Gary Mishuris (02:56):
And tying that into overconfidence, you look at the last 10 years and large growth stocks of returns from 20% per year or something like that. And last five it’s been 25% per year. So you could be a monkey throwing darts if you were investing in that universe and you would think that you’re an amazing investor. The reality is that there are some amazing investors for sure, and that’s not to take anything away from them. But I think that there are also many people who just are as the saying goes bull market players as you alluded to.

Gary Mishuris (03:30):
And so how do you tell a difference? So I think you have to separate what are you forecasting and what are you getting right versus your outcome. Here’s what I mean. So let’s say you buy a stock because you think it’s a high growth stock, chances are most of the market participants don’t disagree with it being currently high growth stock. Usually disagreement is about the years are far out. So maybe right now the company is growing 30% and maybe you think that the opportunity is so large and the management team is so good that this company is capable of growing at that rate for 10, 15, whatever years. And maybe the market is not discounting that.

Gary Mishuris (04:08):
And so what does that mean? In the first few years, you don’t really learn that much about whether you’re right or not. Now, it might look different to you because you might buy the stock and all of a sudden, the crowd agrees with you and the stock doubles or triples or quadruples, but that’s not you being right or wrong, that’s just people voting with their dollars at a point in time. And as we’ve seen recently, those votes can change very, very suddenly. And so I think that one way of making sure that really you’re getting the right things correct is focusing on, are you getting the fundamentals right? Approximately it’s not the game of precision, but approximately right.

Gary Mishuris (04:44):
The same thing applies if you are a value investor, quote unquote, “traditional value investors.” Let’s say you’re buying mature business and you think that the long term earnings power of this business is a dollar per share. And right now maybe it’s earning 25 cents per share because maybe it’s cyclically depressed. Well, if it doubles tomorrow, that doesn’t say anything about whether you were right or not, it says just about what the market thinks at a point in time. But to tell whether you’re right, you need to wait a number of years and see if the earnings power comes to fruition. And so I think to come back to your premise is what we have is we’re all overconfident investors. And I really see all, maybe there’s one person on earth who’s not overconfident or something like that, and obviously the funny thing would be to say we’re all over confident except for me, but I know I’m over confident as well.

Gary Mishuris (05:31):
And so I think you have to build in structural humility into your investment process, because if you assume that you’re not overconfident, well, you’re just proving the point you are overconfident about not being overconfident. The issue is how do you acknowledge, yes, I’m likely to be susceptible to overconfidence and let’s build in a structural checks and balances to try to minimize that? That’s at least my approach.

Trey Lockerbie (05:56):
I think you made a really good call out there which is so challenging for any investor, but especially those focused on growth. And you start to realize why growth investors are so interested in R&D and these intangibles. And to give you an example, I think it was in year 25 or 26 for Amazon, it was year 2019 going to 2020. In 2020, Amazon grew 37.62% from 2019. And that was 25 years into business, something like that. So these growth companies, even though it’s unlikely that they persist at these growth rates, they can surprise you. And a lot of that comes from this R&D that they’ve been doing, maybe even under the hood that you don’t see.

Trey Lockerbie (06:34):
You see Facebook, for example, putting almost two billion into the metaverse and you could say, you could write that off, but five years from now, maybe Facebook grows another 40% in one year. This is why it makes these growth investments so difficult to project.

Gary Mishuris (06:49):
Absolutely. And I think it’s something that it’s wonderful when it happens. I think the other part that we have to think about is what are all the other companies that people thought were going to be Facebook, what people thought were going to be Amazon, that nobody knows anymore. So there is definitely a selection bias at play where we see vividly the examples of success, but when the style works and we forget that for every success there are many, many failures and that in the past, there were very smart people, perhaps just as smart as we are, who predicted those companies that we no longer remember the names of were going to be the next Facebook or the next Amazon. And that’s something just to keep in mind that it’s not as easy as it sounds, but when it happens, it’s pretty wonderful.

Trey Lockerbie (07:32):
Another way to think about overconfidence is simply the sheer hubris we have as investors to think we can outsmart the market. So, for example, we can use filters to find businesses that match our required metrics, but it often feels like we could be the Patsy at the table, because as you mentioned, every analyst is probably doing that. What are some ways to know if we’re avoiding a value trap and actually discovering an undervalued business?

Gary Mishuris (07:58):
Your question reminds me of, I was listening to a talk many years ago in person by Jean-Marie Eveillard from First Eagle Investments who’s a legend of international value investing. And he said something that surprised me at the time, which is there’s no such thing as a value trap number. What do you mean? In value investing, value trap is a common term. He said, “Well, there’s no such thing as a value trap, there are just investments whose fundamentals you get wrong.” And so I think that one thing you can do is to start with seeking out the opposite point of view fairly early and understanding if someone is, let’s say you’re buying a business, if someone were to be short this stock or at least someone were to be avoiding it with extreme prejudice, why would that be? And so it’s interesting.

Gary Mishuris (08:43):
So I have all these checks and balances I try to insert into my process to guard against behavioral biases. By the way, understanding that even with the best efforts, I’m still going to have some biases. The perfection is not the goal. The goal is to minimize them as much as possible. So you are going to have these biases, but if we can limit them, that’s better. So I used to have this app exercise called the devil’s advocate exercise. And I would ask other investors whether someone, an analyst or another investor friend to present a strong alternative point of view on existing holding. And then I had this idea, wait a second, why am I waiting until I own this thing, because there’s all kinds of biases that kick in like anchoring, endowment effect. By the way, some of those of you listening, the endowment effect is not like the Harvard endowment. It’s like we like things we already own more than the same thing that we don’t know. Just the act of owning something makes us like it more. And they’ve done experiments quite frequently to show that it’s a persistent effect.

Gary Mishuris (09:41):
So my question to myself was why am I waiting to have this devil’s advocate presented once I own something? Why not have the devil’s advocate be done as I’m researching something before I’ve really anchored on that idea? And so now what I do is as I’m researching the ideas, I’m finding information. Now, obviously, as I’m pursuing it, there’s some amount of likeness already occurring. I’m not spending time on the idea. Hate, that would be silly. So the fact that I’m researching it already means that I like it to some degree and there’s some formation of biases that’s happening.

Gary Mishuris (10:12):
So in parallel, now I’m asking some of my interns, for example, to go and say, present me with the strongest possible negative case on this business. Find out everything that’s wrong, that’s right there. And I want it early, because time, especially if you do deep research, which I try to do is a very valuable commodity. And I can’t afford to constantly spend time on things that you never invest in or at least you need to shorten that time if you can. And so having someone de-bias me early in the research process and point something out that would make me kill the idea, it’s hugely valuable for two reasons. One is the time, but the other is I’m much more likely to listen to someone’s opposing viewpoint before I really anchor on the idea than if, imagine this, you buy an idea and then tomorrow someone presents you with a strong negative thesis. It is super hard to sell it the next day after you bought it. But if they present it to you the day before you bought it, how much easier is it to just not buy it in the first place?

Gary Mishuris (11:08):
So just having those checks and balances early in the process, I think is again, not perfect, but I think it’s an important step in minimizing those biases.

Trey Lockerbie (11:18):
That’s interesting. I haven’t actually come across the endowment effect. That’s a really interesting one. What you were just describing is reminding me of this conversation I had with Bill Nygren at Oakmark. And it sounds like they have this investment panel, I guess you would call it, or before they do make any decisions, they do I think what you’re mentioning, which is having a devil’s advocate in the room to shoot down the idea. And that is something that could be so beneficial for retail investors to find a little cohort of people around you that might be willing to do that for you. I think that’s something that’s probably pretty uncommon in the retail space, but so valuable.

Gary Mishuris (11:53):
I think it’s valuable. And I think it’s interesting in my prior firm. So I launched Silver Ring Value Partners about six years ago. Prior to that, I spent 15 years at large firms. My last firm, I had the same idea and I went to the head of the team and they said, “Listen, let’s do this basically.” I have a lot of respect for Bill Nygren. And I think the way he approaches it is a reasonable way of implementing this idea. And I got nowhere. And it’s like, well, we have the resources. I was part of a team that was managing over 10 billion in assets, we had plenty of analysts, why not? Well, is this going to distract our analysts from finding new ideas? I’m like, really? It is really hard. We’re so busy finding all these amazing ideas that we can’t spend X% of the analyst time doing these things.

Gary Mishuris (12:37):
So yeah. So I guess what I was saying is you’d be surprised how often you have these possibilities to have a devising step in your research process formally, not off the cuff, not over lunch somewhere, but systematically inserts into the research process in an institutional setting, but it just doesn’t happen. And I think a big part of that is incentives. Think about it. You take a typical asset management team, let’s say they’re whatever, 10 analysts and a portfolio manager, what’s the reward for the analyst to kill the portfolio manager’s favorite idea? How do they get paid from that? How do they get promoted from that? It’s hard. It just there is really no incentive. They might say, no, we really want you to give us your strongest possible view, but that’s not where their brother is buttered, their brother is buttered by potentially finding new winners or something like that.

Gary Mishuris (13:24):
And by the way, an interesting question would be how many times does this devil’s advocate process kill an idea before it makes its way into the portfolio? Because it can’t be just a fig leaf, it can’t be just, okay, we check the box, we had the devil’s advocate thing, now we can go ahead and buy, the consciousness clear. It needs to be a real process really with people empowered to really change the minds of the decision makers. Otherwise, it’s pointless.

Trey Lockerbie (13:49):
Well, I have a quick question for you about that. So let’s say, for example, you’re a generalist and you are researching, let’s say a healthcare company. Would you try and find someone who is an expert in the healthcare industry or sector to help you be the devil’s advocate or do you think that creates its own bias? That might be interesting, I’m curious.

Gary Mishuris (14:07):
Yeah. Right. So domain expertise is trickier. And so I think that a great idea should be obvious to a non-specialist. And the granted the specialist might need to explain some key terminology or something like that. Let’s say it’s a drug, but you don’t need to know the deep science of a drug to appreciate the economic potential of the drug in the market. And so if it’s not obvious in terms of economics, the science might not matter. It might matter from a humanity point of view, but from an investment point of view, it has a thoughtful generalist who has experience should be able to give you a good devil’s advocate case. But again, if the devil is in some detail and it really requires analyzing some phase three study and finding out some design flaw in the study that only a deep expert could find, it’s going to be harder. So we shouldn’t kid ourselves.

Gary Mishuris (14:57):
But I think most of the time, the problem is not some tiny nuance. The problem is it’s just not that compelling. And I think I’ll give you one piece of evidence to this. So I manage a small partnership. I have friends who manage their own multiples of money professionally. And all the people I’m professionally friends with are intrinsic value investors. Some people tend towards more the growth side of intrinsic value investor. Some people tend towards more the traditional value than Graham style. Regardless, we’re all speaking the same intrinsic value language, but our portfolios of vastly different.

Gary Mishuris (15:29):
Moreover, when we talk to each other about our portfolios and share ideas, very infrequently does someone end up taking someone else’s idea and actually putting it into their own portfolio. And to me that says that there’s just enough biases out there, because someone with similar intelligence, similar quality process and so forth, did the research, found the idea to be attractive, here we are being pitched that idea by similar respect and yet we don’t buy it.

Gary Mishuris (15:56):
So we have our own unique circles of competence. That’s one thing. And that’s a legitimate bias. That’s a good example of a bias, I would say. Maybe it’s a fact based bias in the sense that we have patterns of investing that we are more comfortable with or experiences that lead us to be experts in something that someone else is not. But I think there’s just a lot of subjectivity in investing and I think a good generalist can take even a specialist idea and find holes in it that the specialist might not be self-aware enough about.

Trey Lockerbie (16:25):
Fascinating stuff. So I want to move on to the next one, which is base-rate neglect. So there’s this phrase that’s come up, I don’t know, maybe over the last decade, maybe longer, but it’s don’t fight the Fed. And we’ve seen a lot of help from the Fed when markets have declined in the past and we’ve seen the Fed reverse course on say, raising interest rates quickly due to recessions and other liquidation problems around the world. So from this, we may have misconceived notions on how either the Fed will react to markets if they continue to decline from here, for example, which would thus enact this base-rate neglect human bias. So walk us through what the base-rate neglect bias is and how we might be able to avoid it.

Gary Mishuris (17:05):
Yeah. So I think it’s fascinating that… And I think sometimes people talk about inside view versus outside view. So base-rate neglect refers to ignoring the experience of others in similar situations and just making an assumption based on what we think we can do in this situation. So let’s say a very simplistic example of someone flips coins 1,000 times, they get 50% heads, 50% tails for a fair coin. And somehow we convince ourself that we can take a fair coin and flip tails 70% of the time. And that sounds ridiculous when they phrase it that way, but sometimes essentially that’s what is happening.

Gary Mishuris (17:42):
So, for example, if you study great investment records, which I’m sure you do, you realize that there’s a certain range of access returns over decades that the best investors have been capable of. And if you take Warren Buffett out of the picture and if you take people who use leverage out of the picture, unlevered returns, there’s almost nobody over decades has exceeded 5% per year access returns with no leverage and so forth. Obviously, Buffett has done close to 10, but I don’t think there’s going to be another Buffett necessarily.

Gary Mishuris (18:11):
So when someone shows up and they think they can do 10, what they’re doing is they’re exhibiting example of base-rate neglect. They’re looking at their own strategy and they’re saying, I have these clever mental models, I have this process, I have this special sauce. So they start to believe their own marketing deck a little bit too much, and they forget that the people who tried and failed to achieve the 10% for years, as an example, have also had their special sauce and their analyst teams and this and that, and yet they were only able to do a certain…

Gary Mishuris (18:42):
Think about someone like John Neff who record is public or who had three decades of returns. He beat the market by 3% per year in arguably less efficient markets than they are today. So when someone shows up and says, “Oh, I’m going to beat the market by 10%,” that’s a little bit crazy, it’s a little bit arrogant. And again, I think we’re all overconfident, but come back to the Fed. So look at the last 10 years, we had almost a perfect confluence of events. We had interest rates coming down. We had unrivaled Fed manipulation of markets far beyond just the short term end of the curve. We had maybe as a result there or maybe as a coincidence, huge amount of speculation, both by retail investors and by a number of “institutional” investors, institutional in quotes, not naming any names, don’t ask. And you basically had over the last five years, you had 25% CAGR for large growth stocks or all cap growth stocks.

Gary Mishuris (19:33):
So if you are investing in the universe, it’s pretty easy to start believing your own BS and start saying, well, gee, yeah, no, I can crush the… I can do 20, 25% per year, but like really? Let’s zoom out over the long term US equities return inflation plus six to seven, depending on the time period. So if you think you can do 20% plus, you think you’re going to beat the market by double digit percent per year. And I know everyone thinks they’re very special, but that’s just a perfect example of the inside view. The inside view is all these specific details for why the past experience of others doesn’t matter. And the base rate is the past experience of others in a similar situation. And I think the best thing you can do is zoom out and say, “Well, whatever I think about my own capabilities, let me put a heavy weight on the experience of others and a small weight on why I think I’m going to do so much better.” And that’s probably the best you can do.

Trey Lockerbie (20:25):
That’s interesting, because I was wondering the distinction here between say the base-rate neglect effect versus say the recency bias effect, because what I was describing, I don’t know, it could maybe fall into both categories depending on how you look at it. So recency bias is when you’re essentially taking events from the past and extrapolating them into the future. So how exactly is that different or what are maybe some other distinctions between that and the base-rate neglect effect?

Gary Mishuris (20:49):
So I think a recency bias is almost a special case of base-rate neglect. So what are some examples of recency bias? Let’s say you have a company over the last couple of years, it’s been growing 30% per year and you assume it’s going to grow at 30% per year for the next one year. I’m obviously using extreme example. So that’s recency bias. You take a near term past and assume that’s going to be the same in the long term future. On the other side, let’s say you have a company that over the cycle has barely earned its cost of capital and averaged a dollar per share. But now the last couple of years been earning $2 per share and averaging 20% return on capital. So you are going to extrapolate that $2 and assume that’s the new normalized earnings for the business and say the new long term average earnings is $2. And this now all of a sudden, the 20% return on capital business or something like that.

Gary Mishuris (21:40):
In each case, you’re ignoring the base rate, the base rate in this case being the history of the company or the history of similar companies. So in the first case, the history of companies growing 30% for two years is mean version in the growth rate towards the growth rate in all companies. So just to level set everything that the average company’s profits over long periods of time grow in line with nominal GDP. But, by the way, ironically, if you look at Wall Street estimates, hey, now they assume the average company grow is going to grow earnings in double digits. Well, it hasn’t, it’s been growing five to 6%. And that’s an example of base-rate neglect because they forget that a fifth of the market is going to have negative earnings growth, but that’s a separate thing.

Gary Mishuris (22:20):
And then the base rate for a company that’s been earning its cost of capital and had a couple of good years is that the long term history is much more likely to be the best predictor than the last couple of years, which could be a cyclical high or something like that. So I think ignoring the base rate leads to the recency bias, where we put a disproportionate weight on what just happened and assume that’s a proxy for what’s going to happen as opposed to zooming out and looking at a much longer data series.

Trey Lockerbie (22:49):
Got it. Another one you touched on a minute ago was anchoring. And as we mentioned, the NASDAQ is obviously 20% from the high or even hearing something like some stock is at its 52 week low. When I hear those things, I just immediately think anchoring bias. So walk us through anchoring and please provide some examples, whether it be from a study or maybe what you’ve seen from other investors.

Gary Mishuris (23:11):
I think a good one that comes to mind is when I was at Fidelity early in my career, Peter Lynch used to tell the story that probably illustrates anchoring pretty well, where he started doing research on the company and the stock was at 10. He thought the business was worth $30 per share, but he wanted to do some extra checking and have his analyst check things out and so forth. And while he was doing these checks that basically the stock went up to 15. And he never bought the stock. Why? Well, because he anchored in the 10 and he did not want to buy at 15, because he kept waiting it for… Even though from 15 to 30 is still a double, which is a pretty good return, he was waiting for it to come back to 10 so he could buy it again, his original price he anchored on. And never did and he missed out.

Gary Mishuris (23:54):
So that’s a common thing. It’s hard to buy something where you started doing work at one price point that moves up even if there’s still a lot of upside. Another example is just I’ve done this for over 20 years and I’ve mentored a lot of analysts along the way. And I see the same developmental arc in a lot of investors. So first of all, most investors are taught to be very disciplined in sticking to their price target. I’m talking about fundamental intrinsic value investors. I’m not talking about people who read in charts or something like that. I’m talking about people come in and they’re taught that Wall Street analysts just change their price targets willy nilly.

Gary Mishuris (24:28):
So imagine a donkey with carrot hung in front of the donkey. That’s the Wall Street price target. If the stock is at 10, the price target is 15. If the stock gets to 15, guess what? No change in fundamentals. The new price target is 20, because the way Wall Street works is you start with a conclusion, I XYZ bulge bracket, firm analyst want to recommend the stock, what upside do I need to put into my template to justify that 30% or whatever so I’m going to have a price target 30% ahead of the stock price? So the young analyst sees that and he’s thought by his elders that, that’s a bad way to invest. That’s very undisciplined.

Gary Mishuris (25:03):
And so he now or she come in and they say, okay, well, I estimate the intrinsic value of this business to be about 100. Now, obviously it’s a range. Maybe, it’s 50 to 150, but I’ll just use 100 for simplicity purposes. And they anchor to that. And then fundamental developments happen and they stick to this 100. So let’s say something happens, a number of quarters occur, fundamental information comes out and the stock now goes from boy 60, let’s say goes to 30. Well, they rarely really update that 100. They stick to this 100 as if it’s the truth as opposed to just an estimate at a point in time. And then they double down and triple down. And then when they lose their shirts, they’re like what happened? But what happened is they underacted to new information. They weren’t responsive to fundamental developments that should have caused them to take that 100 as their value estimate and bring it down.

Gary Mishuris (25:53):
So how do you combat that? How would either? Because they’re worried about flip flopping and having their value estimate move all over the place. They don’t want to do that, but then how do you do it? So my solution has been to have small changes all the time proportionate to small fundamental developments. And that might seem intuitive because you might say, well, Gary, value estimates aren’t precise anyway. So what’s the value of making small changes? The value of making small changes is you get in the habit of changing your value and de-anchoring.

Gary Mishuris (26:25):
And another thing. So I have this, what I call thesis tracker. So for every investment, so I have 10 investments right now in the portfolio, for every investment, every quarter I have Excel cell and it’s color coded bright red to bright green. And bright red means they really deviated in that quarter from my thesis actually based on the facts. Now, based on my opinion, it could be a COVID, it could be a recession, there are no excuses, it’s purely a comparison between what I think the business should be doing and what happened. And there are certain actions that get triggered as a function of that thesis tracker.

Gary Mishuris (26:58):
So, for instance, let’s say I have two or three orange cells in a row, meaning three quarters in a row the company slightly underperform my expectations. That automatically forces me to re-underwrite the investment, number one. Number two, I freeze an investment from adding additional funds to it. There was an old joke with Fidelity about a portfolio manager who lost half of his fund in a single 5% position. And, of course, how does that happen? Well, it gets cut in half, you put more, bring it back to five, cut in half, bring it back to five. So Peter Lynch used to talk about cutting the flowers and watering the weeds.

Gary Mishuris (27:31):
So I think it’s very important once the thesis is tracking to re-underwrite the investment. So having this rigorous… I’m an MIT engineer by training, having this rigorous process where I’m forced to re-underwrite and I’m prevented by my own rules from adding capital if certain things occur, is really helpful. Same thing, if there’s a bright red cell, even if for one quarter, immediately re-underwrite.

Gary Mishuris (27:53):
And there’s a recent example where Netflix now stock I own or have an opinion on, but there was a well known hedge fund manager who I’m sure you know who I’m talking about, who very publicly bought the company in large amount and very publicly sold it. And time will tell if he is right, but good for him at least for being able to change his mind on something that was both painful locking in losses and just so visible in public, where he was able to say, listen, the thesis is bright red, it’s not tracking. I thought X was going to happen, instead Y is happening. I got to bail. And so I don’t know if that’s the right decision in this case either way, I have no opinion, but the fact that he’s capable of making that change, which would be too hard for many people, it’s a powerful thing.

Trey Lockerbie (28:39):
Yeah. And that manager, I think you’re talking about who shall not be named Bill Ackman is actually, I think gone on record to say he’s going to be less vocal about his investments at least the Activist one. So yes, I’m with you. I’m really eager to see if this was the right move or the wrong move, but you have to give him credit for going against his anchoring maybe in this example.

Trey Lockerbie (29:01):
All right. So another one I want to talk about, and this is a big one, and sadly, I see this one all too often in venture capital, but you can easily see how you can fall for it in the stock market as well. And that is social proof. It’s almost like the opposite of the devil’s advocate tool we were talking about earlier. So a recent example of this could be Buffett buying a large steak in Occidental Petroleum, you could be bullish on oil, interviewing multiple companies, but upon hearing Buffett has picked a horse in the race, it’s really hard to not let that influence your behavior or decision making.

Trey Lockerbie (29:33):
So Buffett says he even moved from Wall Street to Omaha just to get away from the noise and eliminate social proof of Wall Street. This one feels a little more primal than the others and thus, even harder to correct. So what are some tips you’ve picked up for eliminating things like social proof?

Gary Mishuris (29:53):
So I teach a value investing seminar at the local business school in the Boston area. And the framework I always use with my students is understand, apply, and then customize. And what I’m talking about is when you study great investors, I think there’s a different school of thought out there with some well known proponents that you want to clone great investors or copy them or whatever the case may be. And I strongly disagree. I think that you are not Warren Buffett, no offense, neither am I, and neither is anyone listening to this. And nonetheless, Warren Buffett has a lot to teach us.

Gary Mishuris (30:24):
The goal isn’t to copy Buffett’s approach or this, the goal is to understand and figure out how can we tease out things that are applicable to our own investment approach and circumstances and how does that interact with our circle of competence, because you and I might have very different circle of competence and therefore we might be taking the same framework, the intrinsic value framework that Buffett uses and be applying it somewhat differently than he does.

Gary Mishuris (30:47):
So that’s one thing. And it took me a long time. They say that the old cliche about 10,000 hours or 10 years of deliberate practice to achieve mastery, it took me a long time, because you start as an investor in this hero worship stage, you start and you say, oh, pick your hero or set up heroes, and you want to do everything like them. And I remember there was a very well known fund manager who has beaten the S&P at that point from one of the decade. I’m not going to say the name. You might know who that is. And then I read there was a publication back in the day called Outstanding Investor Digest.

Gary Mishuris (31:20):
And I read an interview with this, and this was maybe mid-career where I was seven or eight years into my practice as a financial analyst, as an investor. And I read an interview with him on the stock that I knew well. And his thesis was so shallow. I was shocked. And I was waiting to hear that there was so much more behind the curtain he’s just summarizing and keeping it brief because of the format. And no, the thing he said almost made no sense. He basically was talking about a company. By the way, this is a company I owned and I lost a lot of money on it back in the day at Sprint. So I remember my mistakes very well. And he used some very simplistic argument of Sprint is trading at 1000 per subscriber and Comcast is trading at 3000 per subscriber. And I was like, uh, but Comcast has three streams and Sprint has one. Three, one, 1000. It’s like, I hope you have more than that.

Gary Mishuris (32:12):
By the way, I had more than that. Didn’t help me from not losing a bunch of money on that. Plenty of behavioral mistakes there, maybe a whole bunch of them. But the point is you start from the hero worship phase and you run into this, wow, my heroes are not perfect. And or, wow, my hero might want to do it this way. Fine, but I’m different. And I have these strengths. So I’m an engineer. I studied economics, computer science at MIT. I think very linearly A to B to C. I’m very process oriented. I like repeatable things. I’m a terrible stock picker. By the way, please don’t make this into a soundbite. But when I say I’m a terrible stock picker, meaning I have no stock sense. I can’t tell you which stock is likely to trade in which direction.

Gary Mishuris (32:51):
I was at Fidelity and there were people who had good stock sense. And so I started saying, well, I need to build a process that plays to my strengths and minimizes my weaknesses. So my process is very much about a systems engineering approach of a process as opposed to relying on my gut. So come back to your question about how do we avoid social proof though? One of the interesting thing is like Phil Fisher, who is pretty much almost every growth investor is hero for compounders and all of that stuff. He talks in his book that his best ideas are the ones that worked out the best, mostly came from other investors. So you don’t want to completely disregard other investors.

Gary Mishuris (33:27):
So here’s how I do it. When my idea generation processes run, I have my funnel. One of the sources of the funnel is other investors I respect. And so I have a very loose set up criteria for something going into the top of my funnel. For instance, let’s say Warren Buffett buys something, yeah, it’ll go into the top of the funnel, but so will 100 other things. I purposefully do not track the source of like I have… I have investors I respect, I have screens, I have a watch list of high quality businesses and I have special situations. And these are all orthogonal to each other for independent. And they’re complimentary in terms of making sure I’m catching different types of potential pricings.

Gary Mishuris (34:06):
Once something goes on the top of the funnel, I no longer keep track of where it came from. And then the next step is a kill phase where I try to kill things very quickly. So for me, I don’t invest in energy. Why? I believe that I cannot forecast the long term price of oil. I haven’t met anyone who can either. And so I think it’s outside my circle of competence. It doesn’t mean it’s outside of Buffett’s or anyone else’s, but it’s outside of mine at this point in time, despite trying. But I’ve seen is I’ve seen a lot of value investors humbled in energy because they are overconfident about their ability.

Gary Mishuris (34:35):
There was a very famous investor, someone who you would know if I mentioned the name, but I won’t. And Columbia Business School has this CSIMA conference. Their investment club has very high profile speakers. And this person came and presented and talked about Chesapeake. The guests come in, and he got up on the stage and said, “Well, it was my largest holding, I got everything right micro-economically, the market share, the cost position, this and that, but the only thing I got wrong was the price of gas. And that’s why the investment didn’t work out.” And that was like, yeah, but dude, it’s a gas EMP company, what else is there?

Gary Mishuris (35:09):
And so by the way, the interesting thing is he didn’t say, and I learned that it’s too unpredictable. Despite my best efforts and all the things I got right, it still got the stock wrong because the one thing I couldn’t forecast was the main driver of the business. He said, no. And I still like it. I double down. I’m like, no, that’s not the conclusion. The conclusion is if this one macro variable driven by things you can’t predict overwhelms all this microeconomic analysis that you can do, you can’t do it. So the conclusion I’ve reached is I can’t really successfully predict the price of gas and oil five, 10, 20 years out. And without that, you can’t come up with cash flows for these businesses. And without that, you can’t invest in them. That’s my belief.

Gary Mishuris (35:48):
So when someone like Buffett invests in something outside my circle of competence, my initial response is fast. Now, let’s say he invests in something that is within my circle of competence, then it goes through the same processes as if a friend of mine who you’ve never heard of, but who is a good investor recommended to me or if it came through a screen and I try to diminish the impact of it having come from the famous investor and focus on the merits of the idea once it’s in the funnel. Hopefully, that makes sense.

Trey Lockerbie (36:15):
No, it does. And going back to Buffett in 2008, he put a bet on ConocoPhillips that played out pretty poorly for that exact reason. He said he couldn’t really predict the price of oil and had such a massive impact, which is really interesting. I’m also reminded when you’re talking about a thin thesis and following along, there was a fund manager who we won’t name, but it was on CNBC and they asked him, “Hey, what does this company do?” And he was like, “Wait, what? I can’t hear anything.”

Gary Mishuris (36:40):
Yeah, so static.

Trey Lockerbie (36:44):
He opted out. So that’s why you want to avoid social proof. I think social proof, I feel like it comes out of this natural human tendency to have a fear of failure because it somewhat gives you an out. So if that goes against you, your investment goes against you, but Buffett put money in. It’s easier to be like, well, hey look, even Buffet got it wrong. And so I think that’s why it’s so tempting to give you that out.

Gary Mishuris (37:07):
Well, so when I started at Fidelity over 20 years ago, GE was a very popular stock and everybody owned GE. And you know how well or not well GE has done over the 20 years since then. But you couldn’t go wrong because everybody liked Jack Welch and how could you go wrong with owning GE? And so how in Karate Kid Part II they say the secret of karate, maybe I’m dating myself here. I’ve been re-watching that with my kids, but it’s this little thing that creates the beat. Well, the secret of investing, I hope you all are listening is this, it’s the balance between conviction and flexibility, but where to be and when, nobody can tell you have to decide that.

Gary Mishuris (37:43):
And I think that a lot of people think that to be a good investor you have to be a contrarian, because they hear that. I hear this a lot, oh, I’m a contrarian. That’s terrible. Don’t be a contrarian, because contrarian implies you go against the crowd. Well, the crowd gets it right almost 50% of the time. Now, a little bit more probably in their frictional cost. So if you take it inverse, the opposite of that, you’re going to be right about 50% of the time, give or take. And if you go against the crowd, you are going to about 50% of the time, which is obviously not enough.

Gary Mishuris (38:11):
And so you are or you want to be an independent thinker, think from our first principles and basically reach your own conclusions based on evidence. And then overlay that with your strengths and weaknesses and your circle of competence. And I think it has to do with just being comfortable in your own skin. Like Warren Buffett could teleport into my office, tell me that he hates every single investment of mine. And in and of itself, that will mean nothing. But if he were to give me reasons, then potentially that’ll influence me quite a bit. But so yeah, I think you have to get to the point where… And by the way, it’s not just because I’m rebelling those authorities because I respect the Warren Buffett tremendously, but I’ve also achieved my own level of proficiency. And I make decisions based on my own process.

Gary Mishuris (38:52):
So someone agreeing with you can’t be the major source of comfort or reason to move on from idea, has to be their reasoning. And Buffett himself has said that. He said… I forget exactly how the quote goes, but something along the lines, it’s not because others agree or disagree with you, it’s because your facts and reasoning is correct. And so the funny thing about the people who are recommending that we clone Buffett is Buffett isn’t cloning someone else, Buffett is learning from people, whether it’s from Ben Graham early in his career or Charlie Munger or Phil Fisher, and then he’s reaching his own conclusions.

Gary Mishuris (39:24):
Incidentally, look at Charlie Munger and the Warren Buffett. Charlie Munger is on the board of Costco, and he has just levered up at Daily Journal to buy some Alibaba with Lulu or something like that. Again, I might be misrepresenting the details, but that’s my impression. Well, as far as I know, we might find out different in a couple of weeks. Buffett doesn’t hold a big stake in Costco and he has 100 billion cash. So how come? Well, because he’s his own person, he’s own approach, he’s own style, he’s own circle of competence. And while I’m sure he respects Charlie Munger tremendously, there are different people as investors. And I think that’s what master is. It’s reaching that comfort in your own skin, not blindly copying someone else.

Trey Lockerbie (40:04):
I love this Karate Kid analogy, this yin and yang or wax on wax off example of conviction and flexibility. It’s reminding me of a quote from billionaire Marc Andreessen who basically coined the phrase strong opinion to weekly held. And so I think that’s the growth mindset mentality. You have to constantly be learning, evolving and being flexible enough to change your opinion, which as you’re pointing out, Buffett has done many times over his career.

Trey Lockerbie (40:30):
So moving on, we’ve got a couple more of these I want to touch on. The scarcity bias seems to be just ubiquitous these days, especially in markets like NFTs where almost the entire point is the scarcity of the object. Scarcity is proven to create value in some instances like real estate comes to mind. So how should we approach scarcity either from a defensive position or maybe even an offensive position?

Gary Mishuris (40:57):
Yeah. And I think that’s a great point that… So lately, the markets have decided that just because something is scarce, it means it’s inherently valuable. Well, look, I have three kids and if some of them doodle and create a little piece of artwork and I scan that in, that’s unique, nobody else can recreate that. Does it mean it’s valuable? To me as a proud father, yes. But to the market, maybe I can make an NFT out of it, but it shouldn’t be right, it shouldn’t be valuable to most people.

Gary Mishuris (41:26):
So, well, if you are in the desert and there is water, well, yeah, that’s hugely valuable. So for something to be valuable, it should be scarce somewhat, but also very useful. And I think lately, people have been going on this craze where just because something is unique and scarce, it’s all of a sudden, hugely valuable. And that is just not true. I’m thinking of writing this article about… So I got my wife these pre tulips, because I’m into Bonsai as a hobby. And I went to a tree nursery looking for a Bonsai stock and I saw these tulips, I got them for my wife. And I’m like, I’m going to take a picture of them and write. I already got this article title, something like red tulips or the pretty crypto or something like that. Just because something is unique, like those tulips doesn’t make them valuable.

Gary Mishuris (42:10):
So I think that where scarcity valuable in business is when you have a scarcity of assets that someone can’t replicate, usually there’s some intellectual property involved or some competitive position. And yet it’s a bottleneck for others to achieve their means. So an example early for my career that I missed is Monsanto. So the Monsanto was a company that was doing genetically modified crops and it had tremendous intellectual property. It had approved to modified crops. It had trust with farmers. It had seeds and seed strains that they could integrate with genetically modified crops and eventually got bought up. So I think finding scarcity that’s useful in the business sense is a good metric for potential targets of a strategic acquirer. So I think that’s where scarcity could be useful.

Gary Mishuris (42:57):
And another good question I always tell my analyst or my students is if you try to judge how good a business is, think how much time and or capital would it take for someone else to make it a bad business. And I think that’s a good kind of… If you have scarce things, whether it’s a brand, whether it’s intellectual property, whether it’s a low cost position, it should take a lot of time and or capital for someone else to overcome that. That’s where scarcity is useful. Just because some scribble, someone really scarce, and it’s just now it’s digitally unique, like really, have we fallen so low as a society that… But anyway, I don’t want to offend anyone too much.

Trey Lockerbie (43:34):
I think it’s a great point. I always think about this fact where scarcity is obviously a big component of something like Bitcoin and people seem to just get so riled up about the idea that Bitcoin could go into the hundreds of thousands of dollars per share just because it’s scarce. And the utility is not comparable here, so don’t get me wrong. But I’m always reminded about this humble guy from Omaha who was able to do it with a share price. So Berkshire Hathaway A shares are now worth over half a million dollars per share. And that’s because of the scarcity of those shares to some degree. The utility, yes, and the growth, but the scarcity, he’s not willing to dilute those shares, like some other companies are willing to do with their own outstanding shares.

Gary Mishuris (44:15):
Well, I think it’s not just the scarcity of the shares, it’s the value he has created from the cash flow stream and the assets that he’s produced. Well, so I guess what we’re talking about Warren Buffett is he has created something incredibly valuable because the cash flow stream that Berkshire Hathaway produces today is immensely bigger than it was many years ago. And so I would push back on the premise that it’s because he hasn’t split the shares. It’s always a little bit suspect to me when… You come into a pizzeria and I used to live in Brooklyn, New York, as a kid, and there were a lot of Italian places and you come in, there’s some guy throwing up pizza pies, and they caught it usually in eight slices and let’s say $2 a slice or whatever it is. All over inflation, maybe wait time, this goes live, it’ll be $3 a slice, you never know, or four.

Gary Mishuris (45:03):
But let’s say you come in and some guy says, well, how about I caught this pizza in 16 slices instead of eight and still charge you $2 a slice? How does that sound like? Well, no, that doesn’t sound good to me. I get the same amount of pizza. So you’re charging me twice as much. And I’ve seen these. It’s actually where there was a company recently I saw announced a stock split after the stock collapsed 50%. And I found that to be tremendously amusing that they’re trying to essentially prop up their own stock after a stock collapse by doing a share split, which economically does nothing.

Gary Mishuris (45:34):
But anyway, coming back to Buffett, I think that it’s fundamentally different from cryptocurrency. And I’m not an expert in crypto, so I’m going to stay away from that. But I think the issue with crypto is just belief of others. And the issue with Berkshire Hathaway is the cash flow stream now and in the future. And that’s fundamentally a different question to answer.

Trey Lockerbie (45:53):
Totally agree. Belief seems to replace analysis for lots of market participants, which might just be an unfortunate truth that we have to live with. But it’s important to recognize that this can also be somewhat of a self-fulfilling prophecy. So since, let’s take game stop, for example, it once hit a market cap of 22 billion in 2021 due to this short selling phenomenon that occurred. And some people might now believe that it could double where it currently is, which is 10 billion back up to 20, 22 billion because it’s been there before. And if enough people believe that, well might just come true in these markets.

Trey Lockerbie (46:30):
And so right now, a lot of people believe that we’re nearing the burst of possibly the biggest stock market bubble in history. So what are some steps to take if you actually believe something like this, which again, may just occur simply because the belief is there?

Gary Mishuris (46:48):
Right. So I think first of all, whenever you use belief or belief enters your lexicon for investment, that’s a dangerous sign. And I’ve seen this. A lot of times when you have these called stocks and you push back on someone’s thesis, they get emotionally upset. If someone pushes back on one of my investments in one of my thesis, I’m very happy, because I just got a free chance to de-bias myself. And so when someone is reacting emotionally to disagreement, that’s a rewarding sign for them that they don’t really have a lot of basis for their thesis because basically they see an attack on their thesis as an attack on them. Well, as I see an attack on my thesis as an attack on my thesis, which is welcomed.

Gary Mishuris (47:29):
And so I think we are experiencing a bubble. I’ve started my career right before the last bubble burst. And I was starting computer science and economics at MIT during the tech bubble over 20 years ago. I was poor growing up as an immigrant. And I put my savings to work in the one tech stock that didn’t go up. And right around that time, Warren Buffett came on campus and gave a talk at Sloan, which is the business school at MIT. And he was talking about intrinsic value, long term competitive advantage, which all made sense, but it was foreign to me at the time. But at the very least, it made me realize I was speculating and not investing. And that’s how I entered the path towards value investing.

Gary Mishuris (48:03):
I think at the same time, most people today in the markets haven’t lived through a bubble before. Maybe some of them have seen the ’08, ’09 crash, but that wasn’t really a bubble. It was more dislocation in the sector that was infecting the rest of the financial system. And so very few investors today operating have really experienced that phenomenon. And it’s very different experiencing it viscerally than reading about it. And so people have forgotten about web band or some other crazy or price to eyeballs or some other BS from the late 90s. And they’ve also forgotten how long it took for that bubble to burst.

Gary Mishuris (48:37):
I think Alan Greenspan talked about irrational exuberance in 1996. And the NASDAQ I think troughed in whatever, 2002. That’s a long time career wise, emotionally and so forth. So I think we are going through a period where everything was right, went right for financial assets. Many of them, not all, but many of them got to extreme prices and that’s now correcting itself. Unfortunately, usually prices don’t stop in the middle at rational. And frequently they go to the other extreme or at least partway towards the other extreme.

Gary Mishuris (49:09):
So as I said in the beginning, my approach is safety first. It’s always safety first, no matter the environment, but I think it’s particularly important to be a safety first mind investor. Now, how can you do it? So there are a couple of ways. One is you can try to hedge out various tail risks. And that’s tricky, but you have to think what some obvious tail risks are. Obviously, market, there’s interest rate tail risk, there’s just stock valuation tail risk. Most people are not likely to do that, but that’s one approach. It’s tricky to do it at scale, and it’s tricky to do it as a cost effective way, but it makes sense if you can do it. You can’t hedge every single thing out nor are you trying to hedge against a 10% drop in the market. You’re trying to really hedge against a disastrous event.

Gary Mishuris (49:51):
Benjamin Graham with European security analysis had just experienced massive losses in the great depression in the 1920s and 1930s, because even though he was an experienced investor, he just wasn’t prepared for the magnitude of the losses that came. And, by the way, one of the ways he lost money was margin debt. So stay away from leverage, always a good idea. But especially at a time like today, I would say stay away from questionable balance sheets, because think about a business is either path dependent or it’s not, meaning, let’s say you have a business where it’s going to be worth a lot if there is no recession or it’s going to be worth a lot if their recession is mild, but it’s going to go bankrupt if there’s a very sharp recession. You don’t want to be in that investment because you have to know which path the future will take and we don’t. So stronger balance sheets.

Gary Mishuris (50:38):
And also I think that just there’s a lot of gambling stocks out there, and they’re greater full stocks. And that would say maybe just to pause. A lot of times, there’s this debate between growth and value investing. That’s really not the main distinction, the main distinction is between intrinsic value investing where you think a stock is a partial ownership piece of a business and greater full investing, where whether it’s from a value point of view or growth point of view, you are just buying an asset because you think someone else will pay more for it tomorrow. That can be a growth approach where you buy some growth company because you think they’re going to raise guidance or give a long term growth forecast that gets the market to revalue it up or it could be a boring cyclical where maybe over a cycle there are 30 cents, but you say, “Well, I don’t care, they’re going to earn 25 cents in a quarter. The market will annualize that to a dollar and multiply that by 15. And the stock will do well.”

Gary Mishuris (51:31):
Either of those examples, regardless whether they’re growth or value, they’re just gambling. It’s just greater fool. You’re just betting what someone will pay as opposed to thinking about the cash flow stream in the value. So I think staying away from greater fool stocks, again, always a good idea, but even if you are one of the people who had fun with them in the last five years, I predict that it’s going to be a little bit less fun over the next number of years. So just focusing on businesses that have solid balance sheets, have real cash flow streams and where there is positive asymmetry, where if you’re wrong, your losses will be modest, but if you’re right, you can have substantial gains. You’ll do fine.

Gary Mishuris (52:09):
And then finally, this is very important. Set yourself up to never be a forced seller, because you can do everything right, but if you manage your affairs, whether it’s because of margin or because of external circumstances where you have to sell none of your own volition, that is a huge issue, because you can have the market… Let’s say, imagine you’re managing someone else’s money and you have short term clients, and the market goes down 50% and your clients will redeem and you’re forced to sell. Well, it really doesn’t matter what three years from now will be, you’ll be forced to sell. So you have to set your affairs up so that you are never a forced seller.

Gary Mishuris (52:44):
As a matter of fact, I make a good chunk of my money buying from forced sellers or non-economic sellers. And that’s why it’s so important when I partner with people is to have people who share my long term view and they don’t judge short term progress by price duration, the short term. So again, don’t be a forced seller, don’t buy path dependent stocks and just don’t gamble. If you need to go gamble, buy a lottery ticket. With your serious money, focus on safety first. That would be my message.

Trey Lockerbie (53:12):
I love that. And so I know that you and I are both aligned, I think on this philosophy, for example, a big believer in running a concentrated portfolio. And what I mean by that is staying within, let’s say 10 to 15 investments. What is always curious to me is how much to stay within our circle of competence without over-weighting the portfolio into highly correlated assets. So, for example, you mentioned staying away from oil as being outside of your circle of competence. That eliminates one sector, let’s say part of the energy sector, but then you’re maybe building a portfolio that might have overlap with other sectors potentially. So how do you look at that diversification within a concentrated portfolio?

Gary Mishuris (53:55):
Yeah. And I think it’s a good question for someone with a concentrated portfolio, because if you’re running a widely diversified portfolio, you’re automatically diversified. So you don’t need to worry too much. But if you are like me and you have 10 to 15 investments, and then you are potentially exposed to undue correlation of risk. Now, what I’m trying to guard against is not that there’s some mark to market loss in some quarter or year where all these investments move in unison. I don’t really care all that much about that. What I do care very much about is that the business outcomes aren’t too correlated, because when you’re investing into 10 to 15 names, you need to make sure that they’re as close to independent of each other as possible.

Gary Mishuris (54:36):
And like you said, if you have areas where you don’t invest, that squeezes those 10 to 15 investments into the rest of the opportunity set, meaning that you might be correlated. But it’s not about gig sectors, which is a common misconception. So I’ll give you an example. So prior to starting Silver Ring, I managed a fund at my prior employer and I had two investments. One was SABMiller, which was a beer company, and the second one was Qualcomm. If you are running some bar risk model, and you’re looking at overlap, they’re completely different gig sectors. One is technology, the other is consumer. So no relationship, you’re good, you’re diversified. But the thesis for each one was predicated on rising middle class in emerging markets, meaning people were going to trade up and buy more expensive beer in China and other emerging economies and people were going to trade up to fancier smartphones, which was going to drive demand for Qualcomm’s products.

Gary Mishuris (55:28):
So here are two completely different industries where the same macro force, which is a tailwind, if it doesn’t play out would hurt the thesis. So looking for those correlations as systematically as possible, and thinking about what do I have to be right about each business five plus years out as opposed to what do I have to be right about each stock five quarters out, that’s the mindset you want to have. And also frankly, you have a set of risk reward trade-offs. Too many people make the mistake of sizing their largest investments based on upside. But again, going back to the safety first mentality, I size my positions based on downside, meaning my largest investments have the smallest downside. I have an investment, which maybe it’s a 30% of my base case value as to 30 cents in a dollar, but if that has 100% downside, that might not be my biggest position. So again, you want to have multiple layers of defense.

Gary Mishuris (56:22):
You want to have devising and thorough research at the security selection level. You want to size the position based on how much you can lose. And then finally you want to look at the correlation and you want to make sure the way I do it is I don’t want any one thing that I have to be right on to account for more than 10% head to the portfolio. Why 10? Well, I have 10 fingers, but more seriously, it’s also, if I lose 10%, I’m being wrong on some decent judgment. The 90% at reasonable rates of return can overcome that in a year. But if I lose 20% or 30% on something, it’s too much. It’s very hard to recover from that.

Gary Mishuris (56:58):
So longevity in investing, whether you’re investing your own capital or someone else’s, is super important. And it’s okay to have slightly lower returns at some period of time and always recover from that. But losing big chunks of money permanently, very hard to recover from. And that’s what I try to guard against.

Trey Lockerbie (57:15):
Well, Gary, this has just been a fascinating discussion and I learned a ton. I really hope we could do this again sometime soon. Before I let you go, give a hand off to our audience where they can learn more about you, your blog. I know you’re writing a blog, that’s great, your fund, any other resources you want to share?

Gary Mishuris (57:31):
Sure. So behavioralvalueinvestor.com is where you can read some articles, usually once a month, about intersection of investing and behavioral finance. And silverringvaluepartners.com is where you can find my company. And I have something I called the owner’s manual there, which is an in-depth explanation of my investment process. And I’m happy to share that with anyone. Most of the time I have students or others who just want to learn and improve themselves, who request it. And if you request it, no matter who you are, I’ll be happy to share it with you. And hopefully, there’s something in there that can help and happy to stay in touch. There’s contact info there as well, if you want to reach out.

Trey Lockerbie (58:10):
Fantastic. Well, thank you again so much, Gary, for coming on the show. I really hope we can do it again and I will be following along on the blog. So appreciate your time.

Gary Mishuris (58:18):
Thank you so much for having me. I appreciate it.

Trey Lockerbie (58:20):
All right, everybody. That’s all we had for you this week. If you’re loving the show, please don’t forget to follow us on your favorite podcast app. And if you would be so kind to leave us a review, we would really appreciate it. And I can’t emphasize this enough, please check out our resources at theinvestorspodcast.com or simply Google TIP Finance. And lastly, reach out with any feedback. I’m on Twitter at Trey Lockerbie. And with that, we will see you again next time.

Outro (58:44):
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