30 December 2023

On today’s show, Stig Brodersen talks with co-host Clay Finck. They outline how and why you should invest in high-quality businesses.

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  • How to identify the best businesses
  • Why you need to focus on barriers of entry when assessing a stock
  • Why competition is for losers
  • When management is important and not important in high-quality investing
  • How you want the management to be compensated
  • Why insider ownership is not only important but even more so how it was acquired.  
  • Why you should invest in stocks with two engines 
  • What is the Berkshire Summit, and how do you attend?


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:03] Stig Brodersen: In today’s episode, my co-host Clay Finck and I discuss how and why we should invest in high-quality businesses. It is a bit ironic that we’re doing this episode almost 10 years into the tenure of The Investor’s Podcast. I remember reading about Buffett early in my investment career and how long it took him to realize that investing in high-quality companies is the best approach. Now investing in high-quality companies intuitively sounds easy, but it’s so hard to pay off for quality. Our brains just think linearly and not exponentially, which is how we should be thinking to understand the power of Buffett’s best investments. Join Clay and me as we explore the benefits of high-quality businesses in today’s episode.

[00:00:44] Stig Brodersen: And if you plan to go to Omaha for the Berkshire Hathaway’s annual shareholders meeting, make sure to stay until the very end to learn more about our events. We talk about how you can meet our hosts, William Green, Clay Finck, and Kyle Grieve, but also guests of the podcast and this is including, but not limited to Anthony Kingsley, François Rochon, and Chris Beck.

[00:01:09] Intro: You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:01:28] Stig Brodersen: Welcome to The Investor’s Podcast. I’m your host, Stig Brodersen, and I’m here with my co-host, Clay Finck. Clay, how are you today?

[00:01:36] Clay Finck: Doing great, Stig. It’s always great to chat with you on the show and excited to dive into today’s episode.

[00:01:43] Stig Brodersen: I’m excited too, talking about high-quality investing and one of the things that I learned early on is that if you pick the wrong stocks, you’re going to lose money.

[00:01:53] Stig Brodersen: And you might be thinking, Stig, that’s so obvious. Like, yes, of course, you’re going to lose money if you don’t pick the right stocks, but I want to add something to that because it probably sounded too obvious. There is something to be said about buying high-quality businesses because if you’re right about the business, even though your valuation might be off, the company will grow into that valuation eventually.

[00:02:14] Stig Brodersen: One example could be Microsoft, it traded at a very high price compared to its value during the dot com bubble for example and it took, what, 16-ish years, depending on how you measured it before it grew into that valuation, but it eventually got there. Whereas if you bought the wrong business, you would have lost all your money.

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[00:02:31] Stig Brodersen: And I should also say that it is a bit courageous now, whenever Clay and I are talking about what is high quality businesses, there’s no exact definition of what high quality is. You can’t look up and say it’s exactly those 10 metrics and then it’s a high quality business with most things in life, it’s easier to say what quality is not.

[00:02:53] Stig Brodersen: Perhaps compared to what quality is and I think I heard from one of the book clubs that you did, Clay, that was it from what was the name? Like the Art of the Motorcycle Maintenance, something, called you whenever you see it. I think that was how it went.

[00:03:08] Clay Finck: Yeah. Robert Pirsig’s book, Zen and the Art of Motorcycle Maintenance. That’s a, it’s a grind to read through, but there’s those nuggets in there where, like that quote. When you see quality, it’s there when you see it and he talks about it in his first day in his classroom. He’s got a classroom full of students. They’ve never really dove into the concept of quality.

[00:03:27] Clay Finck: I mean, who really has, but, when he shows them like a high quality, he shows them two papers and he has everyone sort of grade each one and each everyone sort of agreed on what quality looks like. And that applies to so many things in life.

[00:03:41] Stig Brodersen: Yeah, and that’s very well said and I think I want to use that as a segue into talking about this study created by Besson Beiner.

[00:03:47] Stig Brodersen: And this is quite a famous study, at least if you’re into stock investing but yes, this study has been quoted quite a few times, and he’s using data all the way back to 1926. And he found that only 4%, I’m just going to say that again, only 4% of stocks outperformed U.S. government bonds. Now, originally this study was made on U.S. businesses, but it was more or less the same conclusion whenever he was looking at international stocks. I think it was even fewer stocks whenever he looked at international but more or less, regardless the conclusion still held true and you can look at this different ways. You can say, well, if only 4% of stocks are outperforming T bills, I don’t want to look for those companies because it’s just too hard, let me just buy an ETF.

[00:04:30] Stig Brodersen: And I think that’s a completely reasonable conclusion to make. You can also say, well, if stocks overall, despite this, are drastically outperforming T bills. Then you get really rewarded if you can find one of those 4% stocks and that’s what Clay and I are setting out to do in this episode. So yeah, let’s dive right in.

[00:04:52] Stig Brodersen: I want to start by talking about the business before I talk about the management and I wanted to put that disclaimer there and well, I should say why I wanted to do that because. Whenever I started out investing, I know a lot of the listeners, they’re, some of them are very experienced. Some of them are just starting on their journey.

[00:05:09] Stig Brodersen: I kind of feel I got blinded by these charismatic leaders, larger in life stories. And I think in another segment here, later in this episode, we’re going to talk about the importance of leadership, because this is not my way of saying that leadership is not important. It is very important, but it’s even more important what the business is more than, what the leadership is.

[00:05:28] Stig Brodersen: And I wanted to emphasize why being at the right place at the right time, that means a lot too. Bill Gates has famously talked about how him, Steve Jobs, Steve Case, clearly super smart people, but he talked about how they were at the right place at the right time and, if the three of them were born 10 years earlier, 10 years later, it was just the sweet spot in whenever personal computers took over the world.

[00:05:49] Stig Brodersen: And it was just a huge addressable market and this is not my way of saying that rise and tide lifts all boats. It’s not that easy. Many companies in the car manufacturing business and they’ve come and gone, but it takes me to the next point about barriers of entry. It’s just so important for a business that you have high barriers of entry.

[00:06:09] Stig Brodersen: It’s immensely difficult, for example, to be successful in retail for a sustained period of time or, to run restaurants, which is another sector with very low barriers of entry. You don’t have a lot of valuable IP you can protect. It doesn’t require your billions of billions in capital to go into that market.

[00:06:27] Stig Brodersen: And I’m not saying that it’s impossible in any means, you might be looking at Walmart or McDonald’s and great businesses for sure. But I also want to say that they’re the exceptions, they’re not the rule. And perhaps, and this is probably a story for another day, but McDonald’s business model is not so much built around food.

[00:06:44] Stig Brodersen: Yes, that’s important, but they have this entire wonderful business model around, around real estate. But again, that might be a story for another day. And so I guess this is my way of saying that Peter Thiel has this wonderful quote where he talks about the competition is for losers. And I couldn’t agree more.

[00:07:00] Stig Brodersen: You want to invest in companies without competition, if you can, but of course that’s easier said than done. There are very few of them. And those that do exist are under scrutiny from antitrust. Alphabet, meta comes to mind. Of course, I should say competition is good for us as consumers. But for us as investors, we generally don’t want competitors to the companies we invest in because they drive down margins and stock or shareholder return.

[00:07:27] Stig Brodersen: And I should also say with the lack of competition, you also have more pricing power. Pricing power is always important, but especially in a world with higher inflation. Consider a company with 10 million in revenue, 9 million in costs. If the company can just raise the price by 10 % without incurring additional costs, then they’re doubling the profit.

[00:07:48] Stig Brodersen: And I should probably also say in this quest that Clay and I have set out to do in this episode, we are not looking to find a company that has a competitive advantage that cannot be eroded. Like that company just. Unfortunately, it doesn’t exist, but you can find a company that has a competitive advantage that lasts longer than others, for a long time, and some probably would even argue today, a company like NVIDIA, they look like they have very strong competitive advantage, but even NVIDIA feeling the pressure of export restrictions and big tech companies that want to develop their own chips because they don’t want to be you know, depending on video.

[00:08:23] Stig Brodersen: And I can’t tell you whenever it will happen, but I am 100 % sure that Nvidia will eventually lose their edge. It’s just the world of capitalism. It’s an iron rule. And I think I want to stay in the world of semiconductors just here for a bit. One company that I found very exciting for a time was Micron Technologies.

[00:08:43] Stig Brodersen: Micron Technologies is an interesting company because it operates in what you call an oligopoly, which is basically just a fancy way of saying that you have a microstructure with very few competitors. You only have two others, Hynix and Samsung. And if you only have three players and they quote unquote act rational, they don’t compete on price, they compete on other things and they don’t drive down the margins, but even that is no guarantee and actually, it’s sort of like a cartel where as long as they don’t really call each other, it’s not illegal, but they can more or less go about that.

[00:09:15] Stig Brodersen: But even. that temptation very often, even if there’s only three players, are just so high in terms of breaching that cartel to gain more market share, which Samsung did and to some extent, eroded the business there for the three of them. Because it usually gets repaid in kind. If one company lowers the price, then the others also have an incentive to do that.

[00:09:34] Stig Brodersen: So it’s very difficult to find the perfect market structure. If you have a monopoly, you have antitrust issues. If you have oligopoly with just a few players, like we talked about before. Then you really rely on them to act rational and think long term, which is really hard. And then you also have other market structures where there’s a lot more competition, which by definition is even harder.

[00:09:55] Stig Brodersen: But of course, if you could choose, you want as little competition as possible. All of that being said, and perhaps this is my way of going back to the beginning here, the costly mistakes are really in not finding the right business. And I should say, even, if you bought Berkshire Hathaway back in 1965, whenever Buffett took over, like, even if you bought it at a P of say a hundred, you would still have made your money back, again, going back to the power of finding the right business.

[00:10:22] Stig Brodersen: But all of that being said, I want to throw it over to you. I kind of feel I rambled enough there, Clay.

[00:10:28] Clay Finck: Yeah, you make a lot of great points there, Stig, and I’m reminded of Chris Mayer’s book, 100 Baggers, which is sitting right behind me. The number one company in his study of 100 Baggers was Berkshire Hathaway.

[00:10:40] Clay Finck: So, if we are paying a PE of 100 for a company, we should be very careful because I don’t think the base rates are very high on Making a stellar return on that are very good. But the study you mentioned is quite interesting. The 4% study and I think it’s so easy for people to get intimidated by that 4% number and think, how in the world am I going to be able to pick the company that happens to just, outperform treasuries over the long timeframe.

[00:11:09] Clay Finck: But when I look at some of the research around quality investing, I think there’s still a case to be made that a lot of investors can still identify those companies that are high quality, or maybe they’re cut from a different cloth, for lack of a better term, and I like to fall back on some of these.

[00:11:27] Clay Finck: The ideas are these sort of rules of thumb that Chris Mayer talks about quite often. I’ll name a few of them here, strong balance sheets, a strong balance sheet, helps a company, weather through those really difficult periods. You can probably find a long list of companies that, had average or maybe weak balance sheets in the great financial crisis, and they couldn’t get access to capital markets.

[00:11:49] Clay Finck: And the stock essentially gets annihilated in that sort of situation where You know, they can’t cover their costs and maybe that leads to enormous share dilution at the worst time you want to issue shares if it’s even possible for them to do so. So strong balance sheet is something where it allows a company to endure for a really long time and weather through those difficult periods.

[00:12:11] Clay Finck: A few others here I’ll mention is just consistently profitable company that’s profitable. They have access to cash and they’re able to continue to weather through those periods. And I think there’s a case to be made that profitable companies that continually reinvest, they have high return on capital, usually tends to correlate well with stock returns.

[00:12:29] Clay Finck: I’m reminded of one investor in William’s book, Richer, Wiser, Happier. He talked about they’re just a simple idea. Stocks follow earnings. Some people might do well investing in unprofitable companies, but it’s just not the game I want to play. I think it’s a game that’s really hard. And I like games that are relatively easy at least.

[00:12:47] Clay Finck: And then managers with skin in the game is something we’re going to talk about today as well, Stig and obviously there are companies that do well that don’t have managers with a lot of skin in the game, but I think it makes it a lot easier to find these businesses cut from a different cloth.

[00:13:01] Clay Finck: I’ve recently been reading this amazing book. It’s called Quality Investing by Lawrence Cunningham. And Cunningham, he lists three characteristics that indicate a high quality business in his eyes. This is strong and predictable cash generation, so like I mentioned, profitable businesses, sustainably high returns on capital, and attractive growth opportunities.

[00:13:24] Clay Finck: Part of all this, I think is being lucky in some sort of sense, or a company just being in the right place at the right time and there’s the story of Bill Gates, he’s obviously very smart, but he was also born in Malcolm Gladwell talks about this in his books, where he was just born in the right city, he got introduced to computers at a very early age, and the rest is history, and there’s just so much to the story though too, in terms of the luck factor.

[00:13:51] Clay Finck: There’s a quote at the start of this book, Quality Investing. That’s a quote by John Ruskin. It says, Quality is never an accident. It’s always the result of intelligent effort and you mentioned Zen and the Art of Motorcycle Maintenance. He has that quote in that book. First thing, whether you’re mending a chair, sewing a dress, or sharpening a knife, He writes that there’s an ugly way of doing it and a high quality, beautiful way of doing it.

[00:14:16] Clay Finck: And I just absolutely love that quote and then, I can’t help but also mention Nick Sleep. He’s written that you really want to do everything with quality, as that is where the satisfaction and peace is. So it’s really turns into sort of this philosophical concept once you dive into quality but for the purposes of this discussion, we’ll stick to the investing side and it makes me believe that when you have a business that really puts in the work, they’re able to have some sort of first mover advantage, or they have some sort of opportunity to get ahead of their competition.

[00:14:47] Clay Finck: I think there’s just those situations where it’s just so difficult for businesses to chip away at that competitive advantage. They can see maybe a lot of what the company’s doing, but even if competitors, they quote unquote, do all the right things. I think there’s still those cases where it’s just so, so hard for other companies to replicate what the leader’s doing.

[00:15:10] Clay Finck: And it reminds me of what Christian Billinger told me on the show on episode 582. Christian said that sometimes it’s great when you find a quality company and It’s really difficult to clearly communicate what makes it high quality and when it’s difficult to explain and, tell others, what makes a company so great, then it’s more likely to be misunderstood or underappreciated by the market.

[00:15:32] Clay Finck: And I think this is part of the reason why people can get attracted to these super high quality businesses. Maybe they have, they’re trading at higher multiples. You can look at the financial, these of these companies, you can see the earnings, you can see the assets on the balance sheet. There’s really no debating it.

[00:15:48] Clay Finck: But when you have a quality business, you’re also making a judgment about the future. How long can they grow? How much capital will it take for them to grow? And that’s really where a lot of the difficulty lies as well as, what sort of future is coming for the business. And I mentioned that quote about quality not being an accident and being the result of intelligent effort.

[00:16:11] Clay Finck: I personally not to, don’t really like to have to guess where the company is going to be a few years down the road, say three years out. If a company has grown, say for 10 or 15 years, then odds are that probably wasn’t an accident. And you see that sort of consistency. It’s very predictable. They have a model that’s very repeatable.

[00:16:33] Clay Finck: And it’s pretty reasonable for me to believe if nothing materially changes within the industry or nothing materially changes within the company, Managers have skin in the game. Then, that helps give me the confidence in being able to forecast growth, just say, for the next few years. And that really gives me comfort in figuring out the right price I should be paying.

[00:16:53] Clay Finck: And Cunningham, of course, talks about valuation in this book as well. He said, quote, Quality companies thrive in the long term, but stock markets tend to overweight the short term. And that long term versus short term focus is so, so important to understand. He talks about how Wall Street is just so short term focused and really, they’re rewarded on, oftentimes, quarterly or annual results.

[00:17:15] Clay Finck: So, oftentimes they’re buying stocks that they believe are positioned to outperform in the short term. They might be going out and buying Apple even though it’s trading, at an all-time high in terms of its multiple. And they just think it’s sort of a momentum play and all these funds are allocating to these mega caps.

[00:17:33] Clay Finck: And he also points to the declining average holding period in the overall stock market and how over a one year time period, 80% of the moves in stock prices are explained by the change in the multiple. And to me, that’s just sort of random. You can’t really predict whether the market’s going to re rate a stock from a 25 multiple to a 30 over the next 12 months.

[00:17:56] Clay Finck: Like I’m not in the game of predicting that, but the most important factor in the long run is not the multiple, but it’s the earnings growth. And that points to your point earlier where, the business quality and where the business is going to be in the long run and not so much how the market’s viewing it in terms of the multiple.

[00:18:14] Clay Finck: So if you’re investing for the short term like many on Wall Street, then you should probably put a lot of focus on the multiple you’re paying. If you’re investing in quality businesses for the long-term, then earnings growth is what ends up being most important.

[00:18:28] Stig Brodersen: Yeah, and I think you make such good points here, Clay, about the short term and the long term, because we often tend to think that what other people are doing, which might not be what we’re doing, that’s crazy.

[00:18:39] Stig Brodersen: Like, why would they do that? And I think you point to a really good point of we have different motives, let’s say, let’s look at Berkshire Hathaway right now. So it’s trading at the time of recording 357. So what is the intrinsic value of that? Let’s say it’s probably north of 400, perhaps 450.

[00:18:56] Stig Brodersen: We can always go into a discussion about that, but let’s just say that is more or less the intrinsic value. So is it crazy to sell Berkshire Hathaway today? It depends on a lot of things. Perhaps if you want to go out and buy it now and someone is selling, perhaps they found something that’s even more undervalued, that they would rather own.

[00:19:14] Stig Brodersen: So that’s not crazy. Perhaps the seller is a retiree that is well aware that Berkshire is undervalued, but You know, he needs money to live on and he perhaps can’t afford the risk of even though that Berkshire Hathaway is, he agrees that it’s undervalued, it can still tank and he’s well aware that it can tank.

[00:19:31] Stig Brodersen: So, you have to consider that if he has to pay rent next month. And so I think it’s important to understand that people just come from different angles and perhaps you’re 25, perhaps you have, I don’t know, four year investment horizon and you don’t have a very broad universe and you really love Berkshire Hathaway.

[00:19:47] Stig Brodersen: Well, in that case, it’s probably crazy to sell it. Especially if you’re sitting on some capital gains. And so I think that really also goes to Clay’s point about Wall Street might act crazy, but if their incentive, if they get a bonus next quarter, well, perhaps it’s not crazy for that person. But anyway, speaking of Berkshire Hathaway, Warren Buffett, he has this wonderful quote he talks about that you should invest in a company that can be run by an idiot because one day someone, well, and I think with that in mind, it really goes back to this idea behind, it’s really the characteristic of the business more than the management that’s important but it’s also very important to focus on the management.

[00:20:28] Stig Brodersen: If we talk again about at Warren Buffett. That story has been told many times about, how he bought Berkshire Hathaway and how he felt it was probably one of the worst investments decision, if not the worst investment decision he ever did, because it was a terrible textile mill.

[00:20:42] Stig Brodersen: And in today, it’s a sprawling conglomerate, but if he had continued to plow money back into and wanted to continue for that to be a textile mill, like there’s no way it would be the company it is today. And so. That was a management decision. Like it was an active management decision to move away from that and then invest into something else that was way more profitable.

[00:21:01] Stig Brodersen: So I think that’s important to keep in mind. Another thing to keep in mind is to avoid double accounting. So let’s say that you’re looking at Apple right now and you conclude that Tim Cook is a fantastic CEO, which he is, and you say, well, this is how much it’s grown in the past and because it’s Tim Cook, that’s leading the company is probably going to grow more because we really have to put a premium on great management.

[00:21:23] Stig Brodersen: Well, you can already look at the track record of that great management. So it’s really important you don’t do double accounting because you can already see what has happened. And we would like high insider ownership.

[00:21:34] Stig Brodersen: Now then the question comes, what is high insider ownership? Is it 5%? Is it 20%? It’s very difficult to answer. And I think more than an exact number because everything else equal, you would say that the higher, the better. You want to investigate how has the management, especially the CEO built their ownership stake.

[00:21:54] Stig Brodersen: Preferably want the company to be found to let, there’s a lot of caveats to that, but you would preferably want that. They typically have a high insider share just from the sheer fact of them founding it originally owning close to a hundred % of the company, if not all of a 100% before it IPO’d.

[00:22:10] Stig Brodersen: And there are multiple studies that support the thesis of founder companies and that they typically perform better. They don’t take excess leverage. They have a very long term view. And some companies that we might think of today could be a company like Meta. LVMH is another. For a long time, you could say Amazon and Alphabet.

[00:22:27] Stig Brodersen: Now the founders are sitting at the board. Another thing I look for is frugal management. Mark Leonard, CEO of Constellation Software, travels on his own dime. He doesn’t take a salary. I should also say that he’s the exception and not the rule. Unfortunately, that’s the way it is in corporate life. And you would also want a higher ownership from insiders.

[00:22:48] Stig Brodersen: Ball in the open market if that’s possible. not through stock options. But that is a very tall order and that’s, it’s not something you regularly see. The board of directors for Berkshire is the exception. It’s certainly not the rule. Very often it’s through stock options that the management would have acquired their ownership stake.

[00:23:07] Stig Brodersen: You also want to ensure that KPIs are set for the management. That’s within their control and aligned with shareholders. My favorite metric is a return on investor capital. If you see someone being compensated sold based on earnings per share, you probably want to run away screaming. There’s just so many misalignments there with debt and financial engineering, and it’s just terrible. Another thing I like to do is I like to read the earnings transcripts or sometimes listen to the earning transcripts if I can.

[00:23:33] Stig Brodersen: I’m a bit guilty here because the main reason why I don’t listen to them is because it’s hard because they’re typically a lot of numbers and they’re easier to read but also because I cannot figure out how I can read them at like 1. 5 speed or two times. Like, it just drives me crazy how slow it is.

[00:23:48] Stig Brodersen: But anyways, go through the earnings transcripts and you can quickly tell how well the executives understand capital allocation. Often, they don’t. Being a great capital allocator is very often not how you become the CEO in the first place. And I would also say that of those who do speak like good capital allocators, in our world, there’s a lot of people who talk Buffett fluently, they talk the talk, but do the walk, and you have to go back and look at the track record for how do they allocate dividends, share repurchase, how do they act on acquisitions.

[00:24:20] Stig Brodersen: And so, before I throw it back over to Clay, I should probably also say that lots of disclaimers here. I hold the shares in Berkshire Hathaway and I mentioned the Constellation Software, even though I actually pitched it a long time ago on the mastermind meeting, I was not smart enough to actually buy shares in the company. I think you did, Clay. So I just want to put all the appropriate disclaimers out there.

[00:24:41] Clay Finck: Of course. Yeah, I do own shares in Constellation Software and you make just great points on insider ownership. In the end, I think it really comes back to the incentives if the CEO or whoever’s on the management team, if they clearly have a significant portion of their net worth tied up in the company, then I think that’s a pretty good sign.

[00:25:05] Clay Finck: And you also make a good point of how did they get those shares? Was it just handed out via stock based compensation or did they purchase the shares on the open market? You might have one CEO that makes two and a half million dollars a year and they have 10 million invested in the stock. But a lot of that might’ve been acquired through stock based compensation.

[00:25:24] Clay Finck: That’s not necessarily a bad thing, but it’s just something to keep in mind in terms of the incentives. How did they get the shares? Was it just handed to them or did they go out and purchase it themselves? And then you might have another CEO that makes 250, 000 or 500, 000 in a year. And then they have say 5 million invested in the company.

[00:25:41] Clay Finck: And on top of that, very little or no stock based compensations performed. You see that they purchased those shares in the open market maybe five or ten plus years ago when the stock was way lower and then they’ve made all these long term decisions that have played out well for them. So when it comes to insider ownership, there’s definitely not a hard number.

[00:25:59] Clay Finck: It’s just getting a sense of how managers are incentivized and then getting a sense of whether they’re working for the company to enrich themselves. Or if they’re in it to make the best capital allocation decision for shareholders. So, it’s like, getting clues to give us an idea of where the manager’s head is at where their mind is thinking.

[00:26:20] Clay Finck: And you mentioned Mark Leonard and, paying for his travels on his own dime. I think that says a lot about where his head is at. Like, who’s he thinking for? Is he thinking for himself or is he thinking for shareholders in terms of that one decision there? So, what kind of shareholders are managers trying to attract?

[00:26:36] Clay Finck: All these can serve as clues. But there’s no one hard rule for what makes an exceptional manager. You can look at the compensation structure, the bonus incentives, stock repurchase programs, their dividend policy, and then I also like to think about whether management and the CEO is overly promotional or not, or are they just working on the business, keeping their head down, and not really talking with the media at all.

[00:27:03] Clay Finck: And naturally, I think newer investors naturally get excited about the overly promotional CEOs. They turn on CNBC, they see the interviews, they see whoever, CEO, you can, I won’t name names here, but you know, some people tend to be on in the news headlines every single week. And part of me gets really excited when I see a company with a really great track record, exceptional track record.

[00:27:29] Clay Finck: There’s little to no analyst coverage. The company doesn’t really care about chatting with Wall Street and I try and find some interviews with the CEO and you can’t find a single one. It’s just like a totally private person. And those are clues for me that the company might be overlooked. A lot of retail investors probably aren’t interested or probably don’t even know the name exists and they aren’t on the radar for a lot of people.

[00:27:53] Clay Finck: At the end of the day, we really want managers who are good stewards of shareholder capital. And I think a fantastic book for this is William Thorndike’s book, The Outsiders. We’ve covered this book a couple of times on the show. You and Preston did one and then I did one as well just because it’s so good.

[00:28:11] Clay Finck: And it really gave me a better sense of what a quality manager looks like. That’s in quotes there. Some of the things that come to mind from that book is just discipline, patience, independent, and thinks long term. When these great opportunities come, they’re willing to make these really bold bets when these great opportunities present themselves.

[00:28:30] Clay Finck: And then. Just basic principles to live like a good life. Honesty, integrity, operating with a high level of ethics. It’s all sort of clues you want to try and dig up and all these items I mentioned earlier in Lawrence Cunningham. He had this quote that I absolutely loved that I wanted to share here.

[00:28:47] Clay Finck: Good managers are never satisfied but are instead driven by an indefiable and passionate quest for improvement. And company performance, it really comes down to people at the end of the day, and we want to make sure that we’re partnering with good people with high levels of integrity.

[00:29:05] Stig Brodersen: Yeah, and Clay, if you allow me to pull on that thread about managers never being satisfied, I think that’s so important.

[00:29:11] Stig Brodersen: And I like to use metaphors from sports and you can just tell from some players, whenever they win their first championship, they’re like, they’re golden. They’re set. And then they’re just not as driven anymore because they already won. And then there are others who are thinking, well, I won one.

[00:29:25] Stig Brodersen: So I’m just getting started. I need to win a lot more. And., I think that’s also very telling of managers. I look at Elon Musk, he made so much money from selling PayPal that he could be riding into the sunset. Did he do that very much? No. And he founded Tesla and SpaceX and he was about to go bankrupt.

[00:29:48] Stig Brodersen: I want to say multiple times. I think you just read this book and I think you’re going to do an episode on that soon, Clay. So you probably know that, but like, I want to say, I read the first book about, or one of the books, the one that Ben something wrote in 16 and whatnot and I think he was telling something to his wife or ex-wife about like, he was willing to move back with his parents because he wants to put everything into his new businesses.

[00:30:08] Stig Brodersen: There’s just a selection bias there or someone who’s willing to, and a selection and a survivor bias to someone who is willing to put everything into the businesses and not being satisfied. There’s a lot of truth to, you have the Intel founder Andy Grove, and he has this, I want to say what’s the name of one of his books, or perhaps the book, only the Paranoid Survives.

[00:30:30] Stig Brodersen: You want to, if you want to compete for the best in business and sports, you can never be too satisfied because it will just make you complacent and as soon as you become complacent, someone’s going to eat your lunch. And Mark Cuban, he has this book that we covered, it was a long time ago Preston and I read I don’t even remember his code or something, but I remember he talked about the greatest sport in life is the sport of business because it’s 24/7.

[00:30:54] Stig Brodersen: I absolutely love that quote. I think that’s so true. So for the highest quality companies, you’re looking for management that’s never satisfied and they can really channel that eagerness into value for shareholders. And because there’s just so many examples of management that are becoming dissatisfied, perhaps even bored.

[00:31:11] Stig Brodersen: And then all of a sudden, they start deploying capital into ridiculous projects. And I feel that I don’t want to be the guy who’s talking about the most successful people in the world and say, oh, but like, they have terrible relationships. I kind of feel it’s in a way, it’s a little unfair because it’s almost like you want to say, yes, Elon Musk has so much more money than me, but you know, he has terrible relationships.

[00:31:39] Stig Brodersen: And I should also say for the record, I also know people without money that has terrible relationships. So it’s not an either or, that’s not my point. But I think there was something to be said about those people who have that drive and you almost need to be a bit of, I don’t know what the right word here is without it coming across as too negative, but like you have to wake up and have a billion dollars and be like, no, this is not enough and have that personality. And I kind of feel like most of us would probably, if we woke up one day with a billion dollars, be very satisfied and perhaps chill more.

[00:32:12] Clay Finck: Stig, you’re really tapping into something there where I mentioned the term cut from a different cloth.

[00:32:18] Clay Finck: And I can’t help but think of the company, Kyle Grieve, and I just chatted about Dino Polska, that episode we did. I own shares in this company, so I’m not trying to pump my own stock, but I just want to mention just one thing with that company that just, it just sort of blows me away. How this guy starts this retail business, which we said isn’t the best industry to get into, but they seem to be sort of an exception so far at least, similar to a Costco or Walmart.

[00:32:44] Clay Finck: And this guy starts this company in the late 90s. He ends up selling a bit of his, he sells 49% of the business to raise funding in 2010. So from 2010, he had a 51% stake in this business, and he was just all in growth mode. Like they had something like a hundred stores now and now they have over 2,000 stores.

[00:33:08] Clay Finck: In the last 13 years, he’s never sold a single share and this company’s just been a compound machine after, ever since then. And I’m sure in 2012, 2013, 2014, he could have just sold a bunch of his shares. hired someone else to run the business and go live a wonderful life. And for him, I’ve never listened to an interview with him or anything, and he’s not a public guy.

[00:33:31] Clay Finck: And it just seems that there’s something there where he’s just, he loves the game of business. If I had to just based on all the clues, I’ve seen in terms of the studying the company, reading their reports, diving into some of the capital allocation decisions they make, they reinvest a 100% of cash flows.

[00:33:50] Clay Finck: And I think he could be a case study of an outsider type CEO. So it’s just you really have to be cut from a different cloth to have that sort of time horizon where I’m not thinking one year, two year, three years out. I’m thinking like decades out. So I can like, hand these shares off to like, my grandchildren someday is probably some of the things he’s thinking.

[00:34:09] Clay Finck: So I think it’s just such an interesting point in a case study. It’s sort of why you and Preston started the show. It’s like these really successful people, what makes them click? What makes them get up and work 12 or 16 hour days like Elon Musk?

[00:34:24] Stig Brodersen: Yeah, and that’s the point because most people would be listening and saying, that doesn’t make any sense.

[00:34:29] Stig Brodersen: If I had a billion, I mean, I guess a lot more than a billion dollars, like I would stop working. But that is exactly why he has so much money because he does have all that money and he’s still working. And so there’s this selection bias, if you ever watched the last dance with it was the bulls in the, in, in the nineties, you could just see how insanely competitive Mike Jordan is.

[00:34:48] Stig Brodersen: And you would be thinking with all those championships and with all his glory and money. And why didn’t he just stop? He did though. But that was to play baseball and then he stopped again. But like, why didn’t he stop way sooner with all that’s going on. But that’s because he was so competitive and so you’re absolutely right, clay, you can’t really compare cause it’s just, yeah, just cut, confirm different cloth.

[00:35:09] Stig Brodersen: And I was speaking with Manish about this the other day and we were talking about serial acquirers and he was basically saying that’s a terrible business model. And then I said, what about Mark Leonard and Constellation Software? And he said, look Stig, it’s just cut from a different cloth.

[00:35:24] Stig Brodersen: You can’t even, like, you talk about serial acquirers in general. That sucks. But then you have a select few and what they do is just in their own league, regardless of what they’re doing. So you can’t even compare. I think it’s important to, to think about that also whenever, we have these disclaimers about, it’s really the business.

[00:35:42] Stig Brodersen: It’s not the management. There are some type of management also makes the business. And I never owned shares in Tesla or anything like that, but I’ll be the first one to say, I can see why a character Like Elon Musk can drive things in a different ways for better or for worse than other CEOs can. So let me see if I can rope myself back in talking about high quality companies.

[00:36:02] Stig Brodersen: So what am I looking for here? Can we filter on any key ratios? I think the short answer is yes, but we’re also coming with different disclaimers. open any investment book, listen to any podcast. They will tell you how flawed any metric is that you’re looking at. And that would be right. So it’s the nature of investing.

[00:36:20] Stig Brodersen: You cannot find one key metric that explains everything. If it was that easy, there were no money to be made because everyone would be looking at that metric. And the future is always unknown and stock investing is certainly no different. History can give you clues, but it’s really the future cash flows that’s all that matters.

[00:36:36] Stig Brodersen: But if you really put me on the spot and you asked me to pick one metric, for me, I would say it would be ROIC, or Return on Invested Capital. I would also say that Return on Capital Employed would come relatively close. It’s really an imperfect proxy of the quality of the business. And if you see a company with a long track record of a high ROIC, and you estimate that it will continue to do so, you likely have a winner in your hands.

[00:37:03] Stig Brodersen: And over time, you will find that whatever that number is for your ROIC, that is the return that you will get, especially if you hold it long enough, more than necessarily multiple that you paid. And so why is that so? Well, A company with a high ROIC, it tells you that it’s probably operating in the industry with good growth opportunities.

[00:37:24] Stig Brodersen: You probably also have good capital allocators, probably also in a good sector and they think really well about how they, well, I also already mentioned allocated capital. So how much is put into buybacks, dividends, how much can be reinvested back in the company. And that is really key ingredients for the success of businesses like Berkshire Hathaway.

[00:37:47] Stig Brodersen: That’s for example, not paying a dividend. Then you also have LVMH that’s actually paying a dividend, but they’re doing it in a very intelligent way because if they can’t deploy the capital in a good way, it’s also better than they pay that out to investors. And you want them to have an incentive to send money back to the headquarters.

[00:38:04] Stig Brodersen: So the capital allocators there can deploy it the best possible way and I actually spoke with someone from the mastermind community that is speaking or have information for the management from the CEO branch of LVMH, for example. And they are compensated based on ROIC, which I don’t think is any surprise.

[00:38:22] Stig Brodersen: Whenever you look at the track record, you have companies like Alphabet and Apple, they have ROICs higher than 20% for many years and you can also. I always have all of these disclaimers, that’s because numbers tell you one, one thing, and you always have to dig deeper. You could argue that a company like Amazon would have that too, but then you have to adjust for the growth.

[00:38:42] Stig Brodersen: So if you calculate, you can argue that they don’t have, but you can rearrange the numbers, which is a bit difficult to do here on the podcast. But then you can see that they have a really high return on investor capital, but perhaps not in the reported earnings. So I keep on saying ROIC, as you probably just mentioned, once again, is a turn on investor capital.

[00:39:00] Stig Brodersen: You also have a very late number return on capital employed. It’s almost the same. One is before tax. Another one is after tax. There’s something with short term liabilities. There were a few differences there, but you can just think of it as. If you put money into this machine, how much is it spitting out on the other side of it?

[00:39:19] Stig Brodersen: Just to make it as simple as possible. And then of course, another advantage, and one of the reasons why Berkshire has been so successful is because they don’t pay out a dividend and because they’ve been able to reinvest back that into the business for decades and decades. So that also gives you a tax advantage because you could be sitting on those capital gains, whereas you will be taxed on the dividend. So, you can seem to wait and let that compounder compound.

[00:39:43] Clay Finck: Stig, I wanted to transition here and mention some of the challenges as it relates to investing in high quality companies. It’s so easy to read books like this one by Cunningham or read Chris Mayer’s book. But as we talk about often times, Stig, most things in life, business, investing, aren’t easy.

[00:40:02] Clay Finck: You have to sort of choose your heart, right? And the first challenge I wanted to mention here that comes to mind is that although quality companies can deliver high returns, there can also be periods where, you know, frankly, it’s just quite boring. I’m reminded of the hunter bagger study where he mentioned Berkshire Hathaway.

[00:40:21] Clay Finck: It was the best performing stock in that study, but there was like a five to seven year period where the stock went nowhere. So, obviously, long term investors in that business had to be extremely patient, patience is absolutely required in letting that magic of compounding work for you, and you should more so focus on what’s going on with the business, is Berkshire reinvesting, are they making wise capital allocation decisions, and pay a little bit less attention to the stock price, because I’m sure after that period of it going nowhere It had pretty good returns after and it kind of caught back up with itself.

[00:40:55] Clay Finck: And I’m also reminded that Chris Mayer mentions this time and time again, that these compounders or high quality businesses, they tend to have significant draw downs. Berkshire Hathaway for example, they’ve been their stock has been cut in half four times over its lifetime and Netflix is another example that’s sort of been a highflyer.

[00:41:15] Clay Finck: They’ve had four drawdowns of 25% in a single day. I mean, talk about testing your conviction 25% drop in a single day. Investors tend to get spooked with that company on their subscriber numbers and whatnot. And there was one period where Netflix dropped by 80% and seeing an 80% drop in a stock.

[00:41:36] Clay Finck: I mean, I can’t imagine that the base rates are very high on it recovering and making new highs. So the market definitely has a way of testing your conviction in most companies and testing whether you actually know what it is that you own. And this is actually a checklist item for me. I like to think about, I like to just ask myself if this stock were to decline by 50% over the next 6 to 12 months, which is entirely possible with a lot of stocks, whether we go into a recession or whatnot.

[00:42:03] Clay Finck: If it were to decline by 50%, how would that make me feel? And if I start to get feelings of anxiety or start to get anxious, then maybe there’s something with the business that’s unstable or there’s some sort of fundamental vulnerability. It’s sort of like a gut check. It’s like checking with your gut on how you’d feel and you put yourself sort of in that situation mentally.

[00:42:27] Stig Brodersen: Yeah and I should also say it’s easier said than done because very often whenever you do see that 50% drop, there is a really good narrative to it and so whenever we think about how would I feel if this was like 50% off, we might be thinking, well, nothing changed. So I would love to buy more CS for the same price.

[00:42:46] Stig Brodersen: but that’s very often, unfortunately, whenever a stock trades down 50%, perhaps not in the case with Berkshire Hathaway, it does so for a reason. One painful example that I have and I’ve mentioned it a few times because I learned so much from the painful experience of him investing in Alibaba was that it dropped 50% not for my average price but it did drop 50% but it also did that for good reason, unfortunately. And so I actually did buy some back and then I lost even more. But it doesn’t work in a vacuum and having that conviction is really important. So it’s one of those things that intellectually makes a lot of sense and then you see it happening and you go like, wait, it’s not that easy.

[00:43:30] Clay Finck: Yeah. It comes back to being really diving in and understanding the business. I am of course, no expert on Alibaba, but when you feel that the Mo is really strong and you feel confident in the business and its long term prospects, then. Of course, a 50 % drawdown should be one of the best things to hear because the stock is now essentially trading at a bargain and your prospective returns are higher.

[00:43:56] Clay Finck: And yeah, that’s the trick that that’s the sort of trap that a lot of investors find themselves in where they get excited about a business, buy it when the stock is rising. It’s so much easier to buy a stock when it’s rising than when it’s falling. They can fall into that narrative of.

[00:44:11] Clay Finck: Oh, this is, price follows narrative. So whenever the price falls, people do sort of have a narrative behind that and oftentimes there is good reasons for the stock price falling. But sometimes it’s just Mr. Market sort of gyrating and throwing its fits and when a company on my watch list is going through some turbulence in terms of the stock price, I also like to see, like, is that normal within its history?

[00:44:34] Clay Finck: There’s one company I added to this year. It was down nearly 50% and then I looked at the fundamentals and it wasn’t really the case of like something like Alibaba where there’s a lot of pressure on the business. I look at the underlying business and the business seems to be growing and doing as good as it’s ever done.

[00:44:54] Clay Finck: And I look back at this company’s history and it’s had a 50% drawdown in 2022 and then it’s had a number of 30% corrections in the past and I just saw it as a really good opportunity and I’m also reminded of the interview I just released with Andrew Brenton where he’s able to outperform not only the market, but outperform his own investments because he’s adding at those opportune times and, it’s obviously it’s easier said than done.

[00:45:20] Clay Finck: And I’m also reminded we just did an episode on Dino Polska. And it quickly traded down and I was able to get an average price around the 360, 370 range and then in a matter of weeks, it rose up to around 460. It’s something like that right now and that’s not me saying like, Oh, I’m like a master market timer or anything.

[00:45:43] Clay Finck: It’s just so easy to think I can get in at a lower price. I’ll wait for the future to be more clear about this business or. It’s so easy to think, I’ll get a better price later. And I just view it as short term thinking when you’re trying to time when the market is, and you just have to be able to see the opportunity and then be able to hold on and if the facts changed and maybe you end up selling it at a loss later, if you determined you were wrong about the business.

[00:46:09] Stig Brodersen: We might be taught in school at least, if you go to business school the markets are efficient and then you start your education in value investing, you realize that’s not the case but there’s also something to be said about the market very often is somewhat efficient.

[00:46:22] Stig Brodersen: So if it does drop, there’s very often a reason for it. Perhaps it’s a value trap and so there might be a stock that used to trade at, I don’t know, 100 and you felt you wanted to take a position because the intrinsic value was 200 and now it’s sliced to 50 but now we also have to adjust, what’s the intrinsic value now?

[00:46:41] Stig Brodersen: Are you still buying it at a 50 % discount? And then you go into all of these kinds of thoughts of, well, it might still be selling at 50 % to its intrinsic value, but now it’s not a high quality company anymore. And we just talked about at the top of the episode that, time is the friend of a wonderful company and the enemy of a poor company.

[00:47:00] Stig Brodersen: It’s not that easy as perhaps we make it out to be here and short term it can also look like, hindsight’s always 2020 and if you’ve been one of those who’ve been holding on to Berkshire Hathaway and it took, a 50% drawdown, if you’re going to look like a genius because you held on but, perhaps whenever Berkshire were trading at $12 in the mid-1960s, you were like, no, I’m going to wait until it goes to $11 for in [Inaudible]

[00:47:26] Stig Brodersen: And then it never did and now it’s like more than a half a million dollars and so it’s not that easy but what I hope what you get out from out of listening to this episode is what’s the framework you’re going to apply when you’re looking for these high quality businesses.

[00:47:41] Clay Finck: Yeah and I think another point there, obviously there’s the Benjamin Graham saying of the markets of voting machine in the short term and a weighing machine in the long term and one of the things I like to think about or consider, obviously each company and each situation is different, but I think one positive sign is seeing, if the stock price goes way down and the company starts repurchasing shares opportunistically. I think that’s a pretty good sign and I know [Inaudible] has done that in the past where they have a really strong balance sheet, the stock traded way down and they start repurchasing those shares.

[00:48:16] Clay Finck: And another sign I think is quite interesting to think about is when you see a CEO or a manager start repurchasing shares themselves, making a major purchase in the company. I think that’s also a really interesting sign that, hey, managers, they have plenty of reasons to sell a stock but there’s probably only one reason they’re going to Buy a stock and that’s because they think they’re going to make money doing so transitioning back here to some of the challenges with quality investing.

[00:48:43] Clay Finck: Cunningham, he listed four challenges that I wanted to mention here in his book, quality investing. So the first challenge is to have a long term outlook, which is, we’ve talked a lot about in this discussion, thinking in years five plus ideally five plus or more instead of a few quarters.

[00:48:59] Clay Finck: And he also tells the example that I really liked how he pointed out the power of compounding and how important your rate of return is. You talked about return on invested capital and how returns sort of tend to correlate with that. He writes, the concept of compounding is one of the most important and valuable ideas in the world of business and investing.

[00:49:18] Clay Finck: Its power is relatively invisible over short periods of time but galactic over long periods of time. Consider an investment of 10,000 that earns 10% or 7% annually. So you have two different scenarios here. During a single year, that amounts to just a 300 difference in your investments in those two scenarios.

[00:49:40] Clay Finck: But if you expand it out all the way over 25 years, very long term, it adds up to a difference of over 54,000. So the 10% annual return won. Investment is worth twice as much as the one yielding 7%. So really putting focus on I’m reminded of Chuck Ockrey. He said, investing is all about your rate of return in this concept.

[00:50:01] Clay Finck: It really applies to everything in life. You can how just the small things they really matter. Looking for those clues, you can know in other areas of life, you have your health, your relationships, your work, the small things matter because over the long run, they add up to really big things.

[00:50:17] Clay Finck: And I think of individual investors, they adopt that long term approach. It can really give them a massive leg up over. a lot of other investors. The second challenge he mentions here is living with short term underperformance and those years of pain where the stock’s not going the direction you want it to all great investors, they always have periods where they trail the markets. 2021 when markets were euphoric and irrational, I’m sure many great managers underperformed the NASDAQ or whatever else, underperforming these highflyers that are sort of carrying the indexes or carrying the markets.

[00:50:51] Clay Finck: And It’s estimated that quality companies, Cunningham states, quality companies tend to underperform the market every two or three years out of every decade. So, yeah, Chris Mayer and I talked about this too where these great managers, they always have periods where they underperform and the key is to stick with your original strategy and not, being swayed by whatever the market’s doing.

[00:51:13] Clay Finck: Then the third challenge is that quality is very subjective and it’s based on these qualitative factors. You can’t just look at a number and just buy based on the numbers alone and the quote he has here in the book that I thought just rings so true. It’s easier to explain that a stock is cheap than a company is great.

[00:51:30] Clay Finck: So, investors that are able to look under the hood, get a good understanding of the business, the market dynamics, that can give themselves a big edge if the company is generally misunderstood and underpriced by the market and then the fourth challenge here. I’ll mention before I throw it over to you, is that this approach can be essentially boring quality businesses in a way they’re explained in the book at least they tend to have products that aren’t going to revolutionize the world.

[00:51:57] Clay Finck: Tesla obviously is like a 50 or a hundred bag or whatever, and has all these great products, but most big winners aren’t like the Teslas of the world that get all the attention, like I mentioned Copart, who wants to analyze and study like a junkyard business that just, has these strong, steady returns year after year.

[00:52:15] Clay Finck: Not very many people are willing to sit on that. So it can, it’s businesses that aren’t typically making headlines. They aren’t going to double or triple, in a few months, like, like what a lot of investors are trying to do if they’re newer to the markets. These businesses just tend to be really simple.

[00:52:32] Clay Finck: They’re management teams that just do the same thing over and over again and they find this formula that works for them and they’re able to implement this formula for decades over time and Cunningham points out that some sophisticated investors, they sometimes get interested in these obscure companies or turnaround situations, or even a company with a, like a revolutionary product, like an Nvidia, that takes a lot of understanding in terms of market dynamic, there’s plenty of money going into that space, I’m sure, which is, I like businesses that are.

[00:53:05] Clay Finck: Simple for me to wrap my head around and this approach, it really requires you to stay disciplined and stay away from the new shiny objects that come up every few months.

[00:53:15] Stig Brodersen: Yeah, I’m really happy that you say that I was speaking about micro technologies before, sort of like to your point about semiconductors and so I was invested in that company through Minus’ fund but I was very excited about it. I saw Li Lu take a big position. He usually never trades anything in the States and I think a lot of the followers here at the show, they know how much we respect Lee Liu, partly because of his own track record, but also because it’s the only person Charlie Munger I have trusted his money with.

[00:53:42] Stig Brodersen: And so, he speaks so highly about him. What Li Lu does just always seem to make a lot of sense and so he invested in micro-technologies at some point in time and he also made a decent amount of money and now he’s out, but I couldn’t help, but think, okay, so Mohnish has invested in Li Lu invested in Micron.

[00:53:57] Stig Brodersen: I think even Mohnish, he mentioned, I don’t remember if it was on our show or it was one of his, the other interviews he did where he talked about. No, he got the blessing from Charlie Munger that it was a great pick. I don’t, I never saw it on Charlie Munger’s 13F, but like, he was looking at it like, yes, like God himself has said my technology is, and I was looking at it and I was like, I just don’t understand it.

[00:54:17] Stig Brodersen: I was reading a book about semiconductors and I went through the theory and I was like, I just don’t think I’m wired that way. I don’t think I’m supposed to be invested in that company. So anyways, I think it goes back to this idea behind only invest what you understand.

[00:54:34] Clay Finck: So you bring up a great point there, Stig. You can see all these people get into a certain investment but the good news is there’s countless opportunities in the market. If you find a great company and you just decide, it’s just not at the right price or it’s. It’s just not a business I can fully understand.

[00:54:51] Clay Finck: There’s always other companies out there. You probably just maybe haven’t found yet or you haven’t researched enough. There’s always new opportunities and, markets are always moving. Prices are always changing and for example, we’re going to be chatting about our mastermind group and, people are always sharing companies in there.

[00:55:07] Clay Finck: And for me, like, this year it’s been, it’s really been a year of change for me in terms of my portfolio and like selling a good amount of my index funds, holding a little bit of cash, always looking for the next opportunity and like right now I have something like a 5 or 6% cash position and I’m kind of waiting for the next opportunity.

[00:55:27] Clay Finck: I’m looking to find, and I don’t know when it’ll come, but I’m, have that confidence that eventually come around. Maybe Mr. Market will give it to me, or maybe I’ll just find some new idea.

[00:55:36] Stig Brodersen: I think if there’s one thing to take away from this episode about high quality investing is that. It’s really all about compounding.

[00:55:45] Stig Brodersen: Preferably you would like what Chris Mayer, and we’ve mentioned Chris Mayer quite a few times here, but he is, he’s an amazing ambassador and he talks about the double engines, right? So you’re buying at a low multiple, but you’re also buying a company that’s going to compound its earnings. So you have those two engines.

[00:56:02] Stig Brodersen: I’m going to do the humble brag and say that a year ago I bought into Spotify and I want to say I bought in at like 78, 79, something like that. It’s run up 150%. So I’m only mentioning that as a humble brag because it never happens. Whenever I buy a stock, it always drops. So for me to make 150% usually it never happens, but that is sort of like one of the examples of the double engine.

[00:56:21] Stig Brodersen: You’re buying a great company at a low multiple, then earnings go up and you have the multiple expansion too and I should also say, if you do go in and look at Spotify right now, I still think it’s reasonable value. I think I’m going to talk about it perhaps in one of the mastermind episodes here soon, but you have to adjust the earnings.

[00:56:37] Stig Brodersen: Otherwise it looks completely messed up, but that’s sort of like a story for another day. So it’s really all about compounding, but I’ll be the first one to say, it’s not because you cannot make money other ways. If you could buy, I don’t know AT&T, all the common stock for $1, obviously that’s a no brainer.

[00:56:52] Stig Brodersen: The answer to that is yes. It’s not because you can only make money with high quality investing, but I would, I’d probably say that it’s a simpler, if I dare say simpler in the world of investing, it’s a simpler way of making money in investing. Nothing is easy whenever it comes to investing, but I would argue that it’s probably easier to have, now I said easier, but having that conviction whenever you see a 50% drawdown, if it’s a high quality business, It’s a bit different than whenever you have this special situation, you have this catalyst and there’s too much debt and then you see cut in half after you’ve, you thought you bought it at a very low price that’s whenever you start to be like, ah, do I really have the conviction to hold on to this?

[00:57:40] Clay Finck: Cunningham doesn’t list this as a challenge but I feel like we can’t talk about this, quality investing approach without talking about valuation. I’m reminded again of how I like to look at the historical drawdowns and maybe the historical multiple, just to kind of get a sense of, where’s the stock at.

[00:57:57] Clay Finck: In terms of where it’s been historically, and, some of the companies I’ve got into after they’ve had a drawdown is like, this is one of the most, I look at the history and if I see this is one of the most extreme drawdowns it’s had in its history, and it feels, it’s sort of this gut feeling where it feels like the market’s sort of whatever it’s thinking or whatever reason it’s trading down, it feels like it’s overdone.

[00:58:19] Clay Finck: So it’s kind of looking for those opportunities to stack the odds in your favor and see those twin engines that you mentioned and I do think quality of business is obviously really important. But we also, of course, need to be mindful of valuation and I think valuation is something that’s really important.

[00:58:35] Clay Finck: The classic example is Microsoft in 1999, I was just talking with Scott Phillips who works at Templeton and Phillips Capital Management. His wife is the great niece of Sir John Templeton. He also mentioned the Microsoft example and he mentioned that it was trading at over 20 times sales at that time.

[00:58:53] Clay Finck: So in terms of valuation, the hardest part, or one of the hard parts of this quality investing approach is that a lot of these companies, they are going to look expensive over a lot of its history. It’s oftentimes not going to be trading at a multiple to owner’s earnings of 10 at the return on capital of 30, if you find that feel free to let me know because I’d love to, I’d love to check it out.

[00:59:15] Clay Finck: But I usually don’t see that and Amazon is another prime example where you really needed to look under the hood and understand the value creation that was happening throughout its history and Bill Miller, he’s a great investor to study in terms of someone who he went against the crowd.

[00:59:31] Clay Finck: He went against the people that said, Amazon doesn’t make any money and I think another great example is Constellation Software. When I shared my episode talking about that company, people are like it’s a great company, but it’s got a PE of 90 or a hundred. And it’s like, they, there’s of course I’m not looking out, looking to go out and buy companies that are trading at a PE of 90 or a hundred, but you need to really understand again, the value creation at play.

[00:59:54] Clay Finck: And in the case of Constellation Software, there are adjustments you need to make to normalize the multiple to better reflect economic reality. Essentially, so you need to understand the shortcomings of accounting and then how that ties into valuation and even those companies with multiples around 25 to 35 just to give a broad range, you really need to develop that conviction in the long term sustainability of the business model, You don’t want to buy these businesses trying to earn a 50% return in a year like some people might do in a special situation or a cyclical, it’s really a thinking long term in terms of the valuation because, say a company’s growing at 15% per year and it’s at a multiple of 30, well, odds are you aren’t going to make a ton of money over the next year unless, there’s some sort of a huge surprise, earning surprise to the upside.

[01:00:47] Clay Finck: But when you look at that level of compounding, if they’re able to compound at that rate for 10 years then in hindsight, the multiple oftentimes seems to look pretty reasonable. So yeah, having that good understanding of valuation and not getting caught up and just because the stock’s gone up, oh, this is a great business because the stock’s gone up, you need to be aware of your own biases and natural human instincts at play.

[01:01:10] Stig Brodersen: I absolutely love what you said there about looking under the hood. You really need to be able to adjust the numbers because the reporting earnings are just reporting earnings. But of course, whenever you do that, you also set yourself up to all types of biases, especially confirmation bias. And one mistake that I was very public about, I think you can probably go back to 2015 whenever Preston and I did a recording.

[01:01:32] Stig Brodersen: And we talked about Amazon and it was trading at 400 at the time. This was before the stock split, 20 to 1 stock split. So it was equivalent to 20. And today I should say it’s trading 156 and I remember telling Preston, I would not buy shares in Amazon because, they’re not making any money.

[01:01:51] Stig Brodersen: And I thought I understood the company. Clearly, I didn’t at all, because they were just reinvesting everything that, that they made into the business. And here we are, it’s more than seven X up. And that was like Amazon 2015. That was a huge company and it’s one of those things where, I think Buffett has this quote where his biggest mistakes are by omission.

[01:02:11] Stig Brodersen: And he talks about how he should have invested in Google. He should have invested in Walmart. He did that in Walmart but much, much later and didn’t make as much money as he could but anyways, speaking about Buffett, he said that one of the shareholders meetings that he very often get asked the same question, which is very different ways of asking, how do I get to become as rich as you just faster?

[01:02:33] Stig Brodersen: So anyway, speaking about Buffett and high quality companies, I wanted to talk about the Berkshire Hathaway annual shareholders meeting the first week of May and we’re doing something different in 2024 than we’ve done in the past. We have two different options. The first option is what we call the Berkshire summit. You’ll be hosting that. You’re going to have a dinner with William Green, a few other guests. Could you talk more about the Berkshire Summit?

[01:02:58] Clay Finck: Of course. Very excited for both events we’re going to be hosting in Omaha. Starting with the Berkshire Summit. This is going to be an exclusive event we’re hosting for a select number of members in our audience.

[01:03:11] Clay Finck: So the highlight of the summit is having dinner with a number of special guests. So on Friday, May 3rd, 2024, so far, we have a few different people lined up to join us for dinner as special guests. We have Gautam Baid, the author of The Joys of Compounding, and then we also have Johan Steene and Daniel Zhang.

[01:03:31] Clay Finck: They are both managers at Teqnion, which is a serial acquirer based in Sweden. Stig and I both own shares in this company, is what I should mention since I mentioned the company’s name and François Rochon, he also plans on joining us on Friday, who’s been a guest on William Green’s Richer Wiser Happier podcast.

[01:03:51] Clay Finck: And then, we’re also having dinner on Saturday, May 4th, 2024, as well. William Green is going to be joining us, and then William was kind enough to invite a number of the guests who have been on his Richer Wiser Happier show or are going to be future guests. Those are Christopher Sy, Chris Begg, Anthony Kingsley, and Edgner Knudson, hoping I pronounce that correctly, and they’re all going to be joining us Saturday evening, so it should make for quite a fun night seeing William, and his guests are really quite special, so I’m really looking forward to the opportunity to see you there, see all of them.

[01:04:26] Clay Finck: So it really should make for a quite memorable weekend for those who register and plan on joining us for the summit and then we also are going to have social hours after each dinner and really give members the opportunity to really get to know each other and have the opportunity to chat with all these You know just amazing investors and as of now, we plan on allowing roughly eight attendees for the Berkshire Summit.

[01:04:51] Clay Finck: I think that’s all we’re really going to have room for, given all the special guests that are going to be joining us and the very limited seating we have. And then we also have a few other things lined up for the weekend for those who sign up for the Summit. We are going to help those members, plan out their weekend, select the hotel for those that happen to not be aware.

[01:05:09] Clay Finck: I’m from Lincoln, Nebraska. I used to live in Omaha. So I’m quite aware of the Berkshire weekend. It’s not your eyes first rodeo Stig. And we’re well aware of the headaches that come with that can come with Berkshire weekend. We also, I mentioned members will have a chance to really get to know each other, I plan on hosting a couple of pre-calls going into the weekend, just to give people a chance to who they’re going to be meeting, who they’re going to be sitting down for dinner with, and we’re going to be also saving seats at the Berkshire meeting for our attendees, it can be such a headache getting decent seats without waking up, at like 5 a.m.

[01:05:45] Clay Finck: For those who haven’t been to Omaha you get to the CHI center. It’s just sort of a madhouse in terms of the line goes for blocks and yeah, we’ll be sure to have great seats safe for those that attend the summit. But really the bottom line is that we want our summit attendees to just have the best experience possible during their time in Omaha.

[01:06:05] Stig Brodersen: Clay, please give a hand off. Where can people learn more if they’re interested in learning more about the Berkshire Summit?

[01:06:10] Clay Finck: Yeah, I personally expect this to be quite popular. So if you’re interested, I’d encourage you to get in touch with us as soon as possible. Oftentimes with Omaha, people are planning out months in advance because just the flights can get pretty crazy as you get to February, March timeframe.

[01:06:26] Clay Finck: So the easiest way to sign up for this and learn more would be to go to theinvestorspodcast.com/BerkshireSummit. Just enter your name, enter your email, and that’s an easy way to get in touch with us or if you just, like to get information right away. You can also just shoot me an email. My email is clay@theinvestorspodcast.com and that’ll put you in touch with me directly.

[01:06:53] Stig Brodersen: And I should also mention, Clay. So we have two different offers. So we have the Berkshire Summit that we just talked about. We also have meetups for a mastermind community, which is something different and the last thing I want to do is to confuse the listeners.

[01:07:05] Stig Brodersen: So now we heard one, then there’s another offer. So let me throw it back over to you to talk about that.

[01:07:11] Clay Finck: Yes, so just full transparency for those tuning in, the Berkshire Summit is a higher ticket event and the TIP mastermind community, this is totally separate and this is our highly vetted community that we just do a ton of things for.

[01:07:28] Clay Finck: A lot of the community is based online. But one of the benefits of being a part of the TIP Mastermind community is that we have two live events each year that we host for the community to allow, people to develop those, develop those deeper relationships and get together in person.

[01:07:45] Clay Finck: So our next official live event is going to be over the Berkshire weekend. We have two social hours planned. That’s for Friday and Saturday evening. And yeah, that’s again, May 3rd and 4th 2024 in Omaha and these social hours are solely for those in our community. And then, maybe people bring their spouses or friends that tag along, but primarily those in our community.

[01:08:08] Clay Finck: And we started this in April 2023, and already we’re close to approaching 100 members, and I expect, after having the New York City event and seeing sort of what happened last year in Omaha, I expect us to have around 30 people attending, what depends if you include some of the people that tag along spouses and whatnot, But we’ll have a good number of people at our social events, and it’ll just be a great opportunity to get together with just some amazing people in our group.

[01:08:38] Clay Finck: And, what I really like about this, I’ve mentioned this in the past on the show, is that when you go in, and you know a lot of the people that are going to be there, It’s really easy to get past those surface level conversations, you know what their background is, what sort of investments are sort of interested in, where they live, the city they live in, obviously not where I’m in the city, but you know what, where they’re coming from, I’m sure we have some members from Europe that are going to be making it.

[01:09:03] Clay Finck: We have, I know some of people who I’d call friends that live in New York city. They’ll be coming to Omaha to my neck of the woods. So it’s just amazing to So we have this opportunity to get together with people that are just so likeminded. And we’ll also put together a group chat for our community members.

[01:09:21] Clay Finck: So whenever you land in Omaha, it’s just so easy to coordinate. Hey, I landed in Omaha, who’s in town? And you can just go, and maybe Thursday evening you go grab drinks with a few of the members. So that’ll be super helpful. And then it’ll give you the chance just to ask quick questions. I can respond quickly if you have issues getting around Omaha or whatever issues you have in terms of your time during the Berkshire weekend, and this is really an extension of everything else we do in the community.

[01:09:50] Clay Finck: We’re constantly having members hop on Zoom, have discussions, talk about stocks, talk about, some of the issues they’re having with their investing style and their journey, constantly sharing stock ideas, and then we’re just hosting various events all the time on Zoom and whether we talk about different books.

[01:10:07] Clay Finck: I’ll mention that we’re one of the book club events that we have coming up is talking about Morgan Housel’s book. Who’s going to be a guest on the show here soon. He releases new books, same as ever and I said, hey, I’m going to be reading this book and just book an event. And I know a ton of people in our group are going to be reading it too, because so many are just like voracious readers.

[01:10:26] Clay Finck: It sort of blows me away. Some of the members that joined and they’re just like, hey, I, read a book a week or whatever and it’s like, people ask me how I read so many books. It’s like, talk to these people. They know something that I don’t, but we also have a special guests come in and chat that are oftentimes guests on We Study Billionaires.

[01:10:43] Clay Finck: So the Q and A coming up here on January 4th is with Ian Cassle. So if you’re, for example, if you’re super interested in having a chance to ask Ian questions, you can shoot me an email and you can apply for the group if you’re super interested in that or super interested in the book club. That’s just a sneak peek at what’s coming here soon.

[01:11:00] Clay Finck: And it’s been so exciting just to see the community to continue to grow. See the amazing people that continue to join, and I’m really excited to see everyone in Omaha. We had a really fun time in New York City recently. So if this is of interest to you, sounds like something that you really want to be a part of, you can get on the waitlist to apply to the community at the URL here, theinvestorspodcast.com/mastermind. Again, we’re approaching a hundred members and we plan on eventually capping it around 150. So, that’s theinvestorspodcast.com/mastermind or again, feel free to shoot me an email. I’d be happy to shoot more information your way and help you out in any way I can. That’s clay@theinvestorspodcast.com.

[01:11:44] Stig Brodersen: Thank you, Clay. And just one quick note to that 150 number. So a lot of some people might be familiar with that number. It’s called the Dunbar number named after you guessed it. His name was Dunbar and it’s about like how many people you can have a relationship with and there’d be done a lot of studies and all kinds of tribes and going all the way back and like 150 people seems to be the magic number.

[01:12:06] Stig Brodersen: So whenever Clay and I were, and Kyle were talking about, we got so many members coming in, we have to cap it at some point in time. Otherwise, it won’t be the same experience that we talked about. Should we cut it off at the Dunbar number? And that’s apparently 150. But you know what, I think what I like very much about the mastermind community is I think I used to think that I was a bit like screaming into a void. Like, I was, I might be really interested in one stock, but I don’t really have any of my friends who would be interested in, well, first of all, they’re really interested in stock investing, but they certainly wouldn’t be interested in this specific stock pick or they would never have read the financial statements of that specific stock pick. And so, for example, after the last mastermind discussion I had with Tobi and Hari, a few days after we had a call where we discussed LVMH and only people who are interested in LVMH jumped on that call to talk about the stock.

[01:12:55] Stig Brodersen: And so I think it’s the, an opportunity just to get more specific feedback on your stock ideas. And like you mentioned, Clay, we had quite a few guests who will also be guests on We Study Billionaires that engaged with the community. Tobi was there not too long ago, Chris Mayer has been there Gautam Baid, we hope to bring them on again and then, just speaking with other readers, for example, going into this episode. Whenever Clay and I decided that we were talking about high quality investing, I tapped up in our group chat, like, oh, we’re going to do a discussion about high quality investing.

[01:13:23] Stig Brodersen: What is that to you? And George from my community said, why don’t you read this book called High Quality Investing, that Lawrence Cunningham wrote. And so we picked it up and read it and used it in our preparation for this episode. And so I think that’s why I’m so excited about it because there’s just one thing to be said about being surrounded by likeminded people and not just like minded as in we’re interested in investing, but that specific stock pick or that specific counting rule, if you’re really going to be geeky about it and I don’t really have close friends nearby that I meet up and discuss them with. So it’s really a privilege for me to have the ability to jump on Zoom and speak with like-minded people about that.

[01:14:04] Clay Finck: I’m reminded when I was in college, I was exploring just various books, I was super interested in just the self-help personal development space.

[01:14:12] Clay Finck: Sometimes you, you get into some of these and they’re just sort of ridiculous. But one of the little quotes that one of the books had, I have no idea what book it was from it, but it said, your net worth is your network. It was something like that, like associating the net worth and the network. I’m like, okay, that’s like, totally ridiculous.

[01:14:29] Clay Finck: But like when I have this community to bounce ideas off of, I can like see like the huge value in it and I like, for me, it’s personally a huge asset, especially when I find a member that knows a whole lot more about a stock than I do. For example, I won’t mention the name of this company just because it’s so small, but I found this name.

[01:14:49] Clay Finck: I found some research that was behind it and obviously, it’s super easy to get excited about a name when you read this specific research, and then you’re hearing all the right things, and you get this sort of Lollapalooza effect, as Munger would call it, and, just having people to bounce the idea off of really helps, and I shared this idea, I shared the research, I’m like, hey, I started looking into this name, it looks pretty interesting, and I just shared it with the group.

[01:15:12] Clay Finck: And it, the company happened to be from Australia and we’ve had a number of members joined from Australia, at least a handful over the last couple months. And one of the members, he manages his own money and manages a fund. And he it was like, just like a few days later, after I shared it, we were on a zoom call and he mentioned, hey, Clay, I looked into that company you shared and he said, he spent 30 or 40 hours researching it. And I’m like, Oh man, that’s like, it’s hard to put a value on something like that to where like, this obscure company in Australia, and then now you have someone in your network that knows all about this company, he’s just someone that really gets deep in the weeds on this stuff.

[01:15:49] Clay Finck: And for me, like, I personally see a lot of value on that. And then Kyle and I, we talked about Dino Polska here on We Study Billionaires and we sort of made an exception to what we typically do on the show. I mean, most in our audience probably aren’t that interested in some random company out of Poland, but so we can’t do it too often, of course, but many in the community are very interested in such a company.

[01:16:12] Clay Finck: And there are many of them are invested alongside us and in some of the companies we talk about and these companies that are just so high quality and obviously, you don’t want to find yourself in an eco-chamber where you’re just sort of saying the same things and that’s one of the other nice things about the community is there’s plenty of people in the group who are willing to share their opinion on, why they aren’t buying it, why they don’t like it and why they look at other things. So yeah, it’s quite an interesting thing we’ve started here, Stig, and I’m super excited to see where it goes over the next year.

[01:16:43] Stig Brodersen: Very much so. Clay, any concluding remarks here before we end the episode? It was fun chatting about high quality investing.

[01:16:50] Clay Finck: Yeah. Well, I’d love to record another episode with you in 2024 when the time comes and it’s always fun recording episodes with you, Stig.

[01:16:59] Stig Brodersen: Likewise. All right, ladies and gents, that was all that we had for this episode of The Investor’s Podcast, and we’ll soon be back with another episode.

[01:17:07] Outro: Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses, Go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


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