Preston Pysh  7:32  

Alright, so going on to the next chapter. This one’s titled, “What to Buy – The Fifteen Points to Look for in a Common Stock”. So instead of going through all 15 points, what we’re going to do is just kind of highlight a few that stood out here. And, one of the main ones that I captured was to find a stock that has a long time horizon, and that’s definitely referred to something that you’re looking at with a short time horizon. I completely agree with that traders that do these one-month kinds of trade or like a two-week kind of trade is not something that I really understand. I don’t really understand how you can do anything other than something that has a time horizon in excess of a year. I would think would be at a minimum.

Stig Brodersen  8:14  

And one way that Phil Fisher is actually looking at this is he’s investigating the company’s relationship with suppliers. And he’s saying, so how do they treat them? Is it like a long term negotiation strategy? Or is it short term? Are they consistently pressuring their suppliers or are they also willing to give a little something to build goodwill? And I think that’s a really interesting approach to it. 

And another thing I’d like to stress is, one of the points is, how effective are the company’s research and development (R&D) efforts in relationship to its size? And he comes up with a lot of different metrics that you can look at. And basically you need to speak to the company but you can also look at how much money they’re spending compared to the sales. I love new tricks here. But I kind of think that this point about R&D really highlights one of Warren Buffett’s main things – don’t invest in companies that have too much R&D. I don’t know if he’s been quoted to say that, but he’s really looking at very simple products. Actually, the books even though it tries to simplify the whole technology process, but also think that it really illustrates that, if you’re too caught up in too much of the technology and trying to figure out what’s happening, you probably shouldn’t invest in that company in the first place.

Preston Pysh  9:32  

I understand that argument. And I’ve read that  all the Warren Buffett’s stuff. But at the same time, I just want to kind of throw out a contrarian point of view for people just to consider. I mean, I’m not saying that this is right or anything, I’m just trying to give people maybe a different perspective and something to think about. So whenever you talk about R&D from an accounting standpoint, R&D is something that is turned directly into an expense. And then whenever you’re looking at how R&D carries over, and I’m strictly talking from accounting in the United States. When you talk about how once that company makes that investment, let’s say, Google would be a great example. Let’s say Google invests $10 million in an idea in an R&D research effort. And they’re dropping all that money into whatever, let’s say it’s driverless car technology. As they’re spending that money, that is immediately being an expense on their income statement. None of that is being carried over into an asset unless it’s just for the patent application. That’s really kind of the only thing that they can carry over as an asset onto their balance sheet. 

So as an investor looking at that, and if an investor is looking at just the balance sheet, and this is more of a caution for people that would look at that. That just from a book value or balance sheet standpoint, you’re not necessarily going to see the value of some of those intangible and tangible assets that have been test articles, or whatever that are created inside of that R&D veil. So a perfect example is what I said there as far as the driverless technology. That might be a huge asset for Google moving forward into the future, in the next 10 or 20 years, and when you’re thinking about future cash flows that that might generate if they’re able to move into this massively huge car market, and the technology unable to license the software for this to some of the other car companies. You think about all of that, and how that’s showing up anywhere in the company’s financials. I don’t think that you’re really seeing it anywhere other than being an expense on the income statement. 

So, you read a book like this. And you know these guys are super smart. Warren Buffett buys into this, but then there’s other things that I feel like I do know from my own experience and things that I’ve studied that add kind of a wrench into all this, and that’s where it’s really hard. And I think it’s really important for people that are just starting off to let them know how insanely difficult some of this qualitative stuff becomes. 

Phil Fisher’s book, this is really the qualitative piece of Warren Buffett’s investing approach. The quantitative side, the number side of figuring out the value of things, that’s really all Benjamin Graham type of stuff. So when you read this book, it’s very qualitative. It’s talking about these things that are intangible, and it’s hard to put a value on it. But I think when you get into his discussion of R&D, I think that you got to also understand some of these rules of accounting and understand how it could maybe not necessarily be 100% true. And I hate to confuse the audience, but I think it’s important to grow that knowledge base as well as we’re having these discussions.

Stig Brodersen  12:42  

I love the approach you have to this, Preston in terms of looking at the accounting because the first thing that comes to mind whenever I read this was, “yeah, you said that sales for R&D is a good indicator”. It depends on how you measure R&D, and how the accounting rules have changed since I think it was written in the late ’50s. I don’t know if it’s still valuable.

Preston Pysh  13:02  

Here’s another thing to think about. Let’s say you’re doing R&D work, and you have insanely talented and smart people working for your company versus the R&D of a company that’s not doing a revolutionary kind of stuff and they’re just basically burning money because maybe they don’t have the most talented people working for the company. You take the R&D of some mediocre company and compare it to the R&D efforts of Google. I think that for every dollar spent, you’re probably getting 10 times the performance. So, you always got to ask yourself why. And then you got to try to understand the second, third, and fourth order effects of maybe why your opinion might be wrong.

Stig Brodersen  13:41  

To include here on chapter three, I think all the 15 points are extremely relevant. I would definitely encourage everyone to go in and read our executive summaries where we have a brief explanation of all of them. But I think there is one thing I would like to pinpoint here and that is that none of the 15 points are important if the management does not have integrity. I mean that this is really the one point ruling all of them. And, the way that Fisher measures that, I’m really cautious about using the word measuring because the whole book is about, you can’t really measure all this qualitative stuff. But he’s saying, one of the best measures if you have to, is to look at how the management handles a crisis. And he’s saying that he just sees so many managements just clam up if something goes wrong. He’s saying that is an amazing indicator of the integrity of the business. If they have hardship and they’re shared with the investors or with the owners of the company, then they have integrity.

Preston Pysh  14:39  

So the next chapter is “What to Buy – Applying This to Your Own Needs”. So in this chapter, Fisher argues that many investors do not spend the time and effort required to make good investments. The results of this is the misunderstanding and half truth about investing. And so, I completely agree with his opinion on this and where he’s going. And I think that I am a victim of this as well. Where sometimes I’ll go and buy a company, and I just, I know, I could have done more research on it. But I think it’s important to highlight that the amount of your portfolio that you’re putting into the position should be somewhat correlated to the amount of time and research that you put into it. So if you’re going to take a very large position, if it takes up 10% or more of your portfolio, you probably need to spend a ridiculous amount of time, especially if it’s an individual pick to really know what in the world you’re talking about, and understanding that array of risk versus reward that could potentially come your way. So we completely agree with Fisher on his main thesis for this chapter.

Stig Brodersen  15:45  

I think what’s really interesting in this chapter is how he’s talking about how to pick a good person to manage your portfolio because he’s also acknowledging that not all private investors really like to manage their own portfolio. So, he’s saying how do you actually figure out who is good and who is bad? Because he’s talking about track records using that, all the pitfalls on that. I mean, just an example, one person might be outperforming the market, but he might take on additional risks. So is that really good performance or bad performance? And he’s saying that there’s really no objective way to measure which portfolio manager you should trust in comparison to a lawyer. How do you figure out if a lawyer is good? Is it, how many cases he has won? Well, that might only tell half of the truth because he might only take on winning cases. 

I think this discussion itself is really interesting, but he comes up with two things you could do. The first one is to test the integrity and honesty of the person. And the second thing is that his investment philosophy should be like your own, which again is the 15 points he talks about before. So if you understand the 15 points, and you can have a good discussion with a portfolio manager about those 15 points, and you believe that he has integrity and is honest, he’s saying that might be a good manager to go with.

Preston Pysh  17:03  

I think it’s important just like from my personal experience. I know whenever I talk with different investment bankers and things like that, you talk to people that you have with your brokerage. In my experience is that people that are handling it are usually more on a sales kind of position, and they’re just trying to push a product or push a certain fund that they kind of get a higher fee on. And so if you’re out there, and you are having other people manage your stuff, and you feel fairly comfortable asking some of the hard questions of things and topics that we’ve discussed on the show, I would highly encourage you to do that with that person who’s helping you manage your portfolio. 

I think the further that you dig into those questions, you might be surprised at some of the answers that you actually get back. The surprise might not be in a good way. So for example, you’d say “hey, so what do you think the general yield or return I would get by being invested in the S&P 500”, and then see how they respond to that. And then, based on their answers, just ask them a follow-on question that digs even deeper into that area. And I think when you do that, you kind of just sit back and listen to the way that they respond, and ask them intelligent questions, and maybe even write them down before you’d call so that you can make sure that you can test their level of expertise, and what it is that they know and don’t know. That I think would be a really good decision to filter some of these people. So you can find somebody who really does know what they’re talking about. 

Stig Brodersen  18:32  

I think it was one of the first questions I’ve run on the show. There was this young guy who was talking about how he was home with his parents and how they had a financial planner visit them. And, he was doing the good thing for his parents and he asked, “okay, so you suggest those eight stock picks, what’s the PE (price to earnings ratio) of them?”. And the financial planner was like, “what’s a PE?”. That was a great question, by the way. And his question was also in terms of, as far as I remember, in terms of how to find the right person to take care of his family’s money. And well, if they don’t know what PE is that’s probably a good indicator that you shouldn’t trust that person. 

Preston Pysh  19:08  

A good indicator you should run. 

So the next chapter is chapter five. And in this one we talk about when to buy. And so Fisher starts off talking about this market timing idea, and just how difficult it is for an investor to time the market. And so instead, he suggests is that a person should look for outstanding companies that have temporary problems or setbacks for some reason that the market is not pricing them favorably. And that’s where you are able to, quote, unquote, “time the position better”. And so I agree with this, I think that I kind of look at it more by sector as kind of my personal approach. I try to look for sectors that are severely depressed that are having very difficult times. And then I really try to go find the business or couple of businesses that are performing best in that sector. So for example, oil has really had a just a brutal time for the last two years, last year and a half-ish. And if you take that approach with the oil industry, and you’re lining up, “okay, this company has the fattest margins, this company has the best brand”. You start lining up all those reasons why you think company X, Y and Z might be the best in that industry. That’s when you really want to kind of start taking a position, whether it’s slow, whether it’s fast, or however your approaches into getting into the pick. But this is how Fisher suggests that a person does it, is they look more in that way for their timing than to time an entire market.

Stig Brodersen  20:45  

And I think it’s interesting that he’s saying that on one hand, you would take a company that has temporary problems. But then he continues talking about, well, if you think problems in terms of taking a hit on the earnings, well, why’s that so? Is it really because the customers are running away, or is it because the increased expenses are from developing new products? He’s saying that if you know a company really well, pay close attention to their expenses, on again, you might call it R&D, or however it’s accounted for. What are they doing right now? And he’s saying that he sees so often that a big investment is made. Investors would run away screaming because the earnings take a small dip. But then in the long run, whenever they start monetizing these products, that’s really when you see the spike in their earnings. So don’t look only at the bottom line, but look at why the bottom line has changed for these companies.

Preston Pysh  21:41  

And just as kind of a final note for this chapter, is really this idea that his overall recommendation about when to buy is, base your investment decisions on solid knowledge about the individual company and disregard the fears and hope about conjecture and conclusions that are based on assumptions. So he’s really getting into this. You got to have some quantifiable facts of why you’re maybe changing your opinion as opposed to just maybe an article you read about some journalist’s opinion or whatnot. That’s what kind of causes the market to go in these swings in a weekly or monthly timeframe. But when you actually look at what Stig was discussing, was like, “hey, they just created a brand new asset that’s going to add more to their top and bottom line, but it’s just being delayed because of maybe an assembly line was delayed or whatever”, that’s when you are seeing big opportunity in the price. 

Okay, so this next one, chapter six is something that I think a lot of people are interested in. This is a really common question that we hear from people when we’re talking to them and that’s – when to sell and when not to? So Fisher has an entire chapter dedicated to this, and as Stig briefly mentioned, if we’re not going through these chapters in enough detail, please sign up for our email list. You’ll get the entire executive summary that we wrote on this which is fairly detailed. You’ll get it completely for free if you sign up and we don’t send out any advertising. So it’s a great deal. So just sign up and you can get all of our detailed notes on this. 

So Stig, go ahead and talk to the audience here a little bit about when to sell.

Stig Brodersen  23:14  

So what Phil Fisher does here is that he outlines the three reasons why stock investors should sell his stock. The first reason is pretty simple. He says that if it’s less attractive than originally anticipated, you should just go ahead and sell that stock. I think that point is really interesting because there was also something that we discussed with Guy Spier when we had him on. And he [Guy] was talking about how he had started to give himself like a two-year period where he couldn’t sell a stock because he knew that, assuming that he was making a mistake of course, but the reason for that was that if he knew that he can just sell a stock wherever he regretted that, he might be overtrading, he might not do his research well enough. And if he was forced to hold on to a stock for as much as two years if he was mistaken, he would work really, really hard on not being mistaken. So I just think that I would like to put that out there. I think I can definitely see why Phil Fisher is saying if you made a mistake, just correct that mistake. That makes a lot of sense. But I also think Guy Spier’s argument carries a lot of weight.

Preston Pysh  24:17  

Yeah, that’s an interesting idea that you brought up. And I think that it’s really hard to, I mean, just turn around the next day and be like, “oh, I didn’t account for this one thing. So I’m going to sell the position”. Like, how do you really think maybe it’s experienced after you’ve done it enough, and you’ve learned from just doing it enough times, that you’re about to make that mistake. But that’s something that you really got to think about. And I think it’s a very strong point. You do have to be in the position that if you recognize you’ve made a mistake, and you didn’t account for all the risk that was there, you got to get out of the position. You absolutely got to get out of the position. So that’s something that I think is going to be very difficult for new investors, but it’s something that experienced investors. I think have a knack for just from their own personal experience in doing this enough times.

Stig Brodersen  25:03  

Before I said there were three reasons. So the first one that is you should sell if it turned out to be less attractive. The second reason is really related to this. He [Philip] is saying that you have your 15 criteria. Now he’s also saying in chapter three, we have discussed the 15 criteria that it might be okay if you have like 13 or 14 of them. But he’s saying that if you see the company fail in too many of the criteria, you should probably also sell your stocks, especially if you see the integrity of the management is starting to deteriorate. So, in that case, no matter the products, the company’s future prospects are no longer interesting. 

The third reason for selling is if the investor finds a better investment. And again, this is really, really tricky. I definitely understand when he’s saying, “well, if you find a better investment, why don’t you just go ahead and sell what you haven’t bought into that company”. The problem about being a stock investor, and I guess being a human being is that there was always a new shiny item out there. There’s always something you might be finding more attractive. Perhaps you just read an article about the stock you just bought, and you feel, “well, perhaps it wasn’t that interesting in the first place”. So I think what I really enjoy about this discussion here, is that how he would factor in the capital gains tax and his saying, basically, well, the future returns, they are uncertain. But if you have to pay taxes now, you know you have to pay taxes now there is no way around it. So I think that’s a really great example. He’s very cautious about that. 

Another thing in terms of sales is that he’s saying, “well, what if the stock is priced too high? Shouldn’t he just sell it and take my profit and go on to the next stock?”. What he’s saying and this is super interesting is that even if stock might be trading at 35 times earnings. Well, if you have found the right company and if it’s really growing, if you really, really see the profit’s going to spike, why take the capital gains tax loss? Now, why not just hold on to it because that was your investment in the first place?

Preston Pysh  27:12  

I think that a common mistake that people make is, they have a company that they buy, it just does extremely well, they’re getting tons of movement on the stock market price. Maybe they’ve seen a 50% gain. And they’re like, “wow, I made so much money. I got to get out of this and just take my win and walk out of the casino”, quote, unquote. I think that’s a person who’s demonstrating just a total lack of business knowledge that would be thinking like that. Where I think that you get a really smart savvy investor is whenever they see a company that’s growing like crazy, and they know how to really recognize the signs that demonstrate that it’s real growth and fundamental growth that’s driving that price action. And there’s a lot more room for the price action to continue even going higher. And I don’t see that as a form of greed at all. 

I think that one of the key factors to look for in determining whether that’s a fundamental growth or not, is really in the top line revenue or sales or whatever you want to call it. But when you look at the top line of the income statement, and that thing is growing by 20 to 30%, and you’re seeing the stock price move with it, that is something you want to hang on to. That is absolutely something you want to hang on to even if you’ve seen an enormous jump in the price because then you’d obviously have to know the direction and what the product is that’s driving that and all those kind of things. But if you’ve got something that’s growing like that, and the top line is growing with it, a perfect example would be Amazon for the last five years. Look at the sales and look at the top line on the income statement. It’s growing like crazy, then you’d been crazy to sell out of that position as that thing was fluctuating and going along for the ride because fundamentally they were showing that that growth was real and that it’s continuing to grow. So it really comes down to in my opinion, watching the top line. I’m real curious to see if Stig would agree with that statement.

Stig Brodersen  29:05  

This is a great discussion that we’re having because I remember the two of us sitting in Omaha and arguing about this. And I think I’m more like a bottom line kind of person and you look more at the top line. And again, I kind of feel we agree, but we just put different weight to it. I can definitely see why you were on that top line to grow. I just want to see it materialize at the very bottom. Where you are, I don’t want to put words in your mouth but you were really looking at top line. For instance, someone like Amazon because you see a lot of future potential for that. 

Preston Pysh  29:42  

For me, I guess I look at it this way. For value, I’m much more of a bottom line kind of guy. But for growth, if you’re talking, is the price justified for a growth company?, is the premium that you’re paying for this growth company justified? For me, I’m really looking at the top line because it’s such a raw number. It hasn’t been adjusted because let’s get into this. So, from an accounting standpoint, I can sell something off of my balance sheet and run it over to my income statement and then my net income’s higher, or I could do the inverse of that, and then I have no bottom line at all, just based off of action that you’re doing on your balance sheet. 

When you’re talking about the top line, none of that impacts any of it. The balance sheet doesn’t come into question at all. And it’s such a raw and pure number that you’re seeing on a company that’s really kind of going through a growth spurt because they have a brand new product or they have a brand new service that’s being introduced to the market. That’s the market’s acting favorably towards. That’s something that if you see it, and I guess, when you’re looking at a company that has a larger market cap, I think that you’re going to see a much more smooth curve of that top line, and it’s going to be a little bit more predictable than a small cap company that might just had a six month burst in their top line. So for me, I really like looking at the top line when you’re dealing with a mid to large cap company because I think it gives you a better indicator of, “hey, don’t sell the position. It’s got more to run”.

Stig Brodersen  31:07  

So just to give some piece of context to the discussion we’re having right now. Preston and I were, back then actually discussing if there’s any way one could put an equation on this. And, clearly the answer’s no, but perhaps one could estimate it one way or the other. So how would we value top line growth if it didn’t materialize at the very bottom? I think that in itself is a super interesting discussion. 

What I think one should be very careful about looking at a company like Amazon, or perhaps Tesla, as an even better example is that, yes, they are growing their top line, but how are they doing that? Well, they’re taking a lot of debt because they’re not making money, and they’re issuing a lot of shares. So I would say if you have to look at sales, and clearly sales are important, but also look at the sales per share because you don’t want your company to grow by 1000% if they’re just issued a bunch of shares and your ownership of the company has been completely diluted. So it’s a very complex discussion. I don’t think there’s necessarily a right answer. I think this discussion was interesting just in terms of how we are perhaps a bit different looking at the top line of the company.

Preston Pysh  32:12  

Alright, so the next chapter that we’re going to discuss is titled, “The Hullabaloo About Dividends”. And so Fisher starts off arguing that high dividend payments, not by definition should be preferred, as many people out there believe. And I completely agree with him on this. I get this topic so many times when I talk to people about investing, and it’s like, “oh, well, they have a really fat dividend. It’s paying like a 6% dividend.” And, whenever you’re in an overvalued market situation like you are today in the US, if a company is paying a 6% dividend, my immediate question for that person is, “okay, so what’s the payout ratio?”. And so when you talk about the payout ratio, what you’re looking at is, of that money that the company made, the earnings or the cash flow that that company made, how much of that as a percentage is being paid out as a dividend to the investors? And if it’s 100%, to me, that’s absolutely crazy. Why in the world would a company take everything that they made and pay it straight to the investor without retaining any of that for a rainy day or having some type of flexibility to create a new product or any of that kind of stuff? So, that’s where you guys need to go when you’re looking at dividends is, what’s the payout ratio? 

I think a good rule of thumb is that if a company is gonna pay a dividend, which we could get into a really long discussion on whether a company should even pay a dividend. But if a company does pay a dividend, I think a good rule of thumb is only about 33% of it should be paid out to the shareholders and the other 66% should be retained. And that obviously is a function of how well the management can invest their retained earnings, but I think is kind of a rule of thumb, that’s kind of what most people would be looking for as a reasonable dividend.

Stig Brodersen  34:06  

So a few comments to that. So the first thing is that whenever I hear about payout ratios of 100, or whatever it is. The interesting thing is that if you really look at it and see what is happening in these companies, but there’s high dividend payout, very often it’s a one time thing. And very often, the reason why they’re doing that is because they had just been selling off assets, and then they’re paying out in dividend. And that might be the right thing to do from a shareholder amortization *inaudible. But just think about it. If you want a borrowing intercompany because they have high dividend, but they’re actually setting up profitable assets. To give you that dividend, you can only expect to get less dividend in the future. 

Another comment about why it should be called 33% is that, like Preston, unlike the idea of dividend because it shows that it has steady cash flows. It’s really hard for a company to manipulate cash the same way they can with other accounting. Also it is usually a good sign, not always, but it can be a good sign of the companies still having a lot of growth in it. And I know that you hear us and Preston and I, come off as value investors, and I think we are. But clearly, we also like growth, you can do that. And if a company is paying out consistently almost everything it makes to its shareholders, I know I’m going to pay a lot in tax. That’s one thing. Another thing is that what’s the growth potential in this company if they’re paying everything out to their investors?

Preston Pysh  35:30  

I mean, that’s a fantastic point because those assets that are creating that earnings or that profit that’s being paid to you, how is that going to be sustained? Or how is it going to be flexible for a changing marketplace? Because as you’re they’re collecting all these profits and then paying it to yourself. Okay, let’s assume 100% payout ratio. There’s a competitor out there that’s trying to eat away at that margin somehow, someway. And they will do it eventually. And if you just continue to suck the blood. A good example of this would be, somebody buys a piece of real estate, and they rent it out to somebody, but then they never improve it, they never do any kind of updates, they just continue to suck the blood out of the profit. And then at the end of the day, 10 to 20 years later, they’re sitting there with this building that’s falling apart, the doors falling off, like, you can’t even rent it to anybody because no one wants to live there anymore because they didn’t reinvest, and they didn’t do the right thing as a business owner. 

My other comment about dividends just from kind of a reason I don’t like them is the tax. From an owner’s standpoint, if you own the entire business, just say you owned every single share, then you are going to pay yourself a dividend, you’re getting like double taxed on that. And so as a shareholder, I don’t particularly like that. And I think that’s one of the main reasons why Warren Buffett doesn’t pay a dividend with Berkshire is because it pains him. So that’d be a huge tax burden to himself, when you look at it from that context of owning 40% of the company. So whether you own one share, you earn 40% of the entire business, you’re still paying that tax. And I think that’s how Buffett really looks at it, and that’s why he doesn’t pay any kind of dividend.

Stig Brodersen  37:09  

Yeah, and the way that Phil Fisher also explains this is that he understands why people would like to collect a dividend, especially if they need that to support their way of living. He’s saying that if that’s not the issue, then why do you want that dividend because you probably going to reinvest it. And you don’t have that many different stocks to invest in, in any case, because you only want to buy the very best. So I think his discussion about dividends is really interesting. Hopefully, Preston and I will one day do an entire episode about dividends. A lot of things to discuss about this and it’s it’s one of those things that always sparks a good discussion. So I’m actually having a we have a chance to talk about dividends here as well.

Preston Pysh  37:48  

So, the next chapter is “Five Don’ts for Investors”. The one don’t hear that I read that I felt was really good one and it kind of touches on a conversation we were having earlier. He considers a generic outstanding company that is trading at a high price to earnings ratio, a high PE. And typically let’s just say that this company is double the PE of the Dow Jones Industrial Average. And Fisher says that it’s a mistake that a lot of investors make that they would sell that company because it’s trading at such a high PE without really understanding what the future prospects are. And without understanding the growth potential or the margins of the company, they just sell out of it because it has a high PE. This goes completely back to what Stig and I were saying earlier is if you’ve bought that company, and it’s kind of grown in price to very high levels, and we’re obviously talking about an individual pick here. We’re not talking about an index because I think you got to look at that completely differently than an individual pick. So we’re talking about an individual company that’s performed extremely well with regard to price. You’ve got to dig into it. You got to understand what’s driving that price and understand that fundamental thing. And so that’s one of the things that Fisher says here that a lot of investors one of the top five things that investors do that they shouldn’t.

Stig Brodersen  39:03  

One “don’t” that I really like. I read this before I made the mistake. So this is the story. What he’s saying is that, “you shouldn’t quibble about quarters or eighths”. So in other words, if you find the right stock, you would just buy it. And if you think that the value of that stock is like $100 and is perhaps trading at around $50, don’t be so stubborn that you want to buy it and call it $49. If it’s trading at $50, buy it at $50. So, one and a half years ago or something, I was selling my position in Wells Fargo. And so the spread on Wells Fargo is like really low and it was something like $57.62 or something like that. And this is like an annoying habit that I have from my trader days. I can’t meet the buyer at this price. I need to have him lift me. In other words, I’ll be selling it, call it at $57.63 because I want that $0.01 more. So I was in there, and I would put in a limit order. And what happened, clearly, the market dropped. And I was just so stubborn. I was like, I need to have $57.63. And the market just didn’t want to come back to that. And so I was just getting so frustrated, and it was just $0.01 and I was just, “why do you do this to yourself?”. And then, fortunately, and this was a little lucky, this was not me being a good investor or anything, I held on to it for another week or something, and then I got that $0.01 more. I’d definitely rather be without that. I’ll be paying that got through.

Preston Pysh  40:37  

I love this point. Because my dad and I get in so many arguments about this point. He’s more like you, Stig, where he wants to put in the limit order. He wants to say, “oh, well, if it gets down to this and it’s going to buy and then the decision is made for me”. And I’m much more like Phil Fisher, where it’s like, “hey, if you’ve done the analysis, you think it’s a good buy, just buy it. Don’t play around and nickel and dime the the entry point. Just put in a position and take it because who knows if it’s gonna give you that opportunity or not”. Like, we preach not to do any kind of market timing in the short term because it’s impossible to predict. I find it very silly. And so, dad, I know you’re listening. But when you hear this, Phil Fisher agrees with me, not you.

Stig Brodersen  41:24  

Perfect. And the funny thing is actually that Warren Buffett, now he’s talking about how he lost billions on not buying Walmart because he was talking about $0.01 here and $0.01 there. So, I think it’s one of those things that are really hard to, it’s really hard to break your habit. Even if you’re Warren Buffett, but I think you need to do that this time. And I would like to say $0.01 more regardless of how many stocks, it’s not worth one week of pain. Think about it like that I didn’t get much done because I was so frustrated. So, consider that aspect as well.

Preston Pysh  41:59  

So I’m gonna highlight one more that kind of goes without saying, but it’s in the book. And this was actually in the follow on chapter we had another five don’ts. I don’t know why he titled the chapters that way. It’s a little awkward. But the one that I think is definitely worth mentioning, I think everyone that listens to our show knows this is, “don’t follow the crowd”. Don’t just go against the crowd to go against it. But I think whenever you see the crowd going in a certain direction, that’s giving you a cue, “hey, there’s opportunity here. Let me do my homework and find something that is going against the grain that makes sense for good fundamental reasons”. And I think then you’ll find good opportunity. Don’t just go against the crowd because sometimes you can kind of get burnt that way too. Like, you know, everyone’s selling Deutsche Bank right now on the August of 2016 because everyone thinks it’s insolvent. But it might just be insolvent. They might go down in flames. So that’s where you got to really do your homework. And, we encourage you to go against the crowd. But make sure you’re doing it for good fundamental reasons.

Stig Brodersen  42:59  

So where Phil Fisher definitely goes against the crowd is his discussion about diversification. And that’s another don’t then has an another chapter. He’s talking about that there’s so many stories about people not being diversified enough and losing a lot of money. But we talked very little about all that money that we’re losing because we’re diversifying too much. And this is just such a classic. I don’t even want to say Warren Buffett, but that’s a classic Charlie Munger argument. Like, why would you diversify when you could buy more of the very best stock? And he’s saying that there’s so few of the best of the best of the best stocks. Why would you go ahead and buy 50 stocks? How much can you know about stock number 50? So that was definitely an advice I took out whenever I started stock investing. I should probably have known more about stock investing before I actually decided to follow that advice because I also lost a lot of money on not being diversified enough. But I think his idea of, if you really know what you’re doing, if you’re really done your due diligence, and that’s the whole essence of what Phil Fisher is talking about, do a thorough due diligence, why would you miss out on a great return just because you feel you need to have 50 stocks or 100 stocks or whatnot?

Preston Pysh  44:12  

So I’d like to just talk a little bit about diversification. So, I want to say it was about a year ago. You had this heated debate. I forget where this was at, but it was between Bill Ackman and Ray Dalio. And when you look at those two’s approach, both billionaire. Bill Ackman is a billionaire, right Stig or was I don’t know if he still is, but,

Stig Brodersen  44:32  

Yeah

Preston Pysh  44:32  

Yeah, he’s real high net worth. Carl Icahn-kind of approach guy, mixture between Carl Icahn and Warren Buffett, I would say. And then you got Ray Dalio, which is a drastically different approach – computer algorithm trading. He has tons hundreds of picks in his portfolio and it’s very dynamic and constantly changing. And so, Ray Dalio, I was reading in a book. I believe it was the “Market Wizards” series where they were interviewing Ray Dalio, and Dalio made the comment that he felt that the holy grail of investing was this diversification across international markets that you would take the correlation between asset classes completely out of the mix. That’s what he felt was the holy grail of investing because he was diversifying and minimizing his risk across the entire global portfolio of assets, whether that’s commodities, fixed income, equities, the whole bit. 

While Bill Ackman has a drastically different approach, where he was very focused on like, less than ten companies. I want to say he was like down to eight companies last summer. And, Bill Ackman was really kind of laying the screws to Ray Dalio and really given them a rough time. Lo and behold, six months later, Bill Ackman just got crushed in the market. I mean, absolutely murdered here in 2016, as far as his performance. I think that whenever you get into such a small and focused portfolio of, call it, six stocks, I think you’re just putting yourself in a position where you are assuming that you pretty much know every single facet of risk in those six companies. I think that that might be an overstatement. And I think it also might be an oversimplification of the array of crazy things that can just happen. You know, like weird stuff can happen in the world. And you might think that you’ve accounted for every risk, and then something random, some black swan comes out of nowhere, and just totally shows you how you did not account for something when you have that few of picks. 

And so I think that a more reasonable number, and I think that this is where I’m really going with the conversation is, what is a reasonable number of picks at a minimum threshold? And I would really say that I think that that number’s, some might argue it’s ten. I would probably argue that fifteen is probably a good number to really kind of shoot for, and I would give that a plus or minus five. Maybe go up to twenty, maybe no less than ten. But I think around that fifteen mark is probably the best place to be. And I think that Phil Fisher would agree with kind of that mark as well. And I think there’s a lot of other great investors that would probably, that’s really where I’m pulling it from. It’s not Preston Pysh’s opinion. I’m pulling it from other investors that say, fifteen is probably the mark.

Stig Brodersen  47:22  

I think this discussion is really interesting because you’re making yourself really vulnerable. I mean, on one hand, if your portfolio is so concentrated, and then you make a mistake, clearly, you come off wrong. And then you have someone like Charlie Munger and Warren Buffett, when I think that was like around 30% of their portfolio in Coca Cola in ’89 and ’90. So, but I think if you ask me how many securities I think I would like to own, I think I’m probably closer to ten. But when I say ten, it’s not necessarily ten individual stock picks. So I think that was also what we’re talking about, Preston. When I’m saying ten, it’s more like, for me, one stock pick could also be this ETF (exchange-traded fund) that’s following their strategy. And then you know, that ETF might be three hundred stocks. So I think I’m probably more ten. I can definitely see that a lot of good reasons why you might do fifteen or twenty, but it’s probably somewhere around that.

Preston Pysh  48:19  

Alright guys, so we’re just going to kind of conclude the review of this book. I think you guys kind of catch the drift of some of the different concepts and ideas that are in here. It’s it’s a lot of stuff that we’ve talked about through the last hundred episodes or so. But I think the really important thing here is the executive summary that we have typed up for this thing is phenomenal. So, please go to our email list. We will send this out to everyone who subscribes to that. And it goes into a lot more detail about all these different points. And, go out there read this book. I think this is a good book. It’s not one of my favorite books, to be quite honest with you. I think that it gives you some stuff to think about. But whenever people are asking me, “what’s your favorite investing books?”, “what’s your top five books that you’d recommend?”, this is definitely not one that’s in it. But I do think that there’s some value to be had from going through some of these different ideas.

Stig Brodersen  49:11  

I think it’s really interesting because when I’m thinking about something like “Security Analysis” or “The Intelligent Investor”, they’re outdated too. It seems like the advice from those two books are just more timeless. It’s probably because this book comes down *inaudible* on profits are based on gross stocks. And I kind of have the same idea that things really changed, haven’t they? Not so much in the Benjamin Graham world in terms of the balance sheet and how to analyze that, but in terms of valuating the moat. I think a lot of things have changed, and I think, a book about how to value and how to cope with competitive advantage, that can only be an input by definition. 

Okay, guys, that was all we had for this week’s episode. We will see each other again next week.

Outro  51:51  

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