We Study Billionaires - The Investor’s Podcast Network - TIP710: Common Stocks and Common Sense w/ Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. Ed Walkenheim is an unknown investor with an impeccable track record. From 1998 to 2017, his fund Greenhaven generated 19% returns before fees compared to the S&P 500's annual return of just 7%. Now, what drew me to his book is simplicity, or, as Ed calls it, common sense. You won't see any mention of complicated formulas or academic jargon in his book. Instead of over-complicating investing, Ed focuses on what really matters, using common sense to make quality investment decisions.

Starting point is 00:00:32 Now, one of Ed's first points in the book is just how good common stocks are. The historic returns are so good that if we just can avoid common emotional mistakes such as panic selling, we can accrue more wealth than we'll ever need. Throughout this episode, we'll go over several mistakes that Ed has observed in his decades in the market and made himself. Now, another hallmark of most great investors is the ability to just think differently. We'll cover many companies that you're going to be familiar with, but most lack the glamour that you'll see on the front pages of the news. Ed made much of his returns looking at relatively boring businesses, often in low-growth industries.

Starting point is 00:01:07 We'll review his reasoning for his success in investing in companies that many would just avoid due to the stigma of low returns in mediocre industries. Now, this leads well into talking about the circle of competence. There are several examples where Ed believed management and even analysts' forecasts were incorrect. These are examples where he saw further upside because of his knowledge of the industry. Housing is one such industry that Ed knows like the back of his hand. So there have been times in his investing career where he had a contrarian opinion on a business inside of that industry and has been very successful placing bets where he just saw asymmetric upside. And just as important as being a contrarian is knowing when it's crucial to change your mind.

Starting point is 00:01:48 Ed asks three simple questions to help challenge his hypothesis when new information is released. We'll review a case study using Ed's framework to see how I navigated a 37% drawdown in one of my larger holdings. One trade of Ed I highly admire is his ability to sell out of a position only to re-enter it later and succeed in both investments. I've never been able to do this, so we'll cover how he managed to do this on IBM and a few potential lessons on how you can incorporate this into your own investing strategy. If you enjoy common sense, simplicity, and paths to clear thinking, you'll learn a lot

Starting point is 00:02:20 from Ed's lessons in this book. Now, let's dive right in. to this week's episode. Since 2014 and through more than 180 million downloads, we've 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 host, Kyle Greve.

Starting point is 00:02:53 Welcome to the Investors' Podcast. I'm your host Kyle Greve and today I'm coming out at you solo discussing a highly underrated investing book, Common Stocks and Common Sense by Ed Wacheneheim. I enjoyed the book so much because of its essence, which is common sense. I found Ed's points very refreshing, especially when you see many other investors attempting to outsmart the market by using several esoteric investing concepts that I think just do more to confuse everyone, including themselves, than to educate. Ed's common sense approach resonates with me very, very much.

Starting point is 00:03:23 Since I have learned investing through hard work and determination, I connect with simple concepts that are both easy to learn and understand, but also very easy to use in real life. This book has no mention of things like beta, discounted cash flows, modern portfolio theory, efficient market hypothesis, capital asset pricing model, market timing, or even technical analysis. Now, I have no idea if Ed actually uses any of that, but in the spirit of common sense, he mentions it zero times in his book, which I very much appreciated. This episode will be structured so that I share some of the common sense approaches that Ed uses for his investing and then discuss some of his investments in light, specifically of some of these common sense. sense points. Now let's dig into some of Ed's investing principles. The first one is simple. It's that investing is common sense. The stock market, for instance, averages returns of approximately 10%. This means that owning common stocks is just a simple way to generate wealth while offering liquidity.

Starting point is 00:04:21 The key challenge to this assumption is avoiding behavioral mistakes like selling when the market goes down. The next is volatility. Like Buffett and other investing legends, Ed doesn't believe that risk is found in a stock's volatility. However, since there is a divergence between what he thinks and what the market does, value investors have some major advantages. When the market attributes volatility as risk, price often comes down. And those are the times to back up the truck on an investment and not be panic selling. Ed mentioned a great story during the panic of October 19, 1987, when the market declined by 21% in one day. He saw a friend on the subway who looked dejected while heading home from work. His friend was depressed and said that he had

Starting point is 00:05:01 sold a lot of stock. He also mentioned that he would continue selling stock because the event would likely precipitate more selling pressure over the next few days, weeks, months. However, Ed points out that his thinking was wrong as the market ended up appreciating 50% over the next two years. Now, investors make the common mistake of attributing the present and forecasting that out into the future for way too long. It happens in bear and bull markets, and it's a mistake in each instance. So in bare markets, investors believe that markets will never return to previous levels or it's going to just take forever to do so. They end up selling out and then they end up buying back in when the stock market's gone up and it's more expensive. Now, in bull markets, investors

Starting point is 00:05:41 attribute the best possible scenarios for the best performing stocks for multiple years into the future. Once a degree of normalcy returns to a business's operations, the market is usually quick to sell stocks when previous expectations can no longer be met. Now, this is a very difficult bias to combat. The best way I know how to do it is to pay attention to a business's fundamentals and not its stock price. Pretend that you are a private investor and your only performance benchmark is whether your business is growing and making a decent profit. If you look at investing in this light, holding businesses that the market doesn't like becomes much easier.

Starting point is 00:06:13 Now, this brings us to an essential aspect of long-term investing, the ability to think differently from the crowd and embrace a contrarian mindset. Most people are not genetic contrarians. Learning to be a contrarian is a very, very tough task. It's much easier just to be a contrarian if that's your natural tendency. If you tend not to care about what others think, then you're on the right path. Ed questioned popular opinions at a young age, so I think it was part of his DNA. But even if you aren't a contrarian by nature, you likely have an opinion on certain

Starting point is 00:06:41 things that others don't necessarily agree with. Now, you can utilize that part of your life to help you identify as a contrarian through the lens of investing. Nearly all of Ed's investments interested him because they were out of favor and he saw something in the prospects of these businesses that the market just didn't see. Once you had this variant perception, the trick is to keep it when the market is going to tell you very, very specifically that you are wrong. So if you could do that and you're right, you're going to do very, very well in investing. Ed wrote, to earn outsized returns, we need to hold opinions about

Starting point is 00:07:10 the future that are different and more accurate than those of the majority of other investors. In fact, it can be said that successful investing is all about predicting the future more accurately than the majority of other investors. To have a non-consensus view, you must be confident that your conclusions are correct. Investing is a game of uncertainty, and we can never be 100% certain that we're going to be right. So the key that Ed highlights is the use of probabilistic thinking. Now, he doesn't discuss this too much in the examples that he's going to give in the book, but the fact that he mentions it in the first chapter of his book means that he probably

Starting point is 00:07:44 uses it and just takes it for granted. Now, another key insight to piggyback on the topic of emotional control is to understand when you need to change your assumptions. Ed mentions a few questions to ask to help us make sense of positive or negative events. What has really changed? How has the changes affected the value of the investment under consideration? And lastly, is my appraisal of the change is rational and am I not being overly influenced by the immediacy and severity of the news? Now, I like this framework because it's simple and should reveal that many things can happen in the market and don't necessarily affect my business. One business that I own and that was severely punished in 2024 and that many listeners will be familiar with is a business

Starting point is 00:08:25 that me and Clay have gone over, which is called Dino Polska. Now, I've held this business since about mid-2020. Only over the past few weeks has the price rebounded to around the level when I first started buying it. Now, let's run this analysis specifically on Dino Pulska. In 2024, Dino's growth slowed. Revenue grew in low double digits, earnings per share in low single digits, U-store openings declined and sales dropped from the high 20s to low single digits due to deflation. Margins were also pressured by price competition from a few of its competitors. Now, despite the short-term headwinds, my thesis remain intact. Like-for-like sales rebounded, prior high-comparative periods were inflation-driven, and new store openings were beginning to accelerate. Investments into distribution centers,

Starting point is 00:09:11 had temporarily diverted capital, but definitely would support long-term growth. I feel the market was kind of getting that wrong. Now, additionally, I mentioned that competitive price cutting, and this is just an unsustainable business model. It's just not going to happen forever. So the store economics for Dino remained quite strong with very, very good customer demand and good returns on new locations. Market reaction to what happened with Dino reflected myopic loss version. The business was being punished for investing in future growth, which, you know, as a long-term investor, obviously doesn't really make sense. I mean, I'm perfectly fine with the business investing in itself now, taking short-term losses so that it's going to be greater a couple years for now.

Starting point is 00:09:52 That's exactly what Dino was doing. And I took its advantage to get more shares. And I think Dino Polskills Outlook, even for 2025, looks incredible. And I think it looks great going forward as well. Now, this is a great exercise that I think helps me think rationally about my investing decisions. Now, transitioning here to a couple of other investing principles that Ed holds in high regard. So there's a couple here, just having good analytical skills and confidence. Confidence is very important. So we're going to weave these principles into the stock ideas as we proceed through the episode. So he goes through in his book about 15.

Starting point is 00:10:24 We're going to go through most of them, not all of them. But now that we know some of these foundational principles, let's analyze how they apply to real world investments. And we're also going to be adding tons of other lessons along the way here. Now, I mentioned contrarianism as one of Ed's core principles. And this is a very, very good segue into discussing the first company that I want to go over, which is IBM, which was a true contrarian play. Now, IBM was an interesting investment for Ed because it showed a major attribute that

Starting point is 00:10:52 he looks for in businesses. And that's that if a business can remove bloat, it can improve profits without the need for massive increases in revenue. Now, at the time that Ed was looking at it, IBM had about 400,000. employees. This was in 1985 before a new management team took over. As part of the new management's initiative, Ed found out that there would be cost cutting going around by removing personnel that weren't delivering value to the business. Ed felt that IBM had gotten to a point where it was just an employer of people and not necessarily a business trying to maximize efficiency. So, you know,

Starting point is 00:11:27 Ed started learning more about the business. Once he realized that he was very, very interested in it, He bought a small position because he knows that ownership incentivizes an increased research intensity. And this is a thought that I share as well. Now, as he learned more about the business, he purchased shares in 94 at about $11.50. And actually just ended up selling just a few months later because sentiment shifted positively. And he made a pretty good gain. He ended up selling for about $16. But Ed actually kind of deemed this mistake because of IBM's capital allocation strategy.

Starting point is 00:11:58 So they decided to open up a share of purchase program. And because of that, IBM's EPS grew much faster than its net income. At the end of 1995, it actually ended up reentering the position at $24.50. Ended up holding for another two years or so and sold out at about 48. Now, I find this interesting because I personally know I have a huge problem doing this. You know, once I sell a business that I thought was high quality, it generally means that I won't ever own it again. can't just sell out and then end up getting back in. But Ed showed here that that perhaps is a mistake. Suppose you have a view on a business. In that case, you know, even if it's only a few years

Starting point is 00:12:39 out, you already understand the business at a very high level. And if the opportunity comes again, because you understand the business, you understand its valuation, you understand its cash flows, then perhaps putting the business into purgatory like I do isn't such a good idea. But you could also take a different view on this exact case study. So you could say that Ed should have done nothing. In that case, he would have bought at 1150. Maybe he would have averaged up, but not sold out and added more at $24.50. And his cost basis would be somewhere in between. I don't know how many shares he bought at each of these price points.

Starting point is 00:13:10 And then he could have held it until it reached 48 and made even more profits for his partners than himself. There's a lot of nuance here, so I won't pretend to know the exact scenario, but it's worth mentioning. And I prefer doing this route. I realize that I might hold a stock that might go through a couple of years where the price doesn't move, but if I think the destination in two to three years looks good, I don't have an issue watching the business and making sure the destination is becoming more and more certain.

Starting point is 00:13:36 In that case, there's just no reason for me to sell, despite what the stock price does. Ed wrote about a disagreement that he had with one of Warren Buffett's most popular quotes. Warren Buffett wrote in Berkshire Hathaway's 1998 annual report that when Berkshire owns shares of a wonderful business, our holding period is forever. I greatly admire Warren Buffett. He's one of the greatest investors of all time. But I strongly disagree that the shares of most wonderful businesses can be held forever because most wonderful businesses become less wonderful over time, and many eventually run into difficulties. Now, I resonate deeply with what Ed said here. I've spoken before on the podcast about how I felt that having a never sell mentality

Starting point is 00:14:17 has probably actually done more harm than good to me because it's biased me towards keeping mediocre businesses that I labeled as high quality businesses. Now, if the writing is on the wall that you made a mistake on the quality of a business, you must be willing to part ways probably quicker than you think and admit that you were wrong and admit defeat. Now, Buffett's quote is excellent if you can be correct on 100% of your stock picks. But the fact is nobody can do that or nobody has done that for a long period. Not even Buffett, not munger, nobody. Ed gives the example of Coca-Cola, where from 2003 to 2013, it was just a mediocre investment.

Starting point is 00:14:52 He knows that its revenue and earnings per share increased at about 8% and 7% during this period and a share price increased by a meager 5% annually. So while Buffett's investment into Coca-Cola worked incredibly well for the first 10 plus years, one could easily argue that it's been a pretty big dud since 2003. So I looked it up and since 2003 it's compounded at about 8.6% versus 9.8% for the S&P 500. Now obviously Coca-Cola does pay dividends so that plays into it, but the share price, obviously, appreciation just hasn't been there. Now the next lesson I want to cover here is based on the power of management to lead a successful turnaround. The example here is going to be in another business that Ed invested in, which was interstate bakeries. This was a

Starting point is 00:15:35 business that owned several bread brands, super boring. But it was not a good business by any means. Now, what sparked Ed's interest in the business was a large investment by another investor that he highly respected a gentleman named Howard Berkowitz. Howard ended up purchasing about 12% of the shares of the business. Once Howard had this large share position, he helped install a new CEO, this gentleman named Bob Hatch. Now, Bob's goals were simple. Reduce interstate's debt, improve its profitability by divesting its inefficient plants, optimize the routing of deliveries, and instituting just general cost-cutting and increasing efficiencies of the business. In other words, there obviously was a lot of work to be done in this business, but if it was managed well,

Starting point is 00:16:16 Ed saw a lot of upside for the business. So here's the very simple way that Ed analyzed the share price. So first thing off, he wanted to know the revenue growth. It was about 5% growth annually. that's what he model going forward. He looked at their pre-tax profit margins, which were low at 3.5%. He found out that their defective tax rate was about 30%. The diluted shares outstanding would be about 8.2 million shares. And with those numbers, he input it, and he found that earnings per share in two years would be about $2.30.

Starting point is 00:16:44 Now, from that EPS number, you obviously have to evaluate it by applying some sort of multiple and thought that interstate was a below average business. And so he felt that the shares deserved an earnings multiple. probably below the market multiple. So he thought 11 seemed appropriate. Therefore, he felt the shares were worth about $25 in a two-year period. The shares were then trading at 50%. So he saw about a 66% upside. He ended up purchasing about 12% of interstate's bakery's shares outstanding in 1986. Now, this was a very good investment because the investment actually went better than he could have imagined. After just a few years, the business was taken private for $40. But Ed had some critical

Starting point is 00:17:22 lessons from this investment. So the first one here is that a highly incentivized, and skillful chairman can help deliver a lot of value to a business, even if it's of a lower quality. Ed ended up partnering here with Howard Berkowitz on this investment because specifically Howard owned a large block of shares. Because of this large ownership, it was more likely that owners would cash in when there were short-term tailwinds. And the short-term tailwind ended up happening because wheat and gasoline prices created, which created this short-term tailwind that management could take advantage of by selling the business. So this business is a good example of how a low-quality business can still make a high-quality investment. While this investing

Starting point is 00:18:01 strategy doesn't interest me very much personally, I know there are a number of value investors who make a living off of these types of investments. Unlike Ed, I don't like investing too much in turnarounds. I prefer good businesses that are just floating around and picking up shares opportunistically. This allows me to hold shares for a lot longer, rather than have to continue finding new places to put capital once the price and intrinsic value. value meat. I do enjoy my microcasts, but I don't think there are necessarily turnarounds. Often these businesses develop brand new products or are in these very, very small niche industries. And because of that, it can completely transform a business from being in one industry to actually being in a

Starting point is 00:18:42 completely different industry and allow it to scale a lot. So I like those types of businesses. And then even probably more so, I just like businesses that are of a passable amount of quality that are experiencing maybe some temporary headwinds that are depressing their share price. I found a few of these in a variety of market cap arenas. But for my experiences, the smaller I go, the greater the inefficiencies. Now, inefficiencies lead to our next set of businesses that I want to discuss, which are underpriced industries that have trouble becoming fairly priced. Now, he has a short chapter on a business called US Home, where Ed ends up discussing

Starting point is 00:19:16 how the business was a home builder that ended up coming out of bankruptcy. And he thought it was trading incredibly cheap, specifically because of this bankruptcy stigma, as well as just natural home builder discount. So when he found U.S. home, it was cheap. The shares were about $17. They were priced at 0.6 times book value and about seven times earnings. This was in 1991. Now, this immediately caught his eye because Ed believed this business had some latent

Starting point is 00:19:41 growth potential and could end up re-rating its multiple. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three-day. 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. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists,

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Starting point is 00:24:01 Then he slapped on about a 10 times earnings multiple. And he thought the shares were very attractive. But the business turned out to be a bit of a dog for Ed, unfortunately. Fundamentally speaking, the business actually did better than Ed had envisioned. earnings per share ended up going past his predictions and went all the way up to about $5.30. The problem here was that the market just refused to re-rate the shares and the business continued to trade at about six to seven times earnings. U.S. home eventually was bought out by Lenar at about only 6.6 times earnings.

Starting point is 00:24:31 It ended up making about a 12% annual return on this investment, but since his goal is 15% to 20%, he was a little bit disappointed. Now, this is an interesting case study because I think it shows how important earnings growth can be for a business. If you buy a business that has no ability to have multiple expansion, your entire return will come from earnings growth. Now, this case study is a good warning to investors who rely on multiple expansion to generate returns. Like pretty much any value investor, I also rely on this in some of my investments to generate some of my returns. Growing earnings matter even more, especially when you are buying high quality and expensive businesses. So a business that

Starting point is 00:25:11 I own that I think many of the listeners are going to be familiar with is Topicus. This is a business that trades at a massive premium to the market pretty much 100% of the time. And yet I've actually done very well on this investment. And I think that's because the business is just so good that it deserves this premium evaluation due to the quality of the business. And simply because the business continues to grow fast and just doesn't really stumble, it ends up just having this high multiple all the time. So if you could find a business trading and achieve multiple, you need as much conviction

Starting point is 00:25:41 is possible that the multiple can re-rate if that's going to be a driver of the returns in your thesis. If the market doesn't like your business or the industry, the business can just end up floundering with a mediocre multiple for many years, which can obviously sap returns and obviously you have to look at the opportunity costs of making an investment. Now, the great thing about investing is that even when you have a bad or mediocre experience, it often helps lead to other opportunities. And in Wachenheim's case, his knowledge of home builders, which he learned from U.S. home led him to a new business in the home building industry that was called Centex. Due to Ed's knowledge of the home building industry and just his general curiosity,

Starting point is 00:26:17 he discovered that public home builders were building new homes at very, very high rates, much faster than the private home builders. This was because private home builders had largely gone out of business or rapidly declined because of the savings and loan crisis. So the market share they used to own was now being distributed from the private businesses to the public companies. And Centex, to Ed, looked to be the leader of. this public cohort of businesses.

Starting point is 00:26:41 Centex ended up building about 27% more homes in 1999 compared to 1998, which was higher than some of its competitors. So he decided to continue looking at CENTex. Now, his breakdown of CENTACs was very simple. He assumed that they would continue to sell about 12% more homes each year. The average price per home would continue increasing at about a 2% annual rate. And if you put these things together, this would create a revenue growth of about 14% per annum. operating profit margins would go up from about 8% in 1999 to about 10% by 2003 due to just basic

Starting point is 00:27:13 operating leverage. And from there, he simply applied the operating margins to his future revenue growth, deducted taxes, divided it by share account, and got his earnings per share of $5.25. The business was trading at that time for about $12, or $2.2 times 2003 earnings. This definitely caught Ed's eye. He felt a business that Centex's quality could trade at around 12 times earnings because the renewed growth to the industry would rise tides for the entire industry and other home builders would realize an increase multiple. So he thought 12 times was pretty fair. And Centex ended up being a major success and Ed ended up selling at about $70 after holding it for just six years. Ed noticed that land prices were continuing to rise and he felt that Centex

Starting point is 00:27:56 should be hoarding cash waiting for land prices to come back down before buying up more land. but management went ahead and bought more and more land that elevated prices and this ended up spooking Ed. And this is why he sold in 2006, which was great timing because this was right before the great financial crisis. So he made a very, very good decision on that one. Now, I think this business, he held it for six years, which to some people might seem long, so some people that might seem short. But to me, I think this seems like a pretty long holding period.

Starting point is 00:28:24 And I think the key here is, you know, hold on to your winners. I mean, in three years, Centex was already a triple bagger for Greenhaver. which is Ed's fund. However, even after this triple beggar, Ed kept his shares because he felt the business still had further upside into the future. And another thing that helped him stay in was that the multiple was not as high as he'd hoped it would be. So it was sticking around 10.

Starting point is 00:28:46 And, you know, he wanted it to get to around 12 to increase his race of return. Now, at this time, he discovered that there was still a major shorting of housing. So he concluded that CENTex would probably continue to do very well, which obviously it ended up doing. So I think this is just a really good lesson to focus on a business's fundamentals and also to use destination analysis. If you're using destination analysis, kind of how I do, I like to track how earnings per share is moving. And I like to make sure that it's moving towards a goal that I have in the future. So if a business is doing that, then it doesn't really matter too much to me what the share price is doing unless it gets pulled forward, you know,

Starting point is 00:29:23 five or 10 years. Now back to CENTX. If we were to go back in time and maybe CENTX was trading at 12 times earnings, would Ed have sold it? I have no idea. I can't ask him here. But it was quite clear that he was focusing on the fundamentals of home building. And I think that he had high conviction that Centex would continue doing very, very well into the future. So, you know, even if it had gotten to that 12 times multiple, if he felt that EPS would, you know, double or triple from that point, maybe he would have just kept it. Anyways, the lesson here for all investors is focus on the long term. If a business can double its earnings in the next three years, why are you selling it when the share price goes up 20%.

Starting point is 00:29:59 The final lesson here for the Centex investment is that if you understand a cyclical industry very, very well, you can be very successful when you buy it when the cycle is about to turn positive. Obviously, there's not really a general framework for the strategy. It just comes down to how well you know an industry and how much time you spent studying it, what kind of contacts you have inside of it, and your ability to sift through noise to come to a contrarian opinion. And your ability to understand cyclicality doesn't even necessarily need to be on an industry.

Starting point is 00:30:30 It can be on an individual business. If you know a business is going to do very, very well over, say, the next five years, but there's a chance that it may stumble for a few quarters, well, that's great because that just means that you're going to have ample buying opportunities. So it's important not to make the mistake of getting shaken out of a really, really good business and a position that you already own just because the market is punishing the business for short-term headwinds. Selling a business due to short-term headwinds is a blunder in my books.

Starting point is 00:30:55 Now, on the topic of blunders, let's discuss one of Ed's biggest ones, which was American International Group or AIG. Ed saw AIG as a misunderstood business with some very, very quality business lines. They also had a good CEO, this gentleman named Hank Greenberg, but he unfortunately was on the way out before Ed started investing in the business. So Hank was forced to resign because AIG had taken part in some sham reinsurance transactions. His replacement was Martin Sullivan. So Ed thought the scandals had been bad for the business in the short term, but definitely were not something that would break the business.

Starting point is 00:31:26 And it was an event that he thought the market could get passed once they realized that AIG was actually a pretty good business. Now, AIG at its core is an insurance business. When Ed read their 10K, he realized something interesting. The reported earnings and balance sheets of any insurance company are no more than estimates, because management, actuarial firms, and independent accountants must estimate the magnitude of recent future losses and such estimates often are no more than educated guesses. So in 2005, AIG had taken about a 1.82 billion pre-tax loss in order to increase its reserves. Now, well, this clearly doesn't look great in terms of earnings. Ed actually saw this as a positive. So he concluded that new management was right in taking this charge for a few reasons. The first reason was that new management

Starting point is 00:32:13 could just blame the old management team for the charge. And the second one was because the reserves would eventually be released back into the business's income statement, it would actually end up causing a significant spike in earnings against even weaker comparative periods. So Ed used a projected EPS number into the future with an assigned price earnings ratio and came to a conclusion that he thought the shares could approximately double in the next two years. And at first, the business moved in the right direction. So in 2006, the business's earnings per share rose and reported that they were overcapitalized by about 15 to 20 million. As a result, they authorized the repurchase of about $8 billion of shares and increased the dividend by 20%. Two outcomes that were

Starting point is 00:32:55 obviously very, very positive for shareholders. But then the Lehman Brothers filed for bankruptcy, which set off a self-reinforcing financial crisis. So large amounts of illiquidity in the markets drove down asset values, triggering credit ratings downgrades that forced financial institutions to raise more and more cash. And unfortunately, that's something that is nearly impossible in frozen markets. So AIG was hit particularly hard, needing cash to cover collateral on some of its derivative contracts, but they were unable to raise it. So the next day, unfortunately, the U.S. government stepped in with a bailout in exchange for significant ownership of AIG, and this effectively locked in major losses for all of AIG's shareholders.

Starting point is 00:33:36 Now, Ed didn't specify what his losses were during this event. He only said that he experienced a large permanent loss. Now, one lesson that I found interesting from this chapter was about reflecting on your mistakes. Sometimes a stock can go down on price and owning the stock still might not be considered a mistake. You may be scratching your head over the statement, but let's dig in a little bit deeper. So investing is a game of odds. In the case of AIG, if we ran a simulation on Ed's investment and the outcome that ended up happening was, let's say only one in 100, then chances are the bet was still a very good one, despite the outcome that occurred. A few months after the failure of his AIG investment, Ed reflected on the investment and actually,

Starting point is 00:34:15 actually came to similar conclusions. So he said that given the information that he knew at the time, he still would have made the AIG investment. The collapse of Lehman Brothers was an unlikely development. And unfortunately, these unlikely developments can completely derail an investment. But risk-bearing is part of an investing. And if you invest thinking that the next 100-year storm is right around the corner, then you're unlikely to invest in anything. So this point is interesting because it can work both ways. you can make investments where the hypothesis may have been wrong, but you make money anyway.

Starting point is 00:34:47 Now, this happens pretty often in investing. Let's say a newer investor puts money into a position. They get a multi-bagger from this position, but does very little, if any, research into the business. So in this sense, an investor essentially is just playing the lottery because if you don't know why the business appreciated, you haven't created a system to reproduce those results. And you unfortunately run the risk of similar investments just going to zero. The final takeaway from this chapter concerns frequency and magnitude.

Starting point is 00:35:13 So Wachenheim wrote, I find that investing is not about earning a favorable return on every holding. It is about developing a favorable batting average. So he knew that he wouldn't make money on all of his investments, but he also knew that if he made enough on the ones where he was right and didn't lose too much on the bets that didn't work out, his returns would still be very solid. Now, I track the frequency of how often I'm correct on my bets.

Starting point is 00:35:35 I just filled the numbers in in preparation for this episode. and I'm currently at around a 52% hit rate. So this means that about 52% of my decisions have yielded positive returns. Now, last quarter, this actually sat up 65%. So the lower number right now, I think, is because a few of the positions that I've been building just haven't gone up yet in price. And obviously, we're experiencing general market weakness, but my conviction in these positions remain strong and I'm still adding.

Starting point is 00:35:58 I have a pretty high degree of conviction that this number will go back up at some point. We'll go back up to 65%. No idea, but we'll find out. I'll update you. So when I factor in magnitude, which is how much I make when I'm right versus how much I lose when I'm wrong, there's some very interesting insights. So the average return of my misses is about negative 13%. And this is actually pretty good because I've had some pretty big misses. But it's good to know that when I'm missing, I'm actually not losing that much.

Starting point is 00:36:23 I've yet to have any investment go to zero. So knock on wood. Now on my hits, the average total return is about 35%. Now, I look forward to seeing how this plays out over decades. if I continue to win more than I lose and my returns are higher on my winners and low on my losers, then I'll continue to make a good return. It's just that simple. While we're discussing returns, let's look at another one of Ed's winners, which was lows. You'll probably see a trend in many of Ed's investments. He buys stocks when they're unloved, meaning they have some uncertainty that's embedded

Starting point is 00:36:51 in them in the stock price. Ed then learns about the business and its industry and attempts to take his own view on the business. So in the book, he mainly discusses varying perceptions, but I'm sure he often agrees with the market sentiments on businesses, and in those cases, he probably just doesn't invest. And Loz was no different. So Loz is another business inside of the building industry, obviously. And this is an industry in which Ed clearly has immense knowledge and experience, which shows how he's able to play inside of his circle of competence. Loz was also a duopoly inside of the home building supplies and hardware industry. The smaller competitors had a lot of difficulty competing with Loz and Home Depot because they just didn't have the purchasing power,

Starting point is 00:37:29 distribution efficiencies, merchandise variety, efficiencies of scale, and low cost of real estate compared to these two behemoths. So Ed started investing in the lows in 2011 after the great financial crisis. He noted that the general sentiment of Wall Street was that the housing market would be weak for an extended period of time. They came to this conclusion because there was a growing number of shadow inventory houses, which were homes that were near foreclosure, but would end up adding to unsold home inventory. Ed decided to learn more about the industry on his own because he thought there was a chance that the housing market could turn strong in the next few years. His methodology was no surprise, very common sense. So the first thing he did was he estimated the demand for new

Starting point is 00:38:12 houses in the United States. So he said, normal demand is equal to the net increase in the number of families in the United States plus the number of houses torn down each year, plus the increase in the number of vacation and other secondary homes. Between 2000 and 2010, the U.S. U.S. population increased at about a 1% compounding annual growth rate. And if he used the same number, the number of new homes built in 2011 would be approximately 1.2 million. Other resources that he found generally supported this number as well. Now, on top of this 1.2 million, you have to also factor in demolished buildings. And in this case, he factored in about 300,000 demolished buildings that would need replacement. So in total, he estimated a need for about 1.5 million new homes.

Starting point is 00:38:52 Then he did something interesting, which I think is very important, which is to sense check your numbers versus historical data. So between 1980 and 1999, there was an average of about 1.43 million new builds per year. Adjusting that number for the change in population, ended up bringing that all the way back up to 1.78 million. For the most recent periods between 2000 and 2003, the average number of new builds was about 1.62 million. So he felt that his numbers checked out for normalized demand and was even on the conservative side. Here's where things got interesting. So in 2010, due to the great financial crisis, new builds were only at $650,000. The forecast for 2011 were that the number would continue declining. However, given the normalized numbers that Ed came up with, there was a lot of

Starting point is 00:39:34 opportunity for a big rebound towards these normalized numbers. Ed settled on lows for two reasons. The first one, the business had tailwinds due to the upcoming turn in the housing market. And second, lows had further upside due to improved merchandising. Now, we already covered number one. for two, the great financial crisis for some degree of complacency in its merchandising mix. Ed believed they could improve margins by eliminating poorly selling products, introducing new products, obtaining lower price points from suppliers, optimizing prices, optimizing selling space, reducing markdowns via inventory management, and just modernizing his signage and advertising.

Starting point is 00:40:11 Ed then studied Lowe's financials to come up with an earnings model for the year 2014. He then estimated forward revenue based on a square footage growth that he thought Lowe's was capable of doing. And then from there, he simply applied an operating margin to the number using one that they'd hit pre-GFC, which is pretty conservative. And then from there, he just subtracted interest payments and taxes, divided it by the shares outstanding, and generated his forward earnings per share number. And the number he arrived at was $3. He valued shares at about 16 times earnings, giving the shares a price of about $48. The shares were currently trading at $24. So this was a double in three years, which is obviously a very attractive return.

Starting point is 00:40:49 decided to start a position. Then a wonderful capital allocation surprise came his way. So Lowe's announced that they would be buying about half of their outstanding shares. And they also gave 2015 guidance that was lower than Ed's initial numbers. Because of the guidance, he adjusted his own numbers down a little bit, but not as much as management because he thought that their numbers were overly conservative. However, because of the major buybacks, he thought that 2015 EPS would get to about $4.10. The shares of the same earnings multiple were now worth $66. And from there, he just watched the narrative of his thesis unfold. The numbers of new builds went up and by 2014, the shares reached $68. So he was pretty spot on there. The story makes the entire Lowe's investment seem pretty simple.

Starting point is 00:41:30 And I think that's how good investing should be, you know. But investors tend to shoot themselves in the foot by trying to mess around with a good thing. Ed mentioned a run-in with an investor who liked Ed's Lowe's thesis. But the investor chose to take the route that most investors take, which is to wait on the sidelines while unpredictable macro events take place. So in this case, it was in relation to a potential government shutdown. Edge responds that he had no idea what the market would do in the near term. He also wrote, I strongly believe in Warren Buffett's dictum that he never has an opinion on the stock market because if he did, it wouldn't be any good and it might interfere

Starting point is 00:42:04 with opinions that are good. I have monitored the short-term market predictions of many intelligent, knowledgeable investors and I have found they were correct about half the time. Thus, one would do just as well by flipping a coin. Now using this kind of rationale shows how pointless market predictions are. You're best off finding great businesses that can weather economic storms. Then you just hold them while the market panics or even ad shares during this time. And you're going to do very well.

Starting point is 00:42:27 However, the mistake that most investors make is to take the exact opposite approach. They end up selling their shares once the market goes down out of fear of further losses. Now, at the same time that Ed owned Lowe's, he was looking at other businesses that would also benefit from his housing narrative. One such opportunity was Whirlpool. So Whirlpool wasn't the type of business that he would traditionally go for because its growth rates were not very high. But there was a unique opportunity that happened in 2011. For the previous few years, Whirlpool's margins were being compressed due to elevated input price costs.

Starting point is 00:42:57 So things like steel, copper, and plastics all had increased sharply in price. And during this time, Whirlpool was a good enough business luckily to turn a profit, albeit at lower margins than in the past. So Ed ran the numbers and came to an earnings per share of around $20 by 2016. As an added benefit, this number included the increased commodity pricing for steel and copper. But there was a good chance that these commodities would actually end up going down at some point into the future. And this would provide a nice tailwind for the business if the price of their input costs went down. An interesting wrench that Ed throws into the story about Whirlpool

Starting point is 00:43:30 is the evaluation part of the equation. So Ed actually ended up having trouble finding the right multiple to apply to this business. He felt the competitive position of Whirlpool was really hard for Ed to make a conclusion on. So Whirlpool killed off one of its competitors when it ended up buying Maytag, which was great, but also LG and Samsung were trying to steal market share in the same geography. So Ed flipped between, you know, 12 and 15 times earnings and thought that even 10 might be the appropriate multiple. But here's the thing, you know, Ed saw Warren Buffett's fat cow, and therefore it didn't matter how fat the cow really was. So here's how he broke it down. The shares for Whirlpool were trading at about $80. And he thought the business would likely earn

Starting point is 00:44:10 about $20 in earnings per share over the next few years. Now, the business at 10 times earning multiple, was still $120. And if the multiple was higher, then, of course, that would make it an even better investment. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust

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Starting point is 00:47:44 So Ed used an excellent baseball analogy here. He said, when you're hitting home runs, it doesn't matter whether the ball ends up in the lower deck, the upper deck, or outside the park. And Ed ended up making a decent return on World Pool and still ended up holding the shares after the book was published. I have no idea if he still holds them today. He had an update in the book in early 2022 that he held the shares and made about 11.4% returns, including dividends on the investment. He also mentioned that since Whirlpool intended to buy back its shares, he was happy to continue holding onto it. Now, while Whirlpool didn't end up beating his return benchmark of 15%, he was still okay with the investment as he realizes that not all investments will exceed his benchmark.

Starting point is 00:48:21 Ed mentions that the bulk of Greenhaven's success has come from a very small percentage of his holdings. Yes, the goal is 15% and 20% returns, but you only need one multi-begger over a short period to achieve those returns. For instance, if one in five of his holdings triples in three years, other four only have to achieve about 12% per annum for the entire portfolio to reach that 20% threshold. I think he mentioned that specifically because even though Whirlpool didn't make 15%, the return was still sufficient. Now, as you can tell from Lowe's and the Whirlpool examples, Ed would employ the strategy of making somewhat basket-type bets on industries that he felt very comfortable with where he had high conviction of knowing who the winners would be. So it's

Starting point is 00:49:01 no surprise that he would do something similar, but in an industry that is just plain ugly, which is the airline industry. So in the airline industry, he made two bets. One was in Boeing, which obviously manufactures planes, and another on Southwest Airlines, which is one of the very few value-creating airlines that has ever existed. So let's start here with Boeing. So in 2012, Boeing was surrounded by negativity. All of its 787s were grounded by the FAA due to engine failure warnings. Ed felt that the over-pessimism of the market was hiding a pretty decent business that could provide them with a pretty good return. So he dove into the business and as he dove in, he started realizing that the business was very, very moody. Boeing has two business units. It's commercial aviation

Starting point is 00:49:42 unit and its defense unit. According to Ed, the commercial aviation segment was the better business. And he specifically mentions Porter's Five Forces here. So let's just go over them really quickly here. So the first one is a threat of new entrance. The second is threat of substitution. The third is power over suppliers. The fourth is power over customers, and the fifth is the degree of rivalry. Now, Ed believed that Boeing excelled in all five of these areas and that it was nearly impossible to compete with. It had only one competitor, which was Airbus. Now, the two businesses made up a duopoly in aircraft manufacturing. And because of this, suppliers and customers didn't have that many options if they wanted to buy a new plane. And Boeing had some very, very good products

Starting point is 00:50:24 that customers obviously wanted. So, you know, even these 787s, which had been grounded and shrouded in uncertainty, still had 799 outstanding orders that were worth about $100 billion. Like many of Ed's investments, he thought Boeing's shares were undervalued, of course. In Boeing's case, the shares looked to him to be worth about double the current price in three years' time. In a great example of conviction, Ed discusses how an investment manager he knew called him, telling them that he had to actually sell his Boeing shares due to criticism for owning the business after Boeing had the multiple battery incidents on its 787s. Ed writes, I tried to convince the

Starting point is 00:50:59 manager that even if the 787 did develop serious lasting problems, Boeing still had a thriving business producing other models, and therefore there was a large margin of safety in the shares. My analysis fell on deaf ears, and the other manager sold all of his holdings. Now, this is a great point that I think highlight some of the institutional investors' weaknesses. Many times these investors have to sell for non-investing reasons, such as this one where he had to appease his partners. He mentions that most managers have two goals, which are firstly to earn a good return and second, to keep their clients happy.

Starting point is 00:51:31 But Ed says that he has one advantage, and that's that he only has one goal, which is to earn high returns. And he knows that if he earns good returns, the happiness part of the equation will end up taking care of itself. And if a client is unhappy with good returns, then he realizes that the client and Ed probably aren't a good fit and he lets them go somewhere else. Now, the Boeing investment worked out beautifully for Ed as he sold out at about $136 on an original price of 75. There's a great point made in this chapter that sometimes the best defense is actually a good offense. So let me explain

Starting point is 00:52:03 this. So going back to that example where the other fund manager he knew sold Boeing, Ed thought that the fact that he was selling was a major mistake. And the reason for that mistake was that the risk reward for the investment was just so good at $75. So the risk of not owning Boeing at that price was in opportunity cost. So had the investment manager simply done nothing, he would have turned his investment of 75 into 122. And this function to de-risk the portfolio from further losses as he could absorb $47 of future losses before being underwater on this investment.

Starting point is 00:52:37 Now, I think that's really, really important. Investing requires us to think about opportunity cost. And if we're selling a bet that has. asymmetric upside. That means we're foregoing that ability to maintain that asymmetric bed and we're going into something else where theoretically you could find something that had even more asymmetry, but asymmetric bets are really hard to find. Now moving on here to Southwest Airlines. I think Southwest and I think Ed would probably agree with me is in an even worse industry than Boeing. So I mentioned Ports five forces when discussing Boeing, but you're not going to find any mention

Starting point is 00:53:11 of these forces when analyzing a business like Southwest Airlines. Although if you dug in deeply, maybe you would find something. So the primary reason that airlines are such a bad business are due to the excessive amounts of fixed costs. So let's take an example here. A flight from, say, LAX to JFK will have similar expenses, whether the plane is at 50% capacity or 100% capacity. And due to this, airlines are incentivized to offer the lowest possible prices on their flights to ensure that they optimize capacity. But this has resulted in long-term value destruction as airlines must lower prices to sell seats, even if it's uneconomical. But Southwest did a few things differently to generate their rapid growth.

Starting point is 00:53:48 So they had low cost and low fares. They focused on simplicity. They owned and flew only one model of aircraft, which was the Boeing 737. They utilized smaller airports. So for instance, in Dallas, they preferred Love Field to DFW. And in Chicago, they preferred midway to O'Hare. To save on booking costs, they allowed tickets to be bought on the internet. And they issued ticketless tickets as well.

Starting point is 00:54:10 They had no reservations for assigned seats yet to do it on a first come for serve basis. and they built this computerized reservation system to help once passengers arrived at the terminal. Now, these seemingly insignificant adjustments just did wonders for Southwest fundamentals. So between 1980 and 2000, the company increased revenues at a 17% kegare while compounding profits at a similar rate. Now, one of my favorite stories in this entire book was a publicity stunt that Southwest took part on. So in 1992, Southwest started using a motto, which was just plain smart. At the same time, another aircraft maintenance company called Stevens Aviation, had been using the exact same auto for multiple years prior. So Stevens threatened to sue Southwest

Starting point is 00:54:50 for violating its trademark. Instead of a lawsuit, Southwest CEO, Southwest CEO, who was Herbkeleher, and Stephen's CEO, Kurt Hurwold, decided to have an arm wrestle for the use of the phrase. So they ended up making a promotional video, which I watched, which was very humorous. And so it showed Herb Keller training for his match. In the training, he's smoking a cigarette while doing bicep curls with bottles of hard liquor. So the match ended up taking place in the Dallas Sportatorium wrestling arena. And the loser of each round had to pay $5,000 to charity and the winner of the two rounds won the use of the Just Plain Smart trademark. So Kurt Horwald actually ended up winning two of the three rounds, but he allowed the use to the term to Southwest. So I think

Starting point is 00:55:30 this is a pretty funny promo video, not the type of video that you'd see any CEO doing today. But I think it just goes to show how innovative Herb was and how far he was willing to go to do things differently. So from 2000 to 2011, Southwest's earnings dropped. So it went down from an EPS of about 79 cents down to 40 cents. So the cause increased fuel costs and just a soft economy. But as we know from most of the examples we've already outlined, Ed loves businesses that are going through headwinds. Since the earnings per share dropped, the market understandably wasn't crazy about the business. By 2012, it looked like things were beginning to improve. Analysts all thought the business would see a bump in earnings per share, projecting anywhere from 99 cents to $1.35 over the

Starting point is 00:56:12 next two years. So Ed, and I assume his analyst that he refers to in his book, whose name Josh, thought that Wall Street's estimates were overly conservative here. Their narrative was that Southwest had untapped pricing power. As demand for flights normalized, Southwest could simply increase ticket pricing by about 4 to 5% per year and recognize much of the incremental increase in revenue as profits. Now, on top of the pricing power, Southwest had just acquired another region, carrier, Air Trans, and there were significant cost cutting and synergies that they believe would be highly accretive to Southwest's bottom line. And lastly, Southwest was flush with cash, so much cash that it could distribute it back

Starting point is 00:56:48 to shareholders via share repurchases. Now taken together, Josh believed that EPS could go from about 60 cents in 2012 to $2.75 to $3 by 2016. Interestingly, neither Josh nor Ed felt they could properly value the business. But like Whirlpool, Ed knew that the opportunity here was so good that he didn't need to have a number or target because chances were that if the EPS numbers were achieved, he would make an excellent return on the investment. In 2012, Ed started buying their shares at about $9, and at $9, the business was trading at about a 2016 forward PE of, say, three times. So if earnings per share were to compound

Starting point is 00:57:24 at about 50%, which was in line with his projections, he knew that the shares would be worth a lot more than $9. As part of maintenance due diligence, Ed checked up on Southwest's ticket price to make sure that they were increasing ticket prices. And by late, Late 2013, Southwest's ticket prices had increased by about 6.4% and would continue to increase into 2014. Part of this ticket increase was due to increased jet fuel pricing, and therefore it was unlikely that ticket prices would continue going up forever. So in 2014, Ed began selling half of their holdings as they were having difficulty valuing shares in a more normalized environment. They sold their first half of shares around $25, and the second half was sold later

Starting point is 00:58:01 in 2014 for $35. Now, this was a great investment, and the biggest lesson I took from this story is to really keep an open mind, you know, Ed defaulting to wanting to stay as far away from investing in airlines as possible. So when Josh ended up bringing this idea to him, he was very apprehensive. But since he was willing to admit that he might be wrong on an industry or a business, he was able to dig in, learn more, and find a very impressive multi-bagger stock in an admittedly awful industry. Now, this reminds me a lot of Peter Lynch's points in one up on Wall Street, which I covered on TIP 658. He stated that some of the biggest winners can be found in low or no growth industries. And I think Southwest Airlines was a prime example of this. The trick in

Starting point is 00:58:41 finding winners in these types of industries is that you have to be willing to look in the first place. Most investors will gloss over a business in a ban industry and quickly take a pass. I know I've done this more times than I can count and I'll continue doing it more times into the future. But you definitely have to kind of pick your battles and where you want to spend your time. And there's no point beating yourself up over missing something. So you're always going to miss something. The final investment I want to discuss was Ed's investment into General Motors. So General Motors was interesting because Ed felt that the business was very misunderstood, which seems odd given that GM is a very well-known business that nearly everybody probably

Starting point is 00:59:15 sees their products on a nearly daily basis. But where Ed's view was different was on the classification of GM. While the market viewed General Motors as a car company, Ed viewed GM as more of a truck company. And as he wrote in the book, cars are a very poor business. Trucks are a very good business. So when Ed valued GM's shares, he looked very closely at the truck company and thought it deserved a premium multiple compared to the car business.

Starting point is 00:59:39 Ed believed that the catalyst for GM's share price growth would come from other investors recognizing the truck business inside of GM deserving a higher multiple and would therefore re-rate the company higher. Now, this didn't end up happening at first. So Ed became concerned with GM's liquidity due to COVID. The vehicle business has high amounts of accounts payable that must be paid regularly to their suppliers to ensure that they get the parts needed for their vehicles. But accounts receivable tends to be low as the dealer pays for vehicles upon delivery. So if vehicles weren't being

Starting point is 01:00:10 delivered, there was a chance that they could have pretty severe working capital issues. Now, Ed, reason since GM might not be able to get its cars to its dealers for a time, they could run into severe problems if they were forced to close their plants for 9 to 12 months, which was a potential issue at the onset of COVID. So after buying it, he ended up selling most of his position once COVID happened. And he didn't specify whether this was a loss or a gain. So at the peak, GM had about a 59% drawdown once the U.S. declared a national state of emergency during the COVID lockdown.

Starting point is 01:00:41 So I can only assume that he lost money on this investment at that time. Now, from his experience investing during the Great Financial Crisis, Ed knew that undervalued stocks had a lot of upside once a liquidity crisis ended. So if we look at the Great Financial crisis, Ed saw that he could monitor credit speds. and that would help prompt him to take action. So for COVID, instead of credit spreads, he was looking more for a stimulus package. In late March, that is exactly what happened with the CARES Act, which provided about $2 trillion for the economy.

Starting point is 01:01:12 So once this care package, for lack of a better word, ended up happening, he ended up buying back at a GM because he knew that the factories would also reopen. So they announced that factories would reopen in about April 2020. At this time, the shares were selling for about three times. estimated earnings. Now, from the sound of it, he held onto this business and I don't know if he still owns it today or not. As of March 12, 2025, the shares are trading at about $48. So if he'd held from April 2020 until today, he would have made about a 22% compound annual return, not including dividends, which is very impressive. Now, the big lesson from this chapter is that a business can make you

Starting point is 01:01:49 incredible returns when bought just cheap enough. You know, GM, in my view, is just not a very good business. Sure, it has the truck angle, which is something, but then it also has this EV angle, which just seems to be another massive commodity. And I have no idea who the winner is. Maybe Ed does. However, what is shown from this case study is that you can make a lot of money when you deploy capital at the right time. Howard Marks has said something along the lines of any investment is good if you buy it cheap enough. And I think this is a prime example. The key to doing this successfully is having courage. You know, Ed pointed out that he made a lot of returns from businesses that he bought between March 26th and April 30th of 2020. He writes,

Starting point is 01:02:27 To take advantage of situations where individual stocks, groups of stocks, or the entire market are selling at deeply undervalued prices based on normal metrics, an investor cannot wait for the cause of the undervaluations to cease, but rather must act when he believes there is a high probability that the cause will cease in the near future. It is said that successful investing is all about predicting the future more accurately than others. Now, this is an interesting point worth going into a little bit here. So investors can make incredible returns deploying large amounts of capital during secular market panics. I think I'm personally a great example. Some of my top investments I ever made, even though I'm a fraction of the investor in 2020 that I am today, were in a very similar time

Starting point is 01:03:07 period. The reason was that stock were cheap and all I had to do in 2020 was trying to determine what could survive or do well over the next few years. So names like inmode did really well. Another one that I still own is Eritzia, which ended up doing very well from that low point. And another lower quality business I owned at that time was Air Canada. And even though that business isn't any good and there's no chance I would ever buy it at this point, I still made a decent return on it simply because it was just cheap. Now, my favorite case study in deploying capital at very opportune times is Poulac Prasad. So he wrote the wonderful book, what I learned about investing from Darwin, which I discuss in TIP 597. In that book, Poulac writes that he deploys capital

Starting point is 01:03:44 only during times when stocks are abandoned by their former owners. So he points out large events, which were the Great Financial Crisis, the Euro crisis, and COVID-19, which were three times where nearly 46% of his fund's capital was deployed. Now, all this capital was deployed over only 26 months out of the 169 months of Nalanda's existence at the time of writing the book. So in the book, he had this great chart showing the drawdowns of each event. So the Great Financial Crisis had about a 73% market decline. The Euro crisis had a 28% market decline, and COVID-19 had about a 26% market.

Starting point is 01:04:20 decline. Now, I think Pooleck runs a strategy because he knows that it's probably the only time that he can get a decent price on some of the super high quality businesses that he wants in the portfolio. So whether you seek out high quality names or even low quality cheap names, investing during severe market turmoil is a very intelligent strategy. But you must have the courage to do it. And you have to be able to fight the human instinct to flee along with other investors. And right now, as I write this on March 12th of 2025, the S&B 500 has fallen about 7,000 since the inauguration of Donald Trump. So we aren't even in a correction territory of negative 10 percent yet. But if you look at your portfolio today, you will probably notice a lot of your names

Starting point is 01:05:00 are down pretty significantly. While many investors are choosing the path of exiting, the investors who are most likely to do well over the next few years are the ones who are buying cheap shares in the businesses that they like. I'm buying more shares of companies that I own already because I know a few of these are trading at just very, very cheap evaluations and I think their forward returns look very attractive. Now, the final chapter of common stocks and common sense is a letter that Ed wrote to a younger investment manager in 2008. And I think it does a pretty good job of summarizing a lot of Ed's advice and strategy.

Starting point is 01:05:30 So I want to go over some of the points that I thought were very impactful. So the first one here is that Ed's core strategy is based around basic value investing principles. You know, he's looking for deeply undervalued businesses that can appreciate sharply due to some sort of catalyst. he prefers cheaper stocks to more expensive ones because they have less downside risk if growth stalls. Two, don't bother putting time into analyzing a business if you think the investment just has too high of a chance of going down significantly. Three, a creative mind is a highly undervalued concept necessary for investing success.

Starting point is 01:06:04 This aligns well with what Albert Einstein said, which is, the true sign of intelligence is not knowledge, but imagination. Ed adds that you should allow your mind to wander, be open to new ideas, and free yourself from being chained to preconceived ideas. Ed thinks that you should be uncomfortable when buying a stock. You should welcome the feeling rather than welcome comfort. This plays well into the contrarian mindset where your stance differs from the majority. Investing can be lonely, so you must be comfortable with discomfort. Five, don't get complacent. It's easy to hold a thesis true in your head, then block yourself out from gaining new perspective that might just break your thesis. And this has been a problem for me as it's been a problem for probably every single investor.

Starting point is 01:06:43 and I try to combat it as best as possible. The way that I've done this is to constantly look for chinks in the armor of my thesis. This allows me to actively search for where I could be wrong and hopefully exit a business that is unlikely to go anywhere or worse, go down. Six, along the same lines as the previous point, beware of confirmation bias. Actively seek dissenting opinions to widen your perspective. Try to avoid the echo chamber of your positive biases. While you probably will disagree with dissenting opinions,

Starting point is 01:07:10 there might be a kernel of truth in what others think about your idea. And if they uncover something that you've overlooked, that's highly valuable information. 7. Continuing with the theme of information, do not delay a good investment due to delays caused by over-researching an idea. Ed writes, you do not have to drink a whole bowl of soup, no, how it tastes. You can see how he puts us in action with a few of his investments he made where getting to an evaluation was tough, but he knew that it was absurdly cheap and therefore

Starting point is 01:07:36 would make good enough return for his fund. 8. When assessing management teams pay more attention to what they do than what they say. Now, this is one of Stig's favorite saying, so it's been cemented into my brain. But management, you know, tend to be very good salespeople. But if they say they are a superstar and yet they've wasted money on lower turning investments, haven't contributed to intrinsic value, and yet are making a higher and higher salary or bonuses, then that's a powerful signal. You want managers who underpromise and over-deliver.

Starting point is 01:08:05 The results should stand out that they are doing a very, very good job. 9. Since investing is inherently uncertain, we must look at specific strategies to improve our odds of success. One such way is to seek simplicity where the outcomes of our investments are based on fewer rather than more moving parts. Simplicity is a great way of solving this problem. Overly complex investments carry additional risk if the thesis can break down in multiple ways. 10. If you aren't losing on a few of your investments, you are being too risk-averse. Losing doesn't mean going to zero, but it means you are taking calculated risks. Anybody who invests for a few years will have their share of losers. You should expect that.

Starting point is 01:08:44 This means that in your modeling weigh the chances of a loss and don't always focus on the upside. And when you lose, don't beat yourself up. Just learn from it and move on. 11. Invest for the long term. Ed mentions having a minimum two year view. Once you have your long term view, you can de-emphasize the short term. Most hedge funds employ the opposite strategy. They try to optimize just for the next quarter. And for this reason, there is a lot of competition for very intelligent people to find very short-term ideas that are going to do well over the next 90 days. And because of this, a lot of capital will flow to these ideas, which takes capital away from long-term ideas that can outperform. So focus your efforts here.

Starting point is 01:09:21 There will be a lot less competition. 12. Lastly, try to stay positive and optimistic. This is a tough one because I believe some people are wired to be optimistic or pessimistic. But when you think deeply about financial markets, they just tend to go up over time. So when pessimism enters your mind, just remember that the next bull market is right around the corner. That's all I have for you today. If you want to interact with me on Twitter, please follow me at a rational MRKTS or on LinkedIn under Kyle Grief. And if you enjoy my episodes, please feel free to let me know how I can make your listening experience even better. Thanks again for tuning in. Bye bye. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app

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We Study Billionaires - The Investor’s Podcast Network - TIP710: Common Stocks and Common Sense w/ Kyle Grieve

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