Practical Lessons from Michael Mauboussin

[00:00:00] [SPEAKER_05]: So that value growth distinction I feel, I mean Buffets talked about this.

[00:00:03] [SPEAKER_05]: I feel that distinction doesn't make any sense.

[00:00:05] [SPEAKER_05]: There are two ways to lose money.

[00:00:06] [SPEAKER_05]: One's the old fashioned way which is cost are greater than your revenues and that's bad.

[00:00:11] [SPEAKER_05]: So we don't want that.

[00:00:12] [SPEAKER_05]: The second way is exactly what you describe Jack, which is that your investments are showing

[00:00:17] [SPEAKER_05]: up on your income statement.

[00:00:18] [SPEAKER_05]: The point I make over and over is that multiples are not valuation.

[00:00:21] [SPEAKER_05]: Let me just stop there.

[00:00:22] [SPEAKER_05]: Multiple are not valuation.

[00:00:24] [SPEAKER_05]: They are a shorthand for the valuation process and once you never confuse those two things.

[00:00:28] [SPEAKER_05]: So, you know, you can audit some of these guys, you mentioned all these guys doing these

[00:00:33] [SPEAKER_05]: forecasts.

[00:00:33] [SPEAKER_05]: You can audit what they've said at the past and see how they've done and it's not very pretty

[00:00:37] [SPEAKER_05]: right?

[00:00:38] [SPEAKER_05]: And you have to find and appeal to the base rate which may not be your fingertips and often

[00:00:41] [SPEAKER_05]: it's not.

[00:00:42] [SPEAKER_05]: So you have to go out and make a little effort to find it.

[00:00:44] [SPEAKER_05]: But once you do I think it reshapes how you think a lot about the world.

[00:00:48] [SPEAKER_02]: Welcome to Two Quants and a Financial Planner where we bridge the worlds of investing

[00:00:51] [SPEAKER_02]: in financial planning to help investors achieve the long-term goals.

[00:00:53] [SPEAKER_02]: Join Matt Zeigler, Jack Forehand and me, Justin Carbonneau as we cover wide range of

[00:00:56] [SPEAKER_02]: investing in planning topics that impact all of us and discuss how we can apply them

[00:01:00] [SPEAKER_02]: in the real world to achieve the best outcomes in our financial life.

[00:01:03] [SPEAKER_01]: Jack Forehand is a principal at the Lydia Capital Management.

[00:01:06] [SPEAKER_01]: Matt Zeigler is managing director at some point investments.

[00:01:08] [SPEAKER_01]: The opinions expressed in this podcast do not necessarily reflect the opinions of the Lydia

[00:01:11] [SPEAKER_01]: Capital or some point investments.

[00:01:13] [SPEAKER_01]: No information on this podcast should be construed as investment advice.

[00:01:17] [SPEAKER_01]: Securities discussed in the podcast may be holding clients of the Lydia Capital or some

[00:01:20] [SPEAKER_01]: point investments.

[00:01:21] [SPEAKER_04]: So if you just click on a YouTube cover, you might be surprised to know that I am not Michael

[00:01:24] [SPEAKER_04]: Mobison and Matt, you are not like a Mobison either.

[00:01:27] [SPEAKER_03]: Well, let me just check my ID confirmed.

[00:01:32] [SPEAKER_04]: But I think one of the things we want to do is we interviewed Michael Mobison a few years

[00:01:36] [SPEAKER_04]: back in 2021.

[00:01:37] [SPEAKER_04]: If one of our most watched excess returns episodes of all time, and one of the things we

[00:01:41] [SPEAKER_04]: want to do is whenever we interview people like this, we wanted to still down the most important

[00:01:46] [SPEAKER_04]: lessons someone can learn from them.

[00:01:48] [SPEAKER_04]: And so what we're going to do is we're going to go back to that interview.

[00:01:50] [SPEAKER_04]: If you watch this interview, you're going to see a ton of Michael Mobison because we're

[00:01:53] [SPEAKER_04]: going to play this in his words.

[00:01:54] [SPEAKER_04]: We're going to play his clips and then we're going to come in and we're going to talk

[00:01:57] [SPEAKER_04]: about what we think long term investors can learn for him because they're so much to learn

[00:02:01] [SPEAKER_04]: and one of the things that surprised me, I think you said the same thing when you listen

[00:02:03] [SPEAKER_04]: to it is like this is still very, very relevant today.

[00:02:06] [SPEAKER_04]: And we did this interview in the end of 2021 and outside of maybe a midter to where we

[00:02:10] [SPEAKER_04]: talked about it might happen in 2022 or something almost all of it is still relevant today.

[00:02:15] [SPEAKER_03]: Yeah, which will catch you off guard if you go back and listen to the original one.

[00:02:18] [SPEAKER_03]: It'll be like, well, we think we know what will happen in 2021 or whatever.

[00:02:21] [SPEAKER_03]: You're like, wait, wait, hold on.

[00:02:23] [SPEAKER_03]: But Mobison's just one of those guys, too.

[00:02:26] [SPEAKER_03]: I don't know about you, but I mean, I still go back and read those old like Mason posts.

[00:02:31] [SPEAKER_03]: He's one of those people who's great for the way he thinks about markets, complex adaptive

[00:02:37] [SPEAKER_03]: systems, valuations, all this stuff.

[00:02:39] [SPEAKER_03]: He is a default evergreen thinker, his knowledge is forever compounding.

[00:02:43] [SPEAKER_03]: So of course when you have an interview with them, he's going to go into all these wonderful

[00:02:47] [SPEAKER_03]: details and yeah, cannot recommend listening to the full one enough if this clip showed

[00:02:51] [SPEAKER_03]: it doesn't get you excited enough.

[00:02:52] [SPEAKER_04]: And he still put the stuff out today and like that's one of the challenges of interviewing

[00:02:55] [SPEAKER_04]: them and you can see we covered a lot of topics which were going to cover a lot today

[00:02:58] [SPEAKER_04]: because there's just so much stuff you want to talk to him about when you talk to him,

[00:03:00] [SPEAKER_04]: like you could talk to him for four hours.

[00:03:02] [SPEAKER_04]: You know, and he's put out so much stuff since he did this hopefully will have them on

[00:03:05] [SPEAKER_04]: again.

[00:03:06] [SPEAKER_04]: But yeah, there's just so many lessons.

[00:03:07] [SPEAKER_04]: And so we're going to go through 10 of them today.

[00:03:09] [SPEAKER_04]: We've got a bunch of clips of Michael making the lesson and then we're going to explain

[00:03:12] [SPEAKER_04]: maybe what we think about it.

[00:03:14] [SPEAKER_04]: And the first one I think is really, really relevant based on where we are, especially in

[00:03:17] [SPEAKER_04]: the wake of game stuff.

[00:03:18] [SPEAKER_04]: Because I don't know that too many people understand this definition.

[00:03:21] [SPEAKER_04]: So here's Michael talking about the difference between investing and speculating.

[00:03:25] [SPEAKER_05]: So yeah, to me, let's let's go back to basics, Jack, and I like the way you say this.

[00:03:29] [SPEAKER_05]: Like when you, you know, we all get caught up in this like how do we keep ourselves focused

[00:03:32] [SPEAKER_05]: on the North Star?

[00:03:34] [SPEAKER_05]: The key is to thinking about investing versus speculating, right?

[00:03:36] [SPEAKER_05]: So investing is buying a partial stake in a business with an understanding that you are,

[00:03:40] [SPEAKER_05]: you're going to get the benefits of that value growth over time.

[00:03:43] [SPEAKER_05]: Speculating is buying something hoping that it'll go up and is always like to say,

[00:03:48] [SPEAKER_05]: most investors combine too.

[00:03:49] [SPEAKER_05]: I don't want to say everyone, anybody's pure and not any of this stuff.

[00:03:53] [SPEAKER_05]: But the reality is that you should separate those two things as you're participating in markets, right?

[00:03:56] [SPEAKER_05]: So clearly if you're buying or selling a meme stock, you're not doing it because you think

[00:04:00] [SPEAKER_05]: there's fun at least I presume that they, by the way, the original game stop,

[00:04:04] [SPEAKER_05]: there was fundamental value.

[00:04:05] [SPEAKER_05]: So I think the initial buying of that stock back a long time ago was a fundamental case.

[00:04:10] [SPEAKER_05]: But as it starts to make these extraordinary runs, it stops to be a stop to being a fundamental

[00:04:14] [SPEAKER_05]: case. So again, what are you doing?

[00:04:16] [SPEAKER_05]: So and by the way, there's no, I'm not making a moral judgment.

[00:04:19] [SPEAKER_05]: Speculations perfectly fine.

[00:04:20] [SPEAKER_05]: In fact, speculation is actually a very, can some ways can be a healthy thing for markets

[00:04:24] [SPEAKER_05]: in terms of liquidity and so forth.

[00:04:26] [SPEAKER_05]: So let's be clear that's okay, but just just demarcate what you're doing just to be clear about it.

[00:04:31] [SPEAKER_05]: So I think that's the thing.

[00:04:32] [SPEAKER_05]: I would just remind people, what are you doing?

[00:04:35] [SPEAKER_05]: You investing or speculating.

[00:04:35] [SPEAKER_04]: So this one's a really good lesson for me because I think a lot of people confuse these things.

[00:04:40] [SPEAKER_04]: And this came up in our interview with Aswat Demoder and as well.

[00:04:43] [SPEAKER_04]: This idea of am I really investing?

[00:04:46] [SPEAKER_04]: Like am I buying this thing because I've done a fundamental analysis of it?

[00:04:49] [SPEAKER_04]: And I think it's going to go up over a long period of time or am I buying this because

[00:04:53] [SPEAKER_04]: I think the price is going to go up.

[00:04:55] [SPEAKER_04]: And that balance, there can be as Michael talked about in the clip,

[00:04:57] [SPEAKER_04]: there can be components of both of those to a successful investment strategy.

[00:05:01] [SPEAKER_04]: But I think in terms of especially in terms of thinking about your timeframe,

[00:05:04] [SPEAKER_04]: it's really important to delineate when you start which one of these am I doing?

[00:05:09] [SPEAKER_03]: This is also useful.

[00:05:10] [SPEAKER_03]: One to step away from just the investment mentality on it.

[00:05:15] [SPEAKER_03]: Work with a lot of business owners in my and the day to day life.

[00:05:19] [SPEAKER_03]: And we talk a lot about when you're working in the business versus when you're working on the business.

[00:05:26] [SPEAKER_03]: And it's kind of like you could invest in a business or you can work in or for a business,

[00:05:32] [SPEAKER_03]: work on the business itself.

[00:05:34] [SPEAKER_03]: Separating those two things out is really important because when I invest in a company,

[00:05:39] [SPEAKER_03]: I'm actually starting to think about the profits in the future,

[00:05:43] [SPEAKER_03]: then net present value of these different things.

[00:05:45] [SPEAKER_03]: How it's all going to play out where funding is going to come from for an idea versus

[00:05:49] [SPEAKER_03]: if I'm just betting on a stock and where it's going to go,

[00:05:53] [SPEAKER_03]: those are two very different mindsets with very different ranges of outcomes.

[00:05:57] [SPEAKER_03]: And very different ranges of how you want to treat the position,

[00:06:00] [SPEAKER_03]: once it's under your control.

[00:06:03] [SPEAKER_03]: So this one, I think not just in your investing,

[00:06:06] [SPEAKER_03]: it applies on much larger scales for what you're working in versus what you're investing or betting on.

[00:06:12] [SPEAKER_04]: Yeah, the other thing I think that was important that he said is,

[00:06:14] [SPEAKER_04]: neither one is necessarily good or bad.

[00:06:16] [SPEAKER_04]: I think there's this belief by a lot of people including me that investing is this great thing and speculating is this bad thing.

[00:06:21] [SPEAKER_04]: And that's I think in a lot of cases that he is true.

[00:06:23] [SPEAKER_04]: I mean, if you're buying game stop call options and you don't have an edge in game stop call options,

[00:06:27] [SPEAKER_04]: then speculating is very bad.

[00:06:28] [SPEAKER_04]: But I think in general,

[00:06:30] [SPEAKER_04]: some people we know,

[00:06:31] [SPEAKER_04]: we've had people on the podcast who you would probably describe their strategy is not rooted in fundamentals or buying a company over the long term.

[00:06:38] [SPEAKER_04]: They are technically speculating,

[00:06:39] [SPEAKER_04]: but they have an edge in that speculation.

[00:06:41] [SPEAKER_04]: And so speculating cannot it's not good or bad.

[00:06:44] [SPEAKER_04]: It's just it's probably important for you to know which one you're doing because for instance,

[00:06:48] [SPEAKER_04]: if I'm a value investor and I want to buy something because it's cheaper,

[00:06:52] [SPEAKER_04]: something like that.

[00:06:53] [SPEAKER_04]: And then a month later,

[00:06:54] [SPEAKER_04]: I'm thinking about selling it.

[00:06:55] [SPEAKER_04]: Well, I was speculating the whole time.

[00:06:57] [SPEAKER_04]: I was not looking myself as a investor and I've screwed myself up because I would need to know if I'm investing my time frame

[00:07:03] [SPEAKER_04]: is be a lot longer than a month.

[00:07:05] [SPEAKER_04]: And so I think like bringing your timeframe together with what you're doing is one of the important areas of delineating between investing and speculating.

[00:07:13] [SPEAKER_03]: And that I think that right there just and again,

[00:07:16] [SPEAKER_03]: it's like if I'm investing in,

[00:07:17] [SPEAKER_03]: I have this long home mentality of what I am there for.

[00:07:21] [SPEAKER_03]: I'm therefore this long term,

[00:07:23] [SPEAKER_03]: how outcome if I'm speculating on,

[00:07:26] [SPEAKER_03]: I'm thinking about okay,

[00:07:27] [SPEAKER_03]: if this should come to pass that I expect to see this profit and I'm just treating it as an entirely,

[00:07:32] [SPEAKER_03]: an entirely different vehicle.

[00:07:35] [SPEAKER_03]: So the time frames,

[00:07:36] [SPEAKER_03]: the vehicle,

[00:07:37] [SPEAKER_03]: the perspective,

[00:07:38] [SPEAKER_03]: if you know what you're doing,

[00:07:39] [SPEAKER_03]: Grand William talks a lot about this too,

[00:07:41] [SPEAKER_03]: if you know what you're doing,

[00:07:42] [SPEAKER_03]: it's really,

[00:07:42] [SPEAKER_03]: really useful in teeing up your mindsets here in the right frame of reference to make better decisions.

[00:07:47] [SPEAKER_03]: And know if you have an edge or not.

[00:07:49] [SPEAKER_04]: So this next one is probably the biggest lesson I've learned from Michael Mobson.

[00:07:52] [SPEAKER_04]: That's a very, very high bar because there are so many lessons I've learned from Michael Mobson.

[00:07:56] [SPEAKER_04]: But here he introduces the concept of expectation investing,

[00:07:59] [SPEAKER_04]: which is a great, by the way, a great book he wrote together with Al Rappaport.

[00:08:02] [SPEAKER_04]: That'll get into more detail, but here he explains it in more simple terms.

[00:08:06] [SPEAKER_05]: So expectations of esting has three steps.

[00:08:08] [SPEAKER_05]: The first step is to go backwards and say the only thing we know for sure

[00:08:12] [SPEAKER_05]: in this whole equation is the price.

[00:08:15] [SPEAKER_05]: So let's go back and reverse engineer using a discounted cash flow model,

[00:08:18] [SPEAKER_05]: which is an appropriate way to think about economic both theoretically and I think practically.

[00:08:22] [SPEAKER_05]: Think about what has to happen for this current stock price to make sense, right?

[00:08:26] [SPEAKER_05]: So that's going to be typically articulated in things like drivers of value,

[00:08:30] [SPEAKER_05]: which would be sales, growth rate, margins, capital intensity, those kinds of things.

[00:08:35] [SPEAKER_05]: Right? And so the key to step one is to try to be sort of agnostic, right?

[00:08:39] [SPEAKER_05]: Like you don't have a view of the world necessarily.

[00:08:41] [SPEAKER_05]: You just want to say what has to happen or what does one need to believe

[00:08:45] [SPEAKER_05]: for today's stock price to make sense, right? So if you want to metaphor for that it would be

[00:08:49] [SPEAKER_05]: where is the bar been set for the bar a high jumper? We don't know how high the high

[00:08:53] [SPEAKER_05]: high jumper could jump yet, but we know the bar set of two feet, five feet, 10 feet, whatever it is.

[00:08:58] [SPEAKER_05]: Step two is an introducing historical analysis, but more importantly strategic and financial

[00:09:03] [SPEAKER_05]: analysis to judge whether that company is going to meet exceed or come short of those expectations.

[00:09:09] [SPEAKER_05]: Right? So that's really where the rubber meets the road analytically.

[00:09:12] [SPEAKER_05]: And again, history can be a really good guide for that. But but it's also,

[00:09:17] [SPEAKER_05]: and by the way, the other thing that comes out is really important is, you know, typically lower

[00:09:21] [SPEAKER_05]: multiples or associated with lower expectations of the higher multiple high expectations.

[00:09:24] [SPEAKER_05]: But you might notice that that whole discussion goes out the window, right? It's not really

[00:09:27] [SPEAKER_05]: the difference just the low multiples. It's really how will the company perform vis-a-vis what's price

[00:09:33] [SPEAKER_05]: then, right? So that's step two. And of course, the end, and I should say too, that that is a very

[00:09:39] [SPEAKER_05]: probable, holistic exercise. We argue that coming out of step two, what you should have is a number

[00:09:44] [SPEAKER_05]: of scenarios for potential outcomes and you should attach probabilities to those. So we're really

[00:09:49] [SPEAKER_05]: going to think about the world in an expected value terms rather than, you know, here's the

[00:09:53] [SPEAKER_05]: answer, and then step three is, of course, by seller hold as appropriate based on steps one and two.

[00:09:59] [SPEAKER_04]: But I love this idea because first of all, we all know that, you know, the companies can be expensive,

[00:10:04] [SPEAKER_04]: companies can be cheap, but there's always expectations embedded in that price. And so anybody who thinks,

[00:10:10] [SPEAKER_04]: well, I'm just going to buy this company because it's cheap and I'm going to make a lot of money.

[00:10:12] [SPEAKER_04]: And if I buy, if I buy, if I buy a company that expensive is not going to do as well, like it doesn't

[00:10:15] [SPEAKER_04]: work out that way because the market on a regular basis is doing its best to try to figure out what

[00:10:20] [SPEAKER_04]: these things are actually worth. And there's an expectation embedded in that stock price. And if I want to

[00:10:24] [SPEAKER_04]: be, if I want to make money, I've got to be smarter than that. I've got to figure out what is different

[00:10:29] [SPEAKER_04]: in terms of the world that's going to play out compared to what is embedded in that stock price.

[00:10:34] [SPEAKER_04]: And I think just always thinking that way is such a good way to think and investing because

[00:10:39] [SPEAKER_04]: it's how you figure out if you truly have an edge or if you're doing something that, you know,

[00:10:43] [SPEAKER_04]: because you're just doing it and you really have no advantage because if I'm buying something

[00:10:47] [SPEAKER_04]: because that a P you've 12 and that's the only analysis I do, what edge do I have over all those

[00:10:52] [SPEAKER_03]: people that have embedded all those expectations in that stock price? I came, I came into this book originally,

[00:10:58] [SPEAKER_03]: I think was this book published late 90s first, sometime in the 90s I want to say.

[00:11:02] [SPEAKER_03]: I'm not even positive. Might be. Okay. It did a good job. It did a good job. It did a good job. It's

[00:11:04] [SPEAKER_04]: a decision recently. I remember because when he came on the interview, they had just done the revised

[00:11:07] [SPEAKER_03]: edition. So I came to this book well after it was published and I came after it after first discovering

[00:11:14] [SPEAKER_03]: mobs and work when it was a lot more behavioral finance focused still investment focused but in

[00:11:19] [SPEAKER_03]: focused on like the errors we make. This kind of like before I think fast and slow thinking

[00:11:24] [SPEAKER_03]: vassus, so economists book came out and what was really cool about this is you start with like all

[00:11:29] [SPEAKER_03]: these mistakes you make in the real time, in the present, in understanding the future. When I went

[00:11:34] [SPEAKER_03]: back and read expectations investing for the first time, the thing that really cemented in my

[00:11:40] [SPEAKER_03]: brain about this is a lot of times we're learning about investing or we talked to people about investing,

[00:11:46] [SPEAKER_03]: we go at this point in time and we play it forward. What expectations taught me visually and this

[00:11:52] [SPEAKER_03]: is not in the book because my noko had brain making sense of this is never like you're not at zero

[00:11:58] [SPEAKER_03]: going forward for a month or 100 years. You actually start in the middle and that's a really

[00:12:05] [SPEAKER_03]: powerful thing to start in the middle because when you start in the middle, all of a sudden you

[00:12:08] [SPEAKER_03]: can look both backwards and forward. You can look in the rear view mirror, you can look out

[00:12:12] [SPEAKER_03]: the windshield. And when you're doing that, when you're looking both backwards and forwards,

[00:12:16] [SPEAKER_03]: you can stop saying just only looking forward, how do I think are I going to get to this

[00:12:21] [SPEAKER_03]: potential price in the future? I'm also saying how did I get to the potential price of where I am today?

[00:12:28] [SPEAKER_03]: When you start to put that into the assumptions, what do we know now and then what can we project

[00:12:32] [SPEAKER_03]: into the future? It really helps me at least think of that broader range of outcomes that we're

[00:12:38] [SPEAKER_03]: marching towards. More things can happen than will happen, one thing will happen, the past one thing

[00:12:42] [SPEAKER_03]: happened. So how did I get here and then how am I going to go there unpacking the expectations is

[00:12:49] [SPEAKER_03]: I can't even begin to say how enormously useful that all was to me. The other thing I was

[00:12:54] [SPEAKER_04]: mentioned briefly before I moved to the next one is this idea about scenarios and probabilities

[00:12:57] [SPEAKER_04]: is so important that you mentioned at the end. You don't end up with this process saying, well,

[00:13:01] [SPEAKER_04]: the stock is trading at $25. They have expectations or that. And I think it's worth $32 and that's

[00:13:07] [SPEAKER_04]: the only thing that could possibly happen. That's not the way it works. You look at a bunch of different

[00:13:11] [SPEAKER_04]: scenarios for the business and what it could be worth. And you kind of like wait them based on

[00:13:18] [SPEAKER_04]: the case. I think that's another important part of it. So moving on to this next one,

[00:13:22] [SPEAKER_04]: this is something that's been people have been talking about a ton and it's interesting because

[00:13:25] [SPEAKER_04]: we're still talking about it today three years later which is this idea that fundamentals don't

[00:13:30] [SPEAKER_04]: matter. So here we ask Michael about that and here was his take. And then there are whole other

[00:13:33] [SPEAKER_05]: parts of the market that I think we're over here that same exact fundamentals don't matter narrative

[00:13:38] [SPEAKER_05]: and that is when there's a new market developing or a new industry developing. One good example

[00:13:44] [SPEAKER_05]: today is probably electric vehicles. I think we had all agreed that 15 or 20 or 30 years from

[00:13:48] [SPEAKER_05]: now electric vehicles be more prominent on roads than they are today. But we know it's exactly

[00:13:53] [SPEAKER_05]: how this is going to shake out which companies are going to win and how the whole infrastructure

[00:13:56] [SPEAKER_05]: is going to change into one and so forth. So the typical way that markets and this is again,

[00:14:00] [SPEAKER_05]: these are patterns that have played out over centuries. This is not new. Is you just throw a lot. You

[00:14:05] [SPEAKER_05]: try a lot of stuff. You try a lot of new companies, a lot of capital flows into it. It's essentially

[00:14:09] [SPEAKER_05]: an evolutionary process. Huge jobs when you're a number of competitors and then there's a

[00:14:14] [SPEAKER_05]: weeding out process. The market is Darwinian and figures how it's going to go. So in those cases,

[00:14:19] [SPEAKER_05]: in retro respect it feels like the market does a really good job but as you're living through it

[00:14:23] [SPEAKER_05]: it feels like there's a detachment between the prospects for particular companies and the money

[00:14:28] [SPEAKER_05]: and the valuations and so on and so forth. So that was a little bit of what I was trying to go with

[00:14:32] [SPEAKER_05]: all this and you know the just a broader comment is it's very tricky because right now we have

[00:14:38] [SPEAKER_05]: relatively low discount rates which themselves imply very muted returns going forward across different

[00:14:44] [SPEAKER_05]: asset classes and in the case where companies have been able to grow they're getting double benefits

[00:14:50] [SPEAKER_05]: which is obviously the value of the growth and especially the long duration growth and low discount

[00:14:54] [SPEAKER_05]: rates. So that's why we start to see some valuations and below you if you'd asked me,

[00:14:58] [SPEAKER_05]: you know I've been doing this since the mid 1980s. If you'd asked me if we'd ever see you know

[00:15:02] [SPEAKER_05]: 140 earthy, well it was even below 1% 10 year you know back in the 1980s I would have thought you were

[00:15:07] [SPEAKER_05]: completely bonkers and I would have been a lot of money against that happening but here we are right

[00:15:12] [SPEAKER_05]: this is the world that we live in. So yeah you know again I guess I'm expressing some faith in

[00:15:17] [SPEAKER_05]: market efficiency but of course if you're an active investor you have to believe in inefficiency

[00:15:21] [SPEAKER_05]: and inefficiency at the same time right inefficiency means you create opportunities and I think that's

[00:15:27] [SPEAKER_05]: always been true but efficiency means eventually if you're right about how you think about the value

[00:15:31] [SPEAKER_05]: of the business that price to value gap gets closed to something. This is something I'm guilty of

[00:15:35] [SPEAKER_04]: a lot of times this can be an excuse for people. This idea that well this stock had this huge return

[00:15:41] [SPEAKER_04]: you know Tesla had this massive return so fundamentals didn't matter and Nvidia is a good one today

[00:15:46] [SPEAKER_04]: like Nvidia is up so much like it's trading at this valuation fundamentals don't matter and

[00:15:51] [SPEAKER_04]: most of the time and he talked about the idea of electric vehicles and how it's very very hard

[00:15:56] [SPEAKER_04]: to price something like that early in the early stages but most of the time the market get these

[00:16:01] [SPEAKER_04]: things pretty right and if you're sitting here looking at Nvidia going up as much as it has

[00:16:05] [SPEAKER_04]: and said fundamentals don't matter like go look at a chart of its sales or its free cash flow.

[00:16:10] [SPEAKER_04]: A lot of that tracks pretty closely to what the stock is done so I think this has been somewhat

[00:16:15] [SPEAKER_04]: of an excuse for people who who like to buy cheaper companies in recent years to say fundamentals

[00:16:20] [SPEAKER_04]: don't matter and I think there are reasons where fundamentals may matter less but I think they're

[00:16:24] [SPEAKER_03]: still a huge part of what goes on. Everything and this is something you and I talk about all the

[00:16:31] [SPEAKER_03]: time we talk with Ben Hunt and people like that too. Everything that matters has a reason for

[00:16:37] [SPEAKER_03]: mattering predicting like what's going to matter what that reasons going to be be in a catalyst

[00:16:42] [SPEAKER_03]: or something else is one of the hardest things in life let alone in investing. I just came

[00:16:49] [SPEAKER_03]: across this story I don't know if you know this Peter Atwater actually said this to me. The

[00:16:53] [SPEAKER_03]: do you know the song the first cut is the deepest? Are you familiar with the song? Do you know

[00:16:58] [SPEAKER_03]: who wrote the first cut is the deepest? Is it a Cheryl Croson? I'm right. So great guys but

[00:17:05] [SPEAKER_03]: she performed it. She did it was a massive hit for her but this ties into the fundamentals matter.

[00:17:12] [SPEAKER_03]: Like it's a great song it was also a hit for Rod Stewart it was a hit for a whole bunch of other

[00:17:16] [SPEAKER_03]: people it's actually been a hit song at least six times I think it was written by Kat Stevens.

[00:17:22] [SPEAKER_03]: He wrote the song when he was 17 years old in like the 60s he sold it for 30 quid.

[00:17:28] [SPEAKER_03]: Did you ever perform it? He did he did it was a hit for him I think second I want to say it was

[00:17:33] [SPEAKER_03]: after a pp Arnold had it as a hit which is a totally different arrangement version of the song but

[00:17:37] [SPEAKER_03]: really cool the but this idea that you have a song that's fundamentally great but nobody knows

[00:17:43] [SPEAKER_03]: who cats Stevens is there's no reason for that song to matter when it was written so he sold it

[00:17:48] [SPEAKER_03]: like a bargain basement price and then it's gone on to have all these successive versions that have

[00:17:53] [SPEAKER_03]: been massive and yeah that like the Cheryl Croson was the most recent one that was freaking

[00:17:58] [SPEAKER_03]: inescapable so fundamentals matter but they have to have a reason for mattering and sometimes

[00:18:04] [SPEAKER_03]: that means something just climbing and not going away for years you know the greatest thing but

[00:18:08] [SPEAKER_03]: if if the reason isn't applied to it why other people are gonna care you can just sleep on it for

[00:18:15] [SPEAKER_03]: almost for forever if not for forever itself fundamentals matter but they have to have a reason

[00:18:20] [SPEAKER_04]: to matter and that's just really hard to know and this gets into our next one here which is

[00:18:24] [SPEAKER_04]: a lot of value investors like me you didn't really see Amazon and Google and a lot of these big

[00:18:30] [SPEAKER_04]: tech companies for what they were worth and so we asked Michael what do you mean so that

[00:18:34] [SPEAKER_05]: that value growth distinction I feel I mean Buffett's talked about this I feel that distinction doesn't

[00:18:38] [SPEAKER_05]: make any sense and I'll just underscore that but just a level set and you're asking such a profound

[00:18:43] [SPEAKER_05]: question and really is permeates the whole industry is you know going back to 1970s tangible

[00:18:48] [SPEAKER_05]: investments were double those of intangible investments tangible these are things you can touch

[00:18:52] [SPEAKER_05]: and feel so that factories machines inventory right touch and feel intangible assets by definition

[00:18:58] [SPEAKER_05]: are non-physical right so these are things like software code or instructions or training

[00:19:02] [SPEAKER_05]: or branding those kinds of things and so that was two to one tangible intangible and now that

[00:19:07] [SPEAKER_05]: relationship is flipped so twice as much intangible than intangible so that's the basic observation

[00:19:14] [SPEAKER_05]: I think most people agree that makes it makes common sense but here's why it becomes tricky from

[00:19:19] [SPEAKER_05]: from an investing point of view is tangible investments are historically have always been on the

[00:19:23] [SPEAKER_05]: balance sheet right so you capitalize and make and depreciate them over time by contrast intangible

[00:19:28] [SPEAKER_05]: investments by convention are expense and so as a consequence they show up as an expense and hence

[00:19:35] [SPEAKER_05]: they hurt earnings right you have less earnings and so the key question is of the spending let's

[00:19:43] [SPEAKER_05]: say SGA spending what percent of that SGA is necessary to maintain the business and what

[00:19:48] [SPEAKER_05]: percent is discretionary in pursuit of evaluating growth and I think this when you talk about these

[00:19:53] [SPEAKER_05]: sort of large companies what I think the market may have missed is that they were making enormous

[00:19:58] [SPEAKER_05]: investments that were showing up their income statement which made their earnings look very modest

[00:20:03] [SPEAKER_05]: relative to their actual economic propositions and you know today we have very specific examples

[00:20:08] [SPEAKER_05]: of things like you know think of software as a service you know it may it may be very expensive

[00:20:13] [SPEAKER_05]: for me to acquire you as a customer right so my customer acquisition cost may be relatively high

[00:20:18] [SPEAKER_05]: but once I've got you as a customer I know that there's going to be a stream of cash flows going

[00:20:22] [SPEAKER_05]: down the road right so from an accounting point of view however and and pursuing that that's an

[00:20:27] [SPEAKER_05]: NPV calculation right that it's good for me to have you as a customer the fast right grow the

[00:20:32] [SPEAKER_05]: warm and lose money right which is horrible in some weeks right so I think that's that's the

[00:20:36] [SPEAKER_05]: distortion we have to we get we have to get past so you know the report we wrote about this is

[00:20:41] [SPEAKER_05]: called one job and what we what we argued for is it as an investor you need to go down to the

[00:20:45] [SPEAKER_05]: basic unit of analysis right which is understand how that company makes money and then separate

[00:20:51] [SPEAKER_05]: separately focus on the cash flows in order to understand the prospects right so if you do those two

[00:20:56] [SPEAKER_05]: things and again you know you're jack you've asked you sort of said this long-term thing

[00:21:00] [SPEAKER_05]: you know I mean you want to have a North Star right on in all these cases you want to have a North

[00:21:04] [SPEAKER_05]: Star the guides how you think about these things and that's a good example of the accounting is just

[00:21:08] [SPEAKER_05]: not kept up with the actual underlying economics yes I think this is an interesting topic because

[00:21:13] [SPEAKER_04]: he's 100% right about this I mean I mean basically companies today are investing for their future

[00:21:18] [SPEAKER_04]: in a different way than companies in the past investors for their future you're seeing a lot more R&D

[00:21:23] [SPEAKER_04]: you're seeing a lot more SGNA you're seeing you know less of the hard cap actually saw and so

[00:21:27] [SPEAKER_04]: one of those things you know R&D is expense SGNA and more advertising expense are expense

[00:21:33] [SPEAKER_04]: and so those companies are going to look less profitable on their financial statements

[00:21:38] [SPEAKER_04]: than somebody who's you know an old school company so it definitely right but I think it also

[00:21:43] [SPEAKER_04]: it's also very interesting in that it it's a very tricky thing to do and this is true the

[00:21:48] [SPEAKER_04]: cap X and the R&D and everything together which is it doesn't mean that we necessarily would have

[00:21:53] [SPEAKER_04]: seen Google and Amazon if we had known this because pets.com was doing a shit load of R&D as well

[00:21:59] [SPEAKER_04]: like it didn't go that well for pets.com the R&D so we had every company what they're going to get

[00:22:05] [SPEAKER_04]: out of that R&D in real time and the present is very hard to figure out but he's 100% right

[00:22:09] [SPEAKER_04]: that that's what we missed is you know we look at these companies and we didn't necessarily see what

[00:22:14] [SPEAKER_04]: was going on which is things were getting expense to make them look less profitable but those

[00:22:19] [SPEAKER_04]: things were the things that we're going to lead to them being huge companies in the future.

[00:22:23] [SPEAKER_03]: Back to this matters like what matters is what matters like over time and that's going to change

[00:22:28] [SPEAKER_03]: over time if you were just starting at the beginning and you're looking at you in an Amazon

[00:22:34] [SPEAKER_03]: versus a Walmart or whatever the scenario you want to come up with if you're just starting out

[00:22:38] [SPEAKER_03]: at the beginning and looking forward and not thinking about what is what got us here if you're

[00:22:42] [SPEAKER_03]: thinking about what got us here you can start to say well this stuff that's happened in the period

[00:22:47] [SPEAKER_03]: leading up to the price today I actually see this change in expectations if you totally ignore that

[00:22:52] [SPEAKER_03]: and just go I look at the past as a perfect regression of this thing and I'm just using price to

[00:22:56] [SPEAKER_03]: book and I'm ignoring everything else well you ignored all the changes in the counting standards

[00:23:00] [SPEAKER_03]: you ignored all the changes in raising capital and all the things that have gone on

[00:23:04] [SPEAKER_03]: and those all have frustratingly small sample sizes and whatever else frustratingly smaller

[00:23:09] [SPEAKER_03]: than the empirical sample sizes of the data you're trying to pull from to do that regression analysis

[00:23:14] [SPEAKER_03]: and find your factor so this is another reminder where like when you start in the middle

[00:23:18] [SPEAKER_03]: and you look backwards you're not just looking backwards statistically you're looking backwards

[00:23:23] [SPEAKER_03]: at what's mattered how's it evolved over time and then using that to map forward that doesn't

[00:23:28] [SPEAKER_03]: mean you're going to pick and hold on to Amazon in 1999 but it does mean that you have some

[00:23:33] [SPEAKER_03]: baseline awareness that hey maybe tangible versus intangibles is kind of an a trend of changing a lot

[00:23:39] [SPEAKER_03]: and even if it doesn't mean revert all the way back to where it was in the future certainly

[00:23:43] [SPEAKER_03]: some of this stuff is going to upset the old apple cart I'm going to respond to that and I also

[00:23:47] [SPEAKER_04]: want to use an example but first I want to play this next clip because we also asked him about this idea

[00:23:51] [SPEAKER_04]: you know if you look at the Russell 2000 today there are way more money losing companies

[00:23:55] [SPEAKER_04]: than there have been for a long period of time and we asked him whether that means anything

[00:23:59] [SPEAKER_04]: because he in his answer he brought up the idea of Walmart you brought up so I think that's something

[00:24:02] [SPEAKER_04]: important to talk about but I want to play the clip first there are two ways to lose money one's

[00:24:05] [SPEAKER_05]: fast and which is cost are greater than your revenues and that's bad right so we don't want that

[00:24:10] [SPEAKER_05]: the second way is exactly what you describe jack which is that your investments are showing up on

[00:24:16] [SPEAKER_05]: your income statement those are attractive and pv positive investments and as a consequence they

[00:24:20] [SPEAKER_05]: don't really have they don't really tell you about the value of the company and so that that to me

[00:24:25] [SPEAKER_05]: is the distinction that you want to make sure you're making you know one of the things I always

[00:24:30] [SPEAKER_05]: like to point out is that you know Walmart for the first 15 years it was public had negative free

[00:24:35] [SPEAKER_05]: cash flow every year so it was profitable but it invested more than attorneys and hence free cash flow

[00:24:40] [SPEAKER_05]: was negative Walmart was spectacular right I mean had great returns on capital stock performed three

[00:24:45] [SPEAKER_05]: times the benchmark of the S&P 500 over that period so it was a great stock but again that's only

[00:24:51] [SPEAKER_05]: a message of the accounting right so let's say the modern day verb version of Walmart would have been

[00:24:56] [SPEAKER_05]: expensing all those same investment they would have looked look like it was losing money the free cash

[00:25:00] [SPEAKER_05]: will be a bit exactly the same and what if had you know what if had similar type of economic

[00:25:04] [SPEAKER_05]: performance so so let's not get confused by the accounting let's focus the focus on that trail of

[00:25:09] [SPEAKER_05]: what are the underlying economic proposition and again that's why we call one job let's keep our

[00:25:14] [SPEAKER_05]: let's focus you know like they say in basketball when you're playing defense watch that watch the

[00:25:18] [SPEAKER_05]: hips right because not everything's going to follow the hips up and that this is a little bit

[00:25:21] [SPEAKER_05]: of following the hips kind of idea which is let's focus on the basic unit of analysis and really

[00:25:26] [SPEAKER_05]: understanding that so to your point um look it's not eventually all companies have to you know you

[00:25:31] [SPEAKER_05]: want to make sure that your economic proposition is good but um yeah losing money in and of

[00:25:36] [SPEAKER_05]: itself doesn't really tell you whether a company is an attractive business. Yeah so a couple

[00:25:42] [SPEAKER_04]: of things on this for first of all this idea you know Walmart and Amazon are not that different

[00:25:46] [SPEAKER_04]: now what was different is the money Amazon was spending for its future growth was treated differently

[00:25:51] [SPEAKER_04]: from an expense standpoint like Amazon was was better than Walmart on a free cash flow basis

[00:25:56] [SPEAKER_04]: Walmart was better than Amazon on an accounting basis but they both were doing the same thing

[00:26:01] [SPEAKER_04]: they both were investing in very high profitability things with a long-term focus knowing that

[00:26:07] [SPEAKER_04]: eventually this was going to make them a lot of money and so we want to look at both of them

[00:26:11] [SPEAKER_04]: differently and obviously they're different businesses they have different margins they have all

[00:26:14] [SPEAKER_04]: that stuff but they they both were doing sort of similar that similar ideas behind what they were doing

[00:26:19] [SPEAKER_04]: just one was being treated completely differently on the accounting statements than the other was

[00:26:24] [SPEAKER_03]: this basic idea that that that mobison will talk about over and over again is

[00:26:29] [SPEAKER_03]: just building a model of a company to understand where's where's top line revenue come from

[00:26:35] [SPEAKER_03]: then what do you do with that revenue and I think it gets to this fundamental case in these money

[00:26:40] [SPEAKER_03]: losing companies when we talk about them. It's just asking the question is this thing bootstrapped

[00:26:45] [SPEAKER_03]: is the money that it's being reinvested in everything else is it entirely coming from the company

[00:26:50] [SPEAKER_03]: and from revenue from stuff it's selling and then how are they how are they accounting for that

[00:26:55] [SPEAKER_03]: is it venture backed or is it just is it backed by something else? Are they taking loans from a bank

[00:27:01] [SPEAKER_03]: to do this or taking loans from are they issuing bonds to do this? Are they issuing stock to do this

[00:27:06] [SPEAKER_03]: and when you start to do this you start to see both the shape of the different business models

[00:27:11] [SPEAKER_03]: the shape of the decisions being made and in the shape of the different ways you can start to think about

[00:27:15] [SPEAKER_03]: what is not just the business practices the business model itself the everything store online versus

[00:27:23] [SPEAKER_03]: everything store in the purest retail sense but how do they arrive at growing that enterprise? How

[00:27:29] [SPEAKER_03]: do they arrive at that when you play it out three years five years ten years however many years

[00:27:33] [SPEAKER_03]: into the future if this is something you are going to invest in or speculate on you might say

[00:27:39] [SPEAKER_03]: okay if this money is getting raised by shareholders and these things are getting plowed in

[00:27:43] [SPEAKER_03]: well they have a structural advantage over somebody who's only bootstrapping this stuff to get

[00:27:47] [SPEAKER_03]: to the same point if this works out for them they could be way ahead on the curve with the consumer

[00:27:52] [SPEAKER_03]: you can start to see and now in the rear view mirror how that took place and how Amazon was able to

[00:27:58] [SPEAKER_03]: go into all sorts of other markets in front of in front of Walmart it's really really fascinating

[00:28:03] [SPEAKER_03]: thing to look at pairs like this that had similar looking businesses but fundamentally totally different

[00:28:09] [SPEAKER_04]: business models let me give an example because it relates to like the business on and because this is

[00:28:13] [SPEAKER_04]: how it really like I understood this concept so we're in the subscription business let's just say

[00:28:17] [SPEAKER_04]: I've used round numbers we charge $250 a year for validity now let's say it costs us basically

[00:28:23] [SPEAKER_04]: let's say it costs us $300 to acquire a subscriber in our average subscriber stays of less for two

[00:28:28] [SPEAKER_04]: years so my value of that subscriber is $500 because they stay for two years I'm acquiring that

[00:28:34] [SPEAKER_04]: subscriber for $300 that is a profitable long-term transaction but now let's go back to the accounting

[00:28:40] [SPEAKER_04]: statement and let's say every time I acquire a subscriber I'm taking their annual fee they pay to

[00:28:45] [SPEAKER_04]: I'm investing it back to acquire more and more subscribers what do my accounting statements look like they

[00:28:50] [SPEAKER_04]: look like a disaster I am losing money every single year because but I'm gonna get big payouts in the

[00:28:56] [SPEAKER_04]: future and if you think of about a business like Salesforce that's sort of explains what they did

[00:29:01] [SPEAKER_04]: they were spending a bunch of money to acquire a customer but sales force is a much better business

[00:29:05] [SPEAKER_04]: than like a subscription investment business because subscription investment business you know you

[00:29:09] [SPEAKER_04]: might have a couple years as like your average life of a subscriber for a sales for it's a really

[00:29:13] [SPEAKER_04]: long time which is similar like the asset management business which both of us are in so you can

[00:29:17] [SPEAKER_04]: pay a lot of money to acquire these people it can look forable in the present especially if you're

[00:29:22] [SPEAKER_04]: investing that back that money back to acquire even more and more people but long-term it ends up

[00:29:27] [SPEAKER_04]: being an incredibly profitable transaction so I think that's a simple way to think about like a business

[00:29:31] [SPEAKER_04]: like Salesforce and what people were getting wrong about it and then who you're trying to appease with

[00:29:36] [SPEAKER_03]: that decision if you have investors in the business who are committed to that long-term vision

[00:29:41] [SPEAKER_03]: and aren't looking for a quick turn people who aren't speculating on what you're going to do next

[00:29:46] [SPEAKER_03]: there's a lot easier to appeal people if you have them in that long-term vision if you

[00:29:50] [SPEAKER_03]: you know are promising that your car company's gonna go to Mars or something. The longer term

[00:29:55] [SPEAKER_03]: that thing is the more people who are invested in can stay true to that story because they can say

[00:30:00] [SPEAKER_03]: I need all this time for it to play out. The more you have pressures whether it's from a bank

[00:30:05] [SPEAKER_03]: because you have a loan or it's from shareholders who want to get paid out that dividend the more

[00:30:09] [SPEAKER_03]: pressure you have on you to maybe not make that decision. Not look at that I'm two years

[00:30:14] [SPEAKER_03]: to profitability and here's my turn right on my customer versus my lifetime value and all those

[00:30:18] [SPEAKER_03]: very important things that you have to bake into a business model. Where the money comes from,

[00:30:24] [SPEAKER_03]: how you're getting there and how you tell that story kind of everything that's how you're

[00:30:29] [SPEAKER_03]: defying to the people who are giving you that money how it matters. So this next one maybe

[00:30:34] [SPEAKER_04]: the most eye opening one of what he said because you'll see people drop multiples all the time like

[00:30:38] [SPEAKER_04]: I do it all the time you probably do it it's like oh this company trades at 15 times earnings

[00:30:41] [SPEAKER_04]: but how many people who say that can actually explain what that means so he talks about

[00:30:45] [SPEAKER_04]: earning the right to use multiples. The point I make over and over is that multiples are not

[00:30:49] [SPEAKER_05]: valuation let me just stop there. Multiple or not valuation they are a short hand for the valuation

[00:30:54] [SPEAKER_05]: process and once you never confuse those two things right so the valuation process is the

[00:31:00] [SPEAKER_05]: present value future cash flows. Multiple or short hand now what's good about multiples what's good

[00:31:05] [SPEAKER_05]: short hands in general right they save you time right and by the way I should just be clear I use

[00:31:08] [SPEAKER_05]: multiples if you were an hour having a conversation we might I would maybe drop multiples about a

[00:31:13] [SPEAKER_05]: particular business whatever that's fine but the key is that you understand the economic implications

[00:31:19] [SPEAKER_05]: of the multiples that you're using so you're saying I think this should be a 15 times EBITDA or

[00:31:23] [SPEAKER_05]: the 30 times earnings so what is that what do I have to believe for those multiples to make sense and so

[00:31:29] [SPEAKER_05]: as you know we spend a lot of time writing about we wrote a piece called what does it P you multiple mean

[00:31:33] [SPEAKER_05]: we wrote a piece called what does EBITDA multiple mean essentially creating a bridge between those

[00:31:38] [SPEAKER_05]: multiples as people tend to use them and the economic the underlying economic assumptions that you

[00:31:43] [SPEAKER_05]: need to make in order for those to justify those multiples it just to be really explicit about those

[00:31:48] [SPEAKER_05]: things and you know as what the motor in at New York University sort of the dean evaluation

[00:31:52] [SPEAKER_05]: he's talked a lot about this he surveyed investor reports and he's found or analyst reports pardon me

[00:31:57] [SPEAKER_05]: he's found that you know nine out of ten rely predominantly on multiples so this is how people tend to

[00:32:03] [SPEAKER_05]: tell my students the end of you know sort of end of our evaluation module you have to sort of earn

[00:32:07] [SPEAKER_05]: the rights to you multiple you can use them but earn the right and and the way you earn the right

[00:32:11] [SPEAKER_05]: is to demonstrate that you understand the underlying economic assumptions that are embedded right

[00:32:16] [SPEAKER_05]: so last thing I'll say and it goes back to expectations of asking broadly speaking which is

[00:32:20] [SPEAKER_05]: the assumptions about future value creation investment needs all the time that's implicit in a

[00:32:32] [SPEAKER_05]: explicit right so people go oh well you just change the assumption a little bit the value

[00:32:36] [SPEAKER_05]: absolutely but that's explicit so the question is would you rather have something implicit and

[00:32:41] [SPEAKER_05]: buried and then we don't really know what's actually what we're doing or explicit and overt

[00:32:45] [SPEAKER_05]: and then we could debate right and then that that to me of course the latter is of asthma it

[00:32:50] [SPEAKER_05]: vastly more attractive proposition than the former so so economic holisect might be a little bit strong

[00:32:55] [SPEAKER_05]: but but that's that's the basic idea and then a related ideal just mentioned quickly is

[00:32:59] [SPEAKER_05]: there's a presumption often that growth in and of itself is a good thing and what we and we

[00:33:04] [SPEAKER_05]: demonstrate this in a simple appendix in chapter one I think it is actually the growth in and of

[00:33:09] [SPEAKER_05]: itself is not value it doesn't need to be value creating so the key concept is growth adds value

[00:33:14] [SPEAKER_05]: when a company's earning above the cost of capital right so qualifying growth the fact the way

[00:33:19] [SPEAKER_05]: you should think about it is return on capital cost of capital spread is first and foremost and then

[00:33:24] [SPEAKER_05]: growth amplifies right makes a good thing better and if your spread is negative it makes a bad

[00:33:29] [SPEAKER_04]: thing even this one is great and you know we won't go through the that you know how this relates to

[00:33:33] [SPEAKER_04]: a discounted cash flow analysis but it does and you know you probably shouldn't be using

[00:33:38] [SPEAKER_04]: multiples if you're someone who is looking at individual businesses and valuing those businesses

[00:33:43] [SPEAKER_04]: you probably shouldn't be using multiples and buying something because it trades at 12 times earnings

[00:33:48] [SPEAKER_04]: unless you know what the fact that it trades 12 at 12 times earnings actually means now I think

[00:33:53] [SPEAKER_04]: it's a little bit different in fact or investing and we'll get that in a second but I think this

[00:33:56] [SPEAKER_04]: so important is anything you do like you have to earn the right to do it by understanding what

[00:34:01] [SPEAKER_04]: underlies what you're doing and what it actually means so I'm just real quick calculating

[00:34:06] [SPEAKER_03]: the multiple and excess returns but it keeps coming up with a negative number my do this

[00:34:11] [SPEAKER_03]: from those from their true unfortunately this is one of those things there's that great

[00:34:17] [SPEAKER_03]: Michael Mowes and paper on this the the earned the right to use the multiple paper highly highly

[00:34:21] [SPEAKER_03]: recommend if you haven't read this but this just says it's okay to use the multiples as he said

[00:34:27] [SPEAKER_03]: you just have to earn the right to do it you have to learn to build the financial model you have to

[00:34:31] [SPEAKER_03]: stub your toe and some stuff I am as guilty as this is anybody you get wrapped up in the excitement

[00:34:37] [SPEAKER_03]: of learning about quantitative models and how to take stuff and how to apply it but then you

[00:34:43] [SPEAKER_03]: have to understand wait why is greenblatt in the magic formula excluding banks and financials why are

[00:34:49] [SPEAKER_03]: these things happening what else do I have to do are there different multiples for different

[00:34:53] [SPEAKER_03]: industries or sub sectors or whatever else that help me more articulate better articulate the

[00:34:58] [SPEAKER_03]: you know the way to think about these things relative to each other and on an absolute basis

[00:35:03] [SPEAKER_03]: that little subtle adjustment of saying do you actually understand the inputs and how they

[00:35:08] [SPEAKER_03]: influence this numerator and denominator goes a long long long long long long long long long way

[00:35:15] [SPEAKER_04]: yeah just my last point is that I think it's a little less apical someone like me who's a factor investor

[00:35:19] [SPEAKER_04]: because as a factor investor I'm not looking at individual company and saying oh it because it's 15

[00:35:24] [SPEAKER_04]: times earnings I think it's cheap I'm looking at the system wide things and saying because this

[00:35:28] [SPEAKER_04]: basket of companies is riskier than the market I expect to get paid for that or because people across

[00:35:33] [SPEAKER_04]: a wide number of companies are systematically remiss pracing them in overestimating bad news I get paid

[00:35:38] [SPEAKER_04]: for that so it's less important to like a factor investor they're not going to go in for every

[00:35:42] [SPEAKER_04]: company and be like I need to understand and earn the right to use the multiples but it is important

[00:35:46] [SPEAKER_04]: and this gets back to the idea you want to earn the right to get paid in investing so you want

[00:35:50] [SPEAKER_04]: to understand why you're getting paid and in Michael's world that means you have to earn the

[00:35:54] [SPEAKER_04]: right to use the multiple and in the factor world it means you have to understand why I'm getting

[00:35:57] [SPEAKER_04]: this return by investing in these companies with these common characteristics so I think it does carry across

[00:36:01] [SPEAKER_03]: so as a fundamental or quantitative value factor investor that's how we just fire appearances on

[00:36:08] [SPEAKER_03]: success charts right that's what you say that is pretty much what it is okay we also truly

[00:36:12] [SPEAKER_03]: paid the right to use the multiple for this length so there's next one is also one that until I

[00:36:17] [SPEAKER_04]: heard him originally say this I didn't get this so I had been one of these people who had said

[00:36:22] [SPEAKER_04]: all right you know one of the great things about the rise of passive investing is there's less

[00:36:25] [SPEAKER_04]: active investors out there so those of us that are active investors we got a much better chance

[00:36:30] [SPEAKER_05]: Michael will explain why I'm completely wrong about that by the way Peter Lynch I think very recently

[00:36:33] [SPEAKER_05]: made a comment about why active is good in this context it's very intuitive to think to yourself

[00:36:39] [SPEAKER_05]: well gee if everybody's just going for average it's easier to become above average but it actually

[00:36:43] [SPEAKER_05]: is I think the actual the actual answer is completely the opposite which is interesting right so

[00:36:49] [SPEAKER_05]: the first thing just to state by the bill bill sharp wrote a very famous paper on the arithmetic

[00:36:54] [SPEAKER_05]: of active management he basically said if you think about it this has to be roughly right and

[00:36:58] [SPEAKER_05]: it's not perfectly right but it's roughly right right so there's the return let's just say the

[00:37:02] [SPEAKER_05]: markets yes and p 500 is obviously much bigger let's just say the s and p 500 to constrain our

[00:37:05] [SPEAKER_05]: discussion you're going to have some percent of his index right and they're going to earn the

[00:37:09] [SPEAKER_05]: greater return of the market minus their small fees and then the other part is active right

[00:37:13] [SPEAKER_05]: and and and and act the active managers in the aggregate are also going to run the market right

[00:37:17] [SPEAKER_05]: of turn because the two pieces have to equal to total right so by definition they're going to

[00:37:20] [SPEAKER_05]: market better turn now the keys there fees are higher than the indexers right so by definition

[00:37:26] [SPEAKER_05]: indexers are going to outperform the accurate active managers in the aggregate that's been true

[00:37:30] [SPEAKER_05]: nothing new about that so now let's zoom in a little bit on the active managers right what we

[00:37:34] [SPEAKER_05]: what we have is a distribution of returns right so if you do that positive alpha and the

[00:37:39] [SPEAKER_05]: even before fees forget about fees if you do a positive alpha someone has to have negative alpha

[00:37:44] [SPEAKER_05]: right and the exact same dollar amount right by mathematically that has to be true alpha is a

[00:37:49] [SPEAKER_05]: y intercept on a on a regression right so it's a y-intercept it has to be zero net so so the question is

[00:37:58] [SPEAKER_05]: Who's on the other side of my trade right and so what what I argue what I would argue and I'm not sure

[00:38:03] [SPEAKER_05]: This is completely true all the ethic directionally people would buy in larger agree with it is the the money has

[00:38:09] [SPEAKER_05]: Float out of the weaker hands in terms of the active community and that could be weaker mutual funds

[00:38:14] [SPEAKER_05]: weaker individuals they've mostly gone to indexing and as a consequence those who remain are actually smarter right

[00:38:21] [SPEAKER_05]: and so just in the metaphor I would use is something like a poker table right so let's say you have a

[00:38:27] [SPEAKER_05]: poker game Friday night you brought you brought you you invite your buddies over and of course

[00:38:31] [SPEAKER_05]: your buddies are going to have some distribution of skill right some will be better players and others

[00:38:35] [SPEAKER_05]: and the smarter players will take money from the weaker players over time right for sure not any

[00:38:40] [SPEAKER_05]: particular type of over time but if all of a sudden your the weaker players decide they don't want

[00:38:44] [SPEAKER_05]: a plany more or they just come and drink your beer which they might do and not play right

[00:38:50] [SPEAKER_05]: which is which in the sense by the way the active community by the way just to be super clear

[00:38:55] [SPEAKER_05]: the invest the the passive community the indexing community is free riding off the active community right so

[00:39:01] [SPEAKER_05]: there's free riding here just to be super clear about this and that's why drinking your beers a free ride

[00:39:04] [SPEAKER_05]: but if those weak players leave the people around your your poker table Friday night

[00:39:09] [SPEAKER_05]: are only the best players and as you imagine if it's only the good players it becomes more difficult to win

[00:39:13] [SPEAKER_05]: so I think that poker metaphor is actually a pretty good way to think about this is that if you

[00:39:18] [SPEAKER_05]: accept the premise and I think we can mostly show this but if you accept the premise that those who have

[00:39:23] [SPEAKER_05]: fled the active market are the weaker players those who are left over are the stronger ones

[00:39:28] [SPEAKER_04]: and it becomes harder yeah so this is great I mean this idea of obviously as you know I just

[00:39:33] [SPEAKER_04]: hadn't thought when I thought this through the first time that as active managers are getting hit here

[00:39:38] [SPEAKER_04]: by the fact that they're underperforming in people are you know passive investing is rising

[00:39:42] [SPEAKER_04]: like what's left is the good people and you know that makes it harder so it's completely counterintuitive

[00:39:47] [SPEAKER_04]: to think that less active managers lead to a more difficult asset management business but that is what it is I think

[00:39:54] [SPEAKER_03]: so we used to play in these these like Sunday pick-up soccer games and I was a kid in town

[00:40:00] [SPEAKER_03]: and and at first it was just like some some dads from the team whatever and the sons and a few other

[00:40:06] [SPEAKER_03]: like just random people who'd like be around but then what ends up so this is this is my comparison

[00:40:11] [SPEAKER_03]: like you know there are probably little active markets and little like pick-up games like all

[00:40:15] [SPEAKER_03]: all scattered about but nobody really had that many people for whatever reason you know all the

[00:40:21] [SPEAKER_03]: sudden my friend Adam has some older cousins and they come and they they join the league and then

[00:40:26] [SPEAKER_03]: they bring some friends from some other places no of a sudden the pickup game turns into like

[00:40:30] [SPEAKER_03]: this bigger thing but it turned into this bigger thing where all of a sudden we had some college

[00:40:35] [SPEAKER_03]: kids who were like D1 athletes all of a sudden that attracts like a couple of the basically like

[00:40:41] [SPEAKER_03]: the immigrant families like we had this this like this Italian like 60 year old and it's like

[00:40:47] [SPEAKER_03]: grandkids would come and you brought all these incredibly talented people into the pool all of a

[00:40:52] [SPEAKER_03]: sudden so it's kind of like it's just a pickup Sunday league game but you had these friggin ringers

[00:40:57] [SPEAKER_03]: showing up and defecting from other things and coming to ours so what ends up happening is like

[00:41:02] [SPEAKER_03]: the level of skill just kept going higher and higher and higher until it was this crucible of

[00:41:07] [SPEAKER_03]: where you're just like I'm just gonna get my butt kicked like all the way out there with the whole

[00:41:12] [SPEAKER_03]: passive active thing it's like yeah the weekends get flushed out as you keep raising that bar

[00:41:17] [SPEAKER_03]: and a lot of I think what we're seeing now and we see it when we hear people like Mike Green or

[00:41:21] [SPEAKER_03]: I know or people like that just talk about this it's actually it still matters and it is

[00:41:27] [SPEAKER_03]: crazy competitive because the people of stuck it out are really really smart really really good and they're competing

[00:41:32] [SPEAKER_03]: over a much more limited amount of like when are we gonna be right when's this thing gonna matter

[00:41:39] [SPEAKER_03]: how's this gonna work and they all know that that's where they're competing against that really changes

[00:41:43] [SPEAKER_03]: the dynamic not unlike my Sunday league pickup soccer games on us kid so this next clip gets into

[00:41:50] [SPEAKER_04]: related to this in many ways so Michael here is talking about the idea of the paradox of

[00:41:53] [SPEAKER_05]: skills one of these things is not at first blush intuitive but it's I think it's right so

[00:41:58] [SPEAKER_05]: when you think about skill you can think about it on two levels the first is absolute skill and

[00:42:02] [SPEAKER_05]: I think we'd all agree and all the listeners would agree that if you look around the world

[00:42:06] [SPEAKER_05]: not just investing but business and sports or whatever it is that the absolute skill has never been

[00:42:10] [SPEAKER_05]: higher right and part of that is because we have better training better techniques better in

[00:42:16] [SPEAKER_05]: investing we have you know computing power and access information and so on so forth right

[00:42:20] [SPEAKER_05]: so I think that's there's not a lot of doubt about that the second issue though is the one

[00:42:24] [SPEAKER_05]: that's more important for our discussion which is relative skill right which is the difference between

[00:42:29] [SPEAKER_05]: the very best in the average participants in each field now I learned about this idea it was

[00:42:35] [SPEAKER_05]: not my idea at all I learned about it from Stephen J. Gould who wrote a book called Full House back

[00:42:39] [SPEAKER_05]: in the mid 1990s and he was ruminating on why no one has hit over 400 immediately baseball

[00:42:45] [SPEAKER_05]: since Ted Williams did that in 1941 and you know the argument he said was because essentially

[00:42:51] [SPEAKER_05]: the standard deviation of batting average has come down a lot which is there's more uniform

[00:42:55] [SPEAKER_05]: skill so even though the batting average hasn't changed all that much in fact the powers

[00:42:59] [SPEAKER_05]: it'd be immediately baseball will change the rules to keep it sort of in an reasonable band

[00:43:04] [SPEAKER_05]: the standard deviations come down a lot so Ted Williams was a three standard deviation event

[00:43:09] [SPEAKER_05]: when if you were a three standard deviation event now you'd hit like 380 or 385 which is awesome

[00:43:14] [SPEAKER_05]: you'd win the batting title but you're not anywhere near breaching that 400 level so I have

[00:43:19] [SPEAKER_05]: the same thing's true in investing and we can measure that right we we measured by looking at essentially

[00:43:23] [SPEAKER_05]: the equivalent of batting average which is this standard deviation of alpha and historically

[00:43:28] [SPEAKER_05]: that's come down a lot now I'll just say one thing Justin which is a little bit weird is it it's

[00:43:33] [SPEAKER_05]: actually flattened and bumped up a little bit in the last couple of years so for reasons I'm not sure

[00:43:38] [SPEAKER_05]: I can pull my arms around so apart I might just be it's correlated with the actual dispersion

[00:43:44] [SPEAKER_05]: of markets to some degree so there's some other external factors that come into play but

[00:43:52] [SPEAKER_05]: but yeah so so that's the way to measure it so when you look around and by the way sports

[00:43:56] [SPEAKER_05]: leaks this is a really good sort of framework to think about this sportly sports leagues are actually

[00:44:02] [SPEAKER_05]: grinding toward parity at breaching and some have like salary caps in order to try to

[00:44:06] [SPEAKER_05]: encourage parity but they're all grinding toward parity because these guys are all so good

[00:44:10] [SPEAKER_05]: so even the bad teams are really good right and and certain sports like baseball or hockey

[00:44:16] [SPEAKER_05]: are very very the level skills very high in very uniform and as a consequence the luck has it

[00:44:24] [SPEAKER_05]: peers to make make a bigger have a bigger role in the outcome so that this is the thing I

[00:44:28] [SPEAKER_05]: and I push back you know in Danny Connames book thinking fast and slow he's got a little section where

[00:44:33] [SPEAKER_05]: he talks about investment managers and gee they're so clueless about there's no skill in this

[00:44:38] [SPEAKER_05]: and I would to him and I said you know it's actually the opposite you know the way to think about it

[00:44:42] [SPEAKER_05]: is the skill is not not only high but it's uniform right and you think about how many smart people

[00:44:47] [SPEAKER_05]: go into this industry and and how motivated they are and how hardworking they are and how thoughtful

[00:44:52] [SPEAKER_05]: they are it justifies logic that there's no skills there's huge amounts of skill it's just that's

[00:44:57] [SPEAKER_05]: the problem right and that skill gets reflected in prices and if prices to be reduced they're largely

[00:45:01] [SPEAKER_05]: efficient then means that means the random wall kind of thing comes into play so that this is again

[00:45:05] [SPEAKER_04]: counter intuitive you would think as as absolute skill rises and I think in many places I mean

[00:45:11] [SPEAKER_04]: he's talked about sports we we've taught in investing you know you've got computers you know

[00:45:15] [SPEAKER_04]: way more computer power you've got smarter people I mean it's hard not to argue that absolute skill

[00:45:20] [SPEAKER_04]: is higher in the investing world you would think what I need to do is my relative skill becomes

[00:45:25] [SPEAKER_04]: more important now because everyone is so good I gotta be even better but what happens is

[00:45:30] [SPEAKER_04]: luck becomes much more important because you have less variation you have less standard

[00:45:34] [SPEAKER_04]: so as an active manager what I want is I might have this this median average outcome that

[00:45:40] [SPEAKER_04]: everybody gets I want a lot of spread around that because that spread gives me an opportunity to be in

[00:45:44] [SPEAKER_04]: the top portion of that spread and to be one of the outperforming people but as you narrow that spread

[00:45:49] [SPEAKER_04]: it becomes harder and harder and harder and harder to be the active manager it becomes harder and

[00:45:54] [SPEAKER_04]: harder and harder to express your skill and it also in this this guy we got into this with Adam Butler

[00:45:58] [SPEAKER_04]: it also becomes harder to distinguish your skill from luck like our episode of Adam Butler was

[00:46:04] [SPEAKER_04]: something like your alpha you know your alpha is hard to distinguish from noise or something

[00:46:07] [SPEAKER_04]: was our title and the idea is it's very hard to even tell if you're skilled in a world like that

[00:46:13] [SPEAKER_04]: it's hard to distinguish the skill from luck in real time this concept are just thinking in layers

[00:46:18] [SPEAKER_03]: of thinking about you as you compare to yourself then you as you compare to the two up here group

[00:46:24] [SPEAKER_03]: and then the peer group as it compares across the peer group those layers are just enormously

[00:46:30] [SPEAKER_03]: and as that bar gets raised for what's considered skill or what we perceive as luck you start to

[00:46:37] [SPEAKER_03]: understand kind of the only thing you can control is going back to yourself and figuring out what

[00:46:42] [SPEAKER_03]: makes you either potentially have that edge over the peer group or just be able to stand out

[00:46:48] [SPEAKER_03]: and you can't have all these things it's really hard at the highest levels to do this stuff

[00:46:52] [SPEAKER_03]: this concept of absolute versus relative skill when there's luck was at the success equation

[00:46:58] [SPEAKER_03]: that book that he wrote to another one that just lays this out across different domains so intensely

[00:47:03] [SPEAKER_03]: valuable and so many more walks of life than just investing markets. The second last one is

[00:47:09] [SPEAKER_04]: a concept that I struggle with a lot of investor struggle with which as you'll see these

[00:47:13] [SPEAKER_04]: expected returns for markets you know a lot of the big places do you know the GMOs the research

[00:47:17] [SPEAKER_04]: affiliates Vanguard does it a lot of people will say you know based on where we are in the markets

[00:47:21] [SPEAKER_04]: here's kind of your seven to ten year expected return and here's Michael talking about what he

[00:47:26] [SPEAKER_04]: thinks those are good and what they're not good for well the first thing I'll just say is

[00:47:30] [SPEAKER_05]: unless there are ranges you should be very careful about paying attention to it so

[00:47:35] [SPEAKER_05]: you know there you can audit some of these guy you mentioned all these guys doing these

[00:47:38] [SPEAKER_05]: forecasts you can audit what they've said at the past and see how they've done and it's not

[00:47:42] [SPEAKER_05]: very pretty right the answer is it's a range of outcomes and people should think about that specifically

[00:47:47] [SPEAKER_05]: now I will say that what I I mean when I think about for looking returns and obviously

[00:47:53] [SPEAKER_05]: you know we do things like cost to capital calculations and I do these for my course

[00:47:57] [SPEAKER_05]: what I actually use is as worth the motor and you know as every month as Roth publishes a market

[00:48:03] [SPEAKER_05]: risk premium to which you can add the risk free rate to tenure treasury no yield

[00:48:07] [SPEAKER_05]: and you come up with an expected return from the market so the other day we just did this fairly

[00:48:11] [SPEAKER_05]: recent the I was keen to understand like how good is this right and so what we did is and as

[00:48:16] [SPEAKER_05]: Roth has he's dated back to 1961 so we actually on the x-axis put the you know the number for that

[00:48:22] [SPEAKER_05]: particular year and then we looked at the ten years subsequent total share of returns

[00:48:25] [SPEAKER_05]: when the correlation was about 0.7 so it's not perfect but it's pretty good and again that's a

[00:48:31] [SPEAKER_05]: single point estimate I'm sure as Roth himself would say for sure you should have a range around

[00:48:34] [SPEAKER_05]: those things like you said 68% up or down based on one standard deviation and so that's pretty

[00:48:39] [SPEAKER_05]: good so I think that gets you into the ballpark and the other thing I'll say just in that

[00:48:42] [SPEAKER_05]: think is important is when people get worked up about this is we have a lot of other touchstones

[00:48:47] [SPEAKER_05]: and markets that we can we can appeal to that allow us to give us some guidance and and by far

[00:48:51] [SPEAKER_05]: most important for equity investors is obviously credit bond markets right so we know for example you

[00:48:57] [SPEAKER_05]: can go to the triple beat go to Fred we go to website every day and you'll get the triple be spread

[00:49:01] [SPEAKER_05]: for instance so you know exactly what bonds are returning so that's going to be and there's

[00:49:05] [SPEAKER_05]: usually a relationship between you know these are they're just stacked on the capital structure

[00:49:09] [SPEAKER_05]: there's going to be some relationship between these things over time so then you can even look at things

[00:49:14] [SPEAKER_05]: like implied volatility you could look at things like credit default swaps with their liquidity

[00:49:17] [SPEAKER_05]: so there's there's a bunch of different ways that you can try to kind of create a little bit of a

[00:49:21] [SPEAKER_05]: zig to understand where you are the punchline by the way today because I mentioned to a few moments ago

[00:49:27] [SPEAKER_05]: is that expect the returns are fairly muted I think as was numbers for December 1st were something

[00:49:32] [SPEAKER_05]: like an expected return for the market in the low sixes that's nominal by the way so if you apply

[00:49:38] [SPEAKER_05]: and you know who knows what inflation's going to be but if you do 10 year break evens you know you

[00:49:42] [SPEAKER_05]: should get in the 3.5 or 1.5% real return from markets equity markets in the US and that's you

[00:49:51] [SPEAKER_05]: know it's I don't know what that is two thirds 70% of the historical returns is probably a reasonable

[00:49:56] [SPEAKER_05]: expectation today and so it's more muted now again that's again you can you see that everywhere

[00:50:02] [SPEAKER_05]: if you buy bonds you're in the same boat and so on and so forth so it's a great question I

[00:50:06] [SPEAKER_05]: it's a tease just to think about these things probably the easiest to think about things scenario

[00:50:10] [SPEAKER_04]: well I think the one of the things he said is really important is and this he was talking about

[00:50:15] [SPEAKER_04]: forecasts and he was talking about expected returns and they're a little bit different but the idea is

[00:50:19] [SPEAKER_04]: I think you want to see a range for somebody who's doing this well and you will see this from the

[00:50:23] [SPEAKER_04]: good people to do expected returns they won't tell you you know expected returns are 4.2% or something

[00:50:27] [SPEAKER_04]: they'll give you a range of different outcomes and I think that's really important and that's a

[00:50:32] [SPEAKER_04]: good way to do it but the the other thing to think about is it's just important isn't investor

[00:50:35] [SPEAKER_04]: and I don't know that these expected returns I mean you could talk a little bit more about how you

[00:50:39] [SPEAKER_04]: use them in modeling and stuff but it's it's hard for investors to use these expected returns because

[00:50:44] [SPEAKER_04]: there is a wide range around them like he said and a lot of times like what people thought were

[00:50:48] [SPEAKER_04]: expected returns for the markets like if you go back you know 3.5 years from now and you look at

[00:50:53] [SPEAKER_04]: what people thought the expected returns were going to be what they actually ended up being

[00:50:57] [SPEAKER_04]: they're usually very very different and so although you can say over you know 7.10 year time frame

[00:51:02] [SPEAKER_04]: we can more accurately predict expected returns than we can over one to three years there's still

[00:51:07] [SPEAKER_04]: a lot of variation in there so it's hard for individual investors they can be very useful in the

[00:51:10] [SPEAKER_04]: planning process but it's very hard for individual investors to figure out what to do with that

[00:51:16] [SPEAKER_03]: another in the middle concept that I learned from people like mobasin and a professor

[00:51:22] [SPEAKER_03]: domitaron and some of the others this is again starting in the middle it's when you're thinking

[00:51:27] [SPEAKER_03]: about probabilities and you're thinking about probabilistic legalistic legalistic talk today

[00:51:32] [SPEAKER_03]: going forward I find it very useful whether it's in an investment case or in a financial plan

[00:51:37] [SPEAKER_03]: or anything else anytime you're modeling the future you're basically looking at not just how

[00:51:43] [SPEAKER_03]: we get up to this point in time before we project forward to understand what's here in the present

[00:51:48] [SPEAKER_03]: but also to understand going forward I need not just my my bull case not just my here's my long-term

[00:51:55] [SPEAKER_03]: average expected returns I want to actually have a base case long-term averages I want to have a

[00:52:02] [SPEAKER_03]: bull case a long-term above average and I want to have some form of a bearish case a below average

[00:52:07] [SPEAKER_03]: expectation and in simple equity terms as he described I think in the clip the like you can have

[00:52:13] [SPEAKER_03]: 10% expected with a plus and minus 15% you know variance in either direction for those cases you

[00:52:18] [SPEAKER_03]: can go really simple as something like that or you can tease out what happens in these and then

[00:52:22] [SPEAKER_03]: you can probabilistically wait them you could say okay we think you know over this especially

[00:52:27] [SPEAKER_03]: if it's a short-term period you might want to evenly disperse them if it's overall long-term

[00:52:31] [SPEAKER_03]: period you might want to just go here's how we plan for three potential eventualities

[00:52:36] [SPEAKER_03]: here's how we plan for if everything goes wrong we end up in long-term care we have all these

[00:52:40] [SPEAKER_03]: growing expenses and all these things great that is a bear case worth discussing but it's not

[00:52:46] [SPEAKER_03]: worth discussing without also having the contest context of a base case this is what it

[00:52:51] [SPEAKER_03]: probably looks like going forward in a bull case oh hey if that equity exposure actually gives us

[00:52:57] [SPEAKER_03]: above average returns for this period of our life like how do we how do we I was using the analogy

[00:53:03] [SPEAKER_03]: how do we pick the apple off the tree when it's ripe how do we know when it's ripe when something

[00:53:07] [SPEAKER_03]: went like oh guess what we did always want that vacation home we always did want to build that

[00:53:12] [SPEAKER_03]: second place you know back in a back where we grew up the market or the business or life

[00:53:17] [SPEAKER_03]: for whatever was kind to us now it's here and now it's okay to go out and do that this exercise

[00:53:22] [SPEAKER_03]: of having a bull case a base case and a bear case to plan probabilistically about the future is

[00:53:30] [SPEAKER_03]: enormously useful and narrow walks like with one investment and in broader walks like financial

[00:53:34] [SPEAKER_04]: and across all the life yeah one place I think you maybe can add a little value these expected

[00:53:38] [SPEAKER_04]: returns is untilting your portfolio but it's something to be really really careful about

[00:53:42] [SPEAKER_04]: because so for instance I could say right now the expected returns of international stocks

[00:53:46] [SPEAKER_04]: particularly international value or way way way higher than you know the expected returns

[00:53:50] [SPEAKER_04]: are like the US market so I could say I want to make a slight adjustment to my portfolio

[00:53:53] [SPEAKER_04]: an overweight international now the way I would argue against myself with that is I could have done

[00:53:58] [SPEAKER_04]: that a decade ago I could have done it before that with international stocks and it just didn't work

[00:54:02] [SPEAKER_04]: and so you almost have to have if you're going to do stuff like that you almost have to have

[00:54:06] [SPEAKER_04]: these really really long timeframes to put it to play out because although expected returns are

[00:54:12] [SPEAKER_04]: usually listed over seven ten years a lot of times it takes more than seven to ten years for

[00:54:16] [SPEAKER_03]: what you expect to actually play out yeah I'm a big big big fan especially in capital market

[00:54:21] [SPEAKER_03]: assumptions for people who do allocation work this is where you should have your long-term

[00:54:26] [SPEAKER_03]: expected returns and you should have some type of more dynamic shorter bound assumption there's a

[00:54:31] [SPEAKER_03]: number of ways you can do this they don't have to be ultra short they don't have to be like

[00:54:35] [SPEAKER_03]: you know three weeks but some people do it as short as you know days and but they should be

[00:54:40] [SPEAKER_03]: like somewhere in that like you know one to five year range and basically go long-term this is

[00:54:45] [SPEAKER_03]: what we expect to get short term you can be a little bit more tactical or opportunistic especially

[00:54:50] [SPEAKER_03]: across different account types different types of things it's easy to get yourself in trouble though

[00:54:54] [SPEAKER_03]: if you fall in love with the idea to your point like international value over the last whatever

[00:55:00] [SPEAKER_03]: 30 years you have had a couple of blips in there though where that really worked so the

[00:55:05] [SPEAKER_03]: question would be in the blip and this is where the people who only use the short term project

[00:55:10] [SPEAKER_03]: or the long-term projections I think get in trouble they have a long-term projections and they

[00:55:14] [SPEAKER_03]: forget to go when I have the blip and get the way above average short term result actually want

[00:55:18] [SPEAKER_03]: to be trimming in those environments and that's that is way easier to say way harder to do

[00:55:24] [SPEAKER_04]: you just need to wrap a process around that so pretty much everything we talked about could have

[00:55:28] [SPEAKER_04]: been the answer to this but we always ask at the end of our episodes all our guests you know

[00:55:32] [SPEAKER_04]: based on your experience in markets what's the one lesson you teach the average investor and

[00:55:35] [SPEAKER_05]: here's what Michael said I think that I would encourage people to learn about and apply base rates

[00:55:40] [SPEAKER_05]: as they think about the world of investing but always not just a valuable for investing but

[00:55:45] [SPEAKER_05]: really business or your life actually it's a career life and again a base rate you know the

[00:55:50] [SPEAKER_05]: the the basic setup is the natural way to think about the world or solve your problems is to

[00:55:54] [SPEAKER_05]: gather a bunch of information and combine with your own inputs and experience and project into

[00:55:58] [SPEAKER_05]: future and that's that's what we all do left our own devices using base rates says I'm going to

[00:56:02] [SPEAKER_05]: think about what I'm facing now or my problem as an instance of a larger reference class I'm

[00:56:06] [SPEAKER_05]: going to basically ask what happened when other people or organizations were in this position before

[00:56:11] [SPEAKER_05]: and it's a very unnatural way to think because you have to leave aside you know sort of your own

[00:56:15] [SPEAKER_05]: information gathering and your own experience we all tend to place a lot of value on that

[00:56:19] [SPEAKER_05]: and you have to find and appeal to the base rate which may not be your fingertips and often

[00:56:23] [SPEAKER_05]: then it's not so you have to go out and make a little effort to find it but once you do I think

[00:56:27] [SPEAKER_05]: it reshapes how you think a lot about the world and I think makes you more grounded in terms of

[00:56:33] [SPEAKER_05]: how you think about how things are likely to unfold so to me if that would be the one ideas to say

[00:56:37] [SPEAKER_05]: let's think about base rates you know you mentioned before jokingly that we're in that sort

[00:56:40] [SPEAKER_05]: of season where people do forecasts you know that's a great example where base rates would be very

[00:56:45] [SPEAKER_05]: helpful and you sort of made the joke 10% with some standard deviation but that's actually

[00:56:49] [SPEAKER_05]: the right way to think about it that's that's actually the right answer and that was that's informed by

[00:56:53] [SPEAKER_05]: base rates so you got to the right place and the right way to think about it using that actual

[00:56:59] [SPEAKER_05]: technique so to me that would be the one bit of advice I would give and if I could go back to my

[00:57:03] [SPEAKER_05]: 20 year old self that's certainly what I would teach. So you and I highlighted this as one of our

[00:57:07] [SPEAKER_04]: best answers to this question we did a separate episode on all 119 answers we've gotten but

[00:57:11] [SPEAKER_04]: this is such an interesting concept and I'm just surprised in Michael's kind of touching this

[00:57:16] [SPEAKER_04]: I'm surprised how little people use it or understand it this idea that I always want to look at

[00:57:21] [SPEAKER_04]: facts in front of me and I want to try to make my own analysis and I want to try to predict

[00:57:25] [SPEAKER_04]: what's going to happen in the future but most of the time just asking myself what happened when

[00:57:30] [SPEAKER_04]: similar situations happen in the past what happened in the future using what they call the

[00:57:35] [SPEAKER_04]: outside view most of the time that is a superior way than trying to do all this detailed analysis

[00:57:40] [SPEAKER_04]: and it's widely as Michael said it's widely underused almost no one does it you don't see

[00:57:44] [SPEAKER_04]: the smart when you do it which is probably one of the reasons it's widely underused but it

[00:57:48] [SPEAKER_03]: works out better I think most of the time. This idea and this is I think one of the core

[00:57:55] [SPEAKER_03]: tenets maybe takeaways from anybody who does factor investing or anybody who thinks in a more

[00:58:00] [SPEAKER_03]: quantitative way can really this can be really useful it's it's the same there are there are factors

[00:58:07] [SPEAKER_03]: are different things to describe things that have happened over time and we can go look as something

[00:58:12] [SPEAKER_03]: as an instance in a prior or a larger reference class and we can find hey this kind of rhymes with that

[00:58:20] [SPEAKER_03]: when's the last time a company like forget about what they're promising in their

[00:58:24] [SPEAKER_03]: team and their total adjustable market and think about like okay when's the last time a company

[00:58:28] [SPEAKER_03]: was on this type of a growth curve and maybe I have to look out at a different industry

[00:58:32] [SPEAKER_03]: uh professor domitaron is really great for doing this regularly. Movis and his really great

[00:58:37] [SPEAKER_03]: work for giving some really wonderful examples of this but just start to look with places where it's

[00:58:42] [SPEAKER_03]: not an exact match but things rhyme and use that as a way to anchor your analysis anchor you're

[00:58:48] [SPEAKER_03]: thinking on okay uh you know if somebody's gonna grow at this fast of a clip how long of other

[00:58:54] [SPEAKER_03]: companies sustain this rate of growth or even using it isn't like that using it as a supplement so

[00:58:59] [SPEAKER_04]: let me give a concrete example so let's say I've got a company that trades at 20 times sales that

[00:59:04] [SPEAKER_04]: let's say I've looked at the company and I think it's got incredible growth prospects and all that stuff

[00:59:08] [SPEAKER_04]: like that's great I might be right about that but one of that so that's my inside view my analysis

[00:59:13] [SPEAKER_04]: of the company that says I think this company's worth a lot more money I might want to couple that

[00:59:16] [SPEAKER_04]: with the outside view which says if I look at all companies historically that traded at 20 times

[00:59:22] [SPEAKER_04]: sales or above what kind of returns that I get on those companies and what you're going to get is

[00:59:26] [SPEAKER_04]: a very sobering thing when you look at that you're going to find out the the reference class has

[00:59:30] [SPEAKER_04]: had very very poor performance now that doesn't mean I'm not right maybe with my inside view

[00:59:34] [SPEAKER_04]: but at least means I want to make a supplement my inside view by using that fact that when this

[00:59:38] [SPEAKER_04]: is happened in the past the returns for investors have been really really warm and I think you

[00:59:44] [SPEAKER_03]: get apply that at the individual security your company level you can apply it all the way up to

[00:59:48] [SPEAKER_03]: the portfolio construction level bring it back to like the uh international value case that you made

[00:59:53] [SPEAKER_03]: earlier I can take something like that and I can say I can now contextualize the places

[00:59:58] [SPEAKER_03]: in my portfolio if nothing else as a hedge against if I have potentially overvalued US stocks at

[01:00:05] [SPEAKER_03]: least as of several months ago I have potentially undervalued international here's a case for me to

[01:00:10] [SPEAKER_03]: do a little bit of rebalancing and just understanding how to pair these things together and you're not

[01:00:16] [SPEAKER_03]: you're just never using one factor in isolation it is just enormously useful and

[01:00:22] [SPEAKER_03]: base rates are a little bit clunky that's why they're they're kind of messy and they will make

[01:00:26] [SPEAKER_03]: sound less smart or less exciting you'll be a little bit of a debby down or at the party when you go

[01:00:30] [SPEAKER_03]: that 20 times sales opportunity you know less than 1% of the time does this ever work out

[01:00:36] [SPEAKER_03]: especially when you're sitting there next to the party man going like hey not on my companies

[01:00:41] [SPEAKER_04]: have any sales look how much they've gone up I'd be the debby down at the party who thing that so

[01:00:46] [SPEAKER_04]: I can certainly relate but uh yeah hopefully um you know if you've enjoyed these please

[01:00:51] [SPEAKER_04]: you know comment on YouTube or like it and these are we're gonna try to do more of these because

[01:00:54] [SPEAKER_04]: one of the things we realized when we go back through our old interviews is there's so many insights

[01:00:58] [SPEAKER_04]: and they still apply today and although maybe people don't watch the interviews as much that happen

[01:01:02] [SPEAKER_04]: three years ago there's so much stuff we can bring forward and maybe apply to what's going on

[01:01:06] [SPEAKER_04]: on the current market so we're gonna do more of these you know hopefully people learn from it

[01:01:09] [SPEAKER_02]: thank you for watching and we'll see you next time hi guys this is Justin again thanks so much

[01:01:17] [SPEAKER_02]: for tuning into this episode you can follow Jack on Twitter at at practical quatt you can follow me

[01:01:23] [SPEAKER_02]: on Twitter at at JJ Carbono and follow Matt on Twitter at at Coltish Creative. If you found

[01:01:29] [SPEAKER_02]: this discussion interesting and valuable please subscribe and either iTunes or on YouTube or leave

[01:01:34] [SPEAKER_02]: a review or a comment. Also if you have any ideas for topics you'd like us to cover in the future

[01:01:39] [SPEAKER_02]: please email us at access returns pod at gmail.com we would like this to be a listener driven podcast

[01:01:45] [SPEAKER_02]: and would appreciate any suggestions thank you