metrics like free cash flow yield tends to be arbitraged away. So it's much more difficult to find and can oftentimes also be value traps as well. Another note that he writes here, schools can't

Starting point is 01:01:47 teach what they can't grade. Things that aren't quantifiable or easily evaluated become niche opportunities. In my view, qualitative analysis is more important than quantitative analysis because quantitative data is often a lagging indicator. By the time you see it in the financial statements, it's oftentimes too late. Making the correct qualitative judgment about a business, including the long-term sustainability of its success attributes, is more important than the entry valuation over a long-term holding period. Within reason, you can survive overpaying, for growing high-quality franchises, end quote. And Buffett once wrote that the really sensational ideas have come from his qualitative insights.

Starting point is 01:02:34 So obviously, this applies to examples of purchases he's made, such as Coca-Cola or Apple, that he's bought and held for a really long time, that have these really strong, durable brands that seem to only get better over time. That's right. So I think Godham just nailed it emphasizing the importance of qualitative measures in investing You hear a lot about, for instance, how AI is going to make the market even more efficient. As its ability to use, say, quantitative metrics for screening purposes will make finding mispricings in the market even harder.

Starting point is 01:03:06 But where AI will never match a human is in our ability to assess qualitative measures, how does management interact with each other or other low-level management, employees, customers, and suppliers? What characteristics does a business have that remind you of a completely different company in a different industry? These are just questions that, you know, AI won't answer. I mean, maybe they'll eventually be able to answer that, but that doesn't seem like anything that's, you know, a possibility here in the near future.

Starting point is 01:03:32 But as Bade kind of points out, you know, those qualitative measures are probably the most valuable pieces of information you can get. So if you are a qualitative investor, there's just so many advantages. And like you also said there, with quantitative measures being a lagging indicator, you're not going to pick them up as a quant, but you can't pick them up as a qualitative investor and see that maybe the forecast or the runway for a business is just going to be a lot longer than a traditional quantitative screen is going to show. So I want to shift here to one of my favorite John Maynard Keynes quotes that states, when the facts change, I change my mind. What do you do, sir?

Starting point is 01:04:06 Godham had a lot of interesting insights in this chapter on updating our existing beliefs. So I'm just interested in knowing a couple of your key takeaways. Yeah, this is another one of my favorite chapters because he has just so many great insights. You mentioned one quote, from John Maynard Keynes in relation to this, and there's a bunch of great quotes, but I'll share another one here from George Soros. To others, being wrong is a source of shame. But to me, recognizing my mistakes is a source of pride. Once we've realized that imperfect understanding is the human condition, there's no shame in being wrong, only in failing to correct our mistake. So the human species or homo sapiens, they first appeared in fossil records roughly 200,000 years ago.

Starting point is 01:04:52 And it's only in the past 200 years that we've drastically improved our standard of living. So Goddham shares an insight from Michael Rothschild's book titled Bionomics. Michael helped put this big, grand scale history of mankind into perspective. So if we collapse these 200,000 years down to a 12,000, 24-hour day. In the first 23 hours or so, we were just hunters and gatherers. Then from 11 p.m. to 11.58 p.m., people survived by subsidence, farming, and crafts. And then as Rothschild puts it, all of modern industrial life has unfolded in the last 90 seconds of humanity's existence. So we are new to change and change is new to us. So to say, to

Starting point is 01:05:43 that we're living in an ever-changing world would be a significant understatement, in my opinion. Regulations are constantly changing, new technologies are constantly emerging, unique business models are constantly evolving, and information is spreading faster than it ever has. So here are some statistics on how long it took for some popular apps to reach 100 million users. Facebook was launched in 2004. It took them four years to reach 100 million users. YouTube was launched in 2005. It also took them roughly four years. Instagram was launched in 2010. It took them two and a half years.

Starting point is 01:06:19 TikTok was launched in 2016. It took them just nine months. Chat GPT was launched in 2022. It took them just two months. And then meta launched their version of Twitter or X, and this is called Threads. It took them five days to reach 100 billion users on threads. So if you're operating in the world of apps or the world of social media, then speed and change is just the name of the game.

Starting point is 01:06:42 One of my favorite investing books that helps highlight the importance of needing to change as value investors is Adam Cecil's wonderful book, Where the Money is. This is a book where he makes the case for investing in tech companies and the increased role of tech companies in our modern day economy. So companies like Amazon and meta, they just need to be looked at from a slightly different perspective than your traditional businesses that are asset heavy and tend to be more capital intensive. And then understanding the value of tech companies means that we need to understand things like network effects, S-curve adoption cycles. And when you think back to say 100 years ago,

Starting point is 01:07:22 the best companies were typically confined to their own industry. And then you just look at Amazon today, they're willing to venture into any industry. Nothing is outside their reach in many ways. So with all that said, a key skill as investors in today's age is flexible thinking. Flexible thinking is the ability to keep an open mind when encountering new facts or situations and to be adaptive to changing our viewpoints from previously held beliefs. So in the book Dead Companies Walking, Scott Fearsen, he talked about what's referred to as the head in the sand syndrome. I quote, failure terrifies people.

Starting point is 01:08:03 They'll do whatever they have to do to downplay it, wish it away, and just plain pretend it doesn't exist. Most of the time, they'll go on living in denial long after the truth of their predicament becomes obvious. So just because we bury our heads in the sand and can no longer see the danger doesn't mean that we aren't threatened by it. Unpleasant facts do not cease to exist just because they're ignored. I'm reminded of the stories we hear of, say, Barnes & Noble dismissing Amazon early on, believing that nobody was going to buy books online or Blockbuster, refusing to take Netflix seriously. Munger has said that, I think that one should recognize reality even when one doesn't like it.

Starting point is 01:08:49 Indeed, especially when one doesn't like it. And then Godham just puts it so well in the book here. I'll quote him one more time again. Good investing is a peculiar balance between the conclusion. conviction to follow your ideas and the flexibility to recognize when you've made a mistake. You need to believe in something, but at the same time, you need to recognize that you will be wrong a considerable number of times over the course of your investing career, end quote. So for the stocks we own, it's just easy to look at a falling stock price and say that the market's

Starting point is 01:09:21 foolish and then potentially double down on it. But we seriously need to ask ourselves, why are other people willing to sell this stock at a cheaper price? Because that's clearly what's happening. So we really need to question our own beliefs, be careful becoming overconfident when the market's displaying disconfirming information or just reality is painting a different picture. Yeah, so this chapter on criticizing our best love of ideas is so good. We all need to look at the other side of the story, just like he pointed out on any investment and understand why someone is willing to take the other side of the trade.

Starting point is 01:09:57 Because for every buyer there is, there's also a seller. And in today's world, it can just be easy to get surrounded by people who think the same as you and who are all given the same bullish arguments while overlooking, you know, potentially critical bear arguments. So Goda made some other really good points in this chapter that I wanted to share. One is about base rates, which can be a very useful mental model. As investors, you know, we want to stack the odds in our favor of making wise and hopefully profitable bets. Before paying a high price earnings multiple for our business, we should understand

Starting point is 01:10:27 our odds of success based on historical examples of stocks trading at these higher or lower PE levels. The same could be said for buying into something like an IPO or buying a turnaround, which Buffett typically avoids, likely due to the base rates that are associated with these types of investments. Now, I think about base rates in kind of two ways. You can search for data among the public. This can obviously give you a very wide sample size and show you that the average investors' returns are from investing in, say, high P businesses or IPOs. But another strategy you can do is look at your own history of investing. How have you done in the past?

Starting point is 01:11:02 What were the average outcomes? Which business models have you failed or succeeded at investing in? While this analysis is obviously going to have a much smaller sample size compared to base rates of the general public, I actually still think it's a very worthwhile thing to do because it can just give you some really, really unique insights into some of the industries or maybe business models that maybe you don't understand as well as you think you do or maybe that you understand better than you think you do. So I just think that this is really important belief updating and probably needs to be done

Starting point is 01:11:31 at a semi-regular basis, you know, maybe once a year, once every six months kind of thing. Now, another interesting thing that I've been exploring lately in relation to belief updating is updating your decision trees, which Bade covers in his section titled Bays Rule as a way of thinking. If a business is taking on something like more debt, perhaps your base case and bull case scenario become less likely, or maybe the potential upside goes down. If a business, for instance, is a leader in a brand new industry, perhaps you're observing that there's new competitors that are entering that market, and this might increase the probability

Starting point is 01:12:04 of your bear case happening. Another interesting point on belief updating is that Bade makes this sound easy to do with all the tools that he outlines in the chapter. But we have to remember that as humans, we have all sorts of biases. And it's easy to rely on our system one thinking to just confirm what we already believe to be true. So it's essential to keep an open mind to the chance that we could be wrong. In Ray Dahlio's excellent book, Principles, he wrote, you must not let your need to be right be more important than your need to find out what's true. Now, I know I have to fight this bias all the time. So I'm

Starting point is 01:12:35 always searching for facts that indicate that I could be wrong. And I guarantee you that I'm wrong on a few of my current holdings that I probably have in my portfolio right now. I'll just have to keep digging to find out where that mistake could be. And hopefully I'll be able to remedy that mistake before prices go down too much. But the point here about being wrong also fits in really nicely with Goddham's point about selling a stock. If you're a long-term investor, you basically have to accept the fact that you're going to be wrong. And even though you may default to wanting to hold investments for long periods of time, there's just no point in holding a losing position, especially when it's obvious that the fundamentals of the business were just not as optimistic

Starting point is 01:13:12 as you were originally envisioned. Next week, I'm interviewing Hendrick Bessonbinder, his studies have been mentioned on her show multiple times and kind of the high point that a lot of people take away is that 4% of companies from 1926 through around 2022 accounted for essentially all of the wealth creation in the stock market. So we're bound to have some losers in the portfolio and I look forward to that interview with Hendrik that'll be coming out after this one. So to wrap up this discussion, I wanted to hit on some of the high points from the final chapter on understanding the true essence of compounding. Goddum reminds us that life is, of course, not just about making money. Money without good health is pointless. Money with no good relationships

Starting point is 01:13:59 is going to leave you feeling lonely. He writes, we spend a lot of time focusing on compounding our financial capital, but we overlooked the fact that social and intellectual capital also compound. Investing in yourself, investing in your relationships, and investing in your understanding of the world pays massive dividends over time. Understand what is truly important to you and pursue your dreams with full dedication in a principled manner. Everything you're looking for is closer than you think, but sometimes you have to go on a journey to find it. And in your journey, the power of compounding will help you achieve what you're striving for. Becoming happier, healthier, better, wealthier, smarter, and more honorable, end quote. So he touches on compounding positive thoughts, compounding good

Starting point is 01:14:45 health and a number of other areas here. And he shares the importance of perseverance if you wish to succeed in life. So we can let our failures tear us down or use them as an opportunity to demonstrate resilience and build character. One of my favorite stories from the book is the one related to Charlie Munger's life, which I had never read before reading it here, and got him pulled this from Joshua Kennan's blog. So at the age of 29, Charlie and his wife, they had had a divorce.

Starting point is 01:15:15 and Charlie lost everything in the divorce, including his home. And shortly after, he learned that his son had leukemia, and then a year later, his son passed away. So at the age of 31, Charlie was divorced, he was broke, and he was burying his 9-year-old son. And then later on in life, Charlie faced a horrific operation that left him blind him one eye with terrible pain, so he decided to get one of his eyes removed. And it's a reminder that, first, adversity is just a natural part of life. And second, my personal adversities are likely nothing in comparison to most people's, including the ones that Charlie had to go through here throughout his life.

Starting point is 01:16:02 And I very much admire Goddham's story as another example in his journey to moving to the U.S., launching his own fun and drawing inspiration from that. We can't control what happens to us in life, but we can control. how we respond to it. And this empowers us to focus on the good and everything, try and find the good in each situation and find the good in each person we encounter along this journey of life. And at the very end, he briefly touches on compounding goodwill and the importance of being a giver rather than a taker and really just giving without any expectation of receiving anything in return. So years back, Godham. He had actually gotten inspiration from Ian Castle's posts online.

Starting point is 01:16:44 and Goddham would have occasionally send Ian posts and content that he might find valuable. Here's a quote that Ian also shared in the book here. So spend time building new relationships. Too many stop building relationships after school or after marriage and find themselves in a rut. Your relationships represent who you used to be and not where you want to go. So this is one of my favorite things about our TIP Mastermind community, for example, because admittedly, I'm surrounded by just some amazing investors, many of which know much more than I do and have much more experience than I do. And this helps me become a better investor.

Starting point is 01:17:23 And then the icing on the cake is that I get to have the opportunity to just build these fantastic relationships, both online and in person, with just very successful people in our audience. And then before I give my closing remarks here, I wanted to mention that in the acknowledgement section of the book, Godham just shared. all these different topics of people he's learned from over the year. So he writes about James Clear and Charles Duhigg. They educated him on the science of positive habit formation. Michael Mobeson and Annie Duke, they taught him about the importance of distinguishing luck and skill. And then Peter Thiel taught him the importance of monopolies, power laws, and highly innovative companies. So there's a long, long list of names here. So I think that's also a good resource. if you're interested in learning more about a specific topic within the value investing space,

Starting point is 01:18:12 you can see some of the resources that Gautum has pulled from. So I think I'll leave it at that. So another point that Gautom made in the conclusion was on the importance of compounding positive thought. So my mom is a nurse who works with an elderly demographic. We had a great conversation once about her observations on the energy and the happiness that she observed in many of the people versus anger and negativity seen in others. And you know, it's just, anecdotal, but her observations were that people who live longer tended to be happier. They found it easier to make new friends or even maintain existing relationships. And they also had a healthy goal about them and maybe looked a little bit younger than their

Starting point is 01:18:49 actual age was. On the other hand, she told me she had some patients who might have been decades younger than some of her others, but they looked the same age. They constantly complained about all the world's negatives, making it harder and harder for them to make new friends or even just maintain existing relationships. Goddum shares an excellent quote here by Buddha, which is, The Mind is Everything, What You Think, You Become. That's all we have for you today on the joys of compounding.

Starting point is 01:19:15 If you're interested in reading it, we'll link the book to the show notes. Thank you so much for tuning into this conversation and take care. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to the Investorspodcast.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 - TIP666: Compounding Beyond Wealth: Unlocking Life’s Hidden Potential w/ Clay Finck & Kyle Grieve

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