One of the biggest names in business literature is Jim Collins. And we recently saw that Billionaire Jeff Bezos recommended Jim’s book, Built to Last. Since we are big fans of both Jim Collins and Jeff Bezos we felt like the book would be a fantastic read for the audience. In Episode 111, we covered Jim’s book, Good to Great. This was a fantastic read that talked about all the fundamental attributes that made a great company. Today’s book, How the Mighty Fall, is the exact opposite. It talks about all the qualities that destroy a great business and what leaders can do to prevent such a dismantling from occurring.

  • In this episode, you’ll learn:
    • The 5 distinctive stages of decline
    • Which 3 key ratios can predict if a company will fall
    • How and why a company can pull itself out of a decline
    • Why a successful management should feel lucky rather than successful
    • Ask the investors: Can Bitcoin benefit from the increasing pressure on the US Dollar?

Tweet your comments about this episode directly to Preston, Stig, and the rest of The Investor’s Podcast Community using #TIPMoney.

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Podcast Transcript and Summary

 

Preston: [00:01:40] Alright. How’s everybody doing out there. You got impatient stick Broders with you. And today’s podcast we’re covering. Jim Collins book How the mighty fall. And I really really enjoyed this book. When we cover good degrade on the show stick and I were very big fans of the book and really gained a lot out of that. And so I had high expectations but I was also kind of expecting to hear maybe some of the same stuff and I was pleasantly surprised. I really liked the way that he laid this out and I think the thing that I liked the most about this book was how simple it was it was just it was simple to follow. It made complete sense. He got straight to the point. I’m kind of curious if you had a similar opinion. I don’t know what you think about this one but I really like this book I thought it was a very good one.

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Stig: [00:02:31] Yeah you know Preston I think probably like this book more than his most published book was is from good to great. I guess the reason why that would be is that you want to know what a great company is and perhaps also how they can work for one or invest in one. I kind of feel that you learn more about companies if you understand why they fail on anything. And I think especially as an investor it’s important to read a book like this because you really understand how to sustain a competitive advantage whenever you’re doing your stock analyses it’s always something about Yeah it has economies of scale. Space is just a fancy way of saying it’s Beke so he can do like a lot of things at a very low cost. But what you can see in this book is symbol as it does is that there’s just so much more to the story and why there more that’s only one of two ways to build a great company. There are so many different ways of failing as a company.
Preston: [00:03:27] All right so let’s go ahead and just kind of summarize what the five stages Arliss. Talk about the five stages and then I also want to start off with this story so I really like this analogy at the start of the book he talks about this person that he had recently seen was out running and that he had found out that the person ended up having cancer and that they had this massive decline and he couldn’t get through his head whenever he saw this. He kept thinking back you know I just saw this person like a year ago climbing up the side of a mountain running up the side of a mountain they were so healthy and they looked like they were in perfect condition. And little did we know that at that moment that person had the seed of their ultimate downfall from a health standpoint. And so he said when I got through this scenario I thought how fitting that is for also businesses and how a business on the surface might seem like everything is perfectly fine. And that they’re going to continue to do great things are going to continue to grow market share. But fundamentally if a person really understands what makes the business tick the seed for their destruction or their down farther pullback is already embedded into that company. And so he thought to himself How can I identify what that is before all this starts to unravel and I really like that analogy and I think that it’s very fitting when you’re thinking about a business because so often management is going along their merry way thinking that everything’s fine and dandy and then all of a sudden it’s quickly unraveling itself faster than they could ever imagine.
Stig: [00:05:03] So he describes this process a company that falls from grace in five stages the first stage is the Huber’s born of success. The second stage is undisciplined pursuit of more. The third stage is denial of risk and peril. The fourth stage is grasping for salvation. In the fifth stage is capitulation to prevalence or death. So what we’re going to do through this episode is we’re gonna talk about each one of these stages we’re going to talk about the things that kind of identify and signify whether you’re in Stage 1 through 5 and just the progression Stage one would be you’re that runner that has the seed of the cancer and you don’t even know it versus stage five is everything is falling apart and you’re at your death phase with the business. So did you have anything else you want to add for the intro and the overall summary of what we’re going to be cover covering.
Stig: [00:05:55] No I think the only thing I want to say as I think it’s important to have respect or why it’s easy to look back at call it Lehman Brothers or Bear Stearns and say yes this is a very simple narrative why things go wrong and how difficult it can be when you are in the middle of the situation. And I think it’s important that we don’t make this too simplistic. There are some very smart people running these companies that we’re talking about. And also that failed and it’s it’s just one of those it’s easier to explain what has happened than what’s going to happen I guess.
Preston: [00:06:32] You know that’s a great point. The other thing that I want to quickly highlight is like any Jim Collins book there’s just a ton of research he backs this up with case studies he backs it up with research from actual companies. That’s the one thing I really like about his writing is this it’s not just anecdotal. He has a lot of examples to substantiate his claims. So let’s go into the stage what hubris Warren of success. So when we’re talking about this first stage what we’re talking about is that accompany I guess the easy way to say it would probably be a company has an ego problem. We’re successful because we do the specific things and they’re going around outing that call and says they should be saying is we are successful because we understand why we do these specific things and understand what conditions would prevent those from happening or that they wouldn’t work any longer. So understanding why the specific things is the important part he provides an example with Motorola. They invented the star TAC cell phone which were the smallest phones in the world at the time using analog technology. But at the time this is where digital was starting to come out. And you can kind of see that phrase that he was saying we’re successful because we do these things but they’re not understanding why they do the specific things. And he talks about how the amount of impact that that had and how that set them back.
Stig: [00:07:58] Yeah and it’s actually very interesting speaking about a company like Motorola. I mean for decades it has been praised as one of the very best companies and you might be thinking it’s because Motorola didn’t reinvent itself like they kept on with the analog technology and that didn’t go digital. That’s definitely a huge explanation but Jim Collins talks about how complacency is really not important. I mean it’s easy to come up with a narrative saying that the company didn’t change the way they should. It’s not a question about changing it’s not a question about innovative if you look at the stats. That was something that also surprised the author when they were he was conducting this research. A company like much a role it never had as many patents as when they were all filing for bankruptcy. They just kept the wrong path. They couldn’t understand why they were successful and with situations that were not successful and it’s very important just to read between the lines and he’s out this chapter of us even the preface about United States leather company and there was once while the very biggest companies in America was like the 15th the 17th at the start of the 20th century but they just didn’t reinvent itself like a kit producing Settle’s which was not a good investment. It’s 10.1 that that car came out. Basically is telling that story to tell you that these stories are not as important as the data that you’re looking at and it’s all about understanding why you are successful.
Preston: [00:09:32] Not all the other what you would call noise. So concluding this first stage let’s talk about some of the indicators that help you identify whether you’re in Stage 1 and this is the one that I really like. And this is the thing that I always stick whenever we’re thinking through our strategy with our business and that’s neglect of the primary flywheel. So going back to Collins first book he talks about this thing the flywheel. What’s that fundamental thing that the business does and does better than anybody else on the planet and is really there a competitive advantage that they’re really really good at in their very efficient. And he says that when a company starts getting away from that thing and they start drifting off maybe focusing on other things or leaders get distracted by the exciting potential earnings that they fail to focus on. That’s when the companies setting themselves up where this stage one. And I like this point too. He talks about refusing to attribute luck to random events. He says that the management thinks that every success that came to the company was 100 percent due to their actions. Opposed to what we did this really well. But if we didn’t have this lucky circumstance over here that happened we would have never been able to win at a. Where we’re at. They’re basically attributing all success completely to their actions and that’s a dangerous thing and that’s where the egos really stepping in and not accounting for the why. And I think that’s the big word in this first stage that you’ve got to really understand is why did we do this so just a couple of points.
Stig: [00:11:11] It really comes back to the episode we did was episode 108 called the outsiders about the very best CEOs and they really owned their mistakes and they own everyone else’s mistakes. Something went wrong. It was always the CEO saying it’s my fault. What can I do about it. Even when he was not his or her fault it was just the approach that they have. Every time things went well you also would have what he called like look outside of the window principle or something like that. It’s basically meant that he would attribute all the good fortune to someone else like his team. The market conditions. Whatever you could come up with and that’s just such a healthy approach and really makes you humble. One of the best stories that Jim Collins comes up with to exemplify this. The first yes he’s talking about Wal-Mart versus Ames and Ames was retail that came out four years before Wal-Mart and it basically have the same concept and save opportunity. But the reason why Wal-Mart was so successful competitor Ames there was really because of Sam Walton’s humility and his willingness to learn and the anecdote that he attached to this story is that at some point of time the 80s Brazilian investors bought a discount chain that was only going run sell this and led us to 10 CEOs in the U.S.
Stig: [00:12:29] to consult with them and like had a brain style meeting on how can we best serve our customers and nine out of 10 people ignore the one person who came to those meetings who made a spend the week with Brazilian CEOs. That was Sam Walton and he did that not just to teach them how to run the retail because he said I’m not sure I know why he said I’m not just in locker room all night so far what can I learn from you. What can I learn from you that is useful so I can sustain the success that we have so we can keep on growing. That just tells you the opposite side of this arrogance of being of course with success. We are AIM’s. Of course we supposed to be successful because our track record the past and yes yes some Wohlsen say I don’t care about the past 10 years. What’s going to happen in next 10 years. And how can I get there. And how can I own up to it.
Preston: [00:13:21] Yup so I’ve got a funny story that I can tell you from whenever I was young I got out of high school I go off to college and I ended up going the West Point and at West Point they have an interesting way to introduce you to the school and on the very first day when you show up you were taught that as a freshman you have four responses. If you’re talking to an upperclassman the four responses are yes sir or ma’am no sir ma’am. I do not understand sir ma’am and sir no excuse sir ma’am no excuse. And I think for a person hearing that from the outside they might be like that is ridiculous. You know like that’s the only thing you’re allowed to say unless they ask you to expound on something. And the last one is the one that I want to highlight because I think it gets into this stage one where we’re talking about taking ownership and when you were forced to say no excuse even if in your mind there is an excuse. There’s a reason why something happened maybe your friend did something and you got in trouble for it. The only thing that you can respond with is no excuse. And I had no appreciation for this at the time but looking back you know decades later and looking at the experience what it forced me to do personally after going through that for an entire year of saying there’s no excuse and sometimes the comeback would be. Well yeah there is an excuse. Tell me what you failed at and so then you’d have to say well if I would have done this better than that circumstance might not have played out. And it forced me to take ownership for every single thing even when it wasn’t my fault.
Preston: [00:14:58] Even if it was my friends fault I had to take ownership for it. And that was a really really powerful thing that I learned at a young age that I still hold with me today and that when something doesn’t go wrong I like to feel like maybe you know other people in my life might argue that this is how I handle things. But I would like that you’ll like. I always look internally at myself first and say How could I have done that better. And it comes back to that lesson that I learned as a young cadet years ago. So moving into the second stage this is undisciplined pursuit of more. I loved his example in this stage here because he talks about Rubbermaid and he talks about Rubbermaid making so many products that they were actually making a product every single day of the year. They got to a point where they were making so many products and they had so many products on the shelves that when they went back and looked at how many products they had versus the time that they did it in they had literally made a product every single day in the year. I mean anybody looking at that from the outside can say that does not make any sense whatsoever. Like you have to know what your market really wants what’s going to give you 80 percent of the return for 20 percent of the effort and you got to just optimize the live in heck out of it. And the example he provides with Rubbermaid was quite amusing. Stig I know you’ve got some notes on this idea.
Stig: [00:16:24] I think the best example I him up with all this undisciplined pursuit for more. That would be Starbucks and Starbucks was actually not mentioned in the example he used Merck as an example. It’s basically the same. So what happened with Starbucks. I want to say it was around 2005 2006 and it really took off was that they decided to grow but they decided to grow for the sake of growth. So the metrics that they started to look at was not bottom line at all. It was not expenses it was just one of the key metrics that was the number of stores which is probably one of the most ridiculous metrics to look at because you can always get a higher topline but just opening new stores. What happened was that they opened up very profitable stores. Nothing would be hiring x amount of people. But one thing I want to have Bill on this long spiel about talking about tax law which was something that Jim Collins highlighted in this chapter and that was that you can grow faster than finding the right people to implement that growth.
Preston: [00:17:29] Think about how we should measured and it is not mentioned on the bottom line you should be very very you know you see this so often with businesses that go and buy or acquire another business and it has no relation to the underlying assets of the original business that they’ve purchased. If a company is doing this from a nonoperational standpoint it works. Unlike the Berkshire Hathaway model where it’s kind of like a non-operational role and even in an operational role if you have the right people in place and the headquarters doesn’t try to go down there and change everything. I think that’s when it gets when they tried to really do the merge and try to bring their their headquarters in there and start bringing some of their leadership down there and it gets messy. I see that bill so much more than it actually works that I think get easily nested up here into this stage too which is undisciplined pursuit of more so some of the indicators that you’re in Stage 2. I really like this one so easy cash erodes the discipline that sustained the company in the first place. How many times do you see a company that goes and does an IPO or raises a bunch of money. Maybe an early start up they raise a bunch of money. I mean you’re seeing this in FinTech right now to the extreme. All this crypto currency Bitcoin stuff like you’re seeing so many companies that are getting very large checks being thrown at them and they’re just going out there and spend and trying to grow and they’re not they’re not getting hardened is the way I like to describe it. When a company is strapped for cash they have to get hard. They have to develop these protocols inside of their organization to be efficient to be lean to do things in the most optimal way possible to generate net income. And I think that’s a really healthy thing for a company to go through. And so anytime you see a very large check being written for a company the immediate question needs to be so what is this for.
Preston: [00:19:32] Like what in the world are you going to use all this money for another thing that’s really a red flag and this is probably not so much from the outside but when you look inside an organization. If people start to think in terms of job instead of responsibility that’s something I’ve seen so many times that people are saying no that’s not me that’s not my job. That’s not in delegated to me. So what can I do about it. And that’s just the wrong approach. You have a responsibility and you can always ask for more.
Preston: [00:20:04] One other point that I have for the indicators for this second stage is will these activities that we’re doing right now help organizations economic engine or is it going to basically create a resource engine. So a lot of the times when these companies grow and they expand what they’re really doing is maybe adding more risk to the business because there’s more cogs in the wheels and there’s not really much economic benefit or margin being added on the income statement. That then gets banked and can be used as retained earnings into the future to give the company that flexibility to maneuver in the market dynamically. Instead they’re just adding more and more and more people to the churn. And you’re not really seeing much more net income being added to the bottom line and that’s when you’re getting yourself into this situation that I look at it like a person walking a tightrope. If you add more and more and more weight to that person as soon as you get a little bit out of balance the whole thing’s going to fall over. That’s you know I guess the best analogy that I could use for this stage to piece something that’s important that Collins talks about in the book is you could start out at Stage 1 and recognize it and pull yourself right out of it. You could get to stage three and recognize it and pull yourself out of it. So a lot of these companies they might start going down this path but they can get themselves back out of it.
Preston: [00:21:22] The ones that just continually go stage 1 2 3 4 and don’t do anything to mitigate work wrecked or self correct themselves or the ones that eventually have the slow and sometimes even death. So let’s go ahead and jump in the stage three stage three is called denial of risk and peril. So this is where you’re really starting to see the numbers demonstrate what’s actually happening here instead of the company still growing their top line and there’s like this thing that’s kind of growing inside of the business this mindset that’s kind of growing inside of the business. Now you’re actually starting to see it play out you’re starting to see that maybe the Starbucks example in this isn’t necessarily what happened but let’s just say they continue to add more and more stores a lot of them are profitable then it’s a strain on resources at the headquarters level and it just compounds and it gets to the point where it’s not sustainable you’re actually seeing the top line start to contract and then management’s way of handling that is. Oh well it’s this outside thing or it’s the economy or it’s anything but us it’s not us it’s everything else it’s the competitor that’s coming into the space we need to just keep doing everything the way we’re doing and we need to keep expanding. That’s what we’re talking about here in stage 3.
Stig: [00:22:40] So he actually gives some really good partners in terms of how to read the financial statements and you found in his research that three key races are more important than others and he mentions gross margins current ratio and debt to equity and all of the fallen companies that he studied saw a deterioration. At least one of those three ratios in states three which will then lead them to states for so the gross margins. It’s basically what you see a lot of in retail right now. So it’s basically just the difference between the revenue so the price that you charge for a product and then the cost to that. If you ever starts to see that erode it’s a big red flag. Now that’s also why retail is so cheap and I guess some people would say it’s it might still be or sold so might be some value there. But it’s definitely a red flag and that’s a good reason why companies like that are trading at a very low multiple and so the current rates you would be how much cash is expected to go in and how much cash is expected to go out within the next 12 months. And if you see a change in that it’s also a red flag. Tell the audience would a normal current ratio look like like as far as the number I would recommend that you have a current rate of around 1 5 or more. And if it’s one point five it basically means that every time we have a hundred and fifty dollars coming in we have 100 dollars going out. This is very different from sectors of sector. There are some good reasons why it is different for a company like Wal-Mart than if you had already company.
Preston: [00:24:15] And if you guys want to go to like a graduate level study of the current ratio go look up Amazon and look at their current ratio in which you’re going to find is that it’s actually under 1.0. I think we talked about this on our form maybe like four or five years ago there was a big long discussion on our form about this and it really comes down to their operational effectiveness and how they’re able to do this and their dealings with vendors.
Stig: [00:24:40] Yeah I think it’s less than one that says something about like credit terms that they can negotiate because size it is more like a math thing. It’s not like we’re not saying that Wal-Mart is going bankrupt. That’s what we’re seeing it all if you look at the numbers. It’s a different type of business but yes it is in general a concern if you have more casque going out and coming in and it’s just a trend that you should definitely look into and then. Then the last thing that’s the debt to equity which is also metric you talked about multiple times you on the show and in the easiest way to think about this metric is basically that a come when the would slowly build equity whenever they have a profit. But then we look at how much they had in comparison. And basically we just don’t want the company to have too much impact to the wealth that they’re accumulated. Another sign that he’s pointing to that’s not like a key Raichu that will be noticeable reorganizations. That was another thing that you point into. And for me it has been very relevant so and I talked about McKesson here a few weeks back and that as a very interesting stock pick and I picked up some and nothing got pressed and correct me if I’m wrong but I think you also picked up a little and there was a very good price.
Stig: [00:25:52] And it shows some very good numbers. One thing that was concerning for me when there was going through the financial statements that was that they are doing some restructuring right now and they had some some things going on the U.K. and they go on to write that off and I’m not saying it’s a huge issue even though whenever I look back at some of the previous financial statements I can see very little. But if you are restructuring and basically this is down to how do you present your data. Because if something is restructured it doesn’t appear as your normal operating income and the way that McKees and a lot of other companies are reporting great income is that they have something called adjusted Abiad and when they were they’re doing their adjusted Abid It’s a different number than the profit that they’re actually making because that would include all the costs that they’re basically just writing off. So we’ll see something like that. It’s not so severe that I will never invest in that company. That’s not what I’m saying especially if I get good value and it’s not like a session. But it is something I definitely plan to monitor closely.
Preston: [00:26:58] Also for this company whenever I find that so anybody that’s listening to this and they’re interested in how something like the current ratio is calculated this is all on the balance sheet when you go onto the balance sheet. There’s current assets listed and their current liabilities. Those are items that are going to be either paid out or collected within 12 months so all you do is you just take the current assets and you divide it by the number for the current liabilities and that’s how you come up with that ratio of a one point five or whatever number is that stick and I were talking about. So let’s talk about the indicators that you get when you’re in stage 3. Just listen to some of these and you guys are just going to be nodding your head like wow this is what my company and more for us. OK listen to these amplify the position and discount the negative. So if you go into a meeting and all they’re talking about is how awesome they are and any negative is just kind of washed away that’s a Stage 3 sign bet big on new goals without empirical evidence or validation of previous small wins.
Preston: [00:28:02] I love this one. Like if you’re going out there and you’re just you know you’re putting all the chips down on something that you have no idea what it’s actually going to do. That’s a sign of Stage 3. Here’s another one debate and dialogue is replaced with consensus. If the boss is sitting at the head of the table when he’s not saying so what’s wrong with this idea. Shoot some holes through this idea tell me why I’m wrong and instead all you hear is people who just kind of nodding their heads and saying oh sir that’s a great idea. We love that idea. Those are some signs. Here’s another one. Paralyzing blame rather than accepting failures in that one is obvious. And here’s one more obsessive organizations within the company. So all of these I think everyone has seen in their in their days in the workplace. But whenever you’re seeing these just permeate your workplace you’re in stage 3 and I don’t want to talk to Mott’s about stock investing separately.
Stig: [00:29:01] But but here goes anyway. Whenever you’re listening and reading through the reports. Of course it’s natural tendency to emphasis good news but it just can be so so dangerous and it just it just needs to bring up this one example. So I called Preston last night and we talked about just business general and then I said that the stock pick that you pitched thing it was like two or three Masuma I mean he said go with Gamestop and I don’t think actually I don’t think you ended up buying that. I bought some stock on that and they were sending out a new quarterly results and the mogę was like trading at eight or 10 percent premarket up. And like everyone was just so happy and I was kind of thrilled too because I’m used to this never right about my stock picks and and then I read through the statement. And so basically they have two growth drivers. I don’t want to talk too much about this stock pick but more for the ExxonMobil. They have something called Technology Brandt’s. Now UBS is very important to them. That’s one of the primary driver growth an array of really important business unit. And I was actually very surprised to learn that the earnings or the gross profit has decreased on that. And I was because they actually took up its sizable debt to buy a lot of tea outlets and to really grow that I mean that was definitely potations and they were asked into that twice and the response when something like this.
Stig: [00:30:25] Yeah there’s a delay on iPhone X. So that’s just why next question like that didn’t talk about that at all. But then they had another business unit that is also growing is called collectibles and it’s significant less severe and that just talk 60 percent of that earnings call where what that was all about the growth that they have in the collectibles complete neglecting the problems they have with technology brand that was actually an even more important business unit. And I haven’t liked sold my positions since I’ve read that is probably I don’t know 2 or 3 or sicko’s read that I was just so taken back about what I felt was a very insincere handling of problems with the management and hey that might have some good reasons for why that has been the case. But nonetheless they need to own that mistake they can blame it on Apple because they’re delaying their release. That’s for me as an investor. That’s not good enough. So for me though Stephanie flaks have suppressed a must write off role. Who knows.
Stig: [00:31:23] Yeah I did not buy it but you know like I said when we recorded that numbers were just so interesting you know when you bring up this point stick about how they’re not owning up to the failures in really kind of making those the focus when you go to a Berkshire meeting and you watch Buffett Munger talk about their decisions. They are so comfortable talking about their failures in fact I think that they almost prefer to talk about their mistakes and their failures because you can see them trying to learn and also teach people how to not make that same mistake and they’re almost obsessive about focusing on that area post talking about all their wins which they just have so many of them you know. So it’s quite interesting to see the dynamic between what he just described and what we see everyday when we go out to their shareholders meeting all right. So stage for grasping for salvation. So this is the point where things start getting a little scary and the business is not only seeing financial decay but they’re also seeing talent decay. They’re seeing flight of investors that have been around for a while. They’re seeing all sorts of things that are happening here and they’re reaching for straws. They’re getting desperate. They’re trying anything and everything they’re firing. You know people that have been there for a long time because they think they’re the reason that they’re underperforming and really this is just the mindset is is kicking in even deeper in pointing more fingers. So for example in the book for stage 4 Hollens talks about HP and IBM. So Stig’s in a cover recap of this.
Preston: [00:33:01] Yes so for HP they had problems at the end of 1998 and basically what they came up with was that they needed a bold new leader. And not only did they want a new leader. They won like a different expression especially in the media. One of the reasons also to attract talent and that was narrative. So they wanted a new leader and the founder won the phone. Like really Karsh magic woman she was featured on Oprah. I think she was even on the front page of Vogue. I think actually the million dollars for that run page and she was very determined. We need to do these two or three things so whatever the boss and we do that we have turned this company around and it just needs to go like this. She was definitely in a hurry and obviously what happened after this short period of time. These initiatives didn’t pan out and she was let go. And then he compares that to the previous IBM CEO that almost on the ground after he was Hinden it didn’t go public at all. Because whenever he was asked he actually said that he did not have a grand plan because how could he he didn’t know the company well enough.
Stig: [00:34:08] So he spent nothing less than three months before he made the first public statement terms of where they were heading. And he still said I just really trying to understand what needs need to do. And that was how IBM and perhaps they could use a CEO like that today who knows. That was really how they turned it around. And this really comes down to some of the markers in terms of when this is happening. Are you seeing someone who is in a hurry to implement a solution for instance like HP. Yeah that’s probably a bad thing and vice versa. Do they look at acquisitions like the silver bullet solution. You see a lot of that whenever you see a new management focus on Monet’s Yushan not the best thing is you should focus on the core competence for a company. Do they have good stories and good narratives in terms of how out of the crisis or are they performance in fact based when they were they making arguments both internally and externally. That’s really what you should be looking for to turn the round stage for a company.
Preston: [00:35:08] So the behaviors that exemplify and perpetuate stage for listen to this will seek a big game changing acquisition based on hope for it has yet unproven synergies to transform the company in a single stroke. That would be something that would exemplify stage 4. Here’s another one. Embark on a program of radical change or revolution transform or up and nearly every aspect of the company jeopardizing or abandoning the core strengths. So if those are things that you’re hearing inside of a company then you know you’re in stage for what Paulines recommends something that could get you out of stage for would be gain clarity about what is core and should be held firm and what needs to change. Building upon proven strengths and eliminating weaknesses. So whenever I read that the thing that immediately comes into my mind if anyone’s read the Steve Jobs book I distinctly remember when Jobs came back to Apple. This was after he had started. Next he’d came back to Apple and he comes in and they’ve got all these odd projects going on. It was just kind of like a mess. It was exactly what would be classic stage for company. So jobs is sitting there with a white board and he’s he’s jotting down all the different products the assets within the company he’s asking them about the competitive advantage of this what’s the competitive advantage that well what’s the technology how long is this technology good for he’s like mapping this all out on the white board.
Stig: [00:36:40] After he’s done hearing all these different people will show up and is like it seemed like there was just yet another department that came out of another department and as he’s writing this stuff now and after he has done he had heard everything he took out his marker on the white board and he circled for things and then he wiped everything else away and he said these are the four things we’re going to do and we’re going to do them better than anybody on the planet. And if anyone comes to me with anything else we’re not going to do it. We are doing these four thing. And that’s what set Apple on the trajectory that it’s at today and that is exactly what Collins is getting at with how to recognize what is stage for what a company needs to do to get through stage 4 and start coming back out. What are those core assets that are bringing home the bacon and how can we optimize those. How can we refine those. How can we be really really really good at that and cut all the excess fat off this company because if we keep running around at 300 pounds we are going to die. So we’ve got to figure out how to save this thing and focus on those things that will save the company. I found that to be a really profound chapter and I really found it profound insights that he gives on how to self recked at this point because this is your next to last phase and if you don’t self correct you’re done.
Preston: [00:38:04] All right. So the last stage is capitulation to irrelevance or death. In this section he doesn’t have any companies that he provides that reach stage 5 most of the companies that he studied throughout the book The Stage 4 and then they started to self correct some of them in a great fashion and some of them just continued to stumble around at the bottom. A company that I would like to talk about today that in my personal opinion that’s in Stage 5 is Sears. The reason I feel like Sears is in Stage 5 is because the company has set themself up or a situation where they have structured the way that they compensate their employees in such a manner that no outside investor is going to have a lot of interest in buying or merging or taking on the responsibilities of that company. There are laws in place that if you have all these obligations and I’m talking about basically retirement obligations to a lot of the employees that you have at Sears that is not something that you can just swipe away and make those disappear. Those are obligations that must be paid at a certain order if the company would liquidate or if the company would be purchased. Those obligations are going to be carried over.
Preston: [00:39:20] I think that’s a big big concern and that was very very very bad or decision making by the management of this company years ago. Think of it like this if you’re going to structure something inside of your company you know what that means financially. So if I offer somebody a retirement package that’s going to be paid if they work for the company for 30 years and it’s going to be X number of dollars. I have to value that in today’s terms. So these managers that would have structured all these deals with all their employees they were making promises that they knew could not be released. I would suspect they had no idea that they could be held. That was the death of this company. Not to mention many many other things. But the reason that I think that company’s going to go into stage 5 is for all those reasons. And like I said he didn’t provide an example in the book of a company that got there. But I think if you’re studying this book and you’re looking at real world examples I personally think that that’s a company that will get there. Maybe I’m wrong maybe somebody will come in and happily pay all those benefits out but I think it’s a big concern and I think that it’s a great example and states 5 is really where the company’s leader perhaps even the founder typically just sells out.
Stig: [00:40:36] And it might be true competitor might even fight off bankruptcy and it’s obvious this is not a good states to be in but I think the best way at least for me to talk about this staes is how to avoid it and I know that we give me a lot of points so far in the first four stages but if there one thing I really wanted to point out that’s the sense of urgency. I mean it’s easy to feel the sense of urgency if you’re just about to go bankrupt but obviously you need to feel that a lot sooner than that. If you feel urgency both in good and bad times and if that is ingrained in your culture that’s really the roadmap to success. Whenever I read about a company that might be states forest it’s 5 and the hog about how they will now improve the bottom line by starting a cost cutting program. That’s some of the worst thing I can ever read. It’s kind of like me telling my wife you know I wanna be a good spouse the next two weeks gonna put a really great effort into being a good spouse. You should not do that just on next two weeks you should just be a good spouse. You just not have a cost cutting program. She just always cut costs. No this comes out like a rant I guess of some sort. But that’s the best way of getting there it’s just it’s fine I guess.
Preston: [00:41:55] You know it reminds me of dieting a person that gains a bunch of weight and like now I’m going to go on a diet. And it lasts for two or three weeks and then it’s just right back to square one. It’s not based on some fundamental change of the person’s lifestyle or the habit and the person’s lifestyle that allows them to keep the fitness or the diet or whatever it might be in the perpetuity. And trust me folks I’m not some beacon of excellence when it comes to health but I’m using that as an example that a person could tie back to a company and what sticks point is is if you’re just saying hey we got to start a cost cutting program that means that it’s temporary in nature that’s something that we’ve got too fat. If you’re getting too fat the problem is is why are you getting too fat in the company why are you not developing very optimized flywheels as Collins would call them before expanding those and growing them out into Balkan into volume throughout your organization. And I think that that’s the really critical part when you’re building the company and also as you’re trying to optimize it. If you’re in a decline. All right. So in general. Loved the book highly recommend this book. This is a really quick read. And all five of these stages are so critical and I think it’s something that a person should probably read often to try to remind themselves and think about these things thoroughly enjoyed this book it was fantastic.
Stig: [00:43:16] We actually required a few books that we don’t talk about on the show. So we think we want to ensure that you are actually getting the very best books so that’s why I guess sometimes we sound or enthusiastic.
Preston: [00:43:27] We probably only do like two of every four books that we read.
Stig: [00:43:30] When you say yeah yeah easily Yeah.
Preston: [00:43:35] All right. So at this point in the show we’re going to play a question from the audience and this question comes from Antonio. Hey guys. Thank you for taking your time and answering my question. I’m a huge fan of the show. Recently there has been some speculation that China is looking to replace the entire dollar like using oil supplying countries such as Russia or Saudi Arabia who accept payments in yuan backed by gold. Is it better the petrodollar as we know it. Will this affect the American economy and it can be growing profits from such a scenario. And you are right Antonio fantastic question Stig’s going to take this first stab at this one.
Stig: [00:44:12] So and So and you thank you for asking this question. First of all without trying to put on my sweet jacket and talking to you about the petrodollar and history like that Professor kind of way please allow me to just provide the foundation for the concept that you introduce here so petrodollar dollar really was something that came up after the collapse of Bretton Woods Gholston us in the early 1970s. And basically what happened at the time was that the U.S. struck a deal with Saudi Arabia to standardize all prices in dollar terms and it had a lot of impact. The dollar was already the main currency the world’s reserve currency actually. And it really became even more important after that. That’s also one of the reasons why the U.S. is able to enjoy persistent trade deficits. And it also provides the U.S. with you know financial markets. It’s a very impressive source of liquidity and foreign capital outflows and actually the latest number I could find on this just to talk to you about Mac and shoot us back in 2013 87 percent of international deals was settled in USD on one side. So basically what you’re talking about is this changing now and what will then happen. And the answer is yes. It is changing now.
Stig: [00:45:28] Now that’s not the same as saying that the U.S. probably won’t be the world’s premier reserve currency. They have been that since 1945 when they replaced the British pound. So first of all I think that’s actually fascinating that it’s not longer than 1945 that the U.S. dollar was not the reserve currency in the world. Think about how fast that has basically changed so if you’re asking can that change one way or the other risk going to China. The answer is obvious yes. Time is infinite. And yes it will happen at some point in time. Will this happen and will this happen with China for instance. If we look at a list of the biggest all importers in the world aside from the U.S. you have China. Yes China probably would like to sell things in their own currency if they could. You have India too and China’s actually primarily import in terms of exports for them. But the total trade with China is actually slightly more than is the case for the U.S. It’s the same with Japan. That’s three on the list. And South Korea where I want to say China is even 2.5 or three times as important in terms of trading partner. So you can come up with many good reasons why in the future a commodity like oil will not settle in USD and why it would be another currency.
Stig: [00:46:49] Now with this dramatically change we talked about having the Chinese currency as a primary reserve currency multiple times before it’s just now being included in IMF. The International Monetary Fund’s basket of currencies and this is a very very little. I don’t see that happening anytime soon despite the fact that I just ate you the second most important currency in the world. All of that will be the euro being European and seeing everything that’s going on in my wildest dreams I can see how the euro can overtake the U.S. dollar with the membership countries being so inconsistent in what they say and what they do and the goals they have the ones her policy so I guess my response to the first part of question would be the U.S. dollar and the current system we have. It’s not perfect but it’s the system we’ve got. And I guess I have a hard time seeing how that’s going to change dramatically at least over the next decade or two. That being said your points about China definitely you will see a shift but perhaps not to the extent that one might argue.
Preston: [00:47:58] I agree with what sticks saying to the extent that I don’t think that you’re going to see any kind of drastic change in the next couple of years. I think when you get out to 10 years from now I’d say seven to 10 years from now you might start to see things start to change around a little bit. But I think in the near term within the next five years I don’t see too much changing. I do find this very interesting though what you talking about and I think that it’s it’s more representing the frustration that a lot of countries in the world have with everything being priced in dollars. And I think that that is probably maybe more important than anything else because I think that that might be what drives the big shift maybe in 10 years from now to some other type of currency emerging as maybe a global reserve currency. And so I guess that leads us to the conversation. So you know you look at Bitcoin just this past summer I want to say in like June you looked at the market cap of bitcoin and it was around oh I don’t know maybe 80 billion dollars was the market cap of bitcoin today. The market cap of bitcoin is 137 billion dollars. So that’s just a couple of months ago. Those like five months ago that you’ve seen that much growth in it. But let’s call this what this is 137 billion dollars of a market cap on a currency is very small insignificant. As far as how small it is but I will say watch the trend on this thing because this trend is like something I have personally never seen in my entire life. And I don’t know that we’d ever see it again. If this trend persists so when we look at the market cap of various currencies so like let’s just start off with gold 7 trillion for gold. When you start talking about like the U.S. dollar I have no idea how big the market cap is on the U.S. dollar but if I had to guess I mean you’re talking tens of trillions of dollars.
Stig: [00:49:48] It’s way up there. It also depends on how much you include as the market cap of the U.S. dollar. I mean we’re not just talking about like notes and coins here. It really depends on what kind of have all these fancy terms call it. One them to whatever you want to include as a currency and how much is credit and how much is not. And if we start seeing a currency backing commodity whatever it is it’s a different world. I mean I know that 137 billion dollars sounds like a lot and all of it is a lot.
Preston: [00:50:20] Yes as Preston set for a currency it’s next to nothing and I don’t want people to hear us say that right there and say oh we’ll press and stick. Don’t think that bitcoin can be a really big deal in the next five or 10 years because we definitely think it can be a very big thing in the next five or 10 years. We just think that where it’s at today as far as market cap that’s not going to happen in the next couple of years where Bitcoin is now going to be with oil and things are priced in in the next three years. That’s not happening even at the pace that bitcoin is going out. It’s not going to be there in three years but give it 10 years and it keeps trending the way it is. And you see all this money that’s stuffed up into fixed income with a zero percent return starts flowing out and a lot of people were selling out of that and they start chasing the 300 or 500 percent return that Bitcoin has been returning every single year for like the last seven years. Yeah you might start to see some interesting things happen. If that trend continues and I think that’s our best advice for people when they’re thinking about bitcoin is if you’re not studying it and you’re not aware of it there are some interesting things happening here and we’re not saying it’s going to replace or become the world reserve currency. It’s something that I think people need to be aware of.
Stig: [00:51:32] And I think Antonio if your question this morning the direction of will countries use call a bit Corneau another cryptocurrency to sell action. I think that is highly unlikely because all nations really have a incentive to use their own currency at least not using crypto currency so that’s probably not it. Right now we see a lot of individuals settling transactions with richer currencies. You probably also see companies starting to do that but you will probably not see them institutions doing that for a very long time. But if you ask in the sense that what will happen if it Bhaga loses faith in the U.S. dollar whether it’s gradually it’s just slightly or is it if it’s more significant yes it will have an impact on other currencies. So remember what is one dollar worth one way comprises that would be in other currency. I can tell you what it’s worth in euros or I can tell you what’s worth yen and if people start to lose faith in us dollar or whatever reason less money will be flowing into the U.S. dollar. And basically you know a currency is now no different than the price of a stock. You know you had Imane. You have supply and if you have less demand for U.S. dollar and that money’s going elsewhere you will see a sore in that type of currency instead. Now whether or not that will be bitcoin is what you’re saying I don’t know. I mean I think a lot of money that would potentially flow out of the U.S. dollar I think it will go to the other major currencies definitely first. But you’re right in the sense that you don’t need a get lots percentage of funds from fixed income or whatever it might be to pump up something that’s only one hundred thirty seven billion dollars and thinly traded.
Preston: [00:53:10] So this is worse thing and I see things a little differently. So he said that if money flows out of the U.S. dollar into other currencies he thinks that they’re going to go into other currencies before crypto currencies. I would agree with that. Up until probably the next year and then I think that that’s going to start to change. I think when you look at the price action of bitcoin specifically it is following Metcalf’s law almost to a T and Metcalf’s law is how when you look at the growth of Facebook you look at the growth of Google Ali Baba 100 percent correlated the Metcalf’s law since the start of bitcoin it has been following Metcalf’s law almost to a T. Could you elaborate more on that law and what it means. Yes the law is if you’ve ever taken a business class or you’ve seen a chart that shows a network effect where the pricing of something looks like a hockey stick where it starts off slow then all of a sudden it’s almost completely parabolic and it goes almost like a rocket straight up when you look at the pricing you need a logarithmic scale to plot something on a chart to do this. That’s what’s happening with big point today. So I think once you start getting past the market cap of 100 billion dollars you got some really raising their eyes saying What the hell is this thing over here.
Preston: [00:54:33] And then if that continues if that trend continues which it is this has not subsided at all. If this trend continues and we see this go for another year guess what you’re not talking a hundred billion dollars you’re talking like 500 billion dollars. You’re talking some real numbers here. And then once it hits a trillion dollars watch out is I mean the network effect of this is going to only compound on itself. So I really think there’s something here and I think that it’s something that people need to pay attention to. I’m not saying that I guess I’m not saying anything. I’m just describing what has happened over the last seven years and I think that trend you know the perfect example I saw in were here in November of 2017 Coinbase which is the exchange that does crypto currencies here in the United States. Coinbase had something like I want to say 12 million users from the last seven years in the month of November alone they had something like one point two million people sign up for Coinbase just this month. And just a month. So when you have that many influx of buyers versus sellers there are some interesting things happening and I think it should really grab a person’s attention and I think they need to study what the heck happened.
Stig: [00:55:48] I’m glad that we disagree. I force it is not about stocks but from above it kind of I guess I guess we can live with that. I think what I see now whenever you bring up numbers like that. Yes there are definitely a lot of individuals that are signing up going into bitcoins perhaps buying 4000 box or 500 box or whatever this. I’m really curious to see what happens with institutions and we talked about we talked about Shimi before and what they’re doing with fuchsias was this to me a lot more breakthrough in many ways than for instance Japan saying that now you can stop paying for things because even though it sounds a lot bigger the market for bitcoin it’s very thinly traded compared to many other markets and that also means that if you take out 10 trillion from the U.S. dollar and then you put you know nine point eight trillion dollars worth in all occurrences and only 2 trillion which will be 200 billion dollars. You don’t see a market cap going from one hundred thirty seven to 337. That’s not where you’re seeing you’re seeing the number of bitcoin multiply with the last traded price. So the Magu price might go to trillions of dollars suddenly. And also what you see now is that the circulation of Bitcoin. It’s not that much in the sense that you have a lot of people who are using it as an investment or storing value whatever you want to say so you have a lot of buyers going in not too many sellers going in. So if you see a huge influx of money you would see a very interesting pattern in price setting meaning that it will go up more.
Preston: [00:57:20] Yeah no. Interesting. Interesting stuff. I think that when we look back at this in 20 years from now we’re going to be quite amazed maybe what transpired what happened what didn’t happen. It’s just this is stuff is crazy. This is absolutely crazy. It’s very exciting. I guess that’s probably why I have so much emotion in some of this is because it’s really exciting stuff to see what’s happening here through the technology and what people were coming up with to try to egg all these global currencies the mess the currencies. It’s fascinating. All right. Fantastic question So Antonio we went way longer than we had ever expected on that question. But because you submitted this we’re going to give you a free course on our Web site on the VIP Academy website. It’s our intrinsic value course. And for anybody else out there if you want to get a free course on our academy web page go to ask the investors dot com you can record your question if we played on the show you get a free course. And we just really appreciate everything our community does for us and offer up these questions. So thanks for doing that.
Stig: [00:58:21] All right guys that was all that pressed I had this week’s episode of this podcast. We see each other again next week. Thanks for listening to the IP to access the show notes courses for forums. Go to the investors podcast dot com. To get your questions played on the show go to ask the investors dot com and win a free subscription to any of our courses on Antti IP Academy. This show is for entertainment purposes only. Before making investment decisions consult a professional. The show is copyrighted by the IP network. Written permission must be granted before syndication. We’re rebroadcasting.

Books and Resources Mentioned in this Podcast

Jim Collins’ book, How the Mighty Fall – Read reviews of this book

Jim Collins’ book, Good to Great – Read reviews of this book

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