Stig Brodersen  08:47

Well, that’s not value investing, Preston, for sure.

Preston Pysh  08:52

It’s amazing to hear some of these stories. And I think some of it will just blow people’s minds and I’ll tell you this. This is the one thing I want people to take away from this book: if you want to go work on Wall Street, and you want to dive into finance and become a trader, I would say this is a mandatory read for people. Absolutely mandatory read. You have to read this before you dive into that culture because for me, if I read this as a college student or whatever, there is no way, in a million years, I would inject myself into that culture. There’s just no way. I have this firm opinion that when you put yourself in a certain culture, regardless of how moral or how strong you are as an individual, the longer you stay in that culture, you will become that culture. So I would use that as a word of caution for anything that you’re doing, not necessarily going to Wall Street. And I’m not saying everything on Wall Street is bad. I’m just saying that in this particular example of this book, it’s a word of caution to be very mindful of what culture you decide to interject yourself into.

Okay, so with that said, we’re going to go ahead and kick this over to Stig and he’s going to talk about how Salomon Brothers made money during this time.

Stig Brodersen  10:03

Yes. So basically, I would say there are three different ways that you can make money. Bery, very generic. So the first one is by being purely a broker. So you’re probably familiar with that whenever you are trading on an online platform or using your bank’s platform that you might be paying, I think it’s the cheapest out there is probably around $5 or $6 something that per trade. So the broker will collect that money for doing the trade for you. But obviously, that was not the Salomon Brothers did. They were in bonds, and there were talking about a lot more money than just like 10 shares of Coca Cola.

So what they were doing was they were bundling, like, a huge amount of bonds, and they would typically take something like one-eighth of a percent of the total sum. They would take that as a fee. So that was the first one.

The other way that they made money was that they would be a broker with two known parties. And that is something that happens off-screen. So the first one is something that you see on the screen. And when I say on the screen is something you can see on the exchange, but they were also brokering off the screen. So the way this would work was that they would have a client that might be me, and I would have, say $1 million worth of IBM bonds. Now, I would need to sell them. So I would call the Salomon Brothers and they would say, “Okay, I know someone called Preston.” They might not even tell him his name, they probably wouldn’t. And then they will take a small cut from that. And that by handling the deal, basically, as a broker does, getting their commission from facilitating the meeting between the buyer and seller.

11:34

What they also did and that was probably the more interesting part was their trading division. So whenever you’re trading, you’re either doing that for your account, or you’re doing it for a client and Salomon Brothers did both things. So what you’re doing is that you’re basically betting on whether or not the price will go up and down. And since they were in bonds, and as you might know, by following the courses and by following the podcast that we had, if you see an increase in the interest rate, you will see a drop in the price of bonds. So they will bet on the direction of the interest rate and also the bond prices. And by doing so, they were either making money or losing money for their client.

Basically, this is also the very core of trading. I promised or I threatened Preston with a few anecdotes from my trading career. And for instance, what we did because I was in power trading is that we would be betting on the price of electricity. So the mechanism is very, very similar whether or not it’s stocks or bonds, or coffee, or even something like electricity. So we will be looking at the weather forecast. And if we saw a lot of wind coming in, we knew that there would be a higher supply out there which will drive down the price. And this was the same way that Salomon Brothers and everyone out there trading. They’re saying, “Can we predict what will happen in the future?” and then start taking bets based on that.

So basically, if I could just sum up two different ways of making money. One is the broker part where they’re facilitating the buyer and the seller. And then the other one is that they’re taking the position in the market, either for themselves or for the client and bidding on the prices, whatever the asset might be.

Preston Pysh  13:13

So when we talk about what happened in the book… So it goes through the time Lewis was getting through this introductory course that Salomon Brothers offers. He went through that and he’s talking about how they brought down these bigwig executives to talk to the class. The book is full of expletives. So if you’re riding in your car with your kids, you’re probably not going to want to listen to this book through Audibles. But yeah, it’s very, I don’t know… graphic? I guess if you want to describe it that way. So that’s just an FYI.

But it’s talking about these executives that are coming down and talking to his class and using expletives in you know, three expletives in a short sentence. And it’s just interesting to see that and I’m glad that he did do it that way because I think it represents the culture very well and it’s very representative of what the experience would be like to go through this.

So after his course finished up, his introductory course, all the guys there are fit for the culture based on the way that he was describing his classmates that were stepping into Salomon Brothers. They get into the trading floor. And then basically the games begin all the senior guys that are there are just basically using these guys as they’re setting up new accounts and getting new customers. And some senior-level guy walks by, senior-level trader and just totally dupes one of them into taking on some of their securities and some of their accounts. They immediately just start getting screwed is what happens.

And so, they’re all just fending for themselves. And he said the attrition rate, I can’t remember what it was. But I think after a year later, it was something like half of the initial guys or one-third of the initial guys that started out were still there. So the attrition rate was very high for these guys starting out in the firm.

14:53

Now, it talks about Michael Lewis and how he developed this relationship with one of the more senior guys that he could trust. And this gentleman helped him out. And he’s just started making these trades and started doing well for himself and with some of the clients. And so, within a, I would say two years, three years, Michael Lewis build-up to the point where he was basically making $10 million for the company. Based on the time that he had been at the company he was only able to make, I’d say, $80,000 to like, $150,000. Back then that’s a lot of money. That’s a lot of money today, but he was making that back in the 80s. As a young kid, he was, what 24 or 25 years old at this point, Stig? He was pretty young.

Stig Brodersen  15:35

Yeah, he was just fresh out of college, as far as I remember.

Preston Pysh  15:39

Yeah. So I mean, he was making a ton of money, but he was also making a ton of money for the firm. He’s making $10 million a year for the firm. As that number grew, so he started even making more money for the firm. I think he was around 27 or 28 years old when he was describing his time where he was pretty much becoming a middle level to a higher-level executive within the company. He was shooting into the stratosphere and in a quick way within the company. And I think he said his salary was $400,000 or $500,000, or something like that. He was doing quite well. It is as high as his band could be for where he was his duration in the company.

And he got to the point where he just took a step back and he says, “What value am I adding? Like, what is it that I’m doing? You know, how am I creating value for society?” And I think that that was his main reason for getting out and just saying, “I’m doing something different.”

So very interesting stories. That’s the thing that I want people to take away is this book will definitely keep you entertained. It was one of those books that when I’m driving in my car, and I’m listening to this, I get to where I’m going and then I continue to sit in the car to listen to the rest of the chapter. I just get drawn in totally. Not all the books we read are like that. Some of them I can’t wait to turn it off and get out of the car. But for the most part, I like almost all the books we read, but this was a pretty interesting one. I think you will enjoy it. What other stories you got, Stig, that you want to throw out? I know you have quite a few talking points.

Stig Brodersen  17:05

Yeah, I think that the whole interview process was extremely interesting. So if anyone would like to doubt this, I would say that trading is a tough business, and especially the interview is dreaded by a lot of people. And what Michael Lewis does is that he talks about what is called the stress interview. And apparently, that’s something that’s used on Wall Street. And I’ve never heard about it before.

He recalled that he was asked to open a window at the beginning of the interview. And obviously, this is a window that is still shot, so he can’t open it. And then the people will just see how that candidate reacts under pressure. That’s the only intention of that. Or another thing that they did was that they would invite someone in there and just give them a silent treatment. They won’t speak to him at all, and completely ignore him and then see what he did. And often it’s like, but why you might be asking? But again, that’s part of the culture and again, to test you: how do you react under pressure? I like that. So I think it’s a horrible story. But I think it was a fun story too.

Preston Pysh  18:03

I liked that part of the book. I thought that that was hilarious. So the best part I thought was the first story there where they said that they gave them the task of the guy comes in. He’s sitting there the interviewee and the interviewer sitting there. And the interviewer says, “Open that window over there.” And it talks about how some guys go over, they try to open it, and they’re just like, “Well, it’s locked.” And they come back and sit down. Other guys continue to struggle and just try to muscle it open. And they’re there forever, and they’re not going to sit down until they can open the window. And it said that there was one gentleman that got a chair, tried to break open the window with the chair. And I found the story hilarious and I think it was neat to see how they were trying to test their personality and to see their endurance.

Stig Brodersen  18:53

This book put a smile on me because they were talking about the interview and how he was prepping for the interview. And what he was saying why that you always get the question, why do you want to be a trader? Or whatever job you might be applying for? You always ask why do you want to do this?

And he said that the one thing you can never say is that you’re doing it because of the money. So I just remembered, what I thought when I was preparing for my first job interview in the trading world. I remember speaking to my wife about this, and I was telling her well, “So Sophie, should I be saying that it’s because of the money?” because trust me, guys, the money is good when you’re a trader, as Preston also mentioned. And we’ll go more into the conversation how that works.

But that was the big reason to do this for me. But again, it just felt wrong for me to say, “Wow, I want to be trading in your company. And that’s because I can make a lot of money. I don’t care about the rest.” Like that would be the most horrible, horrible answer you can give.

And the answer I came up with was true but only partially true. It’s because of this thrill of making a trade is so awesome that I can’t help doing it something like that. And that is what I said. I eventually got the job. But the reason why it sounded so much fun when I read the book or when I heard the book was that Michael Lewis said, “Apparently that is the golden answer you can provide on Wall Street. You can never ever say you are doing the job because of money. You have to say, you’re doing it because you just love making good trades, even though everyone knows that it’s just a lie.”

Preston Pysh  20:20

It’s like “Liar’s Poker.” Well, that’s an interesting point. I think that’s a good highlight as well, Stig. What else? Did you have any other ones, Stig?

Stig Brodersen  20:30

Yeah, well, I think I want to talk about the compensation as well. First of all, I like to ask you a question, Preston, because one dilemma that he raises is that Salomon Brothers lost a lot of talent because they weren’t willing to compensate the employees, compared to other Wall Street companies.

So he was talking about the best trader they had. He was making like $20 million-plus, like, both years he was there. And like his cut of that was something like $90,000 the first year, which was the like salary cap, and then 175,000, the second year. And Michael Lewis was raising the question, “So how much is it worth? It’s not worth 20 million, but how much is it worth?” Because it’s the company’s risk, the company’s money. So I think I’ll ask you, Preston, how much is someone worth if he can make, say $20 million for his company’s money?

Preston Pysh  21:24

So I would think that it would be a function of how hard would it be to replace that person. So if I can go off the street and take a trained monkey to basically come up with $20 million, just because he’s sitting on something that has an enormous flow of cash flowing through the pipes that you can basically suck some of that off of… I would think that I’d pay them not nearly as much as what some others would think that you would pay. And it would be down his salary was because there’s no competitive advantage for that skill set. I think that’s the discussion here is what’s the competitive advantage for that skillset that you can sit in that seat and do that job.

Do you need to have an MBA from Wharton or from Harvard to sit in that seat and conduct those trades? Or you just need to be a good bluffer? And a good person has good interpersonal skills to develop the relationships and sell one thing here and buy it over here, and just know the delta between the buy and the selling price. So I think you need to have a basic introductory course. But I don’t think that that’s something that you need to even go to a four-year college for necessarily. I think that you could teach somebody that in a year, and then move out. So I guess that’s where I would look at it first is the skill set and how qualified it is.

I mean, this isn’t brain surgery here. Do you know what I mean? It’s just not. It’s not something you need to go to school for 10 years to do effectively. So that’s why I would say because I think a lot of people immediately hear this guy made $20 million. So if you pay him a million dollars, that’s only 5%. It’d be like a 5% royalty on everything he brings home. I don’t see it that way at all. I see it as how hard would it be for me to replace this guy and pay somebody else to do exactly what he just did.. And so, I think that that number is much lower than a million dollars. I say half a million dollars would probably even be a little high.

23:12

Now, the issue that you run into is, let’s say that you own that company or that big bank, and that’s your policies to keep the prices down at that level. And you’re going to have the flight of talent, if you will, within the community and your business. So then you got to ask yourself, say, I make that decision, and I push the price down and I hold to my guns and say, “You know what, these people are replaceable, and I can find this talent reemerge somewhere else.” The thing that you have to ask yourself then is how do you basically retain this talent upfront. This would be the model that I would go to if I was one of the CEOs in this industry. I would say I’m going to do the hard work upfront. I’m going to send these people off to Harvard for free. I’m going to send these people to wherever. I’m going to pay for it. Okay, upfront.

But what I’m going to get in return is a contract that gets out to 5 to 10 years where they have to stay within the business with an automatic price model set, where you’re assuming a lot of risk as to the CEO and the owner of the business, because you might get a total turd that you’re paying for to try to retain and you don’t know that model yet. So that’s where these guys have a tricky… as I’m thinking through the thought process, Stig put me through on the hot seat there. That’s my thought process as I’m going through this because it wasn’t something that we had prepared or I knew that he was going to ask me that. So that’s my thought process.

I’m thinking through this and it’s a very hard thing because let’s say you don’t want to do that model right out of the gate code because you don’t know the personality person and you bring this guy in for the first year and he’s already performing and making you $10 million in the first year. Now you got a problem because he’s not going to want to stick around for 10 years making 200k. He’s going to run somewhere else. So I think that’s the hard thing is just the competitive nature of the business. How many seats are there open in Wall Street? But I definitely don’t think some of these people deserve to be making a million dollars a year because they bring in 20 million. I just do not think that at all.

Stig Brodersen  25:07

Yeah, I completely agree with you. And I think it’s a tricky discussion because I think when you reach that level like you literally wouldn’t be any happier if you made already $175,000 a year. It wouldn’t matter if you got a million dollars instead.

Preston Pysh  25:22

So this is where I get a little frustrated. I apologize if there are people that are in this industry, and they’re listening to this conversation. I want to apologize if you’re offended by what I’m about to say. But the thing that I go back to is what’s the value that’s being created? If I make $20 million for the firm, and it’s all transactional costs, it’s arbitrage. Okay, so these guys arbitraging the deal from one asset, the same asset going from one hand to the other hand. What value am I creating by transferring that from one person? Let’s call it person Y to, person X. What value did I just create? I wouldn’t say all that much. I just help, you know a broker that deal is all I did. So is that worth hundreds of thousands of dollars to broker that deal?

That’s crazy if you think about it because it’s not like you’re going in and helping them analyze the security, the valuation. You’re not going out looking at property and saying this is safe. You’re just basically changing a couple of keystrokes on the account. So whenever I look at that value, it is so lopsided, and not creating anything. It’s creating drag for society. It’s creating drag, and there are efficiencies there that need to be gained from a society standpoint, to make this more effective.

So whenever I look at the value that’s being created, it makes my eyebrow go up, like what in the world are we doing? And that’s where I’ve got some major issues as well, then I think that you know what, I think that the universe will always work things out, and it will always find efficiencies. And that’s going to be a pretty dramatic thing for some folks. And I think that maybe it might be a good thing. But I’m curious to hear if Stig agrees or you see it differently.

Stig Brodersen  27:07

The thing is a tricky discussion because when you are living in this world called Wall Street or trading, whatever, you just get other values. And it’s like, things just change because you are in a bubble. And it’s at this point in time and I think Lewis also addresses that it’s not about how much money you’re making for the sake of money. It’s more a way of keeping score and how you feel you being treated than that you need the money because you can still pay your rent and put food on the table for a family.

But I just want to tell you a brief story about something I experienced myself and I look at myself today and think that I’m a very calm person and I wouldn’t follow all of this. And I also watched Wall Street back then and thought, “Hey, I could never be consumed by this industry.” But I did so when I started, and this was just upon graduation, I was offered a position as a trainee and I made something like… I think they offered me something like $60,000 in like a base salary. And that’s a lot of money but not as much money as you might expect in trading. And this is fairly common.

So whenever you start out, I think Michael Lewis, he said that he made something like $42,000. Now, admittedly, this is also like two decades ago or 25 years ago, but as your base salary in the very beginning is not that high. And it’s definitely not high compared to like the pressure you are under working as a trader, but what’s happening is that they will test you in the beginning. They will test you and see how you handle the pressure, like the games, all that’s going to happen. Then they will work out your compensation based on how you perform.. And so, for us, it was something like six months after that we’ll call you in and then you will negotiate your bonus structure. So you would basically still have a somewhat low base salary but you will get a lot of bonus and company bonus and all of that. I was offered something like 100k more. So I was again right out of college. I was making something like $160,000 a year. Maybe slightly less here now with the dollar being so strong but my head is spinning right now because I’m converting everything from Danish Krone into dollars.

Preston Pysh  29:14

He’s even accounting for the currency devaluation.

Stig Brodersen  29:18

Yeah. Oh, such a geek.

Preston Pysh  29:21

Yes, total geeks.

Stig Brodersen  29:23

Okay, so I was making say $160,000 here and I vividly remember I went out to my boss just a month after that saying, “I want more. I’m not satisfied with 160,000.” And again, why wouldn’t I be but it was like, I have the feeling that someone got more. I felt like I was making all these millions and millions again as Preston said you do, but it’s for someone else’s money and you can probably hire someone else to do it just as good as you, but I was feeling since I’m making so much money. I should also have more money. And so, I think I said something like, “I know it’s only been a few months but I would need at least $40,000 more.”

And obviously, that was declined because they will not negotiate new compensation packages like every 2, 3, 6 months or whatever. And now that I think about it, it doesn’t make any sense why I would do that because my wife, she was also working as a trader back then, we were living in a small 600 square foot apartment, no kids. So with two trader salaries, you might think, “Hey, they got everything they need.” But I was so unhappy for so long because it didn’t get more. After all, it wasn’t about money. It was about keeping score.

So whenever I read these stories, I’m thinking, “Oh, that how can he say I need more? And why is money so important? And he should just be satisfied with what he has.” I mean, it happened to me. And I think, just as Preston mentioned, whenever you are part of a culture that is so strong, and you spend so much time there, it’s just so hard not to be caught in the middle of it.

Preston Pysh  30:54

And the thing that I got from the story Stig and you watch Wolf of Wall Street. I haven’t seen the movie but I’ve heard different parts of it. But the thing that I take away is that it’s a breeding ground forego. It just seems like the ego in these cultures is just crazy. And when you’re exposed to that, either you develop an ego to combat the other egos or you just get eaten alive. Now the question I got for you: who was a better trader, you or Sophie?

Stig Brodersen  31:21

That was definitely me. She was probably a better trader than me, to be quite honest.

Preston Pysh  31:27

Just so everyone knows, Stig’s wife has a doctorate in economics so she’s nobody’s dummy when it comes to this stuff. She could probably do a lot better job at the podcast than the two of us combined. All right, well that’s all I have for the book. I don’t know if you have anything else you want to highlight, Stig.

Stig Brodersen  31:44

No, I think we pretty much got everything covered. I would highly recommend that. I think you might even say this Preston, but I will highly recommend this to all our listeners out there if they’re considering a career on Wall Street to pick up this book, even though it’s old. The whole thing about culture on Wall Street is something that you should be aware of before you start there. And then just remember, I would never point fingers because I read all the books and watched all the movies. And I still did all the same stupid things all the traders, so it might not be helpful, but I definitely think you should read this book.

Preston Pysh  32:18

All right guys, so this is the point in the show where we’re going to take a question from a member of our audience. And this question comes from Julian.

Julian  32:25

Hello, Preston and Stig. This is Julian from Bucharest, Romania. My question is about us investors who are located in smaller developing countries with emerging markets. I wanted to know while learning lessons, would you recommend to study and invest in the local markets only? Or should you consider bigger international markets like the USA or UK with the risk of not understanding the whole context and culture of these foreign markets? Thank you, guys.

Stig Brodersen  32:50

Yes, so I think it’s a good question because like Julian, I live in a small country and I’m not that much invested in Denmark. And there are a few reasons for that. The one is that say that I want to invest in an index. Now biotech is like huge in Denmark and because we don’t have that many companies, you are not that diversified if you like most people start to invest in indexes.

And I think that’s something, I don’t know the Romanian stock market, admittedly. But I think it might be something you should also be looking at, if you’re comparing to S&P 500 in America and thinking, “Well, I’m probably diversified if I buy the national index.”

Another thing is that the selection of stocks is typically not that tempting for you, if you live in a small country, say Romania or something when it’s not a big country. It’s just like if you want to invest in say, oil companies. There might just be 2-4 companies, and it might be hard for you to compare with competitors.

So one thing is that you might have information that is accessible for you specifically, but it’s hard and it’s not that useful if you can’t compare that to an industry and that’s why I also typically favor American stocks because the information out there is just so much better.

Now, there are a few problems with investing in foreign markets like the US, if you live in Europe. For one thing, it’s typically more expensive. So I would usually pay a fee there is, I think, three to four times as high whenever I’m buying American stocks. I could imagine it would be something similar for you, Julian. Another thing is that if you invest in another country you might also be exposed to currency risk.

Preston Pysh  34:29

So Julian, the way I’m going to answer this is to point you towards a book. So there’s this book called “Global Value,” and this is by Meb Faber. And Meb is good at value investing abroad and investing in international markets around the world. So his book, I think it’s only 2.99 for his Kindle. So there’s a cheap book that you can get if you have an e-reader. If you want to read it on your computer, that’s where I would point you.

And what he’s doing is he’s basically teaching you how to do value investing in any country around the world, and basically capitalize on low market values. Also piggybacking on Stig’s comment by using indexes in those countries. So that’s where I would point you or anyone else in the audience that’s interested in doing that.

If you’re not familiar with Meb Faber, we’ve talked about him a couple of times on the show. I know Toby knows him. Meb got this idea where why do I limit myself with value investing principles just in the United States? Why don’t I look globally and say, which country is offering me the best valuations? Why am I not funneling some of my capital into those? And that’s what his book is all about. The name of the book is “Global Value: How to spot bubbles, avoid market crashes, and earn big returns in the stock markets.” That’s the name of it. So we’ll have a link to that in the show notes if anyone’s interested in looking at that book.

Meb has a great talk at Google where he’s talking about this approach by implementing value investing techniques internationally. So what we’ll do is we’ll have that video in our show notes. So after you’re done listening to this, if you want to pull up our website and go to the show notes, we’ll have that in there so you can listen to him talk about, I think it’s about a 30-minute talk, at Google. It’s a fantastic presentation. It’s completely free if you guys want to listen to that and get a glimpse of what he’s talking about in this book.

36:10

All right, Julian. So thank you so much for that question. We’re going to send you a free signed copy of our book, the Warren Buffett Accounting Book. And for anybody else out there, if you want to get your question played on the show, go to asktheinvestors.com and you can record your question there. And for anybody who gets their question played on our show, you’ll get a free signed copy of our book, the Warren Buffett Accounting Book.

Also, if you sign up on our mailing list, you’ll get our executive summary of “Liar’s Poker.” It’s like four or five pages long. So we send those out, we try to send out twice a month, sometimes only once a month. we’ll send out our notes from the books that we’re reading. We don’t send out any spam. We try to talk about the current market conditions whenever we attach the executive summary.

So we highly recommend you guys sign up on our mailing list. And you know what, if you don’t like to be on our mailing list, it’s too easy to unsubscribe and you won’t hurt our feelings. We’re doing this more for the audience to help them out.

If you have any questions at all about this episode, go to #TIP67 on Twitter. And we’ll try to answer your questions there. We’re enjoying the exchange with all the members of our audience on Twitter. But we just can’t tell you enough how much we appreciate our audience. You guys are just absolutely amazing. The amount of information that you guys feed us is just unprecedented. It helps us out tremendously to redistribute that information back to the audience. So keep that flowing, we appreciate it. We might not be the best at responding to everything. But we’re trying very hard to try to respond to everybody. But please realize that what you’re sending us, we are seeing it all. And we are able to then distribute that back to the community, either through the forum or on the podcast. So thank you guys so much. That’s all we have. And we’ll see you guys next week.

Outro  40:17

Thanks for listening to The Investor’s Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www.theinvestorspodcast.com. Submit your questions or request a guest’s appearance to The Investor’s Podcast by going to www.asktheinvestors.com. If your question is answered during the show, you will receive a free autographed copy of The Warren Buffett Accounting Book. This podcast is for entertainment purposes only. This material is copyrighted by the TIP Network and must have written approval before commercial application.