[00:01:57] Buffett described that the company successors would need to have what he called a “Money Mind” in that there are a lot of really smart people who make really poor investment decisions. Just because somebody is smart and bright doesn’t mean they’re good capital allocators and have that money mind that Warren is talking about here.

[00:02:15] So back on episode TIP487, I talked about one of Hagstrom s previous books, which was the Warren Buffett Way, and I walked through Warren Buffett’s 12 investment tenants that Hagstrom lays out in his book. And during this episode, I’m going to be covering his new book, Inside The Ultimate Money Mind.

[00:02:33] It covers the mindset of Buffett, which is just as important as his tactical investment approach. I think. Hagstrom stated that he came to understand that there was a big difference between knowing the path and actually walking the path. Benjamin Graham and Buffett have both emphasized the importance of having the right temperament, so that is why Hagstrom went on to write this book as well.

[00:02:54] Buffett gave us a simple way to characterize how he thinks. He calls it the Money Mind. This can be used to describe how he thinks about major financial issues, such as capital allocation, and as Hagstrom puts it, quote at another level, it summarizes an overall mindset for the business world at a still deeper level, the profound philosophical and ethical constructs at its core.

[00:03:17] Tell us a great deal about the person we call a money mind. A person who is quite likely to be successful in many aspects of life, including. This money mind is a powerful idea and we should learn more about it. End quote, Buffett, for the most part, is known as being the world’s greatest investor, but what is maybe less widely well-known is just how brilliant he is at business.

[00:03:41] At such an early age, such as that. Age 11, he was already investing in stocks, and by high school he was running various small business operations. One of Warren’s introductions to learning about business was picking up the book, 1000 Ways to Make $1,000. One of the stories in that book was a story of a man named Harry Larson, who in 1933 had invested in weighing scales to put around town that people would put one penny in just away themselves.

[00:04:09] He saved up $175 to buy three scales, which would then start earning him $98 in profit per month, which is quite a good return on in. But what really intrigued Warren from this story is that he used these profits from the first three machines to end up expanding to 70 machines, and that didn’t require him putting any more money into the business.

[00:04:32] And this is the essence of what made a career for Warren Buffett. It’s about taking those profits he would earn to go out and invest in order to make more profits and allow compounding to work its magic. The first step in developing that money mind is to study businesses and know everything there is to know about a business that you’re going to invest in.

[00:04:52] Reading books and annual reports allows you to draw off the experience of others and understand what the pros and cons are of a particular business. From another person’s point of view, learning from others who started a business venture might prevent you from wasting your own time and money to discover it’s much different than you might have originally expected.

[00:05:11] What makes Warren so good at understanding business is that he has read about so many public companies and their annual reports. So he has not only learned what works well and is really profitable, but what tends to not work well and fails because he has studied so many businesses, he oftentimes is able to very quickly spot the red flags in the company.

[00:05:32] The second step, Paxter mentions in developing a Money Mind is taking. When Warren invests today, he waits for a business he likes that is trading at a really good price, and then he takes advantage of that opportunity. He doesn’t consider if we are teetering on the edge of a recession or forecast where interest rates are heading and making his decision to buy a business or not.

[00:05:53] Early on in Buffett’s investing journey in his twenties, people were telling him the market was overvalued and there wasn’t much money to be made in stocks yet Buffett was just obsessed with finding bargains in the market and taking massive action as he knew that was the only way he could benefit from a stocks rise, and it’s to find those best opportunities he could possibly find.

[00:06:13] Embedding accordingly. Hagstrom also tells the story of how in the. 1000 Ways to Make $1,000. Chapter 10 in the book is titled Selling Your Services and it gave the advice to readers to take personal inventory, figure out what you do better than anyone else, figure out who needs help with that, and how you can best reach them.

[00:06:34] This sage advice led Warren starting his very own investment partnership. Warren had built his reputation in Omaha as an investing genius. In working for his mentor, Benjamin Graham helped further establish that cred. That first spring in 1956, he had already raised $105,000 to invest money on the behalf of others while he took 25% of the profits above a 6% hurdle rate, which was quite a generous agreement given how good Warren was at investing.

[00:07:03] But above all else, he wanted to do right by his partners. He knew full well that the better he did and the better he could do for his partners, the more money this would attract for him to invest from a larger capital base and make even more money to invest for the long run. From 1957 to 1961, Warren’s partnership returned 251% versus the market’s average of 74.

[00:07:29] At the age of 31 Buffett had accumulated 7.2 million in capital in the partnership, and 1 million of that belonged to. After 10 years, the partnership had 53 million, 10 million of which was Buffett’s. It’s pretty clear that despite being fairly young, Warren knew a thing or two about money and had a money mind himself.

[00:07:50] Already in 1968, Buffett had his best year yet for the partnership with an astounding 59% return relative to the Dows 8%. And then in 1969, Buffett announced that he would be closing the doors on his partner. Now when it was all said and done, the partnership’s assets grew from the original $105,000 to 104,000,025 million of which was Buffett’s.

[00:08:17] Buffett’s original goal was to beat the market by 10% per year, and he ended up beating it by 22% per year. Buffett had taken that idea of compounding he had learned as a child and continued to apply it year after. If owning one pinball machine was good, then he figured that owning five or 10 was great.

[00:08:36] If having one paper route was good, then maybe having two or three was even better. This continuous compounding led him to taking ownership of Berkshire Hathaway, a failed textile maker in 1965 that would then become a conglomerate that owned a wide variety of different businesses. In Buffett’s 2014 annual letter, he hit on the tremendous benefits of owning a conglomerate.

[00:08:59] He stated, if the conglomerate form is used judiciously, it is an ideal structure for maximizing long-term capital. A conglomerate is perfectly positioned to allocate capital rationally and at a minimal cost without incurring much for taxes and other costs. He’s able to move capital from businesses that don’t have much opportunity for reinvestment to businesses that show greater promise.

[00:09:24] So it’s clear that Warren being the learning machine that he is, took these ideas from different people and applied them in a way that really made sense to him. Benjamin Graham’s books don’t really mention the word compounding yet. Buffett learned from Graham how to buy things at a bargain. So he took that idea of the conglomerate and compounding capital and combined it with investing and finding dollars that were trading for 50 cents that he learned from Benjamin.

[00:09:48] A key theme you’ll find in studying Buffett is that he was constantly reading and constantly learning, and then applying all these different ideas in a way that he saw Fit Buffett, took the conglomerate of Berkshire Hathaway and today has turned it into the sixth largest company in the world, not by creating some new innovation or new technology.

[00:10:08] He simply did it by harnessing the power of long-term compound. Angstrom then goes on to discuss more about how Buffett ended up developing the money mind in investment philosophies that he holds. Howard Buffett, Warren’s father was the first person to help shape who Warren would become today. Although Howard served in Congress as a Republican, he was very much remembered politically as a libertarian in a promoter of the private sector’s ability to efficiently solve society’s problems rather than having the government.

[00:10:38] At the heart of Libertarianism is a celebration of self-putting the individual over the state. Hagstrom then goes on to explain the connection between Ralph Waldo Emerson and Howard Buffett, as Emerson was a champion of individual thought in a critic of society’s countervailing forces against individual thought.

[00:10:56] In Emerson’s piece titled Self-Reliance published in 1841, it presents three major themes. First, the importance of solitude in taking the time to learn and reflect. Second is non-conformity and the courage to stand up for what one believes is right, regardless of what others think. And third is spirituality and searching for truth rather than relying on others for truth, because relying on others hinders one’s ability to continue to grow mentally and immediately.

[00:11:25] You can see the similarities in this piece by Emerson in how Buffett. He spends a lot of time on his own reflecting on what he is learning. He’s a non-conformist and in many ways goes against the theories that are taught in schools, and he really thinks for himself and doesn’t rely on others to come up with his own opinions.

[00:11:43] Being a non-conformist like Buffett can create a lot of displeasure to others because you stand out from the crowd and you make them question their worldview. As Emerson stated, to be great is to be misunderstood. In terms of the solitude piece, Omaha, Nebraska made for the perfect location for Buffett to act in solitude as it was far away from all the noise in New York City.

[00:12:05] Now, Warren really greatly admired his father, who really passed along many of these traits that Warren would pick up, one of which would be his love of reading in his sense of patriotism. Warren once said, the best advice I’ve ever been given is by my father who told me it took 20 years to build a reputation in 20 minutes to lose it.

[00:12:26] If you remember that, you’ll do things differently. Ralph Waldo Emerson’s wisdom and teachings are also found in Buffett’s other great mentor, Benjamin Graham, as Graham told us in the intelligent investor to quote, have the courage of your knowledge and experience if you have formed a conclusion from the facts.

[00:12:43] And if you know your judgment is sound, act on it. Even though others may hesitate or differ, you are neither right nor wrong because the crowd disagrees with you. You are right because your data in reasoning are right. End. There are two chapters from Graham’s book that Warren highly encourages people to pay attention to.

[00:13:01] Chapter eight is titled The Investor In Market Fluctuations, and Chapter 20 is titled Margin of Safety as the Central Concept of Investment. Graham really helps Warren master investing, as he stated. To invest successfully over a lifetime does not require a stratospheric iq. What is needed is a sound intellectual framework for making decisions in the ability to keep emotions from corroding that framework end quote.

[00:13:27] While Howard was largely influenced by Ralph Emerson, Benjamin Graham really admired Marcus Aurelius, who was the Roman Emperor from 1 61 to 180 AD and was the last emperor of the Pax Roman, which was an age when Romans lived in peace, stability, and prosperity. Aurelius is widely known for his book meditations, which was really simply his personal writings that served as fundamental principles for life to help him encounter his daily challenge.

[00:13:57] Meditations is largely read by those wanting to learn about the philosophy of stoicism, which encourages people to accept unfortunate events outside of one’s control and not get overly emotional over such events while putting more focus on what we can control. Stoicism really directly lines up with Benjamin Graham’s description of Mr.

[00:14:17] Market. As Hagstrom puts it, Graham asks us to imagine we own a private business with a partner. He calls Mr. Mr. Market is very accommodating. He shows up each day with an offer to either buy your shares in the business or sell you his shares for the same price. But Mr. Market has an acute emotional problem on certain days.

[00:14:39] Mr. Market is widely excited and named you a very high price. Other days he is deeply depressed, seeing nothing but terrible ahead and quote you a very low price. Mr. Market is, of course, the stock. It is exactly that wild manic depressive behavior that causes so many investors to make poor decisions, unable to distinguish between price and value.

[00:15:02] They look at rising prices with greed and envy, and falling prices with fear and anxiety. The exact emotions the stoics seek to avoid. So we really have to learn how to detach ourselves from the prices the market is offering, not getting greedy when prices are up or fearful when prices are. This brings us to a quote from Buffett.

[00:15:22] If you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. And as they say in poker, if you’ve been in the game for 30 minutes and you don’t know who the Patsy is, you’re the Patsy End quote. I believe that this is really important for investors to wrap their head around as I think there’s a lot of investors out there that think they know how markets work and how markets operate, but they’re really just the patsy that’s being taken advantage of by others.

[00:15:50] So Buffett has a really good understanding of how to value a business, and then after he determines what he believes it’s worth, he then looks at the price the market is offering before deciding if he wants to buy or sell shares. Talking about disconnecting a stocks price from the value is really simple to understand and sounds really easy in theory, but actually implementing this in the real world is incredibly difficult, especially with how volatile stocks have been in the past few years.

[00:16:17] This then brings our attention to Buffett’s third influence Charlie Munger. Charlie reminded Warren right off the bat of Benjamin Graham because of his integrity, dedication to objectivity and realism. In studying Charlie, there are three distinct things that stick out the pursuit of worldly wisdom, the study of failure in the moral imperative to embrace rationality.

[00:16:41] In analyzing the wisdom of Munger in Graham, Hagstrom linked the two to two different philosophers in how Munger and Graham had pretty radically different worldviews when it came to investing. How Graham invested consisted of a series of simple steps that were carefully connected and reviewed from beginning to end.

[00:17:00] His approach was very mathematical. He would come up with his own estimation of value based on what he called prior reasoning and not from actual experience of owning and operating a business. Thus, Graham’s investing process led him to look for cheap cigar butts whose value could be based on data that can be collected, data that included tangible items such as the assets on the balance sheet in the company’s earning.

[00:17:25] Whereas Charlie’s investment style and what he believed was true was based on the observable facts and personal experiences that provide evidence towards knowledge. Charlie preferred to purchase good businesses through a process of observing and analyzing the full scope of the company’s operation and not simply buying something at a bargain price.

[00:17:44] When Charlie was asked what one quality accounts for his success, he gave credit to his rationality as he. People who say they are rational should know how things work, what works and what doesn’t, and why. It’s a moral duty to be as rational that you can make yourself. And that becoming more rational is a long process.

[00:18:04] It’s something you get slowly with a variable result, but there’s hardly anything more important. Now in chapter three of his book, Hagstrom outlined Buffett’s evolution as a value investor, breaking it down into three phase. The first phase was the classic value investing, which essentially means buying something cheap with a large margin of safety based on the company’s current earnings, dividends into assets, a big emphasis is put on the margin of safety because the larger the margin of safety when purchasing the lower the potential downside for the investor.

[00:18:36] Hagstrom states that at the heart of value investing stand two golden rules. Rule number one is don’t lose. Rule number two is don’t forget rule number. Benjamin Graham lived through the Great Depression and he really saw just how much stock prices could really fall, especially when you don’t protect yourself with a margin of safety.

[00:18:56] The margin of safety concept was brilliant as most people during this period. Simply thought the stock market was a place to go and gamble your money. The margin of safety was the ultimate hedge for those wanting to reliably make money in the market. If you were right about the company’s intrinsic value, then you would be rewarded handsomely.

[00:19:15] If you were wrong about the intrinsic value, then your downside was limited because you accounted for some potential margin for error. This method of investing did have its drawbacks, though as Warren discovered, it didn’t really make sense to purchase bad wholly owned businesses for Berkshire Hathaway because during his partnership years, he could just hand off the shares to someone else.

[00:19:35] But now he owned the whole thing and it was more cumbersome to sell. Plus, when you reach a certain size, your opportunity set to buy cheap businesses continues to shrink as you grow larger and larger seas. Candy is the perfect example of why buying great businesses pays. In 1972, the asking price to buy seas was 40 million.

[00:19:57] The company had 10 million on the balance sheet, 8 million in tangible assets, and they were earning 4 million per year pre-tax. Munger thought it was a reasonable price, and Warren wasn’t really sure, so he offered 25 million. Still a bit worried that he was paying too much. In hindsight, they were really lucky to get the business for 25 million as from 1972 to 1999.

[00:20:21] The internal rate of return on that purchase was 32% per year. If they had paid double the purchase price, they still would’ve made 21% per. In Buffett’s 2014 annual report, he stated that SEAS candy returned 1.9 billion in pre-tax earnings to Berkshire, which only required 40 million in additional capital investment.

[00:20:43] Warren learned three lessons from purchasing Seas Candy. First, the company’s 40 million. Asking price was not overvalued. In fact, it was undervalued. Second, paying a high multiple for even a slow-growing company is a smart investment if the capital is rationally allocated. Third Buffett stated, I gained a business education about the value of powerful brands that opened my eyes to many other profitable investments.

[00:21:11] Seas really helped Warren realize the power of purchasing great businesses at a reasonable. Which led him to make purchases in great companies such as Coca-Cola and Apple, both of which he made a total fortune on. Apple in particular, may have been the greatest stock investment of all time. While much of the investment world tries to segment companies as a value or a growth investment, Buffett simply thinks about what he believes the company is worth, and if the company is trading well below that intrinsic.

[00:21:40] Just because a company has a low pe, low price to book or high dividend yield does not make it a good value investment. Similarly, just because a company has a high pe, a high price to book or no dividend, doesn’t make it a ridiculous overvalued speculative investment. Buffett says that growth and value are joined at the hip as the growth is included in the intrinsic value calculation when you’re determining the present value of those future free cash flows that go to the owner.

[00:22:09] During the 2010s, we did see this drastic outperformance of what people call growth stocks relative to value stocks in the continued transition of many companies making investments in intangible assets rather than tangible assets. Currently in the US the intangible investment rate is twice that of tangible assets.

[00:22:29] What does this mean for value investors? Well, due to outdated gap accounting rules, investments in intangible assets must be deducted from their current earnings. This means that if someone is simply looking at the PE ratio of a company, they’re looking at a distorted view of whether the company is under or overvalued.

[00:22:47] This means that if someone is simply looking at the PE ratio of a company, they are looking at a distorted view of whether it’s under or overvalued because they aren’t looking at it through the lens of a business owner like Buffett is. Buffett will be the very first to tell you that he isn’t in search of a high PE or a low PE business.

[00:23:06] He says that the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of. Pru states that in Warren’s money mind, it is always about the compounding. More importantly, it is about value creating compounding companies. As I mentioned during my episode covering Buffett’s story in episode TIP 482.

[00:23:29] Buffett also learned a great deal from Phil Fisher, and Fisher really admired Buffett as well. Fisher described how most investors learned one craft and one approach to investing. For example, only buying stocks with low PEs, and then they continue to build their craft, but most of them never change. In contrast, Buffett would continue to evolve decade after decade.

[00:23:52] Hagstrom points out that no one would’ve predicted that Buffett with his original training and value investing would invest in franchise media stocks in the 1970s, yet he added a number of them to Berkshire’s portfolio. Warren began to understand the value that wasn’t stated on the balance sheet that traditional value investors would overlook, such as the value of Coca-Cola’s brand.

[00:24:14] Warren had largely learned how to identify these businesses with above-average economic potential and capable management from Phil Fisher himself. Fisher famously wrote the book, common Stocks in Uncommon Profits, and it was released in 1958. Fisher was impressed with businesses that had the ability to grow sales and profits over the years at rates higher than others in their industry.

[00:24:37] He was also attracted to companies that could grow into the future without requiring additional finance. This is something that Buffett also mentions he looks for in businesses time and time again. Fisher is also a proponent of only investing in companies that are understood by the investor or what Buffett calls investing within your circle of competence.

[00:24:57] Since it’s required that the business is well understood, it also leads him to not overstress diversification because if you own too many businesses, then this may actually increase your risk in your portfolio because you may not have sufficient knowledge about the business. If you owned a portfolio of, say, 50 companies rather than 10, it makes it really difficult to monitor how each position is performing and whether each of them are creating or destroying shareholder value.

[00:25:24] There is a direct correlation between the number of stocks that an investor owns and the level of understanding the investor has about each business. Tom Gayner did a really good job describing the difference between what Hagstrom called stage one and stage two of value investing l. Stage one was the classical value investing methods of simply looking at a snapshot of a company At one specific moment, this method of purchasing mathematically cheap stocks worked great.

[00:25:51] After the Great Depression, it became more and more popular, and as more and more people found out about it and started utilizing the strategy, it became more and more popular, and more and more people found out about it and started utilizing this method. Stage two of value investing is to value a business rather than a.

[00:26:10] Rather than looking at a snapshot of a company’s current assets and earnings, stage two unfolds over time like a movie. This method is more difficult because you have to uncover and understand the intangible value of a business. There isn’t a number that tells you how much the value of Coca-Cola’s brand is.

[00:26:28] You need to have an understanding of the business, it’s management in the industry to come up with that sort of estimate. Hagstrom then went on to discuss stage three of modern-day value investing, which is what he called the value of network economics, which really boils down to companies with strong network effects.

[00:26:46] Hagstrom states that quote in stage three, the cost of the physical input to business models has gone down while the value output has grown exponentially. In stage three billions of dollars in market value are being created by companies generating hundreds of millions of dollars in earnings, all made possible by fractions of the capital employed compared to the Industrial Revolution.

[00:27:09] End quote. The internet and its capabilities have really allowed companies to bring tremendous value to customers at a substantially lower cost than what was ever believed. For many brick-and-mortar type businesses, they reach a point where there is diminishing returns on their investments, meaning that eventually the returns and profits that are generated are less than the money that is invested.

[00:27:31] However, many modern-day technology companies actually experience increasing economic returns because of the network effects that are in place in building a successful business. In today’s economy, a network effect is a phenomenon in which a product or service increases in value. For all users. With each incremental user that is added to the network.

[00:27:53] This includes social networks like Facebook and Twitter tech companies like Amazon, Google, you know, these are all massive beneficiaries of network effects. Network effects are why Google holds 92% of the search market in 2022. Each person who uses Google search is in turn making the Google search algorithm smarter and better, which encourages more people to use it.

[00:28:15] Industries in which these network effects type businesses are common are going to trend towards a winner-takes-all environment. Hagstrom then goes on to talk about Bill Miller’s transition to understanding the new age economy as a value investor, and understanding the psychological reasons why network effects are just so powerful.

[00:28:33] For example, when someone has a positive experience with technology. They want to relive it. And the fact that human beings are very habitual, it can make it sometimes very difficult to get that person to change their behavior. So in order for the current monopoly in an industry to be disrupted, the new entrant can’t just be a little bit better. They need to be significantly better to overcome the friction, to enable people to switch products.

[00:28:57] What really makes these network effects so powerful is the high switching costs because customers really get locked into these networks and it’s really difficult for any competitor to disrupt that.

[00:29:08] This type of transition in understanding the new age economy allowed Bill Miller to greatly excel and see what other traditional value investors weren’t able to see.

[00:29:17] Miller famously purchased Amazon on his IPO Day in May of 1997, and then he actually quickly sold it after the stock had doubled. He then re-entered the position at $88 per share, while many of his value-investing colleagues mocked or chuckled Adam for owning Amazon as it then declined 90% after the tech bust.

[00:29:37] And Miller today actually holds over 40% of his net worth in Amazon stock, and that’s at the time of his conversation with William Green on the Richer, Wiser, Happier podcast. What Miller really saw on Amazon is that they had a direct-to-consumer model and recognized revenue immediately while paying suppliers later.

[00:29:56] Like any other value purchase. Miller wants to own a company with high returns on invested capital, and he actually estimated that Amazon’s return on capital was in excess of 100%. Hagstrom states that Miller is universally considered to be one of the first investors to successfully tackle the value conundrum of technology companies.

[00:30:18] Then I just love this quote from Bill Miller, Hagstrom included here. With money managers turning their portfolios north of 100% per year and a frenetic chase to find something that works. Order glacial R 11%. Turnover is rare. Finding good businesses at cheap prices, taking a big position, and then holding for years used to be sensible investing.

[00:30:40] We are delighted when people use simple-minded accounting-based metrics and then align them on a linear scale and then use that to make buy and sell decisions. It’s much easier than actually doing the work to figure out what a business is worth, and it enables us to generate better returns for our clients by doing more thorough analysis.

[00:31:02] While many value investors still use basic accounting metrics like PE Miller, with his philosophy background, was able to perform second-level thinking and think really pragmatically because of his philosophy background, Miller states that he was able to smell a bad argument from miles away. During Berkshire’s 2019 annual shareholder meeting, Warren gave much praise to Jeff Bezos for creating one of the largest companies in the world from the ground up, and he said that he was an idiot for not buying into Amazon much earlier as today.

[00:31:32] They have a relatively small position relative to their portfolio size. Charlie, on the other hand, acknowledged that his age led him to being a bit less flexible with these new-age companies. But Charlie mentioned he’s really kicking himself for not buying shares in Google. Then Warren, of course, did come around to stage three of benefiting from technology network effects as he started a substantial position in Apple in 2016.

[00:31:57] Making this sort of transition as a value investor is critical to stay ahead of the curve in order to see what others aren’t seeing and develop a superior money mind. Moving along to chapter four, Hagstrom titled this chapter, business Driven Invest. He kicks it off with what Buffett called the nine most important Words about investing, and it’s from a Benjamin Graham quote.

[00:32:20] Investment is most intelligent when it’s most businesslike, and this really drills down to how Buffett thinks of stocks as real companies in real businesses. Graham stated that investors purchase shares in a company. They can view themselves in two ways. The first being that you’re a minority shareholder in a business whose value is dependent on the profits that enterprise produces, or how the assets on the balance sheet change over time.

[00:32:45] Or you can view what you own as a piece of paper, which can be sold in a matter of minutes at a price that varies from moment to moment. And sometimes those prices are far removed from the true underlying value of the company. So when you purchase any stock, you have to decide whether you are a business owner or a stock speculator.

[00:33:02] Graham noticed that those who speculated in the market would get caught up in the day-to-day news and headlines that were fairly irrelevant to the factors that were actually important to the company’s long-term success or failure. Graham stated that quote, the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.

[00:33:28] That man would be better off if his stocks had no quotation at all for he would then be spared the mental anguish caused him by other person’s mistakes of judgment. Buffett adopted this business owner mindset from Graham as he states. As far as I’m concerned, the stock market doesn’t exist. It is only there to see if anybody is offering to do something foolish.

[00:33:50] While most people are caught up in the day-to-day activity, two of the world’s greatest investors say they pay very little to no attention to the day-to-day price movements. Hagstrom then goes on to talk about how it’s impossible to overstate this. The bedrock to forming a money mind is a purposeful detachment from the stock.

[00:34:10] Mentally, you must put on blinders so that the stock market does not absorb your attention during every waking moment. Then he covers Buffett’s 12 investment principles, which I covered during episode TIP 4 87. If you’d like to check out the primary things Buffett looks for in a business. Here’s a quick rundown on those 12 tenants or principles.

[00:34:31] One, the business must be simple and understandable. It must have a consistent operating history. It must have favorable long-term prospects. Management must be rational. Management must act candidly with shareholders. Managers must resist the institutional imperative. It must have an adequate return on equity.

[00:34:50] You need to calculate the owner’s earnings. You want a business with high-profit margins. The business must create at least $1 of market value. For each dollar retained, we must determine the value of the business. In number 12, we want to purchase at a favorable price. Again, I do a deep dive on each of these points in TIP 4 87.

[00:35:10] If you’d like to learn more about Buffett’s investment checklist from a high. Now I really liked how Hagstrom linked a research paper titled The New Theory of Firm Equilibrium, short Horizons of Investors and Firms. Now, this paper looked at investment returns over varying time horizons and looked into investment returns for the s and p 500 from 1970 through 2012.

[00:35:35] During this 43-year period, the average number of stocks in the s and p 500 that doubled in one year averaged around 1.8%, or about nine out of 500 companies over a three-year rolling period. 15.3% of stocks doubled or about 77 out of 500, and over a five-year rolling period, 29.9% of stocks doubled or about 150 out of 500.

[00:36:02] Despite the data showing that long-term investors have the greatest probability of success, the data shows that since the beginning of the 1970s, the average holding period has actually consistently declined. Hagstrom then describes that the stock market does not often efficiently price long-term sustainable growth.

[00:36:21] And that’s because there are so few companies that are able to achieve sustainable growth over a multi-year period. Perhaps the market skepticism is understandable though, but this much is certain for those companies with favorable long-term prospects that generate positive economics and drive above-average future value creation, many of their stocks are likely misprice.

[00:36:42] The key though in achieving good investment returns lies in the robustness of the individual’s ability to pick the right companies in having an effective portfolio management strategy. Hagstrom states to quote, there can be no doubt that those who follow the investment tenants outlined by Warren Buffett stand a good chance of isolating a fair number of outperforming companies.

[00:37:04] However, if you can’t effectively select stocks that have a good chance of outperforming the market over time, then it is probably best to simply own a broadly diversified portfolio like a passive index fund. Hagstrom also wrote extensively on the difference between the way Buffett views risk in the way academia views risk.

[00:37:23] Academia famously defines risk as volatility. The more volatile an investment is, the higher level of risk that is. From Buffett’s point of view, this definition of risk is ridiculous because it doesn’t even consider the company itself, the company’s assets, the company’s earnings, their competitive position in the marketplace, et cetera.

[00:37:43] Benjamin Graham made the important point that there is a difference between short term quotational loss in permanent capital loss. So a difference between the stock price trading down and you actually losing money in the long run. He believes that risk isn’t volatility of the investment, but the risk is the chance that you end up losing money in your investment.

[00:38:04] Buffett doesn’t view volatility as risk in something that should be guarded against. He actually viewed volatility as opportunity. In 1974, Buffett made the Washington Post his largest equity position with a 10.6 million in. By the end of the year, the overall market had fallen by 50%, bringing his portfolio down with it during the worst bear market.

[00:38:26] Since the Great Depression in the 1975 annual report Buffett stated that stock market fluctuations are of little importance to us, except as they may provide buying opportunities, but business performance is of major importance. On this score, we have been delighted with the progress made by practically all of the companies in which we now have significant investments.

[00:38:49] When a business is trading at a good margin of safety relative to the company’s intrinsic value, Warren welcomes lower share prices as lower prices, reduce his risk, and give him a wider margin of safety. Warren believes that the risk that is present when buying stocks or businesses is when you misjudge the prior factors that determine the future profits of your investment, or in other words, misjudging the intrinsic value in Warren’s own words, the risk present breaks down first into the certainty with which the long-term economic characteristics of the business can be evaluated.

[00:39:24] Second, the certainty with which management can be evaluated, both as its ability to realize the potential of the business and to employ its cash flows wisely. And third, the certainty with which management can be counted on to channel the rewards from the business to the shareholder rather than to themselves.

[00:39:42] And then fourth, the purchase price of the business. Furthermore, Warren tells us that risk is inexorably linked to an investor’s time horizon. If you buy a stock today with the intention of selling it tomorrow, this is a really risky transaction as it’s essentially a coin toss, whether the value of that stock is higher or lower.

[00:40:01] But if you extend that time horizon out to a few years, then your odds of making money on your purchase are much greater than if you would sell it tomorrow. Hagstrom states that the cornerstone of the money mind is understanding how to value a business and how to think about market price. To help us better understand why stock price movements oftentimes seem pretty random.

[00:40:22] He also compares the stock market to a game of chess. In chess, you’re making your own moves while the other person is making their own moves as well, and you have to try and figure out why they’re making the moves that they are. So in the stock market, you can try and speculate why a stock is moving higher or lower, except nobody truly knows exactly why.

[00:40:42] You know, stocks move the way they do in the short term. We might have a rough idea, but for the most part nobody really knows. This is because the market has millions of people constantly making buy and sell decisions all at the same time. You have all the following types of investors constantly making changes to their portfolio.

[00:41:01] You have momentum investors who exploit the tendency for stocks prior return to predict future returns. You have technical traders who trade based on the charts they’re seeing. You have asset allocation decisions, which is an investment strategy that divides and continually reallocates between asset classes.

[00:41:20] You have index investors that are just generally buying no matter what the price is. They’re just consistently month after month, putting more and more money into index funds. You have hedging strategies. You have tax loss selling or people gifting shares to other people. Then you have things like ESG, macro investors, high-frequency traders, and then just pure speculators.

[00:41:41] You have all these different players, and all of these people are making buy and sell decisions in the market. Oftentimes, these decisions have very little to do with the value proposition of the company. This is why Warren emphasizes the economics of a business rather than obsessing over the short-term price movements in the stock.

[00:42:00] The majority of people trading these shares might not even, you know, consider the underlying value. They might have their own strategy that really is nothing related to yours, and they might have a time horizon that is much shorter than yours. The final chapter in Hagstrom’s book is chapter six, titled The Money Mind Sportsman Teacher, artist, and he makes the comparison of investing in sports.

[00:42:21] In both sports and investing. Most people are focused on the end result. Did the team win or did the team lose? Did the stock go up or did the stock go down? He describes how sports psychologists divide athletes into two groups, the product-oriented and the process-oriented. The product-oriented athlete is singularly focused on winning while the process-oriented athlete sees the sports in a much broader view and finds the reward in working with others, striving for something outside of themselves, and seeking personal excellence in many other life lessons.

[00:42:55] Meanwhile, investing is also a game of process and outcomes, just like sports are, and like sports fans, many participating in the stock market don’t give much thought to the process. And as Hagstrom puts it, quote, that’s a shame because they will never grasp the beauty of the internal goods that come from the activity of thoughtful, involved investment.

[00:43:16] And as I’m reading this, I can’t help but think of my colleague William Green’s podcast episodes and interviews that dive into the deeper parts of investing, like psychology and morality. Understanding and appreciating the process is critical to being successful in sports and in investing. When you look at the greats in investing or in sports, you see the highlight reels on ESPN N or the documentary talking about Warren Buffett’s, $100 billion fortune.

[00:43:44] But you don’t see the countless hours of discipline and basic, repetitive, boring tasks that it took to get to that point. To expand on that true investing is more so in art than a science. Just like how a painting can be too complex to be fully understood with a quick glance. It’s a similar thing with a company in the game of investing isn’t all about winning to warrant as he lives a virtuous.

[00:44:09] He has pledged to give away 99% of his net worth to charitable organizations and foundations. And 2020 alone, he donated 2.9 billion in Berkshire Hathaway B Shares, Hagstrom states that if virtues are isolated to one activity, such as investing, then they aren’t genuine virtues. One Scottish philosopher stated that quote, the beauty of virtue as the real prize of the competition is that it benefits not just the victor, but also the community at large.

[00:44:39] I just love that quote that hacker mentioned and really enjoyed reading more about how Buffett lives his life, not only to make substantial sums of money but to ultimately leave the world a better place and continue to help others and teach those who are willing to listen. All right. That wraps up my biggest takeaways from Inside The Ultimate Money Mind by Robert Hagstrom.

[00:45:00] If you’d like to pick up the book yourself to read it, I’ll be sure to link that in the show notes. If you guys would like to give me any feedback, I would truly love to hear from you. Whether you like the episode or didn’t like it, I’m always open to feedback so we can provide the best show possible for you guys.

[00:45:17] You can reach me by email at clay@theinvestorspodcast.com, or on Twitter at Clay_Finck. Again, positive or negative feedback, I’m more than happy to hear what you have to say about our show. Thank you so much for tuning in to today’s episode, and I hope to see you again next week.

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