15 October 2016

When investors and leaders think about the best CEO’s in the world, many might name people like Jack Welch or Tim Cook. Although these individuals have had amazing returns and huge impacts, there are other CEO’s that aren’t as famous, but with huge returns. In this episode, Preston and Stig talk about the amazing returns of Tom Murphy, George Kozmetzky, Bill Anders, John Malone, Katherine Graham, Bill Stiritz, and Dick Smith. These individuals are the CEO’s highlighted in William Thorndike’s amazing book, Outsiders. The book came highly recommended by Warren Buffett in his annual shareholder letters.

If you would like to read a more detailed overview of William’s book, please checkout our free executive summary of The Outsiders.

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  • Why you want the CEO to think more like a capital allocator than a traditional CEO.
  • How the best capital allocators create arbitrage on their own stocks.
  • Use to use debt intelligently when growing your company.
  • How and why the most profitable companies does not compete on price.


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

Preston Pysh  1:04  

Hey, how’s everybody doing out there? This is Preston Pysh, and I’m your host for The Investor’s Podcast. And as usual, I’m accompanied by my co-host Stig Brodersen out in Seoul, South Korea. 

Today, we’ve got a book for you, and this one was recommended by Warren Buffett back in his 2012 shareholder letters. This was number one on his recommended reading list for the 2012 meeting. And the name of the book is, “The Outsiders”. This was written by William Thorndike, Jr. The subtitle of this book is, “Eight Unconventional CEOs and Their Radically Rational Blueprint for Success”. So this was a really, really fun read, especially if you’re a value investor, I think you’d thoroughly enjoy this book.

Stig Brodersen  1:45  

Yeah, I think it’s interesting. We talked so much about capital allocation, and we talked so much about leadership. And this book was just perfect in terms of merging those two concepts. So, I’m really happy about that. And I just want to give a quick shout out to Rich Shane who actually recommended this book. Preston and I met Rich here at the Berkshire meeting this year. So, that was really awesome. So, thank you so much for recommending that book to us.

Preston Pysh  2:10  

The book starts off with a really interesting opening, especially considering the last book that we read was all about Jack Welch. And the author starts off by saying, so everybody knows Jack Welch and how great of a leader he was and how awesome he led General Electric (GE) and the returns were phenomenal. And he uses Jack Welch mainly because he’s so well known. And he’s this kind of authority in business leadership and great returns. And he says, he’s done really well. But the thing that a lot of people don’t realize is that there’s other people out there that are performing at an even better level than  Jack Welch. And the returns for the time that they led these organizations will far exceed anything that Jack Welch had while he was managing General Electric. 

He starts off using Jack Welch as the baseline, as being a great leader, and then he says, “hey, check out these other eight guys, and how much more superior they were than Jack Welch”. So I kind of liked that spin. It was an interesting start to the book. And he jumps right into it, right out of the gate. The first chapter is called, “A Perpetual Motion Machine for Returns”, and this profiles a gentleman called Tom Murphy. And so Tom was the CEO of the company for 29 years that he was in the job. And that’s something else that’s a common theme throughout the book is every one of these people that he’s profiling in the book, it wasn’t like they were in the job for five years, and they had like, amazing returns. Most of these people were in the job for at least 25 years, even like a lot more than that. So there was a track record. There was a long period of performance where they were getting, I think, like some of the smallest returns were like 18% annually for some of these folks. When some of them were in excess of 20%. It just talks about how he took CBS (CBS Corporation) and all this media company and how he was able to grow it

Stig Brodersen  4:00  

It’s interesting how he actually did his comparison because one thing was that he compared it to the S&P 500. So that’s okay. And like if the stock market has been good, and they’re looking at their stock returns, clearly you should see that in comparison. But he was also looking at the industry. So it was not enough that they were outperforming S&P 500. If he was a media company, he would say, well how did the other media companies do within that quarter, 29 years. 

And I think that was really neat comparison, because what you also saw was that the industries that were typically leaning in, they were actually typical, also doing better than the stock market. So that is not really my way of saying you shouldn’t appreciate what they’re doing. But I think it’s really important for comparison, that sometimes it’s just easier if you can use that word to get better returns than the other time period. The author had a tremendous respect in terms of saying that these guys have done good, but we need to have the right comparison.

Preston Pysh  4:58  

He always used it as if these guys are swimming with the current in order to get their returns. And a lot of the times they were not. They’re actually swimming into the current and they were still able to get just tremendous returns.

Stig Brodersen  5:10  

And I think it’s interesting what you said before, Preston, in terms of how long that they were CEOs of these companies. It was clear that all of them are thinking like owners and not employees. Let me give you an example. He’s talking about how Tom Murphy stopped the practice of the management driving around limousines. And that just shows that well, first of all, I think it shows that he was thinking like an owner. That’s one thing. But another thing was that he was passionate about the business. He was not passionate about the perks. The fall of being a manager. The whole title didn’t seem to influence Tom Murphy’s decisions at all, that was really not interesting. 

And another thing that was interesting, not only about Tom Murphy, but also I think seven of the eight guys was that he actually knew very little about the industry that he was working in. I mean, you would think that someone like Tom Murphy, that was like one of the big personalities in media. He would know something about media, but he did not. He was the top guy in terms of capital allocation. And then he hired someone else. I can’t remember his name, but he was actually to manage the day-to-day operations. And he had no clue either about media. They were just very, very business savvy. And I think that was really interesting.

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Preston Pysh  6:25  

So the common thread, the thing that Stig was just talking about. And it’s a common thread that we saw between every one of these people that are profiled in this book, all eight of them. They thought like owners from the vantage point where they did not want this big title or the perks that would go along with the job. In fact, they were exactly like Buffett. At the end of the day, these guys were all exactly like Warren Buffett. As far as just making it simple – I don’t need a big headquarters, I don’t need some fancy car driving me to meetings. In fact, if that’s what’s happening with some of my subordinates within the organization, we need to start figuring out why that’s happening. They really took on this approach every single one of them. And I think that’s a really important highlight. 

So let’s hop over to the second chapter. This one is called, “An Unconventional Conglomerate”. This is profiling Henry Singleton. And Henry Singleton was the CEO for Teledyne. This is profiling Teledyne. And he was the CEO from 1963 to 1990. During that period of time, he got a 20.4% annual return every year between 1963 and 1990. So if you invested $1 with him when he first started, it would have turned into $180 by 1990. So pretty amazing track record for this gentleman and same exact thing. So this is the thing that is really kind of separating these gentlemen and Katharine Graham was also in here as well, later on. 

The thing that was separating them was this simple idea that when they had the business, they had these operational assets creating revenue. These guys were and I’m talking about Henry Singleton right now, what he would do is he would take this operational cash flow. He’d be looking at that as “okay, I can invest this back into the business, which I could expect, let’s say at that point in time, maybe he could expect a 10% return”. But that’s not where he stopped. He always looked at his potential options as being just a plethora of opportunities and returns. So I could invest this organically at 10%. I can invest this in some other private equity company, which would give me 12% with a similar risk profile. I could just hold cash and value liquidity. These guys were constantly looking at all the different options and if it was something that was outside of their operational line of business, they often wanted to take a non controlling interest, and if it was 100% stake in whatever their company was that they were acquiring, they treated that new business in a manner that it was completely decentralized and not something that they would step in and try to force their company brand down on it. They just let it operate organically on its own. And I think that that is such an important lesson for leaders out there if they’re in an acquisition mode to think like that.

Stig Brodersen  9:23  

Yeah, and I think, another thing that they all have in common. The author starts off this chapter with a quote from Keynes. And he’s saying that, “I changed my mind when the facts change”. That’s such a profound quote. I think Singleton is probably one of the people out there that has exemplified that the best possible way. Let me give you some examples here. Back in the 1960s, conglomerates were very popular. And his company is sold at 20 to 50 times earnings, which is clearly very high multiples. Now, so what he did was he was actually issuing stocks at 20 to 50 times multiples. And then he bought companies at 12 times and lower. That’s a huge difference. Because then the new companies that he is buying, they are now valued immediately at a much higher price than they can then issue shares. 

So he had this currency, he was almost making arbitrage on his own stocks as a currency. So I think that was really, really interesting. And then when it came to the 70s, in the early 80s, he bought back 90% of his shares. It’s huge, huge buyback procedure here from 1972 to 1984. And he did that at the average PE of 8. So again, you see how that relates back to “I change my mind when the facts change”. Because now his company for one reason or another is really priced very low. And then, at the end, when he could find nothing better to invest in, he started to pay out dividends. I think that was just so profound that he did that. It’s just one more thing that really shows you how smart Singleton was that point in time that he started to take on a lot of debt. The reason why he did that was partly because his stocks was pretty cheap, but also because he had the expectations that the interest rate would go up, which means that he could buy it back in a lower price. And he had also timed this with the pension fund that he was also running that was not taxed on investment gains. And then he actually bought back the bonds. 

So that just shows that no matter what business you’re looking at, he was just the perfect capital allocator. And he kept again, changing his mind when the facts changed.

Preston Pysh  11:46  

So the thing that I really looked at with this is he was doing repurchases at the right time. And the thing that you commonly see, the norm is that you do it the exact opposite right time. And that is through statistical proof. I know we were talking to Toby not on our last Mastermind, but I think it might have been the one before that. Toby was talking about whenever you have repurchases at a peak in the market, it almost completely coincides with whenever you see a stock market high in these cycles. 

And the only thing that I can conclude is that, I guess this is how I’m thinking through normal management. I think normal management starts running out of opportunities out there. And their mindset is, well, I don’t really know that I want to invest in this, it’s priced at a low return. We really don’t have any new ideas because it’s all high risk R&D stuff, so let’s just buy back our stock. Like, we know that our company is a good company, so let’s just buy back our stock and then we’ll hit the earnings target that we’re going after for this quarter. 

I really think that that’s the thought process of most managers when they’re making these decisions. These guys that were profiled in this book would have been doing literally the exact opposite. Whenever the market was pricing their stock at a high multiple, these guys would have been selling shares, not buying them. And whenever the market would tank, they’d say, “hey, I know what’s inside my company. I know it’s here. Let me buy back my shares at ridiculous levels”. And they just totally killed it. The thing that I think is really interesting, too, is of these eight people, every one of these people, absolutely had some of the biggest share buybacks on record of any of the CEOs that he was comparing him to. The one person who didn’t was Warren Buffett. And I think that that’s a really interesting kind of twist in the book because seven of the eight did these massive share buybacks except for Buffett, and whenever you think, well, so why didn’t Buffett do that? Buffett does not really want to buy back shares from people he wants to treat. Everybody is a holder of the company. Do you agree with that, Stig? I can’t put my finger on why.

Stig Brodersen  13:58  

Yeah, well, the take that I had was that Buffett was just the best capital allocator in terms of looking at a lot of different assets. So someone like Singleton, that was an awesome capital allocator. He probably knew his industry. He definitely knew what his company was worth. But he might not have had the chance to buy into various stocks across the board. So I just think for Buffett, it was also a question of finding the very best stocks to invest in and he was just the best stock picker of all them because they were nothing to sell the stock picker. They were buying business units that they knew and learn about, but not stocks as such.

Preston Pysh  14:35  

And I wonder if Berkshire’s ever been priced at a P/E below at 10 in the last 30 years. Has it?

Stig Brodersen  14:41  

I think that’s another good point. It’s been a long time ago since it’s been really cheap. I wouldn’t say that you’re paying a premium because sometimes it is actually undervalued. But I also think it’s because Buffett himself put this floor in the price in terms of he’s saying he will repurchase so it’s really hard for that to have such a low price. For someone as good as Buffett, I think it’s just easier to find other opportunities than buying back Berkshire caught at 10% discount, because that’s not what he’s looking for.

Preston Pysh  15:10  

Yeah, that was one of the interesting parts of the book that they profiled how all these guys were doing massive repurchases and also selling their stock, like Stig said, whenever they had a P/E (price-to-earnings ratio) that was high. These guys were selling it. They were raising money. They were getting liquidity, and then they were sitting on it until the market tanked and then they were buying back their own stock, it was amazing. 

Okay, so let’s go to the next person here. And we’ll go through these a little bit faster. The next one is Bill Anders, and this was with General Dynamics. General Dynamics brought him in and he took over the company and one of the first things that he did whenever he came into the company, was he wanted to change the culture. He went into this company and he’s like this culture is completely broke. And one of his first moves was he replaced 21 of the top business executives in the company to change the culture. And then, the company had a negative cash flow, they were not even positive in their cash flow. And then within three years, they were having a $5 billion free cash flow annually within just three years, after this guy took charge. The titles, the perks, all that stuff, he just totally flushed it. It was like we’re sticking to the basics. We’re going to do these acquisitions. And really saw if he could start generating positive cash flow, he felt like by acquiring other businesses, and then letting them operate organically on their own, and decentralizing that control was going to give them the competitive advantage. 

And so first, it was, a lot of people thought he was gonna come in and destroy the company. But in the long run, it was there for decades. It was there for a long time, and had just an amazing return. He was close to 20% as well for General Dynamics. And anyone who knows defense companies, usually their margins and their rate of growth is a whole lot slower because it’s so regulated. You see, a lot of the defense companies are usually at a top line, the bottom line margin of about 5% to 7.5%.

Stig Brodersen  17:13  

Yeah, I’m really impressed by the CEO, Bill Anders because he was definitely taking over a much more difficult business than some of the other guys. So he was coming in at a time when there was an overcapacity in the market. His company had a strong engineer focus. They were not focused on stock investors at all. I mean, this is also as Preston said, this is defense business. So it’s a high expansion business. I mean, this is not an easy business to run. And it’s definitely not an easy business to generate a lot of cash flow in. 

So, it’s actually interesting to read that one of the first thing he did was to sell off a lot of assets. Because he had this idea that since he was basically doing a turn around, he needed a lot of cash to have a laser focus and to grow. So what I really like about Bill Anders was not only his way of thinking as a capital allocator, in terms of generating cash flow. Another thing was how he treated his shareholders and how he did not act so much as a CEO in that manner. I mean that in the best possible way because he paid out a special dividends at some point in time, close to 50% of the equity in the company. Anyone who studies dividend payments knows that, that’s huge. 50% of equity just as a special dividend payment. 

And so you might be thinking again so why is that so uncommon? Well, if you are CEO, usually you would like to grow it because CEOs are usually measured on revenue, and they’re always measured on profit, really. So when he’s paying out 50% of equity to the shareholders, he’s basically saying, I am limiting my own chance of growing my, call it, empire to show how important I am to the world. And I think that was something that really spoke with the words of his integrity, and how he treated his shareholders. And I really like that about Bill Anderson. How he approached his business.

Preston Pysh  19:09  

Okay, so let’s go ahead and move on to the next profile here, which is John Malone. John Malone was the CEO of TCI (Telecommunications, Inc.). The cable company that started in 1973. He started in 1973. This was one of the shorter ones that were profiled, he finished up his role in 1989. But during that period of time, from 1973 to 1989, he acquired 482 companies during that timeframe, and somehow managed to keep all of this afloat. And not only do that, but do it at just an astounding compounded rate. 

If you would have invested $1 with him in 1973, it would have turned into $900 by the time 1989 rolled around. So just to kind of give you an idea of the return was just astronomical. So this was his big thing. He was really smart in figuring out that if you’re a cable company, and you’ve got the most subscribers, success is going to compound on success. And your rates then are going to go down when you’re dealing with programmers. This is one of his deals where if you have the bigger market share, you’re going to be able to offer things at a better price, which is going to further compound your subscribers. So he went on this race of how can I increase my market size of this business at the fastest clip possible in order to really kind of get in that advantageous spot where I’m the biggest player on the street. So that was really his strategy. 

So I’m gonna throw it over to Stig in here some of his thoughts on this one.

Stig Brodersen  20:39  

Yeah, what I think was an interesting element was how he used debt. Now a lot of these CEOs actually use debt at various degrees. But I think that he was probably the CEO that used debt more significantly. He actually, at some point in time had a debt to revenue of 17%, which is just astronomical to think about. His goal was also to have if you guys are familiar with the term EBITDA, which is the earnings before interest in taxes, depreciation, and amortization, to debt of five. That was his goal which is very highly leveraged. And that was just how he saw it. 

I think, was the first person out there and financial world to use this term, EBITDA to evaluate his business. And the way he thought about that was really that he was taking advantage of the tax laws. He just wanted to have strong cash flow. He didn’t need a high net income that could always come down the line anyway. He thought that if he had a lot of debt, not only could it go a lot faster, it could go even faster by growing without paying taxes because he could deduct the interest payments. So he actually had this saying and he was completely upfront with that, that he would much rather pay interest expenses than taxes. So he grew just by growing his subscribers because he knew he could partly refinance his debt cheaper whenever he has grown, but also because he could sustain a competitive cost advances by having the most subscribers because that was how the industry worked. So he couldn’t care less about the short run implications of having a low EPS or earnings per share in the very beginning because that is what he had. But in the long term, he proved to be right. He did refinance his debt really cheap. And he had sustainable competitive cost advantage.

Preston Pysh  22:30  

Yeah, I think this was a really interesting profile just because there was a lot of aspects of this growth kind of investor mentality when he was growing the business. And also value investor capital allocation of the retained earnings kind of thing going on, which was, I think, a little bit unique and different than some of the others that were profiled. So this was a really interesting one. 

So the next one we’re going to jump to was Katharine Graham. And for anybody that’s a big Warren Buffett fan, you are very familiar with Katharine because she was the CEO at the Washington Post. I should say there’s a lot written about it, but there’s probably little that’s actually known as to what actually went on. That’s probably a better way to put it. But Katharine, regardless of the relationship with Buffett. Katharine took over as the CEO at The Washington Post in 1963. And then she stepped down from her position 30 years later in 1993. And here’s her return, 22.3% annual return whenever she was at the helm of The Washington Post. Now, I know there’s a lot of people out there because I was one of them as well. And I had to look this up that immediately thought, well, you know, Buffett was probably just helping her maybe pull some of the shots and telling her some things and whatnot, because they had this kind of romantic relationship. And you know what, Buffett didn’t even meet Katharine Graham or really start taking an interest in getting to know her until 1973, which was actually 10 years after she was already the CEO of the business. 

So that’s something that I want to throw out there just to kind of give her some more kudos than what some might not want to give her. But she might even had the biggest return in the book at 22.3%. But that’s just astronomical. And there’s something else that I like that they profiled here is just the kind of CEO that she was. I guess she was just really unsure of herself, and just kind of really easygoing. And the way that they described her personality was that she wasn’t really this aggressive CEO that necessarily knew what she wanted or what she didn’t want. But she was very open to suggestions. She was just kind of easy to talk to, and just very thoughtful in the way that she managed the company. And she just made some tremendous capital allocation decisions with the retained earnings of the business just like all these other people.

Stig Brodersen  24:49  

Yeah, and the thing that one quote that I really loved from this relationship she had with Warren Buffett was supposedly, after the first meeting that she had with Buffett. He offered to help, and she said, “you can do that but just remember two things, be gentle and then not hurt my feelings”. I mean, can you think of any other CEO that would say that? But that was just Katharine Graham and I loved that honesty. I think that made her so sincere.

Preston Pysh  25:19  

I think that’s the thing that was really unique. She wasn’t your typical number cruncher that was just playing hardball all the time. Like she was just, you know, it seemed like a really normal and just down to earth kind of person that just had extraordinary results.

Stig Brodersen  25:37  

Yes, because her story was quite unorthodox. I mean, she inherited the company at 46 years old because her late husband committed suicide. And according to her, at least, she had no clue about how to run a company. And back then it was very unorthodox for a woman to run a company. And she was actually the only female CEO in the S&P 500 at that point in time. 

It was also an interesting element in terms of how she was looking at business in general and how she was, in many ways thinking ahead of her time. And I know this might sound weird because I come up with this example where she did not spend millions of dollars in the new technology to print in colors. And you might be thinking, so why was she ahead of her time when she was not the first one to print in colors? Well, she had this idea that it didn’t really make any sense for her because the value added compared to how much the technology cost to implement, it was just not there. And she was very sure that if she would just hold on a few more years, the technology would be so cheap, that she could actually go in and implement the strategy very cheap. And actually a lot of the other publishers went bankrupt in this period. So she got in and bought their printers afterwards at a fire sale price. I was thinking that that was just so clever. She was thinking again ahead of her time.

Preston Pysh  27:02  

Yeah, I guess the thing that I took away is she just came across as being extremely thoughtful. One of these people who thinks through 10 moves instead of just the next 2 moves, just like what Stig described. It’s like, well, what’s the intent of actually having this capability? Are people going to read more of my paper? Not really. I don’t think so. And just kind of sticking to her guns and really not following the crowd is another thing that you see all these people that are profiled in this book. They’re not following the crowd. They’re kind of marching to the beat of their own drum. And then she was able to go ahead and like Stig said, just take advantage of huge opportunities because she thought in this different direction. But just an awesome profile. I mean, just so cool that she had one of the biggest returns, 22.3%. I’m really happy that I looked up when that relationship started with Buffett because she was getting big returns way before Buffett even became a part of the picture here. 

The next one we’re gonna do is Bill Stiritz and he was the CEO of Ralston Purina, which is the food producer. And this was another interesting profile. And again, another person who is just the master at decentralization, capital allocation of retained earnings, and keeping it simple, just focusing on what’s important, and not overextending themselves and trying to push their brand into areas that really doesn’t make any kind of sense.

Stig Brodersen  28:29  

Yes, I think one of the interesting thing about Bill Stiritz was that he actually spent 17 years in the company before he became CEO, which was quite unorthodox for these people because they were not necessarily outsiders, but they didn’t like have a career and then ended up as the CEO. But he actually did that as I think the only one of the eight. I think that his approach was a bit unorthodox in terms of spin offs. I think that was something that I really like to talk about because he was actually spinning off a lot of his companies, which again is not your typical CEO plate. But he did that partly to defer capital gains taxes. But also because he was really big on releasing the entrepreneurial energy that he had besides his company. 

And he also thought it was a better way of compensating the owners, so the shareholders. But also the managers has been spinning off the parent company, and utilize their specific talents. And the thing that creates such a strong culture when you single that out as the CEO. Another thing that I really liked about him was that he often stayed at home. So very, very often, he didn’t come into his office. He was really upfront with not having FaceTime. And he was setting the example in the sense that he felt that the best way he could use his own talents was really to sit around whatever was convenient for him to think about how to allocate your capital the best way. 

And for anyone who’s been in investing, has been in financial industry, I think 99% of them, they will probably say that, well, I’m actually getting the best ideas when I’m talking with good people in a relaxed setting, or basically, I’m just cutting out all the noise in my life, and I’m just thinking about it. But still 99% of these people that would just go to the office and spend a ridiculous amount of hours and thinking they’ll probably be inspired when they’re sitting in front of a laptop or whatnot. But he was actually really big on that and very upfront with sitting wherever is convenient for him. So he had a time to cut off noise and figured out how to best apply his capital.

Preston Pysh  30:39  

Alright, so the next person this is the seventh person of the eight was Dick Smith, and he was with General Cinema. So this is really interesting. He started off as the CEO when he was 37 years old. And he stayed with the company for 43 years after that. And during that period of time, during those 43 years, he got a 16.1% annual return for 43 years, which is unbelievable. Just to kind of compare that. So General Electric, everyone knows General Electric had amazing performance during this period of time. This started in 1962. For those next 43 years, General Electric had a 9.8% return. So, he was almost able to double the return of like a General Electric during his time with General Cinema when he was running the company. 

One of the things that made him really unique, and I love this about his leadership style was not just his ability to do these acquisitions with the retained earnings, but he had this way of management style where he highly encouraged people to disagree with him on issues. He wanted this kind of environment where people were constantly challenging, why something is right or wrong, or will work and not work. And so he felt like they were able to prevent a lot of mistakes because they had this open culture of open dialogue, and trying to really get at the heart of what the truth might be, and able to work things out instead of this domineering type of leadership style, where he’s just forcing ideas and opinions down on people to follow through and execute. So that was a really neat highlight as far as I’m concerned, as far as his leadership style.

Stig Brodersen  32:27  

I had three things I’d like to highlight for this chapter. The first one was actually that he inherited the company. And very often you see that if you did not make a career out of it, or if you have not created it, it can be really hard to continue. So that was one thing that was unusual about him. The other thing was that he was really big on cinema. So he had a relentless focus on cash. And he was very cautious about his working capital. He really talked about how good it was that people paid in cash for work. But then they pay for the movies 90 days later. So he used that liquidity to a very aggressive growth. Because he also was very aware that once the cinema was bought verted *inaudible* was actually needed for capital expenditures. So he was really smart about his cash. 

But really the main thing I took away from this chapter was his acquisition into the soft drink industry. And I think, the best way to explain this and how he was capitalizing on this is to look at Coca-Cola and Pepsi today. Now, Coca-Cola and Pepsi, they’re somewhat the same product, but they’re perceived very differently. You might be thinking, so if you have a similar product, why is price not a huge factor. Because price is actually not a huge factor in terms of soft drinks. Well, this is actually what’s called an oligopoly among structure. And you can think of this in terms of not competing on price but on competing of branding instead. So for instance, you will have a company like Pepsi, Now Pepsi has been trailing Coca-Cola a lot, but their strategy has really been to be associated with famous people. I mean, all the way back from Michael Jackson to Beyonce more recently. So they really want to say that it’s not a drink. It’s a product associated with famous people. Now, then Coca-Cola on the other hand, they are using big box on the marketing terms of sponsoring the big sports events. They would like to think about Coca-Cola in terms of the way thing about happiness. And what’s interesting about this is that the CEO of this chapter, Dick Smith, he was looking at the beverage industry the same way. He was saying that if we would like large margins, we can’t compete on price. And since our products are so similar to other products, we use to do something else. So he was creating a brand. He was delivering more value so he could have a higher profit margin. And I just think that that was such a smart move and such an intelligent move that he was doing.

Preston Pysh  35:04  

So I love this point. And here’s why. What you’re really getting at, Stig is he’s trying to expand his enduring competitive advantage. And if he can’t do that organically, if he can’t invest and grow that competitive advantage for the products that he currently owns, where can I go with that cash and invest it somewhere else where somebody does have a big moat, and have that competitive advantage that will fetch that premium into a long period of time into the future? That’s how every one of these people bought, whenever they were looking at decisions. They were looking at it from a large margin. How can I sustain the margin? How can I grow the margin organically? And if I can’t do that, what kind of business can I buy that has those attributes and has that competitive advantage and has that large premium that’s going to endure. That’s what these people are looking for. And they’re looking for it at the right price. And when they have something at the right price, they take a substantial position. And if they’re in a position where their own company is overvalued or undervalued, they’re going to take advantage of that by either selling more stock or buying back stock. That is really the nuts and bolts of what you really kind of take away from this book. So I’m really glad that you said that because that kind of jarred my thought on that competitive advantage stuff. 

So if you’re listening to this, and you want to hear us talk about Warren Buffett, sorry, but just listen to any one of the other shows, and I’m sure you’ll get your fair share and dose of Warren Buffett. So let’s just wrap it up with like, really kind of three things that we took away that all these people really had. And so the first one that I’m gonna throw out there, and this is in our executive summary. So if you’re wanting to skim through this book and see if you want to read more, or you want to see some of our notes from this, just sign up on our email list. We send this out for free. This is the executive summary of the book. 

The first thing that we highlighted was that all these people relied on numbers before they made any type of move. They’re looking at things from a pure quant standpoint, and they’re looking at it as, “hey, I’ve got all this cash flow right now today. And as I look at it today, what are the options available to me that are going to give me that return that have that competitive advantage tied to it that’s going to persist into the future?”. And they’d look at that snapshot in time, and then they’d make the decision. They would continue to hold the asset, would then generate more cash flow, and then they’d look at the whole new array of options and opportunity costs that then present them again at that point in time. And so they are a numbers driven, quantitative thinking leaders in the organization and they’re very unemotional.

Stig Brodersen  37:46  

Yeah, and I think another high point is that they were shoots on delegating operations. Basically everything that had to do with operations, they were really outsourcing that. Everything that had to do with capital allocation, that was the top guy or woman that was actually doing that. It used to be just one person. I mean, they would really like for them and them only to allocate that capital. I don’t think it was a question of trust, necessarily, but a question of they knew what they were good at and knew what they were not good at. And they were good at allocating capital. And that was really the main job. They were not the manager. They were an investor. They were owners. And I think that was just the way to think about this across the board.

Preston Pysh  38:28  

Adding to what you just said, it almost seemed like that’s obviously where their focus was on that capital allocation side. But if there was something that was operational, or something that was in the day-to-day business part of it was like, “hey, just talk to the CEO. Let’s have him handle that portion of this problem. I don’t want to have to deal with this. I want to be able to think about where I’m going to invest all this money that we’re making, and make wise decisions so we don’t slowly devour our margin over time or slowly become uncompetitive”. They were always thinking like really long term and in these big ideas and for the day-to-day stuff, it was almost process-oriented. Like just keep the process going. If there’s something major you need my help with, let me know. But I’ll be over here thinking about what our next acquisition is or the thing that’s going to add more value to the shareholders.

Stig Brodersen  39:20  

Yeah, so just all in all, I’ve really enjoyed the book. I mean, I think this is definitely one of the other better books but also because it’s a type of book that we haven’t done before. So, what is it 108 episodes now and quite a few books? I think it’s nice also to actually look into a new genre of business books. So I thoroughly enjoyed this book, and I can see that you’re nodding here, Preston. 

Preston Pysh  39:42  

Yeah. When I was reading each one of them, I was like, I just can’t get over how similar each one of these people are to Warren Buffett’s approach. Every one of them like if you would have changed Warren Buffett to the name of every person that they were talking about in the book, you would have thought they were talking about Buffett the whole time because the decision making, the thought process of their decisions was exactly the same of everything we’ve studied about Buffett. And what I find amazing, is every one of them almost had a 20% annual return. 

So, there’s something to it. There’s absolutely something to it. And I’ll tell you, it was neat to kind of see other people profiled that did kind of the same thing, and got the same results. That’s what was kind of neat about it. So at this time, we’re going to go ahead and transition. We’re going to answer a question from the audience. And the question we got here comes from Dale.

Dale  40:30  

I’m from Australia. I was wondering how much money a person should have to start investing. I have $3,000 put away specifically to begin. I was looking at a company called Washington H. Soul Pattinson, ticker symbol Sol, which is an investment company. Is this the right amount and direction?

Preston Pysh  40:30  

Dale, I like this question. And the reason I like this question is because I think there’s a lot more people out there than some of us realize that are in your exact same situation where you’re kind of starting out. You have a couple thousand bucks to play with and you’re asking, “hey, is this something I should get involved in?”. Now, what I tell people is usually, I think a good trade size at a minimum level is maybe $1,000 to $3,000. I think that if you’re investing in, let’s say, you want to buy Apple and you have $200. The cost to just buy the stock is really already handicapping you if you’re only buying $200 worth of Apple. So, I would say that around $1,000 to $3,000 is probably a good position to take whenever you invest in the market. With that said, so if you got $3,000. I would tell you since that’s the size of your entire starting your entire portfolio, I would tell you to distribute your risk a little bit better. And I would tell you to go with some type of ETF (exchange traded fund), instead of going in an individual stock because of the size of your entire portfolio. 

With that said, since you’d be investing in a basket of stocks with that $3,000 and you’d only pay one commission for that. So like let’s just say you picked ticker ABC. I’m just using this generically. You’re only going to pay that transaction fee that one time for that entire $3,000. But you’d be distributing that money across, call it 500 companies if it was the S&P 500, or whatever. Now, what I would tell you right now, because we’re here in the fall now of 2016, you guys know our opinions on the US stock market. We think that it’s really kind of maxed out. I think that if you are invested in the US stock market, you’re really just kind of tap dancing around and playing at the top of a very dangerous situation. And that would be the credit cycle, I think you’re at the top of the credit cycle. 

So what I would tell you is that there’s other places in the world that might give you a much better return for the price that you’re paying. In our show notes, what we’re gonna do is we’re gonna have a link to the P/E ratios of all these different international markets and it’s going to show you from the most expensive to the cheapest where you can potentially get maybe a better return in an index type fund. So that’s my recommendation for you. I would go somewhere else outside of the United States. I’d buy an ETF. And, I would probably put the entire pick into something like that. Then this is what’s important, as you get more cash flow, then you continue to hold that strategy, and then you buy in other areas and other places. 

I do want to throw out this caveat. I think that this credit cycle that we’re about to experience, whether it’s within the next year or three years could have global implications, because it’s going to be I think, I could be dead wrong. I think it’s going to be a doozy. I think it’s going to be very large credit contraction. So, that could have an impact on the short term performance. But as far as the long term performance, if you’re buying a low P/E, you’re gonna do decent relative to all the other options out there. And that’s what’s important.

Stig Brodersen  43:52  

Yeah, I like your advice, Preston in terms of looking at ETFs. It’s actually really interesting that Dale is talking about how he would like to buy an individual stock. And you’re talking about perhaps going to ETFs. I can see that from myself and a lot of other people that whenever we start out being interested in stock investing, do you actually think about, I should probably buy individual stocks. And then as we grow smarter, we perhaps even learn how to pick individual stocks. We actually talk about ETFs instead. It’s just a funny observation of how we usually look at that. 

But yes, Dale, definitely, look at ETFs first simply in terms of spreading your risk. I think if you’re just starting out to be picking individual stocks and going through the entire process. I love the motivation you’re having when you realize how much you actually need to investigate and research first. You will probably feel that’s overwhelming and you might not invest in the first place, which might not be a good long term strategy. So I would definitely look at ETFs that might be easier to conceptually understand and easier to start your investing career. Then slowly as you get more familiar with investing, transition into individual stock picks, if that is something that you want to do. 

I just want to throw it out there that just because we feel that we are familiar with a company, say that we always go to Starbucks, and we might have a few friends working in Starbucks. Going from there and then to really understanding the business model to be able to understand that structure of the company. I think there’s a long way. So if you don’t want to go into that nitty gritty part, finding a low priced ETF is surely one of the best things you can do in terms of starting off your investing career.

Preston Pysh  45:43  

All right, Dale. So thank you so much for recording your question and sending it in. For anybody else out there that wants to get their question played just like Dale, go to asktheinvestors.com, and you can record your question. And here’s the great part. If you get your question played on the show, Stig and I are going to mail you a free signed copy of our book, “The Warren Buffett Accounting Book”, and you’re also going to get a free subscription to Stig’s paid “Intelligent Investor” video course that he’s made that’s on our website. 

So, Dale, we hope that you enjoy these two gifts from us and we really appreciate you calling in.

Stig Brodersen  46:17  

Alright guys, that was all that we have for this episode. We’ll see each other next week.

Outro  48:16  

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 requests of guests. 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.


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