We Study Billionaires - The Investor’s Podcast Network - TIP802: When Genius Was Just Luck: The Go-Go Years w/ Kyle Grieve

Episode Date: March 27, 2026

In today’s episode, Kyle Grieve discusses the speculative boom of the 1960s “Go-Go Years” as presented in John Brooks’ book, highlighting the dangers of euphoria, leverage, and financial engineering. He explores case studies like Ross Perot, Edward Gilbert, Atlantic Acceptance, and Gerry Tsai to reveal how incentives, momentum, and fraud can distort markets. The episode ultimately emphasizes timeless investing lessons around valuation discipline, skepticism, and aligning incentives with long-term outcomes. IN THIS EPISODE YOU’LL LEARN: 00:00:00 - Intro 00:02:02 - About the Nifty Fifty’s rise and the dangers of extreme valuation multiples 00:03:34 - Why great businesses can still be poor investments at high prices 00:05:07 - About Ross Perot’s EDS and the psychology of ignoring market volatility 00:09:45 - The dangers of leverage through Edward Gilbert’s collapse 00:16:13 - Why sharing stock ideas can create unintended consequences 00:19:32 - How fraud fueled Atlantic Acceptance’s explosive growth 00:29:17 - Why rapid growth without explanation signals potential risk 00:33:28 - Gerry Tsai’s momentum strategy and performance-chasing cycles 00:42:07 - How conglomerates used financial engineering to create illusory value Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠TIP Mastermind Community⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Learn how to join us in Omaha for the Berkshire meeting ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠here⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Buy The Go-Go Years. Follow Kyle on ⁠X⁠ and ⁠LinkedIn⁠. Related ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠books⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ mentioned in the podcast. Ad-free episodes on our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Premium Feed⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. NEW TO THE SHOW? Get smarter about valuing businesses through ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Newsletter⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Check out our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠We Study Billionaires Starter Packs⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Follow our official social media accounts: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠X⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ | ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ | ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Try our tool for picking stock winners and managing our portfolios: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠TIP Finance Tool⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Enjoy exclusive perks from our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠favorite Apps and Services⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Learn how to better start, manage, and grow your business with the ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠best business podcasts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. SPONSORS Support our free podcast by supporting our ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sponsors⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠: HardBlock Human Rights Foundation Vanta Unchained Netsuite Shopify Fundrise References to any third-party products, services, or advertisers do not constitute endorsements, and The Investor’s Podcast Network is not responsible for any claims made by them. Learn more about your ad choices. Visit megaphone.fm/adchoices Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm

You're listening to TIP. Did you know that during the 1960s, some of America's greatest companies traded on over 90 times earnings shattering current Meg 7 numbers simply because investors believe there was no price too high to pay? In today's episode, we're going to discuss one of the most fascinating bubbles in American history, the go-go years. We're going to unpack some of the most entertaining narratives through this entire euphoric period. You'll hear how legendary investors and companies rose to fame, why momentum-based strategies made people into geniuses in the moment,

and how entire fortunes were built seemingly overnight. We'll also explore what happens when valuation discipline just completely disappears, how leverage can turn the smallest mistakes into catastrophic losses, and why rapid growth can sometimes be a red flag rather than an opportunity. We'll also look at why stock prices can enable businesses to pursue short-term strategies and harm long-term investors. And along the way, we'll break down the impact. of misaligned incentives, the dangers of financial engineering, and how even the most sophisticated

investors can fall victim to fraud. Now, if you've ever wondered about the details of how a bubble is formed, why they can feel so convincing when you're in them, and what lessons you can take to become a more disciplined, long-term focus investor, then this episode is just for you. So, let's dive right into this week's episode on the Go Go Go Years. Since 2014 and through more than 190 million downloads, We break down the principles of value investing and sit down with some of the world's best asset managers. We uncover potential opportunities in the market and explore the intersection between money, happiness and the art of living a good life. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own and they may have investments in the securities discussed.

Now for your host, Kyle Greve. Welcome to the Investors Podcast. I'm your host, Kyle Greve, and today we're going to discuss a very well-written and highly informative book about one of America's greatest periods of euphoria, the go-go years of the 1960s. So we'll be looking deeply at the book called The Goghers by John Brooks to discuss several investing stories and extract a bunch of lessons from each of them. Now, when I first heard of the go-go years, I tended to think of just one thing, the nifty-50. And this was probably through hearing about it from people like Howard Marks. So in one of of his memos, he wrote, Investor interest in rapid growth led to the anointment of the so-called

nifty-50 stocks, which became the investment focus of many of the money center banks, including my employer, which were the leading institutional investors of the day. This group comprised the 50 companies believed to be the best and fastest growing in America, companies that were considered just so good that nothing bad could happen to them, and there was no price too high for their shares. Like the objects of most manias, the Nifty 50 stocks showed phenomenal performance for the first three years as the company's earnings grew, and their valuations rose to just nosebleed levels before declining precipitously between 1972 and 1974. Now, the Nifty 50 have always captured my attention, and I think that's because I'm

very fond of investments in high-quality businesses. Now, if you look at the Nifty-50, there are still many high-quality businesses from back in the 1960s that are still around today trading as public companies, businesses like Amex and Howser Bush, Coca-Cola, PepsiCo, Philip Morris, McDonald's, IBM, Disney, Walmart, and many others still exist today. The problem with the Nifty 50-50 wasn't because when you bought these businesses, they were likely to disappear after a short period of time due to the competitive nature of capitalism. The risk was actually present in the insane prices that investors were willing to pay for them.

So look at what Marks said there again. Companies that were considered so good that nothing bad could happen to them and that there was no price too high for their shares. Now, I found this fascinating for multiple years because as an investor, I fully realized that no business is worth an infinite price, just like Charlie Munger was sure to mention. But the really good businesses, businesses like Costco that Charlie owned for a long period of time, with ever-increasing earnings multiples, were businesses that he felt he could hold even while they looked optically expensive.

So my brain got to work on exactly why Charlie was able to make that Costco bet work when it looked pretty much really expensive over the last 10 years or so. So, you know, over that time, it's traded north of 30 times earnings since 2016. And since that time, it's offered shareholders still a 22% kegger in share price excluding dividends. But when you get to looking a little deeper at the nifty 50, I think the answer becomes a little more clear. So in 1972, McDonald's traded out a P.E. of 71 times, Polaroid 95 times and Disney

71 times. If you own businesses that have nonsensical multiples, it's just really hard to make any money. You would still have made money in businesses like McDonald's or Disney if you chose to hold them for decades, but that's a pretty tough proposition because it's really hard to know if those businesses would have been around over a multi-decade time period. Now, all this talk of high PE ratios is a great intro for the first story of the book, which covers Ross Perot and the business that really built his fortune, electronic data systems or EDS.

So Perot began his career after the Navy, working as a computer drummer for IBM in Dallas. He was such an incredible salesman that his commission had to be cut by four digits. And if he had annual sales pass a specific benchmark, he just received no commission after that. So in 1962, he made his annual quote by January 19th, basically just putting himself out of business for the rest of the year. So he ended up quitting IBM that June and incorporated his own company, Electronic Data Systems Corps. Now, this business specialized in the early design, installations, and operations of computer systems.

Perot invested $1,000 of his own money, as that was what was required to, to incorporate under Texas law. So the company scaled well. It sold contracts to 11 states, and EDS specialized specifically in providing its computerized systems for the medical industry, helping to pay things like Medicare and Medicaid bills. By 1971, the business had grown to 23 contracts, 323 employees, $10 million in assets, and $1.5 million in earnings. The growth curve was attracting many investors. So 17 investment bankers pitched Perot to go with them to help take his company public. He refused 16 of them, but the 17th banker seemed like a very good fit. And this banker was Ken Langone, who helped found Home Depot. One of the biggest attractors

for Perot to Langone was that Langone wanted to chase pretty high prices for EDS's IPO. Whereas many of the other investment bankers suggested going for, you know, more normalized earnings like 30 times, Langone wanted 100 times. Once Langone was chosen, he worked with Perot to improve EDS's standing with the public. First came the board. The EDS board was typical of even a pre-level listed microcap today. So you just have a bunch of family members on your board. So Perrault's board consisted at that time of his wife, his mother, and his sister. That just unfortunately wouldn't work for Wall Street. So Langone suggested a few current employees and other principals take board seats. So the IPO price would be about $16.50 per share, which was a 118 times earnings multiple.

Now, keep in mind, in 1971 was near peak euphoria when this business had its IPO. But this euphoria had been built over the 1960s. It was a time when the bubble was. just about to pop. So for a tech business growing, you know, quite quickly, you can probably see how a business like this might fetch a very premium multiple. Now, just to give you an idea of EDS's growth, by 1975, the business surpassed $100 million in revenue. By 1979, revenue exploded to $270 million with no debt. Now, I couldn't find a date for its IPO, but my guess is that the growth then would have probably far exceeded that growth that was happening into the mid to late 1970s. So you could have been looking at a business doubling its intrinsic value every one to three

years or so. And those businesses tend to fetch a premium, especially to growth or momentum investors. And since this was the time that the Nifty 50 was so popular, it just wasn't that unusual for investors to pay up for growth. But as with most growth stories, things tend not to end well. And here's where the major lesson from Perot comes in. So on April 22nd of 1969, the market decided it didn't like EDS's stock, punishing its stock price by 50 to 60% in just one day. The book states that Perrault said regarding the event that he felt nothing at all. The event had felt purely abstract for him. Now, I absolutely love this way of thinking because it clearly shows that Perrault had his business owner's hat and knew that he should stay away from the mistake of thinking, you know,

purely as a stock picker. He had additional reasons not to be overly concerned. So his status as a billionaire, even after this gigantic drop was still intact. And he's simply gone from a paper worth of about a billion and a half to just a billion. So to me, as an owner, I would have thought much along the lines of Perot here as well. And the reason was simple. Even though EDS stock had been punished severely, the business was still firing on all cylinders. So in 1969, per share earnings doubled. And knowing this, what could have possibly precipitated a dip of that magnitude? So the thesis was that a large part of EDS's stock was weakly held by mutual funds who would flee at the first sign of any type of weakness. And since one EDS,

comp, a business in the same industry, had just had its stock price cut by 80% of its peak while EDS continued to trade at its peak, the market clearly felt that it was just time for a massive re-rating of EDS. So this is a classic example where re-rating has a massive impact on the risk of a business. And it's why expensive businesses are generally avoided by most intelligent investors. The risk of multiple re-rating downwards is simply a risk that they want to avoid. And by investing in businesses with single-digit PE multiples, you can simply run a lower risk of re-rating being as painful as those businesses, you know, that are trading at a P.E. of 100. Now, another problem with multiple re-ratings is if you're using leverage. If a business goes

down substantially in price while you're leveraged, it's no good because you're going to be forced to sell when the best possible action, if the business is still doing really well and growing, is actually to buy it. So one great story of this exact scenario discussed a gambler named Edward Gilbert. So Edward Gilbert lived an interesting life. His chapter is called the last Gatsby because he appeared to attempt to live a life similar to the Great Gatsby. So his life was full of posh parties, expensive artwork, and high levels of ostentatiousness. Gilbert started out working for his father, Harry Gilbert, and his company called Empire Millwork. Now, Harry wasn't a true operator, but he owned a very substantial stake in this business

called Empire. Once the company went public, Harry's net worth exploded to north of $8 million. Now, Edward had no shortage of ideas to continue expanding empire. But his father wasn't on board with many of his ideas using Empire as some sort of conglomerate. Eddie once demanded to get a position as a director to execute his grand vision, but his father refused him. So as a result of this, Eddie just quit and created a business of his own, specializing specifically in hardwood flooring. Now, there are two competing stories of what happens next, and I don't think anyone other than them would know the truth. So the first story was that the hardwood flooring business was a raging success.

And seeing the success of the business, Harry decided that Edward was worth being brought in to add empire's value. And the second story was that Edward's venture went south incredibly fast, and Harry had to bail him out as a result. Either way, Edward now owned 20,000 shares of empire that were given to him from his father in exchange for the flooring business. Now, one of the businesses that Edward thought would make a lot of sense for Empire Millwork conglomerate was another flooring business called E.L. Bruce. As part of his strategy to one day acquire Bruce, he began socializing with the elite of Wall Street. He'd made the right donations, he got in the right people's good books, and he would start offering stock tips to his friends. And they presumably had some sort of success

as they kept coming back to him for more. But this is when keeping up with the Joneses just kind of started to ruin him. So he spent all of the money that he had, even the money he didn't have, just doing things like the Great Gatsby, throwing these lavish parties and buying expensive artwork. And unfortunately, he was also a gambling addict. And to boot, he wasn't very good at gambling in the first place. So with his growing network of wealthy friends, he began pushing Bruce more and more towards them. So his thinking was that if he could eventually, acquire enough of these friendly shares, he thought that a takeover might be possible. Now, this is what's called cornering the market. Gilbert and his friends have been buying the

business, causing the prices to go up. And sensing a potential raider, the family who owned Bruce began buying even more shares causing the price to continue to rise even further. A third group of investors monitoring the rise wanted to profit from the eventual fall, and they began shorting it. And then there was a short squeeze. So the owners who were short, desperately bought more stock to cover their shorts, creating more and more upward pricing pressure. The stock went from $25 to $70 before the short squeeze. Now, after the short squeeze, the price rocketed to $188. Edwards was now a paper millionaire, and El Bruce had merged with Empire.

Now, to fund his lavish lifestyle that he just couldn't afford, he ended up using money from Empire, which was now called Bruce, as his personal piggy bank. He borrowed money from the Treasury once, but he ended up repaying it before the SEC was notified of his illegal funding methods. But with Edward's success with Bruce, he now thought, thought that he could execute on his plan of growing Empire National into a reality forum. Next, he turned his attention to a manufacturer of building installation materials, a company called Sellotex Corporation.

So this business was even larger than EL Bruce. To get a controlling stake in Sellotex, he shared the name with his family and friends, and he used his shareholdings in Bruce as a collateral to borrow even more shares. Edwards eventually got 10% of Sellotex's shares, which were enough to get him aboard seat. But unfortunately at this time, Edward's personal life was starting to unravel. As part of a divorce, he was required to live in Nevada as a prerequisite for a Nevada divorce. He moved his operations from New York to Nevada, but pretended like he was in New York. He did this to make sure that the market didn't get jittery about Bruce and Sellotex

and his quick relocation from New York to Vegas. Now given his attraction to gambling, while in Vegas, he basically wake up. He'd take calls regarding Bruce and Sellotex, and he just hopped down to the casino and spend the rest of the day gambling. As the market worsened, Gilbert knew that in order to stay afloat, he'd need even more funding. Now, here's what Brooks wrote about this in the go-go years. Gilbert's sellotex holdings now amounted to over 150,000 shares. And for each further point that the stock dropped, he had to fine and deliver $150,000 in additional margin or risk being sold out by his brokers. Those of his friends holding cellotex on his advice now numbered around 50.

And they too, since most of them had held it on margin, were being squeezed as the price continued to fall. Many of them also had positions in Bruce. So their alternatives were three. They could either buy Sellotex, they could sell Bruce shares to cover Sellotex, which would depress the share prices of Bruce and thus be equally disastrous for Gilbert or just find more cash margin. In other words, Gilbert and Bruce were in very bad shape here. So Gilbert chose the last option, which was the least painful of all options. He couldn't find anyone to lend them money, so he decided to try to break the law to find the funds that he needed. So he got Bruce to write checks had two dummy corporations that he owned in the amount of about $2 million, committing

larceny. So his thought process was that if Bruce's share price rebounded, he could just repay the checks while maintaining his position. But if that didn't work out, he'd end up in prison. Unfortunately, his timing couldn't have been any worse. So an event later named Blue Monday, which I'd never actually heard of, occurred shortly after he committed the crime. Now, Blue Monday was a second worst day at publication of this book in the last century. Gilbert's Holdings and Bruce and Sellotex went down precipit. Advertisely. Gilbert was now down to $7 million in debt, 5 million to creditors and 2 million of the money that he stole from Bruce. Gilbert then decided to just move to Brazil before he was found out. His father helped him by sending him money,

but he only actually lasted a few months before just getting bored and for some reason decided to return to New York where he was immediately arrested. As a result, he ended up going to prison, but just for two years, so maybe that's why he returned. Now, the story of Edward Gilbert, I think, teaches several lessons. The first is one that. that has been drilled to me for many years by listening to most long-term investors, which is simply just stay away from leverage. While leverage can be alluring as it simply boosts your results when you're right, it's easy to forget the potential downside. If you are leveraged and the market moves against you, then you're basically forced to sell positions that you probably otherwise keep or even add to if you are unleveraged. And if you're a value investor who enjoys averaging

down, then leverage means your strategy will simply cease to exist. Another lesson here is in sharing ideas with your friends. Now, I know it's fun to talk about ideas and talk your book. But only I know personally how I would deal with a business that I hold. I cannot say the same thing for friends who may listen to me discuss a business that I might own. They may take, you know, a giant position where I might just have a tracking position where I know I need to do more work. Then when things go south, you know, I'm minimally affected while they may be taken to the ringers and sell it the exact wrong time. Edward Gilbert more or less used his friends to achieve his own financial goals. I'm very much against this line of thinking, simply because it's not the right thing to do

to anyone, let alone people that you actually like. Now, one potential strategy here is to just avoid discussing your stocks with family and friends who have an itchy trigger finger. That way, you avoid the risk of having awkward conversations at future dinner parties. But I think the biggest lesson from Gilbert regards his classic gambler's mistake. And that's to take riskier and riskier bets when you're down just to recoup your losses. This is a horrible mistake. in pretty much any area of life. While it might work out for the odd person every now and then, doing it repeatedly is simply just a recipe for failure.

Now, in poker terms, this is called being on tilt. It's basically when you aren't playing your game properly because you're being influenced by certain misjudgments. In the past, when I began feeling this way, maybe I got upset about a bad beat. The best course of action was really just to step away and not dive head first into trying to make my money back. And it's the exact same in investing.

In investing, you know, you can't really step away in the same sense as you can if you're playing poker, but you can simply take a break from action. Let's say you maybe have a position that loses 50% of its price, and you determine that you made a big mistake on the thesis. Let's say in this case, there's just no reason to hold the business as is more likely to go bankrupt than rebound and price. So you end up selling out, and now you have capital to put to work. If you're Edward Gilbert, you go out and find some sort of bet that can maybe double in just a few months. That way you recoup your money and you're no worse for it. But what many investors actually do when trying to replicate this strategy is take incredibly, incredibly, incredibly risky bets. Maybe you decide to bet on some

junior mining company that has just announced that has finished drilling a hole in the ground. If gold is found, the business could quickly multiply in value, but if nothing is found, the business has a bunch of debt and zero assets generating any money. So let's look at this through the lens of expected value. Let's suppose that you're offered a bet with a 5% chance to triple your money and a 10% chance to lose everything and an 85% chance to just lose a little bit. So most people are going to fixate on that 3x. It's exciting. It feels like an opportunity.

But the arithmetic really just tells a different story. In 95% of the outcomes, you lose money. And in a meaningful number of cases, you're completely wiped out. So when you do the math, the expected value is less than what you started with. That is not an investment. That is a transfer of wealth from you to whoever is on the other side of the trade. The lesson is quite simple here. If you're going to take the risk of permanent loss, you should be paid for it.

And if you're not, the game is working against you no matter how attractive the upside appears. The scariest part of investing, in my view, is investing in a fraudulent company. And public markets, unfortunately, are just ripe for it. If you have a person in charge who is able to spin a great lie, then it's completely possible to fool even the most sophisticated investor. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the

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It was a time when there was a cultural shift on Wall Street. So you had younger investors that began proliferating, taking over for some of the older generation. And they were tending to take a much more daring approach to investing compared to that prior generation. They resonated more with speculation and gambling over more boring and predictable routes of, you know, compounding your money slowly. So Atlantic was a product of its time. It basically ended up telling a story to its investors that didn't exist. But let's get into that.

So Atlantic was led by the gentleman by the name of Campbell Morgan, a former accountant who also enjoyed the cheap thrills of a badly placed bet. So let's rewind in 1955 when Morgan realized that he could tap into public markets, Wall Street. Street to raise money for his company. He signed on a number of investors, beginning with Lambert and company who supplied Atlantic with about $300,000. By 1959, the business appeared to be aging very, very well. And U.S. Steel Fund decided to invest. The Ford Foundation quickly followed suit. After that, it was quite easy for him to attract new investors and money just began pouring into this Canadian domiciled business on Wall Street. Now, ironically, one of Atlantic's investors was none other than Moody's, who specialized in assessing the credit quality of corporations.

By the early 1960s, Atlantic was just crushing it. Sales in 1960 were 25 million. In 1961, it was 46 million. And by 1962, it was 81 million. By 1963, it over doubled to 176 million. So you were looking at just one of the cleanest examples of ever seen of a business basically compounding at 100% a year. But here's the thing. The business wasn't based on some sort of pie in the sky technological marvel. It was just a good thing. It was just a business. It's just a lending business. And lending businesses just don't grow like this for long periods of time. There has to be a reason it was growing parabolically.

And the reason it turns out was that it was making loans that its competitors just didn't want to make because they were just too risky. But Atlantic took them on, allowing them to capture more and more premium while just throwing caution to the wind. But here was what Morgan was really doing. So he was basically running a typical Ponzi scheme relying on fraudulent accounting to just dupe investors. Atlantic would use new capital inflows it raised to make these new risky loans, but that risk

was hidden from investors because Atlantic hired complicit accounts that were willing to commit fraud. And these loans obviously made their growth continue to look more and more impressive, which brought in more and more capital. So on their books, they actually overstated assets and they understated their allowance for bad debts. So in 1964, Atlantic published profits of $1.4 million, but in reality, they actually incurred a loss of $16.6 million. By now, In 1965, investors were starting to wonder about their investment. Morgan, who was very fond of gambling, also owned through Atlantic, a hotel with an attached casino in the Bahamas. This, predictably, did not turn out well either. Eventually, TD Bank refused to honor 5 million in Atlantic checks for

notes that had been matured. The same day, 41 different brokers received buy orders for Atlantic stock using checks from the same bank account. But the certification was actually fake. And oddly enough, this wasn't even done by Morgan, but by one of his unsavory associates. As a result, even more, notes were called for a total of $25 million. But now the scheme was up as Atlantic just didn't have the funds to pay. As a result, owners of its debt and equity were completely obliterated. In bankruptcy proceedings, it was found that there is a paucity of credit information and as far as we were able to ascertain no real financial control. There appears to be no reporting procedure for real estate, machinery, and other types of fixed asset loans.

Apparently, no appraisals were obtained and there was no evidence on file of the value of loan collateral. In some, procedures considered necessary in the conduct of financial business were just missing. Now this was a big moment in Canadian history as repercussions from the Atlantic deal had systematic effects on the Canadian economy. The first two months after the default, the central bank of Canada increased the money supply to avoid a credit panic. Foreign investment into Canada from the US all but dried up as well as a result of Atlantic's

Ponzi scheme. Now, even on his deathbed, Morgan would never admit that he was complicit in the fraud. After Morgan passed away, there was a commission that found he was very well aware of the fraud, and he had acted in a highly, highly dishonest way. So here's a great quote from Brooks about Morgan at Atlantic. A smooth operator with a streak of a gambler, a company more interested in attracting investors than in making real profits. The resort to tricky accounting, the eager complicity of long-established supposedly conservative

investing institutions, the desperation plunge into a gambling casino at the last minute, the need for a massive central bank action to localize a disaster, and finally, reform measures that were instituted too late. Now, the hard part about scams is that investors are supposed to be protected from them, but in reality, all we can really rely on is ourselves. And if well-respected investment firms can be duped, what's stopping the retail investor from also being fooled? In Atlantic's story, it seems odd that nobody would have caught on earlier.

There's just plenty of insurance underwriters and lenders that had been operating for a very long time, and it's kind of hard to find out exactly what differentiated Atlantic from its competitors. This is the main lesson from the story. If a company is producing incredible results versus its peers and isn't really doing anything differently, you just have to ask yourself why that is. Either they have some sort of hidden moat maybe that's not easily discovered, or they're taking part in some form of fraud that's deliberately hidden from investors. A more modern example is Luckin Coffee, a Chinese coffee shop. This business exploded from zero stores in 2017 to over 2000 by the time at IPO just two years later. By 2021,

they claimed to have over 4,500 stores, and just like Atlantic, they had exceptional growth, but It was kind of left unchecked, and I think that was probably some sort of a yellow flag. Now, in April of 2020, Luckin disclosed that over 300 million of its 2019 revenue had been completely fabricated. So executives had created fake transactions, fake sales, all with the aim of inflating revenue to meet their lofty growth expectations. They were eventually uncovered by a short-seller report from Muddy Waters back in 2020. While I'm a huge fan of growth businesses, it's very important to remember that growth can become

its own kind of self-fulfilling prophecy. And when management owns things like options or warrants that gain in value, they're actually incentivized to continue growing the stock price. And unfortunately, if they do it in illegal ways, that's something that you have to try to pay very close attention to to try to avoid at all costs. Now, I think with businesses that are growing fast, you must inject some degree of skepticism. And you have to ask yourself if this growth is actually feasible. Are their margins realistic? When you go into their store, do they appear to be busier than their competitors. In the Muddy Waters short report on Luckham, they spent a lot of time, money, and effort trying to figure out if Luckin was being truthful on its growth KPIs. Muddy Waters reportedly

reviewed over 11,000 hours of video footage while hiring 92 full-time and 1,418 part-time staff to run surveillance at stores. And what they found was simply that the growth numbers at Luckin was presented to investors just didn't align with reality. Their surveillance covered things like foot traffic, number of cups sold per store, and the average order size. As a result of the research, they claimed that luck in overinflated numbers of KPI's like number of items per store per day and net selling price per item. Now this is all great, but certainly it's a very hard task to do if you have limited resources and time.

Now let's get back here to the inception of the GoGo Year. So I already mentioned with the Atlantic example that there was this new breed of investors who were willing to take on certain risks that the previous generation may have just skipped. But there are other changes happening as well that are very easy to overlook. So in Boston, the vocation of managing money was one that was taken very seriously. The art of managing money was first by just managing a trust. And when you managed a trust historically, especially in Boston, it was to basically generate profit for the beneficiaries of that trust.

But this notion began to change in the 1960s with the formation of the hedge fund. Well, let's first look here a little more closely at a gentleman named Edward Johnson. So Edward Johnson owned Fidelity, which probably many of you, all of you, are going to familiar with us. It was there that Peter Lynch would go on to post his legendary investing returns. But interestingly, when Edward Johnson assumed control of fidelity, the organization refused to take a dime for it. They were the typical Bostonians who did not believe in profiting from their trustees. Now, I wondered here for a second if Buffett was inspired by this when he was offered money for his Buffett partnerships because I know he decided to skip it too because he simply just didn't

want to benefit or profit from his partners. But back to Edward Johnson. So, Johnson wasn't the typical manager of a trustee who tended to be highly conservative. He was more interested in things like speculation, and his investing idol was a master speculator, Jesse Livermore. So here's what he wrote about the Fidelity Fund. We didn't feel that we were married to a stock when we bought it. You might say that we preferred to think of our relationship to it as a companionate marriage, but that doesn't go far enough either.

Possibly now and again, we like to have a liaison or very occasionally a couple of nights together. Essentially, he was using relationship as a mental model for his holding periods, and he admitted that he wasn't really willing to have a long-term relationship with his stocks. Now, this is very vital because Edward Johnson would bring on the very highly talented Gerald Tsai, who also shared in his sentiment. Now, Jared Tsai absolutely crushed in on Wall Street in his early years. He was one of the first investors celebrities. He gained popularity simply with large amounts of success.

But his success wasn't your, you know, Uber long-term Buffett type of success. His success was more based on short-term high turnover that resonated with the average investor. And I would say that that probably still resonates with the average investor today. Now, what Jerry Tsai was able to do was pick stocks that quickly appreciated in value. And his trading patterns of getting in and out of stocks relatively quickly was what just put him over the top. He was the epitome of Get Rich Quick. One thing that Jerry mentioned when he spoke about his time with Edward Johnson was that Edward was willing to hand off a lot of responsibility to his key employees. So he called it handing them the rope, meaning they could either succeed or they would

grievously injure themselves with the rope. Size rope would be known as a Fidelity Capital Fund. Now, his strategy here was kind of simple, make a few concentrated bets on more speculative businesses like Polaroid, Xerox, and Linton Industries. But the parameters of entering the positions was also key to his strategy. Since he was making these concentrated bets, he'd require his brokers to buy shares in maybe 10,000 share increments. he basically did this intending to move the share price by one or two percent after his order was

filled. And if he talked to the brokers and they couldn't make the share price move, then he just wouldn't use them. It was that simple. And since obviously Jerry was bringing a lot of business to these brokers, if one broker refused to do it, then he could go to the next one to find someone who could fulfill his parameters. Now, next thing he would do when he had these companies was, as I've already discussed, he wasn't really a long-term holder of business looking for these compounders. His turnover rate was apparently well over 100%, meaning he was unlikely to hold a position for longer than a year. Now, due to the fact that he was able to enter and exit large blocks of stock, the companies that he invested in also took note of his presence.

So they wanted to be on the good side of this investor who wielded the ability to just move markets with their stock picking abilities. In mid-1962, Sai had his first hiccup. The market crashed in a strategy of investing in high-growth companies with concentrated positions was severely punished. But a rally ended the year increasing Fidelity growth funds assets by 68% of the end of the year. So after this, the bull market was in full action and Jerry's side strategy was highly successful. In 1965, the fund gained a 50% in net asset value on 120% turnover. But at the same time, Fidelity had come to a sort of crossroads. Its owner, Edward Johnson was now 65 and he was set to retire.

Since Sye had so much success of Fidelity, he figured that he was kind of a shoe in to take over leadership, but it was just not to be. Edward Johnson informed Jerry that his son would be the one who eventually would succeed him. This painful event caused Jerry Tye to quit and just go on on his own. So he ended up selling his stock infidelity for about $2.2 million and he established the Manhattan Fund. As with most success stories in investing, investors tend to, you know, time things all wrong. They invest in successful managers at the apex of their success and they ignore the unsuccessful ones at the apex of their weakness. And this is exactly, unfortunately, what happened with Jerry T's.

So he sold his shares of mutual funds for $10 each. He figured he might be able to raise somewhere in the region of $150 million. But once the funding had been incomplete, Sai was actually handed a check for $247 million. Now, at the standard 1% management fee at the time, Sy's firm started with about $2.5 million in revenue. But the problems that come with early success are quite simple. If you set unrealistic return expectations,

you run a very high risk of redemptions if you fail to make. meet them. And as we know, 50% returns are just not feasible over a multi-year time frame. Size strategy worked incredibly well in bull markets, but take the bull market away and the entire strategy is no longer viable. Now, the first few years that he opened his fund were okay, but by 1968, his fund had taken an absolute beating, declining in value by about 6.6% in placing 29th out of a possible 305 other mutual funds. Now, even with this poor performance, especially on a comparative basis, Manhattan Fund had actually grown by accumulating more and more AUM to over $500 million.

When it became clear to Tsai that he was no longer able to generate outsized returns for his partners, he decided to sell the business. He alone made somewhere around $30 million in that sale in 1968, which equates to approximately $280 million in today's dollars. So clearly, the original standard of not profiting from trust structure no longer existed, at least in Jerry's eyes. Now, what does Jerry Tsai's experience managing money teach us about investing? A hell of a lot.

First, momentum can look like genius. I remember following a lot of funds in 2020. And pretty much all of the most successful ones owned stocks that I had basically no interest in. And the reason being that they were obviously overpriced. These fund managers took a similar strategy to Tsai. They bought these businesses that were growing really fast, but they were all growing fast in a raging bull market. That strategy just works until the bull market reverses course, in which case, you get pretty catastrophic results.

So in the short term, this obviously results in high returns. These high returns attract more and more AUM from new and existing investors. But then things inevitably go south. If you own a portfolio of businesses that are going to suffer from a massive multiple compression and earnings compression once the economic environment no longer supports them, you're going to be in for a large amount of pain. Now, it's important to balance aggression with defensiveness. Yes, you can take advantage of the times to become somewhat imbalanced for short periods,

but don't make the mistake of going completely imbalanced to such an extent that you leave no space for any defensiveness. The second point here is that liquidity can disappear much faster than you expect. When you have a strategy that requires large volumes, then attracting competitors is not the best feature. When other intelligent investors saw what Sai was doing and that it was working, they would have piled into the exact same stocks that he was buying, which would make it harder harder for him to make large concentrated bets while also paying a fairly reasonable price.

And the other problem with liquidity is that it can be fatal when the market moves against you. When you have an ownership basis made largely of momentum investors, when they leave, you're going to lose a lot of money if you don't have the conviction in the business to ride the correction. Now, since Sai was looking to get in and out pretty quickly, if he wasn't ahead of the selling, he exposed himself to a lot of downside risk. The third lesson here is that incentives shape behavior. When Jerry Tsai first started working at Fidelis, Edward Johnson was taking 20% of just the profits. He didn't even have a management fee.

But the times were changing and with larger staff sizes and an increased reliance on technology, management fees are being justified by a number of different funds. As a result, Sye took a 1% management fee. Now, when you have management fees, the incentive structure just really changes. The business makes money by simply gathering assets. The result of what happens to your investors' money matters a lot less. In Sye's case, he was able to continue to attract AUM, despite the fact that he just wasn't creating that much value for the fund.

The lesson here is for investors looking to invest in other managers. So I would highly recommend finding a manager who makes a lion's share of their money when you are also making money. And when you aren't making a reasonable return or even if you're losing money, the manager should also feel the pain of that underperformance as well. Fourth here is to just look at how performance chasing is in relation to where you are in the cycle. So size experience clearly illustrate the cyclicality of markets. You had strong performance, you had massive capital inflows, concentrated bets, then the market conditions

change and you had a rapid reversal. This is a cycle that constantly repeats in the market. Instead of eventually playing the victim to the cycle, try and position yourself best to deal with it. For instance, in the cycle above, if you see the first four attributes in the market, just simply don't partake. Yes, you'll probably miss out on some of the short-term returns that other investors are making, but you'll also take a much smaller part in the rapid reversal that will take place at some point in the future. Now, this doesn't mean selling everything and going to 100% cash.

After all, we never know when a reversal will happen, but it might mean maybe taking some profits and adding to your cash position. If you're still working like me and regularly add cash to your brokerage account, it might mean taking a break on adding to new and existing positions and just allowing your cash to pile up and take advantage of a reversal whenever it happens. Now, one of Jerry Tsai's highly successful investments was a business called Lytton Industries. Now, Lytton was a new form of business that was exploding in popularity during the Go-Go years.

This business is now known as a conglomerate. Today, we might loosely compare them to serial choirs like Berkshire Hathaway, but the similarity mostly ends at the idea of buying more and more businesses. Berkshire buys wonderful businesses at sensible prices and holds them indefinitely. Most conglomerates of the go-go years were exploiting financial engineering rather than building operating excellence. Now, part of the reason the conglomerates were able to get a foothold into Wall Street was due to several very early successes. For instance, in mid-1966, the New York Stock Exchange declined by over 20 percent. But one group of businesses had been shielded from this decline.

So you had Ling Temco Vot, which was up 70 percent. City investing was up 50 percent. Lytton and Textron were each up 15 percent. So clearly, there was a market for businesses that were following this conglomerate structure. So what exactly is a conglomerate? It's a business that diversifies through mergers and other lines of business. Now, this is different from, say, a roll-up that is buying businesses in one line of a business such as, you know, HVAC. A true conglomerate buys businesses in completely separate industries. Perhaps the business started selling machine tools. They systematically add businesses such as ice cream, helicopters, or eyeglass frames. Oddly enough, the word conglomerate was actually frowned upon by conglomerate operators in their early years.

The CEO of Lytton Industries thought conglomerate implied a large mess and instead used the term multi-company industry when describing Lytton. Textron felt similar, referring to itself as engaging in non-related diversification. I find it kind of strange that all these great businesses that were conglomerates looked down upon the term, but that's the way it was. 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

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slash income. This is a paid advertisement. All right. Back to the show. Now, there are three major forces that help build the rise of the conglomerate structure. The first was antitrust laws. With new laws enacted that made M&A within the industry more challenging, these businesses become targets for businesses that are lacking in synergies.

A cable operator owned by a conglomerate just didn't have the same monopoly advantages if it were acquired by another cable operator that could pool additional resources and then leverage a larger customer base. The second was that there was a changing ideology by educational institutions. So Brooks writes, graduate business schools taught that management's ability was an absolute quality not limited by the type of business being managed. This meant new managers were going into businesses not only to specialize in a single business line, but could also use their managerial skills in a more diverse way.

Conglomerates were a great structure to test your absolute quality as a manager. And third here was just rising evaluations. Since businesses had risen in price, it reduced the cost of equity for many businesses. If your business was now growing at a P.E. of 30 versus a previous P.E. of, let's say, 15, it opened up the ability to acquire a much larger base of acquisitions that you just wouldn't want to have acquired if your shares were trading at a major discount. Now, let's go over 0.3 here in some detail because it's very vital to understand why the conglomerate structure at this time worked so well.

So let's create a hypothetical case study to show why these deals worked and how they could easily fail. Let's say we have a business called Grastron, which sells lawn equipment and turf services and has a P of about 20 times. They want to diversify away from their core business, and to do so, they start buying businesses that sell car parts. They find a business called Car Parts Inc, which sells side and rearview mirrors. The sellers are willing to part with a business at a P.E. of just five, as it's a low-growth

business with very steady earnings. Let's say car parts generates 10 million in profits. Grassron is already doing about 50 million of profits. Now, Grass Tron buys car parts for $50 million, using pure equity to purchase it. And this is because they understand the benefits of merger arbitrage. So once they add the earnings stream to Grassron, they are now doing $60 million. profits. But the arbitrage comes in the difference in the PE ratios. Grastron isn't just worth $50 million more. Given its higher PE ratio, it's now worth $200 million more, but it only paid $50 million for that increase in value. Now, let's imagine that Grastron begins getting more and more

excited about making deals. After all, they had a super successful deal with car parts, and maybe they may have some other deals that were really successful, so they're very high on their ability to do M&A. They're so high on that ability that they begin making errors. They know that making acquisitions are very key, but they begin to lose discipline on their purchase price. Instead of creating shareholder value by exploiting arbitrage, they begin focusing on just building a larger and larger empire at the expense of their shareholders. They begin looking for large acquisitions.

This time it's in chemical manufacturing, so Grassron now has $200 million in profits. One chemical business they find is also doing $200 million in profit. But the times in the markets aren't nearly as good as they once were, and Grastron has been a victim, and its P.E ratio has now dropped to 10 times. The chemical manufacturer that I was looking at trades at 15 times. Grastron just says, screw it. Let's get this deal over with double our profits, then the market's going to love it. Now, unlike the first deal, they're now paying 15 times for Kempore to double their profits. Once Kempore is inside Grastron, its earnings are now valued less than before. So this deal basically ends up actually destroying shareholder value rather than adding

to it. They added $2 billion in value, but they actually paid $3 billion to do so. Now let's look at James Ling, who was one of the pioneers of this structure. James started an electrical service company in 1946 with about $2,000 of his own savings. He eventually scaled up to an annual revenue of about $1.5 million. In 1955, he went public at an evaluation of about a million dollars selling shares in a booth at the Texas State Fair. Now, going public was really a lightball moment for Ling. He realized that he could generate cash in exchange for basically paper, and that paper was equity. With his million dollars in cash, he used it to acquire a business called LM electronics. Now, here's what Brooks said about Ling strategy. In essence, though, they are all geared

to the crucial discovery that Ling had made at the Texas Fair, that people like to buy stocks, and that their overpayment for stocks can be capitalized by the issuer to his advantage. His basic tool was leverage, capitalizing on long-term debt to increase current earnings. He built his business up substantially then switched course in 1964. His new initiative called Project Redeployment Reverse Course. Instead of adding new businesses, he decided to spin out certain businesses from his conglomerate and sell them to the public. Essentially, Ling was taking advantage of the public's yearning to buy stocks by spinning out

parts of his business to generate shareholder value. And it worked. He'd sell off 25% of a share in a business and 75% was kept by Ling's company now named Ling TemkoVot. And doing so would make their 75% share worth a lot more than it had been worth weeks before. So in 1965, Ling Temcovot ranked number 204 on the Fortune Directory of largest U.S. industrial businesses. But by 1969, it was ranked 14th. Net income before dilution, which would have been large, I would have assumed here, tripled in 1966 and went up 75% in 1967. Between 1965 and 1967, the stock price increased by 10x. Now, as with most bubbles, the newness of a new paradigm shift, in this case, conglomerates, wears off over time. And what is usually left over is a bunch of angry bagholders kicking themselves

for making the investment in the first place. While some conglomerates gave the illusion of infinite growth, most were pretty unable to make that a reality. Inventors believe that conglomerates had this diversification which protected their downside, and also that a lot of these conglomerates were run by superstar managers that were able to make acquisitions that basically guaranteed growth, but unfortunately they are in for a very rude awakening. As these businesses scaled, their biggest flaws began to be exposed. The businesses had become large and unwieldy, and it became nearly impossible for just one man to run the show without a significant amount of help and decentralization. In the case of Lytton Industries, management had been so disconnected from its subsidiaries that it didn't actually even realize that there was a problem with them until it was too late.

Several Litton's divisions were in very serious trouble, and management discovered that they could actually not even contain the problem. This event caused investors to challenge the premise at the conglomerate was built. on. If a superstar management couldn't control his subsidiaries, what was the value in diversification? Once Lytton reported the quarter, its stock was crushed. Earnings came in at 21 cents per share versus 63 cents for the same quarter in the previous year. Lytton lost about 18% of its price in one week. A month after earnings had gone down 50%. The drop in Litton dragged down all conglomerates with it, just as the rise in conglomerates allowed for them all to take advantage of that merger arbitrage. Now, my first big lesson from this chapter was that high stock prices can create the

illusion of business skill. The conglomerate operators looked like geniuses because their strategies made shareholders money. But the actual success of the strategy came from areas that were outside of their control, and that was from the stock price itself. The high evaluations that euphoric market assigned to them allowed them to have a high evaluation, which gave them access to acquisition currency, which further fueled EPS growth leading to an even higher prices. This is what Howard Marks likes to refer to as the virtuous cycle of rising multiples. Now, the problem is like all cycles, they eventually reverse. And if you were holding on during the reversal, then it becomes this vicious cycle,

as you must prepare to either back up the truck on weakness or just sell out a large loss. But even if the business is improving, there are other attributes that now have changed which will affect their acquisition strategy. If they no longer have a share price, then they can't continue acquiring businesses that would have made sense before. And when you have to reduce your acquisition pace, EPS growth is going to slow down considerably. And when this happens,

you lose the faith of a lot of your investors causing painful multiple compression. And this, unfortunately, is exactly what happened to many conglomerates during this time. The second lesson is that financial engineering can masquerade itself as operational excellence. In the case of Lytton, it was eventually proven out that the conglomerate

simply just wasn't improving its acquisitions after they bought them. They were more focused on simply relayed enabling earnings streams. Now, taking advantage of merger arbitrage works very well when you own businesses that will either maintain or organically grow its earnings power. When it weakens, you obviously expose yourself to a lot of potential risk. One business that I own, I think, would be considered a modern form of conglomerate is a business called Terabest Industries. So in its early days, a large portion of its revenues came from kind of cyclical areas

related to the oil and gas industry. Now, realizing that depending, so much on the cyclical gas industry was too risky, they decided to kind of pivot because they wanted to make sure that their business was protected from cyclicality. So they ended up diversifying into other areas such as compressed gas vessels and HVAC equipment. Additionally, TerraVest does a really good job of creating value for subsidiaries once they're part of the TerraVest family. It's not unusual for post-acquisition EBITDA multiples to drop to maybe two times a year after being acquired. So when you're actually creating value like the way I think Terabest is doing, then the financial

engineering plays very well in your favor and you protect your downside. But if you're looking at a business that can create value strictly through financial engineering, then you must consider what happens if the business declines in earnings power. The third lesson here is in humility. The best modern conglomerates tend to run a pretty decentralized business model. This takes responsibility from upper management and it spreads it out across the company. Berkshire, Consolation Software, and Lyftco are great examples. If all the power was centralized and their leaders, there's probably no chance that these

businesses would have had the success that they had today. The early conglomerates had a lot of key man risk, but the modern equivalent have created business models and cultures where key man risk is a lot less impactful. The fourth lesson regards something you probably notice that I love to speak about, which is incentives. The book doesn't divulge what the incentives were for the CEOs that were evaluated, but one thing they were most likely not incentivized on was long-term metrics. When you're incentivized to outperform in the next year, then making endless acquisitions, empire building, and dilution

are actually highly encouraged. When you have to focus on things like capital efficiency, per share metrics or organic growth, your strategy has to obviously change. Instead of focusing on what you can do to increase profits this year, you're more focused on creating profits it's maybe three to five years from now. And there's a major difference in strategy between these two objectives. I prefer the long-term strategy simply because it just doesn't incentivize nearly as much risk-taking. Brooks had one incredible story that I have to share, and I never knew this, but for a time during the Go-Go years, Wall Street was actually shut down from trading on each Wednesday.

This is a pretty strange event, you know, to shut down trading during a raging bull market, but let's dive into why this happened. As the go-go years progressed, the market's euphoria continued to run. at a very rapid pace. But the technology stack back then was obviously a lot different than it is now. Back in those days, when you bought a stock, your broker had to do the back-end paperwork on your behalf. Much of this was done manually. The broker's back office would be inundated with ever-increasing paperwork having to mail-out share certificates based on each individual trade. Now, as euphoria rises, second-order effects emerge, and one second-order effect is that volume

obviously goes up. More and more stocks are changing hands, which increases the budget, burden on these back offices. And the people doing the back office weren't even the brokers. They had people who specialized in the back office and it was basically an entry level job. Now, as Wall Street became more chaotic due to increasing volumes, the infrastructure needed to keep up with the growing demand from new entrants to the market just wasn't increasing at the same rate. They were very far behind in processing trades and not just days behind, but actually months behind. As a result, the back offices work decreased substantially in quality. Share certificates that were supposed to be mailed out to their new owners were lost, misplaced, or stolen.

And it was so prevalent that it was given its own name, a fail. Now, a fail occurs when on a normal settlement date for any stock trade, five days after the transaction itself. The seller's broker, for some reason, does not physically deliver the actual sold stock certificates to the buyer's broker, or the buyer's broker for some reason, fails to receive it. In January of 1968, the New York Stock Exchange allowed for a certain number of fails as just a regular part of business. So at that time, it amounted to a billion dollars. As a result, the exchange cut trading hours and closed at 2 p.m. to slow down the system with the intention of allowing the back offices to catch up with their missed transactions. By April, though, fails had actually reached 2.67 billion. May was 3.47 billion, and by June, it was just a touch under 4 billion.

As a result, the exchange basically closed the New York Stock Exchange every single Wednesday. This was the first midweek closure since 1929. And the break actually didn't even work, as most brokers just took Wednesday off rather than doing the necessary work to catch up. What eventually fixed this problem was the market just turning bearish, and because of that, volume dried up and so did the fails. Now, I'm not sure there are many modern lessons we can learn from this, but I found this story fascinating. Perhaps it's a lesson in understanding the complexity of seemingly simple things like, you know, back office paperwork. Even today, nearly 60 years later, we still have manual back office events. My wife, who works in an accounting firm, still manually enters data.

Another lesson is a second order effect on the market. There are never any shortage of second order effects, and unfortunately, many of them remain completely hidden until it's too late. And this is a good reminder to ponder the unknowns that could be happening in the background during the next bull or bear market. Now, the next story I want to discuss concerns mental models that I find crucial not only in investing but in life, and that's incentives, particularly in conflicts of interest. Now, in the go-go years, with so many new investors coming to place their first trade, there wasn't a lot of education on how the brokerage industry inside Wall Street really operated.

Back then, just like today, brokerage firms earned revenue through commissions, and the fees were insanely high back then. The SEC continuously had to fight with brokerages just to get them not. to cut their fees. Now, bull markets are great for brokerages. This is why online brokerages today tend to be a pretty good place to invest if you believe that volume will continue to rise. I agree that that's probably the most likely scenario, but I don't think profiting from others needs to gamble on stocks is right for me. Now, in 1966, Francis Huntington was a clergyman at Trinity Church on Wall Street. The church is still there today as you walk uptown from Wall Street.

Francis began having conversations with people like brokers, lawyers, and bankers about what was just bugging them most about their jobs. One finding that Francis had was that brokers, especially were much more open about divulging their deeper problems that they had in their own jobs. And most of the things that were bugging them about their job concerned being written with guilt and frustration. Now, one big question that Francis focused on with his brokers was where to draw the line between investment and speculation. The problem with the brokerage industry is that incentives are just misaligned. A broker who puts his needs above the customers can rake in large fees, but there's a good chance that he's also encouraging his customers to speculate and quickly move in and out of stocks because doing so fattenes his wallet.

Now, in one conversation, Francis had a broker tell him, if you really want to know what bugs me, it's the fact that I can take a client out of General Motors and put him in Chrysler, when in my heart, I feel that he probably shouldn't be in any motors at all. Now, this simple sentence tells you the fine line that brokers are walking. This broker felt that it was in his customer's best interest not to invest in an entire industry, but instead of admitting this to his customer, he basically just had to shuffle him from one automotive company to another just to make a living. Now we reached the apex of the go-go years.

In 1970, the Dow started at around 800, already down 15% from the start of the year in 1969. By April, the Dow was at 750, a few days. days later, 728. President Nixon, when asked for a quote on the market at this time, said that if he had any spare cash, he would be buying in the market as well. Now, Brooks here was clearly trying to draw a few parallels between the crash of the Goghiel years and the Great Depression. So after Black Thursday of 1929, President Hoover said, and I quote, the fundamental business of the country is on a sound and prosperous basis. John D. Rockefeller told the press that he and his son had been buying stocks just to try and reduce the fear in the market as well. So by the end of

In the end of May, the Dow had dropped to below 700, and this prompted the Fed to reduce margin requirement on stock purchases from 80% to 65% to try to get more liquidity back into the market. Investors overseas services, one of the largest mutual funds in the world, which operated as a fund of funds, was hit very hard. They lost about $75 million in value in bad investments and poor loans. It had sold at about $20 in late 1969 and was now selling for just $2. This would have been bad news for a mutual fund investor. that would have obviously had far-reaching consequences to other mutual funds.

Then, look at what happened to James Ling's Ling Temko Vot. The business was now suffering from antitrust suits and had dangerously high levels of debt. They were now at a point where their cash flow just couldn't service their interest payments. The business model obviously once thrived on a high price that could be used as a currency to buy cheaper businesses. But now that the price has been punished from a peak of 170 to a depressing $16, that strategy was completely out of the window. Under pressure from the company's creditors, Ling stepped down as the chairman and CEO. Brooks writes, thus in hardly more than a week, the king of the conglomerates

and the king of the mutual fund operators were boast forced from their thrones. By the end of May, the Dow was now at 640. Doomsares were now talking about a 500-point Dow, but by the end of 1970, the Dow was back up past 840. Now, I'd like to finish this episode by speaking a little bit about Brooks' comparison of the 1970 crash to the Great Depression. So from 1929 to the deepest low of the depression in 1932, the Dow dropped 90%. In the 1970s crash, it dropped 36%. So from the looks of it, it didn't look very comparable to me. The problem with comparing the Dow between both time periods is that the businesses inside

of the Dow in the 1970s wasn't a great representation of the best businesses in America as they had been in 1929. So Brooks decided to use a different yardstick. He looked at a proxy index that a financial consultant named Max Shapiro had discussed. This index consisted of many of America's greatest winners of that time, businesses that were in the portfolio of many average Americans. So the portfolio had 10 leading conglomerates, including Lytton, Lingtem CoVot, 10 computer companies such as IBM, Leaseco, and Sperry Rand, and then 10 technology stocks

including Polaroid, Xerox, and Fairchild Camera. The average decline of these 30 companies from 1969 until 1970 was 81%. But I tend to disagree with some of Brooks's takes on comparing the two. For one thing, while this one index didn't fare so well, it seems a little like cherry-picking data to fit your narrative. Of course, the 30 most hyped up expensive stocks are going to get killed during a bear market. I'm sure if you looked at the 30 most expensive stocks trading during the dot-com bubble after it popped, you could probably also create an index that would have suffered a very similar drawdown.

Now, Brooks goes on to talk about how the crash of 1970 affected a lot more people because more Americans were invested in stocks in the 1970 versus 1929. So in 1929, estimates were that about 4 to 5 million Americans owned stocks, and by 1970, that number swelled to just 31. On this point, I think he was correct, as the total percent of Americans owning stocks during the Great Depression was just 4 percent, and in 1970, it was over 15 percent. Now, that's all I have for you for today. Want to keep the conversation going?

And please follow me on Twitter at Arrational MR, KTS, or connect with me on LinkedIn. Just search for Kyle Grief. I'm always open to feedback, so please feel free to share with me how I can make this podcast even better for you. Thanks for listening and see you next time. Thanks for listening to TIP. Follow We Study Billionaires on your favorite podcast app and visit the Investorspodcast.com for show notes and educational resources.

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