21 November 2023

Kyle Grieve chats with Robert Hagstrom about the benefits of reading fiction for improving your investing process, the best mental models Robert learned from his time working with Bill Miller, the importance of understanding complex adaptive systems for understanding the market, how to use the DCF model according to Buffett and Munger, strategies for using multiple mental models in your day-to-day life to think better, and a whole lot more!

Robert Hagstrom is the Chief Investment Officer at EquityCompass, and the Senior Portfolio Manager of the Global Leaders Portfolio. He currently serves as the Chairman of the SAM Investment Management Committee. He was formerly a portfolio manager for Legg Mason Capital Management. Robert has written 10 books. The Warren Buffett Way has sold a million copies and is published in 18 different languages.



  • Why you should look at the market through a biological model over a physics-based model.
  • Interesting data points on the advantages and disadvantages of a concentrated portfolio.
  • The Lessons from 3 of fiction’s best detectives that will make you a better investor.
  • Insights from investments in Dell Computer and Amazon.
  • The importance of network economics in a digital age.
  • Ways to improve efficiency from books that you read.
  • And much, much more!


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.

[00:00:02] Robert Hagstrom: Today, around 2003, 2004, two professors from Yale University, Martin Kremers and Petta Giusto, brought out a paper called High Active Share. High Active Share is now the academic word for focus investing. You can measure your high active share to the degree that you’re different than your underlying index.

[00:00:21] Robert Hagstrom: If you own everything in the index, your active share is zero. You’re no different than Mark. If you own 15 companies, 16 companies of different weights, you could have an active share, because of your differences in the market, of 85, 90, 95 percent active share. They then concluded, they did the research on all actively traded portfolios and found out those with high active shares, the most concentrated, were the ones that outperformed the market.

[00:00:46] Robert Hagstrom: You had low active share, which is kind of closet indexing, you couldn’t beat the market. And then they followed up this study with turnover ratios and found out within the high active share quadrant, those that had low turnover strategies actually had the single best performance. Just exactly the same portfolio that Warren Buffett does.

[00:01:04] Robert Hagstrom: So concentrated, low turnover portfolios is absolutely 100 percent academically settled, no more debate, the optimal way in which to manage portfolios to generate a return better in the market. 

[00:01:16] Kyle Grieve: In this episode, I chat with Robert Hagstrom about the benefits of reading fiction for improving your investing process, the best mental models Robert learned from his time working with Bill Miller, the importance of understanding complex adaptive systems for understanding the market. How to use the discounted cash flow model according to Buffett and Munger, strategies for using multiple mental models in your day to day life to think better, and a whole lot more.

[00:01:40] Kyle Grieve: The Warren Buffett Portfolio was one of the most influential books I read on investing. It teaches the importance of making concentrated bets, how to manage a concentrated portfolio, the pros and cons of a concentrated portfolio, why you should look outside of the markets in order to determine your performance and many more great bits of wisdom.

[00:01:57] Kyle Grieve: After reading this and the Warren Buffett way, you’ll have a very solid base of investing to build on. But if you really want to learn about the evolution of Warren Buffett, Robert wrote a great book called The Ultimate Money Mind. In this book, he goes through the people who influenced Warren Buffett throughout his life and helped shape him into the person he is today.

[00:02:15] Kyle Grieve: Warren mentioned the Money Mind in an annual meeting which sparked an interest in what it meant for Robert. Money Mind was a result of his research into learning more about what it meant and how to one day achieve it. One of Robert’s strong points is his emphasis on mental models and keeping them simple and usable.

[00:02:30] Kyle Grieve: So I asked him a few questions on his book, Investing, The Last Liberal Art. Once you listen to him speak, you’ll have a very good understanding of his in depth knowledge of mental models and how he uses them to make better decisions. If you’re interested in understanding Buffett in a deep but simple way, you’re going to get a lot out of this episode.

[00:02:47] Kyle Grieve: Now, without further delay, let’s get right into this week’s episode with Robert Hagstrom. 

[00:02:53] Intro: You’re listening to Millennial Investing by The Investor’s Podcast Network, where your hosts, Robert Leonard, Patrick Donley, and Kyle Grieve, interview successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.

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[00:03:17] Kyle Grieve: Welcome to the Millennial Investing Podcast. I’m your host, Kyle Grieve, and today we bring Robert Hagstrom onto the show. Robert, welcome to the podcast. 

[00:03:25] Robert Hagstrom: Kyle, thanks so much for the invitation. Good to be with you. 

[00:03:28] Kyle Grieve: I’ve read most of your books and listened to several of your interviews, so you could say I’m a pretty big fan of yours.

[00:03:32] Kyle Grieve: Today, I want to discuss some important topics I think the audience will enjoy learning from regarding your investing frameworks and interesting takeaways you’ve had, not only from Warren Buffett, but from many different people in many different fields of expertise. To kick it off, let’s discuss a topic that many investors don’t think of very often.

[00:03:48] Kyle Grieve: And that is a use of reading fiction for improving one’s investing. In one of your earlier books, The Detective and the Investor, you do a wonderful job of using the lessons from famous detectives to improve the investing process. Charlie Munger famously says he doesn’t read any fiction, but after reading this book of yours, I can see the value in reading great works of fiction.

[00:04:06] Kyle Grieve: What are your thoughts on reading fiction to improve your investing framework? 

[00:04:10] Robert Hagstrom: I think reading fiction is definitely a big help, because you get to immerse yourself in the experiences of other people that are going through a life, fictitious, whatever, but they’re going through life, solving problems, dealing with issues, and it kind of broadens your awareness of kind of how to think about the world in so many ways.

[00:04:27] Robert Hagstrom: The decision to write the detective book really was a testament to my dad. My dad was a big Rex Stout. Reader. He wrote the mystery books the Nero Wolf books, and I grew up reading them and always thought they were fascinating and what, at the core of reading detective stories, Kyle is a sense of puzzle solving, and let me just back up one more sentence.

[00:04:46] Robert Hagstrom: If a mystery has been done correctly, they should be able to give you enough clues throughout the book some hidden, but, they’re there if you concentrate on them. That can help you solve the puzzle. That’s fair play in detective fiction. And then, furthermore, we drill down into what we’re called the great detectives, the mental detectives, who basically solve mysteries by their mental acumen, as opposed to maybe Sam Spade, who would pistol whip a confession out of you to get the answer.

[00:05:16] Robert Hagstrom: That’s not fair play. We can’t do that in investing. But the three great detectives were Auguste de Bonne, who was obviously the very first detective written by Edgar Allan Poe, and then obviously Sherlock Holmes would be the second one, and the third one was somewhat of a surprise to me. It was a Father Brown, a cleric detective that was the brainchild of a British writer named Gilbert Keith Chesterton.

[00:05:39] Robert Hagstrom: I think personally, I would add, maybe Hercule Poirot from Agatha Christie, but he didn’t make the top three. But anyway, we focused on those three. And went through all of the short stories and I came away with the sense that yeah, there’s something here that if you thought like a detective and trying to solve a mystery, it probably would help you and thinking about analyzing stocks or thinking about markets.

[00:06:03] Kyle Grieve: And I definitely want to talk more about some of the takeaways here, but in terms of investing specifically, do you have any other genres of fiction that you would suggest to the audience members to study? 

[00:06:14] Robert Hagstrom: I’m looking at my library. Yeah, I’ve gone through Cormac McCarthy’s books. I think he was brilliant.

[00:06:19] Robert Hagstrom: He passed away this year at age 82. I liked all of his border trilogies. I thought they were really quite good. I’ve gone through Moby Dick, you always want to read the classics, so you kind of go through Moby Dick, I did a little bit of Faulkner, a little bit of Hemingway, but most of the time I’ve been spending, in philosophy and some of the sciences, so not overdosing on fiction, but turning to it every once in a while just to keep your brain fresh.

[00:06:45] Kyle Grieve: Going back to the detective and investor, my three biggest takeaways were one, always be skeptical and don’t accept conventional wisdom. Number two, remain open to contrary information and don’t be afraid to change your hypothesis when the information available tells you to do and then three, develop a firm understanding of human psychology and develop the ability to put yourself in the market’s shoes.

[00:07:05] Kyle Grieve: So after writing the book, which principles, is it one of these ones that you learned from DuPont Holmes and Father Brown, do you think had the biggest impact how you analyze businesses? 

[00:07:15] Robert Hagstrom: All of them are important, and you touched on the most important ones with DuPont, with DuPont, it really was the thoroughness of the investigation, and when Edgar Allen Poe wrote that, you really were just kind of overwhelmed at how he looked at the tiniest details in putting it together, obviously Sherlock Holmes, also tiniest details, and they also were, I think, unemotional, they didn’t really have any preconceived ideas of who was guilty, who was not, what had happened, they just let the facts lead for themselves, I guess.

[00:07:45] Robert Hagstrom: And what was great about Holmes and kind of reminds you of also John Maynard Keynes, when the facts change, you change, right? And that’s hard. That’s hard for investors because they have a, they kind of come away with a viewpoint about a stock. And if they like it. And even if there’s contrary evidence that says you may not like it as much as you think you do.

[00:08:02] Robert Hagstrom: The tendency is to resist forming a new description of that company. So a lot of people struggle with that. But if you said I had to take away one, it would be Father Brown. And it’s because. What was great about those short stories, Kyle, was how he could twist them in such a way to give you a Redescription of what happened.

[00:08:20] Robert Hagstrom: So he would lay out the mystery and you would go through the mystery and reading what happened, and you had it pretty well, and then the constable would come, or somebody would say, this is what happened. And then Father Brown would look at the same thing, and he would describe it differently. And this relates to philosophy, particularly to Wittgenstein, Linda Wittgenstein, an Austrian philosopher.

[00:08:42] Robert Hagstrom: who considered to be one of the great 20th century philosophers. He was a philosopher of language and by language it was, the words that you choose give things meaning, meaning gives you an explanation and that explanation ultimately forms the description. And so we all have these descriptions based upon explanations, based upon the words we choose to explain what’s going on.

[00:09:04] Robert Hagstrom: But if you have failed to describe what has gone on accurately, and we do that in the markets all the time, we do it with companies all the time. If you fail to accurately describe it, it’s because you had the wrong explanation in the first place. The words that you choose, or you chose, in order to form your hypothesis, your theory about what was going on, were inaccurate.

[00:09:25] Robert Hagstrom: And so one of the things that we worked on early in my career when I worked with Bill Miller at Lake Mason were how many ways we could re describe something. So he’d say, okay, you like this company, tell me what this company does, describe this company to me. And we would describe it, and he goes, now describe it differently.

[00:09:40] Robert Hagstrom: How else could you see it? Turn it upside down, twist it and change it. How many different ways can you think about describing a company? And it’s really fascinating if you really put your mind to work, you can come up with multiple descriptions of the same thing. And if you do that, then you really have to work hard trying to figure out which one is right.

[00:09:59] Robert Hagstrom: So it really takes you down a level of analysis that not many people go through, because they start with what they think is the right explanation to form the description, and they just hang on to that. But we’re always trying to look at things from different angles and trying to figure them out.

[00:10:16] Kyle Grieve: Speaking of Bill Miller, you had a really good little expose about him, about Dell Computer in the same book. He saw that business a lot differently, apparently, to other investors. The evidence in that was that he bought it at a really good price, 5 times earnings, and then he didn’t sell it when it got re rated up to a normal computer manufacturing re rating of, say, 12 times earnings.

[00:10:37] Kyle Grieve: So he saw that Gateway, a business most people would consider a Dell competitor, was trading for a steep discount to Dell. But when Bill dug a little deeper, he saw that Dell had returns on capital of 200 percent versus only 40 percent for Gateway. So the evaluation in that case was justified. So my question for you, and you just went over a really good mental model that you used to do with Bill, but what are some other mental models that Bill imparted to you or that you use with Bill that helped you dig a layer deeper than other investors are willing to do?

[00:11:08] Robert Hagstrom: That’s good, Kyle. Let’s just take a second on that description. The first thing with Dell Computer was, and you hit on it right away, which was, It was a computer manufacturer, but because it was a direct distributor, it didn’t have any retail, margins to deal with. And so by selling direct, they could sell those things at cheaper prices.

[00:11:28] Robert Hagstrom: But what wasn’t quite clear to a lot of people at the time is that Michael Bell could actually purchase on time, keyboards, monitors. The stack, the microprocessor, whatever he could, he wouldn’t have to pay for it for 90 days. He could bring those parts in, assemble the computer, and sell it to a customer that day, get their credit card information, they’d have the cash, and so he had the cash in the company before he actually had to pay the parts suppliers.

[00:11:54] Robert Hagstrom: And so that was a negative working capital, so there was very little capital in the business, but one that I think might be helpful for your listeners. was Amazon. We did the underwriting. We were participating in the IPO of Amazon and we were fascinated at how badly people were describing Amazon at the time.

[00:12:12] Robert Hagstrom: Amazon, it’s amazing, it’s been a high multiple stock since day one, almost a no multiple stock from day one, and it turned into a trillion dollar business, even with a high multiple, which would tell you right out of the box, price earnings ratios have nothing to do with valuation.

[00:12:25] Robert Hagstrom: But we’ll save that for another time. But the problem with Amazon is that they first described it as Barnes and Noble. It was just doing books, right? And so Amazon was selling books, but Barnes and Noble was trading 10 times earnings, price to book value that looked reasonable, and all these things, and they just thought that Amazon was just grossly overvalued.

[00:12:43] Robert Hagstrom: And then they started to do household products and kitchen products, and said, Oh, it’s not Barnes and Noble, it’s Walmart. And then they would look at Walmart, and they would say Walmart’s trading much cheaper than what Amazon is, and so you should basically short Amazon and go long Walmart, which was a terrible pair trade.

[00:12:58] Robert Hagstrom: You got crushed on that one. And so they were misdescribing it all the way down, but Amazon was not Wal Mart. Amazon was not Barnes and Noble. Amazon was actually Dell Computer, because basically it was growing its business off the receivables. In the book business, sometimes you didn’t have to pay for the books for six months, and sometimes you can return them for free.

[00:13:18] Robert Hagstrom: And the same thing else, you could get the product in, get it out the door, get the cash that night. And you were growing your business on the accounts receivables of your customers. And once again, Amazon, before it dropped to the bottom line, was already generating triple digit returns on invested capital.

[00:13:33] Robert Hagstrom: So when we were doing Amazon, we were looking at all the different ways to describe it. And sure enough, the people that misdescribed it had the wrong explanation. It wasn’t a retail store, it was more of a direct distributor. of consumer products that they didn’t have to pay for 60, 90 days, which allowed them to expand the business off the customers receivable.

[00:13:52] Robert Hagstrom: So that, that was a perfectly good example of how to think about descriptions and explanations and things like that with different companies. And then, so your second, Oh, what else did we learn from Bill? Probably, because Bill was, he did his PhD work at Johns Hopkins, absent his dissertation. And so he was a grad student.

[00:14:10] Robert Hagstrom: He taught at the philosophy department. Versed in it. And so in addition to Wittgenstein, we would study William James and pragmatism and stuff like that, which I think is a great poster child for investing because markets change all the time and you have to be pragmatic about how you think about it.

[00:14:25] Robert Hagstrom: But if I were to say that there was one part of the multi discipline, multi model framework that really hit home for us was the work that Bill, latched on to in the Santa Fe Institute out in New Mexico. Santa Fe Institute is a multi discipline research institute that studies complex adaptive systems.

[00:14:43] Robert Hagstrom: Complex adaptive systems are anything from like your nervous system to your molecular system to any biological system that you can think of. What’s in common. is that they have millions and millions of, interacting agents that evolve and adapt over time. And their work that was done early in the 90s with a group of scientists, one economist named Brian Arthur in particular, began to think about markets and economies from a biological perspective, not a physics perspective.

[00:15:11] Robert Hagstrom: Now, all investing and all accounting and everything else kind of grew up in the Newtonian framework. Equilibrium. The third law of Newton, for every action there’s an equal and opposite reaction, so everything was thought to be in equilibrium, and if it got out of equilibrium, it would snap back very quickly.

[00:15:27] Robert Hagstrom: So all the models used to describe markets and the economy are Newtonian in base, but these guys at Santa Fe were saying, no, that’s not the right model, it’s more of a Darwinian model. of evolving and adapting. And so then you go, okay, so if I’m going to study living systems and study adaptive systems, what are the commonalities?

[00:15:44] Robert Hagstrom: And they’re nonlinear, but nonlinearity. Newtonian systems are linear. For every action, there’s an equal and opposite reaction. That’s linear. Non linear is that you could have a very small incremental thing happen in the market and could have a huge consequence. Or you could have a huge consequence that has no impacts on markets.

[00:16:02] Robert Hagstrom: And so it began to help you think about how markets react. They don’t always react to news in a way that you would think that they would react. The other thing that we learned at Santa Fe was how to think about network economics. And we’re really in this kind of fifth stage of technological revolution that’s gone back about 250 years.

[00:16:21] Robert Hagstrom: But we’re now in what’s called the digital technological age where the product is knowledge. The product is your thoughts, information, and things. It’s totally different than the brick and mortar world. Totally different. And the technological revolution that we’re in now, with knowledge being the product, if you will, you get into what’s called increasing returns economics, which is the bigger the network, the better the network.

[00:16:44] Robert Hagstrom: The better the network, the bigger that it becomes. You get path dependence, lock in, feedbacks, and things like that. And the economics of the business can actually continue to go up the bigger the company gets. And this is totally 180 degrees different than how most people think about brick and mortar because in classic economics it’s called diminishing returns.

[00:17:03] Robert Hagstrom: You get to a point where you exhaust the marketplace where if you added one more unit of production you would get a lower return for that investment, diminishing returns. In knowledge based economies, which is what we’re in now, you get increasing returns, where actually the returns on your capital, your returns on your business actually go up more and more the bigger and bigger you get.

[00:17:24] Robert Hagstrom: And that’s counterintuitive. And you hear it all the time, Apple is a 1 trillion business, can’t get any bigger. It’s in a bubble. Then it becomes a 2 trillion business. Oh my God, it’s got to be a bubble, right? All of them now are 2 and 3 trillion businesses. And this is absurd. It’s a bubble.

[00:17:38] Robert Hagstrom: That’s their explanation. No, that’s not the right explanation because I’ve got the wrong description. The description is these are network businesses and network businesses, the bigger they get, the more profitable they become, the higher returns that they can get. And then when you overlay them in the global marketplace, we’re not talking about 360 million people here or 380 million people here in the United States.

[00:18:00] Robert Hagstrom: We’re talking about 8 billion people on the planet, of which Apple has products with 2 billion. So 25 percent of the people on the planet have an Apple product. Okay we know enough about Apple is that those 2 billion people are not going to change phones. They’re going to stay with Apple for a very long time.

[00:18:16] Robert Hagstrom: They’re going to stay in that iOS ecosystem. It’s where they’re comfortable to operate, where they feel good about it. And so it’s very possible, very likely that the Googles and the Amazons and the Microsofts and Apple and the rest of them will continue to grow and be bigger businesses and also have bigger economic returns.

[00:18:34] Robert Hagstrom: It’s amazing to me that Apple today has a 140 percent return on equity. We’re talking about 15 percent return on equity as the norm for the market. And here you have a company that’s, earning 140 percent return on equity. You ought to pay attention to that. That’s, that should be something you should think about.

[00:18:49] Robert Hagstrom: The Santa Fe Institute was a huge home run for us, intellectually speaking, to begin to think about the new franchises. As Buffett says, the next fortunes will be made in the new franchises. The new franchises are network economics. And when you begin to understand the moats that surround network economics, There’s your franchise and there’s your excess return.

[00:19:09] Robert Hagstrom: So that, that was a big deal for us. 

[00:19:12] Kyle Grieve: So John Burr Williams, who you outlined very well in investing the last liberal art, came up with the conclusion that an asset is worth the future cash flows that it produces discounted to present value. But he wrote this in 1938. And in modern times, interest rates are super volatile as, but they’ve been volatile for forever, but they’re out of our control.

[00:19:31] Kyle Grieve: And obviously widely different interest rates can drastically change the intrinsic value of these cash flows. So do you still think that this formula is as useful today as when he wrote it back in 1938? 

[00:19:43] Robert Hagstrom: Oh, No, it is. It’s definitely the right formula. Without a doubt, the discounted present value of the future cash flow streams determines value.

[00:19:50] Robert Hagstrom: And I would even gloss it one more way, is that all the value of an investment is what’s going to happen in the future, not the past. So we have to look forward. But what you hit your finger on, and I think it’s worth a discussion, is what do we discount those things at, right? What do we discount the cash flows?

[00:20:05] Robert Hagstrom: And so when you think about that, it was modern portfolio theory, which is a subject into itself, how that evolved from the 1950s and then actually gain traction. And then after the 1973 74 stock market crash, you might recall that they began to think about discounting cash flows as a combination of the risk free rate plus some equity risk premium.

[00:20:25] Robert Hagstrom: The equity risk premium being determined by the volatility of the underlying stock or the market. So you have these two inputs. And Warren Buffett, who I obviously overdosed at a young age, spent a lot of time he’s the antithesis of modern portfolio theory. He just doesn’t believe that price volatility equals risk, which is the cornerstone of modern portfolio theory and the way Camping down risk is to run broadly diversified portfolios, which is exactly the wrong way if you want to generate returns better in the market.

[00:20:55] Robert Hagstrom: So modern portfolio theory teaches you how to be average and by the time you’ve reduced it by your expenses, trading costs, whatever the case may be, it’s why most modern portfolio theories can’t beat the market. But Charlie Munger, along with Buffett, began to talk about what do they discount those cash flows, the John Burr Williams cash flows.

[00:21:12] Robert Hagstrom: It was 1992 that Warren introduced John Burr Williams to the Berkshire shareholders and said, It’s not high P.E., low P.E., it’s not high price to book, low price, it’s not any of that stuff. It’s the cash that comes out of it. It works for the bond market, it works for the stock market, it works for businesses.

[00:21:27] Robert Hagstrom: That’s how everything is valued. But then the whole idea about discounting got to be puzzling because Warren said that he would discount by the risk free rate, which would be the 10 year treasury. And when I wrote the book in the 1990s, we were looking at 10 year yields at 8%, 7%, 9%. So that was pretty high.

[00:21:45] Robert Hagstrom: He didn’t add an equity risk premium. He would just adjust the purchase price for the riskiness of the underlying business, the predictability of the underlying business. But then Charlie came up with something interesting. He says, we discount by our opportunity costs. And I thought about that. I said, okay, let’s go through that.

[00:22:01] Robert Hagstrom: And he says, if you were to lend money to the stock market, you’re going to lend your capital to the stock market. Your expectation is to get at least a 10 percent rate of return. That’s been the average return for stocks for pretty much a century. So if I’m going to give money to the stock market, I expect to get at least 10 percent back or more.

[00:22:18] Robert Hagstrom: Certainly not less. I’m lending you money. The average return for stocks are 10%. I expect, that’s my opportunity cost. So when we began to think about that, we began to think probably the right idea is to discount your cost of capital by your opportunity cost. You’re lending money with an expectation of 10%, so let’s discount it 10%.

[00:22:37] Robert Hagstrom: Let’s not worry about the risk free rate. Let’s not worry about the equity risk premium. Just the historical rate of return of stocks being 10%, that would be my opportunity cost to lend you money. I’ll discount the cash flows at 10. If we do better than that, great, but we better not do worse than that. So that’s kind of how we get to it.

[00:22:55] Kyle Grieve: In investing the last liberal art, you said, quote, to build good mental models, we need a general awareness of the fundamentals of various disciplines, plus the ability to think metaphorically. So one problem I’ve been trying to solve is making thinking in multiple mental models into a habit. You probably already think this way, but for myself and other investors in the audience, what are the best ways to apply these various mental models into our thinking on a daily basis?

[00:23:19] Robert Hagstrom: You’re right. It does. When I wrote Investing in the Last Liberal Article around 2000, and it takes a while to incorporate it, but the best way that you can do it is I’m looking at my library. I have a, can’t see it here on the camera, but across the room there, I have a library shelf full of books about physics.

[00:23:36] Robert Hagstrom: I have a library shelf about biology. I’ve got sociology over there, psychology, philosophy, mathematics, art. We didn’t talk about art in the book, but we’ll maybe do that one day. History and all that. What I will do every once in a while as I’m heading out the door, I’ll just try to grab a book from a different shelf and just try to keep myself fresh.

[00:23:57] Robert Hagstrom: and the discipline just to kind of keep myself aware. I’m already, I’m not saying that physics is where I’m going in life, because I think it’s more of a biological system than a physics system, but you just begin to allocate your time and your reading to things other than just finance and accounting.

[00:24:14] Robert Hagstrom: You just, I mean, you’ve got to keep up with the news. It’s information. You’ve got to get the facts of the moment. But your allocation of time should be spent studying other things as well. Sociology is big, how to think about markets and the whole idea about diversity breakdown in markets.

[00:24:30] Robert Hagstrom: You can see how that works when attitudes become one way or the other, the wisdom of the crowds type approach that we think about. We think about that as in markets, but you just have to develop a habit. There was a professor, Dr. Beeman at the University of Pennsylvania. who was talking about Benjamin Franklin, who obviously started the University of Pennsylvania and considered to be one of the great liberal arts thinkers.

[00:24:52] Robert Hagstrom: And he called Benjamin Franklin, he had a marvelous habit of mind, habits of mind. And habits of mind are basically to be widely read not singularly read just on one topic. So I think you just have to discipline yourself to always grab a book outside of investing, outside of finance, outside of economics.

[00:25:11] Robert Hagstrom: And just noodle through it and see if there’s anything that helps the lightbulb go off. And I think we did something in the investment of Last Level Art, which was when you read something, you don’t have to read it slowly. You can skim it fast to see if there are any important parts that would be worthwhile for you to spend more time with.

[00:25:27] Robert Hagstrom: So it’s called intelligent skimming. When I go through a book, I’ll try to go through it pretty quickly. And, go through the indexes and footnotes to see if I see anything new and different. And I’ll read the first chapter, sometimes the last chapter, to see if anything sparks. Because your time is valuable, and you don’t want to let a book take up more time than it deserves.

[00:25:45] Robert Hagstrom: If it deserves your time, great. If it doesn’t deserve your time, then you need to move on. But you won’t know that until you get through it pretty quickly. So the first pass through is not like reading, a holy scripture. You’re just trying to get through here. What are the high points here that I want to think about?

[00:26:00] Robert Hagstrom: So you can motor through more books if you do intelligent skimming. Then if it’s good, then you go back and you slow down and you underwrite, highlight and you make notes. But that’s kind of how I attack reading. 

[00:26:12] Kyle Grieve: With markets tanking in the month of September, going over some of Buffett’s major tenets during this volatility is very prescient.

[00:26:19] Kyle Grieve: I think Buffett would agree that volatility is a feature of the market and not a bug. What actions do you think Buffett and other Buffett disciples would be doing during these turbulent times to best take advantage of the volatility we’re seeing in today’s markets? 

[00:26:33] Robert Hagstrom: The one thing that I would say with Warren is that volatility is his friend.

[00:26:36] Robert Hagstrom: Now, he has a longer horizon than we do, and he’s not measured quarter to quarter and month to month, and maybe not even year to year, like mutual fund managers are professional managers that are, I think, unrealistically held to shorter term performance benchmark. But for him, volatility is his friend.

[00:26:51] Robert Hagstrom: I think he, had a quote that I’ve always liked. He said widespread fear is your friend. If the market is gripped with fear and panic, that’s your friend because you’re going to get some great prices. He said personal fear is your enemy because once it becomes a personal fear, then you begin to do stupid things, right?

[00:27:08] Robert Hagstrom: And we see it now. We see it with our advisors that with the headlines and the headlines are very tragic around the world. With what’s going on in Ukraine and what’s going on in the Middle East and in Israel. And then we got headlines with politics coming up and shutting down the government. We got headlines with inflation, we got all these headlines, right?

[00:27:26] Robert Hagstrom: And to the degree that you let them start to rule you and that fear, and it becomes a personal fear, then you’re cooked. You’re just not going to be able to take advantage of it. So widespread fear that then is reflected in stock price volatility. Actually is the friend of the long-term investment because it allows them to pick up more shares at cheaper prices that allows you then to compound a larger number for your portfolio that will increase your rate of return over time.

[00:27:53] Robert Hagstrom: Nobody likes volatility, but price volatility is not risk. Short term quotational loss. It’s not capital loss. There’s a big difference. Short term quotational loss is just the market doing its funny stuff. Permanent capital loss is serious, and that’s what we try to avoid by owning good companies, good balance sheets, low debt, predictable.

[00:28:12] Robert Hagstrom: We’re not concerned about permanent capital loss in our portfolios. We don’t view short term quota as a measure of risk. It’s an opportunity if we can put it to work. 

[00:28:23] Kyle Grieve: Another awesome topic in investing. The last liberal art you discussed was the returns that Warren Buffett and his friend Bill Ruane had during the sideways markets of 1975 to 1982.

[00:28:33] Kyle Grieve: So in these sideways markets, the price of the Dow Jones Industrial average started and ended at 7 84. Yet Buffett and Ruane made cumulative returns of 676% and 415% respectively. And their trick? Extending holding periods. Can you go over the data that you found and the primary lessons that you learned from this research?

[00:28:54] Robert Hagstrom: What a great question. I’m glad you brought that up because I actually we did that research report at the earlier part of the year because I think some people are coming to a viewpoint that maybe we’re in another sideways market. If you think about it for 2 years, we’ve kind of gone sideways. So I was working with Bill back then.

[00:29:08] Robert Hagstrom: It was after the financial crisis. People were saying we’re probably in for a sideways market now. Sideways markets happen all the time, but we have a tendency to think about markets and bulls and bears and don’t realize sometimes they just kind of go sideways for a while and they’re really quite common now, the uncommon ones, as you pointed out, Kyle, thoughtfully is, the 75 to two, and that was a period not, certainly not identical to now.

[00:29:32] Robert Hagstrom: But it was a period of high inflation, high interest rates, geopolitical risks, and as you rightly pointed out, the Dow didn’t move for much of that period. So the total return for the Dow was the dividend returns. Basically, the average return for the Dow was about 4 percent annual, which was the current dividend yield of the Dow.

[00:29:50] Robert Hagstrom: So on a price basis, nothing, and you just got the dividends. S&P did a little better. It was almost an 8 percent average annual return, which was pretty good. Once again, half of that was dividend yields. So we went back and looked, and I, as I said, overdosing on Buffett and stuff like that. I knew Buffett killed it.

[00:30:06] Robert Hagstrom: And we basically did the research to look at the S&P 500 back then and break it apart and discovered that, yes, over, one year period, stocks didn’t do well, but if you extended the time horizon, you basically began to see that there were some stocks that actually were doing pretty well, and there were some stocks that were doing not so well, but in fact that there were stocks going up multiples.

[00:30:30] Robert Hagstrom: Made you think what was going on. So then we parsed the data even further down by sectors and found out that oil was a big performer and that was not difficult to discern because we had the oil embargo in 73. When they had the Middle East War and everybody turned off the oil, they didn’t sell oil to the U.S.

[00:30:47] Robert Hagstrom: S., so oil prices went up, gasoline went up, inflation went up, interest rates went up, and that was a very hard period. Industrials did pretty well, but later down the road was consumer cyclicals, and within the consumer cyclicals, there was Buffett, and there was Sequoia. They own newspapers, magazines, and television stations, right?

[00:31:05] Robert Hagstrom: They weren’t capital-intensive businesses, so they weren’t required to reinvest capital at high rates, high interest rates, because once you put up a TV tower, you put in a printing press, or whatever the case may be, there’s not much capital expenditure after that, so it was just a cash flow business. And they were able to price because before the internet, the only way that you got information or you could get advertising out was either through TV, newspapers, and magazines.

[00:31:30] Robert Hagstrom: And so if you looked at their portfolios, that’s exactly what they own. They also own an advertising business. It’s the same thing. So I went, all right, consumer secularists. And then the second smallest sector in the market was technology. Technology wasn’t a big part of the market in the 1970s, but almost every single stock in the technology sector doubled over five years.

[00:31:51] Robert Hagstrom: So it lends you to think about the difference between trends of the system and the trends in the system, and that’s something important to think about markets, which is the market’s going sideways. That’s the trend of the system. The system’s going sideways, but their trends in the system, whether something’s going up a whole heck of a lot and some things going down a whole heck of a lot, and they basically equalize out and you get this flat line in the market.

[00:32:16] Robert Hagstrom: But recognizing there’s a difference between the trends of the system and the trends in the system, no matter what the market is doing, there’s something going on in the market, you just got to go tease it out. And that became very important for us to think about. And so what we then began to think about is that in sideways markets, there are two pots of money, or two parts of the investment pie that are going to be very important, which is high yield.

[00:32:39] Robert Hagstrom: Anything that’s going to have high income, the price is going sideways. High, gonna do pretty good. High dividend-paying stock. I think the yield on the & P, you can correct me, Kyle, but I think the yield is maybe 0.8%, 1.6%. So if you’re in a sideways market for the &, you’re not gonna get 4%, you’re gonna get 0.6, which is gonna be less estate.

[00:32:59] Robert Hagstrom: So you have to think about, are there dividend-paying stock? It can get me three, four, 5%. That might be interesting. Now, they’ve gotten bruised up a little bit with this last bump in interest rates, but that’s probably coming to an end. So high yielding stocks, high dividend-paying stocks make a lot of sense and then growth companies that can actually grow through this that aren’t capital intensive, that have pricing power that can move that are in high demand around the world.

[00:33:26] Robert Hagstrom: Growth in a sideways market is very valuable. So it’s almost a barbell approach where part of the portfolio might be classic value, high dividend-paying stocks. The other part of the portfolio may be your secularly advantaged growth companies. Like I was talking about network economics and things on the internet, software businesses, this AI thing is the real deal.

[00:33:46] Robert Hagstrom: How does that impact sales and earnings? Things that can grow secularly, advantaged with high returns on invested capital are going to do well, and at the opposite end of the barbell, the high dividend-paying stocks, and not knowing how long this would be a sideways market, it could change, who the heck knows, but if you said to me, we’re going to be pretty much at the same place next year as we were this year, then that’s the kind of portfolio that I would want to run.

[00:34:10] Kyle Grieve: So one of the biggest takeaways that I had from the Warren Buffett portfolio was your excellent research on concentrated portfolios. The research from Compustat that you did in that book looked at 1, 200 companies between 1979 and 1986. The conclusion was that holding fewer stocks increased the probability of generating market-beating returns.

[00:34:29] Kyle Grieve: Could you discuss some of the details you took from this study? 

[00:34:32] Robert Hagstrom: That was Warren once again. So I had written the Warren Buffett way in 93, 94, and it done quite well as a testament to Warren. It was one of the first books to come out that actually went through the methodology and I remember in writing it, that was 30 years ago.

[00:34:45] Robert Hagstrom: Can you believe that Kyle? 30 years coming up 2004, it came out, 94. Basically, I was so challenged, I guess, and anxious about making sure I had the right methodology, what we call the investment tenants. that Warren Buffett used to select stocks. I didn’t spend any time on portfolio management. I think the entire portfolio management explanation in the book was he owns a few stocks and he holds them forever.

[00:35:09] Robert Hagstrom: That was it. I just, I spent all my time analyzing Washington Post, Cap Cities, American Express, Coca Cola, Geico, all that stuff, because I was just, I was going to get that part right. After the book came out, I was watching one of the financial news, programs, and there was a portfolio manager on there, and then said Yeah, I just like to buy, businesses that I understand that have got a good long-term outlook.

[00:35:31] Robert Hagstrom: I went, yeah, that’s Buffett. And he goes, I like cash earnings and, good returns on equity. I went, yeah, that’s Warren Buffett. And we like management who’s rational and how they think about allocating capital and that are honest and straightforward. I went, guy’s on board. This is what I want to hear.

[00:35:45] Robert Hagstrom: And he goes, yeah, and we always find for less than they’re worth. And I went, Oh, touchdown. The Warren Buffett way. And then I’d look up the portfolio and you’d have a hundred stocks and a hundred percent turnover ratio. And I’d think, wait a minute, you got the first part right, which is, not a thing about stock selection, but you totally whiffed on the portfolio management.

[00:36:03] Robert Hagstrom: So that led me to understand and appreciate that I’d left out half, which is stock selection, and the other half is portfolio management. And I left it out. So I had an opportunity to call Warren, and, this was years ago when he wasn’t one-tenth as busy as he is today, right? And I said, I’m thinking about doing a portfolio management book because I left that out.

[00:36:22] Robert Hagstrom: And he said we were focus investors. We just focus on a few stocks. And so focus investing was the subtitle of the book. It was, the Warren Buffett portfolio, mastering the focus investment strategies, something like that. And we did. So basically all we did, and it was very simplistic, very elementary when I go back and look at it.

[00:36:39] Robert Hagstrom: We just took these 12, we needed to get basically 3, 000 portfolios. Once you get to 3, 000 portfolios, it’s statistically significant, the conclusion you draw from. And there weren’t 3, 000 focus portfolios out there at the time. We basically took 3, 000 portfolios and then we did them with, I think, 15 stocks, 50 stocks, 100 stocks, and 250 stocks.

[00:36:59] Robert Hagstrom: And then we just ran them through the computer. both for 10 years and 15 years. And to the T, what you found is, to the degree that you own more stocks, your returns were very much at the market rate of return. And to the degree that you own less stocks, you had a higher percentage number of your portfolios beating the market, but you also had a higher percentage number of the portfolios underperforming the market.

[00:37:20] Robert Hagstrom: And so there was the dilemma, right? And as Warren has said famously, so if you’re a know nothing investor, you can’t do stock analysis. You don’t have the temperament to think about markets in a rational way. Then you should own a bunch of stocks like the S&P 500 and you will get a good 10 percent rate of return over time.

[00:37:36] Robert Hagstrom: Nothing wrong with that. That actually beats about 90 percent of the active managers out there. He said, but if you’re a know something investor that can do analysis that has the temperament, you don’t need that many stocks. And 10, 15, 20, 25 stocks, it’s more than enough. So we looked at Buffett’s performance in the partnership and it was phenomenal.

[00:37:53] Robert Hagstrom: We looked at Charlie Munger’s performance in the partnership. It was phenomenal. We looked at Sequoia Fund. We looked at Lou Simpson, who managed money at Geico. We even looked at John Maynard Keynes, who ran the chess fund for Cambridge for so many years. All concentrated low turnover portfolios, with the exception of Buffett, who never had a bad year in the 13 years that he managed the Buffett partnership.

[00:38:12] Robert Hagstrom: Every one of those guys only outperformed the market about half the time. On a manual basis, but their returns were through the roof, right? And so what happens in concentrated low turnover portfolios, if you’ve got the right company, you’re going to compound money over time, but the market is gravitating around you all the time.

[00:38:30] Robert Hagstrom: Sometimes it likes oil, then it likes pharmaceuticals, now it likes small cap, now it likes international, now it likes technology. So it’s going through all its ebbs and flows. And sometimes the light shines on you and sometimes it doesn’t, and when it doesn’t, you underperform, and when it does, you can make them make a lot of money.

[00:38:46] Robert Hagstrom: And so each of them had great long-term track records, but the frequency in which they beat the market was about batting average 50%. And so then we were led back to a mathematical constant, which is returns in markets are not how many times you beat the market, less how many times you don’t beat the market.

[00:39:02] Robert Hagstrom: It’s how much money you make when you beat the market, less how much money you give back when you don’t. And what we saw with these guys. and others is that when they beat the market, they just killed it. They were off multiples. And when they gave back, they didn’t give back so much.

[00:39:15] Robert Hagstrom: Why? Because they were doing valuation work. They weren’t overpaying for growth stocks, or they weren’t overpaying for stocks. And so when they, when the market moved against them, their downside was not anywhere near as horrible. We then began to understand, okay, this makes a whole lot of sense. Now, let’s fast forward today around 2003, 2004.

[00:39:35] Robert Hagstrom: Two professors from Yale University, Martin Kremers and Petta Giusto, brought out a paper called High Active Share. High Active Share is now the academic word for focus investing. You can measure your high active share to the degree that you’re different than your underlying index. If you own everything in the index, your active share is zero.

[00:39:54] Robert Hagstrom: You’re no different than Mark. If you own 15 companies, 16 companies of different weights, you can have an active share because of your differences in the market of 85, 90, 95 percent active share. They then concluded, they did the research on all actively traded portfolios and found out those with high active shares, the most concentrated, were the ones that outperformed the market.

[00:40:15] Robert Hagstrom: You had low active share, which is kind of closet indexing, you couldn’t beat the market. And then they followed up this study with turnover ratios and found out within the high active share quadrant, those that had low turnover strategies actually had the single best performance. Just exactly the same portfolio that Warren Buffett does.

[00:40:34] Robert Hagstrom: So concentrated low turnover portfolios is absolutely 100 percent academically settled, no more debate, the optimal way in which to manage portfolios to generate a return better in the market. But there’s a problem, because people want to have performance every month, every quarter, every year. They don’t like it when they underperform.

[00:40:51] Robert Hagstrom: And high active share focused low turnover portfolios will underperform from time to time. to make sure you have the right fit between the client, the investor, and a high active share portfolio. Because… I have learned over my 30 years, I’ve never met anybody who disagreed with the methodology that Warren Buffett does.

[00:41:09] Robert Hagstrom: I said, look, this is what Warren’s doing. Do you want to do it? Everyone says yes. And about three months later, two out of three can’t do it anymore. They just fall out. They, being out of sync with the market or not owning what’s going up in the market in the short run. They know it, but they can’t walk the path.

[00:41:24] Robert Hagstrom: It’s a difference between knowing the path and walking the path. They know the path, but walking the path as a focused low turnover portfolio requires a temperament. And Warren would say, it’s a business person’s temperament. You’re not buying a stock, you’re buying a business. And if you frame it as a business.

[00:41:39] Robert Hagstrom: It’s less frightening when you underperform the market because you actually understand your business and you understand the revenues and the earnings of the products. And so when you’re underperforming, you’re like so what? This is a great business. It’ll outperform later, but you have to get the right, you got to get the right mix of people to make it work.

[00:41:55] Kyle Grieve: So in Money Mind, you wrote a great passage, quote, “All these separate components, your view of the market, your methods, and your temperament as an investor reflect the totality of your philosophy of investing. When all three are working in harmony, we might even say we’re looking at a person who displays a Money Mind”.

[00:42:11] Kyle Grieve: For readers who have not read this book, what parts of each of these components should they try and develop skills to one day acquire a Money Mind? 

[00:42:19] Robert Hagstrom: The way in which we kind of approach Money Mind, which is not a method book, the Warren Buffett way and the Warren Buffett portfolio are methods. These are the methods, the steps that you take in order to select stocks optimally, in order to manage portfolios optimally.

[00:42:34] Robert Hagstrom: And I spent the lion’s share of my career. Focusing on methods. If a client was struggling, I’d just sharpen my pencil and try to figure out what I just keep working on the valuation to try to convince them that they have a good investment. So I was always focused on methods, but learned that methods alone is not going to get it done.

[00:42:52] Robert Hagstrom: And that’s where the Money Mind came in that Warren introduced in 2017, which is a term that he used about how to rationally allocate capital, a reflection of their temperament. And when you rationally allocate capital, You think about putting capital work at lower prices, not higher prices. The lower markets are your friends, right?

[00:43:09] Robert Hagstrom: And so how do you just think about allocating capital and how you think about changes in stock prices is a function of temperament. The Money Mind is a temperament model and it works in such a way, Kyle, that you almost have to turn the stock market off. You almost have to disengage with the stock market and treat it as a sideshow versus the centrality of how you think the world is to always look at the screen with red and green on it and what did it do today.

[00:43:37] Robert Hagstrom: It’s interesting, I’ll throw this out at you, Kyle, and you can push back on me. Warren Buffett’s clearly probably the most famous celebrity in the stock market today. Warren Buffett weighs in 18 foreign languages. Everybody knows Warren Buffett. And if you would say to him, you’re a celebrity of the stock market, he would go, it’s kind of a shame because I really don’t agree with the way most people invest in the stock market.

[00:43:57] Robert Hagstrom: It’s just because, stock prices, or companies have a public stock price, it makes people act in perverse ways, which is, let’s just say Apple was a private company, or Google or Amazon was a private company, and once every three months, you could go to the board and you could buy or sell stocks, like shares in those companies.

[00:44:16] Robert Hagstrom: But the rest of the time, there’s no stock price. So what are you going to do? You probably look at the, the quarterly reports, you think about trade magazine, you think about how the business is doing, you go through what a business owner goes through every single day that doesn’t have a stock price.

[00:44:30] Robert Hagstrom: Now, the question then becomes, if that’s the way a business person operates owning a private company, why is that not considered the proper way to think about investing in a common stock when it has a daily price? Or put it differently, just because a common stock has a daily price, why do you act so bizarre?

[00:44:50] Robert Hagstrom: perverse. You’re trading too often. You’re trying to make bets on the economy that you can’t predict. Another thing about the Santa Fe Institute and complex adaptive system. There is no science that can predict the complex adaptive system. It’s not been invented yet. So all these market strategists, all these economists that are constantly telling you what’s going to happen in the economy market, they have no idea because there is no science that can tell them what is going to happen.

[00:45:13] Robert Hagstrom: At best, it’s a hunch, right? At best, they’re weighting probabilities, but if anybody had the model to predict economies in the markets, they’d have all the gold, but they don’t. The question then goes back to, just because there’s daily stock prices, why do we behave so poorly, so badly, in such ways that are adverse to our long-term best interest?

[00:45:34] Robert Hagstrom: And there’s, to me, a puzzle. If you can answer that, and solve that for mankind, people would do a lot better in investing, I can guarantee you. 

[00:45:43] Kyle Grieve: I completely agree. One of the things that I’ve worked on myself for my own investing was just creating a environment where I’m trying to make fewer mistakes.

[00:45:52] Kyle Grieve: Like I know a lot of people check their portfolios, 50 times a day. I used to do that and you just put all this stress on yourself. And so I was just like, you know what, I’m not going to do that. Deleted all my apps. And I just basically refused to kind of bite into that, the dogma that most people follow.

[00:46:07] Kyle Grieve: And that helped me a lot.

[00:46:09] Robert Hagstrom: I think that’s brilliant. I think that’s what people should do. Until at which point you can look at it with detachment. You can look at it just as… It’s almost like a cartoon, it’s oh, I see what he’s doing. It’s acting silly. It’s the roadrunner’s going off the cliff, it’s okay, you can look at it, but you’re not absorbed by it.

[00:46:25] Robert Hagstrom: It’s not ruling you. You’re just observing it, right? To the point when markets are ruling you and forcing you to do things that you otherwise would not do if there were changes in prices. That’s where you run into problems. But people said to me, what’s the best advice? I just say, turn it off, turn off CNBC, turn off Bloomberg, turn off everything and turn it on the weekend.

[00:46:44] Robert Hagstrom: In the old days, before there was Internet, we just get the Barons on Saturday. We look at prices once a week, kind of check the portfolio and check the mutual funds, but now you’re right. People do it. When I leave this afternoon, I’ll stop by, I’ll see people on their phones checking their portfolios.

[00:46:59] Robert Hagstrom: I’m going, you’re no richer today or tomorrow than you’re going to be next week. Relax. It’s going to be fine. You’ve got the right attitude. 

[00:47:06] Kyle Grieve: I really enjoyed how you linked Ralph Waldo Emerson’s teaching on self reliance to how Warren Buffett thinks. You outlined three major themes from Emerson’s essays that Warren has lived by to this day.

[00:47:18] Kyle Grieve: Quote, First is solitude and community. Emerson warns us that community is a distraction to self growth. He believes more time should be spent in quiet reflection. Second is the sense of non conformity. Emerson said, quote, Whoso would be a man must be a non conformist. He argues that an individual must do what is right no matter what others think.

[00:47:38] Kyle Grieve: Lastly, the theme of spirituality is especially important. Emerson tells us truth is within oneself and warns that relying on institutional thought hinders an individual’s ability to mentally grow. Now, can you outline how Warren has utilized these three themes in his investing career and give some examples of how investors can use it to improve their thinking?

[00:47:59] Robert Hagstrom: We said in the book that he learned the philosophy of Emerson from his dad, Howard Coleman Buffett, who was a great man and most important man in Warren’s life. And he was a politician, but he was very much into, he was a libertarian, kind of get at the root of it. He was friends with Murray Rothbard, who was a big libertarian.

[00:48:18] Robert Hagstrom: And libertarian is always about the celebration of the self over the state, where the state is not thought to be able to make the most optimal decisions that the self can’t, that the individual can’t. And so Emerson was trying to point out, to the degree that you sit in quiet reflection and solitude and think and read yourself, as opposed to being in the mosh pit that is the stock market listening to, hundreds of people have opinions and stuff like that, it’s more likely that you’re going to be more successful to the degree that your reflection is in solitude and reading and things like that.

[00:48:52] Robert Hagstrom: So think about Buffett. All Buffett does is read. That’s all he does. Occasionally gets on the phone. Some say he has CNBC, but I’ve heard from credible sources he keeps the volume off, he only leaves it on in the corner for chance of something interesting about a company he owns or might want to flash this across the screen.

[00:49:11] Robert Hagstrom: He doesn’t talk to other people about the market. One, they don’t know what they’re talking about. And two, it’s I’m making the decisions. They’re not making the decisions. I’m making the decisions. I’m not going to turn my money over to them. So what do I care what they have to say? So it’s this whole idea about the self and to the degree that you Invest in yourself by reading, reflection, and educating yourself.

[00:49:32] Robert Hagstrom: You strengthen your ability, you strengthen your resolve to act appropriately, optimally, at those times, independent of what’s going on in the community, what’s going on in the market. And that’s what you have to do. And to be a non conformist, I’ll preface it with this, one of my favorite Buffett days, polling does not replace thinking.

[00:49:52] Robert Hagstrom: Now, I like contrarianism, but there’s some things that go down that are supposed to go down, and there’s some things that are going up that should continue to go up. So contrarianism in of itself is not the right way to think about it. But… You do want to take a different tack. If you’re always walking lockstep with the market, it’s going to be hard to beat it.

[00:50:09] Robert Hagstrom: So you want to find pockets of inefficiencies in the market where the market isn’t right. So you’re not in conform with the market. You’re acting in juxtaposition to the market’s thoughts and wishes. And there goes back to self reliance or the mirror image of self reliance and self confidence.

[00:50:26] Robert Hagstrom: That self reliance, self confidence is what allows you to make bets independent of what’s going on in the market without needing the market to affirm you being right or wrong at any point in time. You’re doing it yourself. It’s in you. And that’s a very big deal. There was a study Michael Mogelson did one time.

[00:50:43] Robert Hagstrom: I don’t know if Michael, but great writer and author and professor at NYU, and he looked at some of the most famous investors in the world, and they typically lived outside the New York City, Omaha, Memphis, different places around the world where they were not near any of the, the chatter.

[00:50:59] Robert Hagstrom: They were not in the chatterboxes. And I know a lot of guys outside of New York, and they just seem to be so happy and so relaxed and just so at peace. And that’s Omaha for Warren. It is, kind of a quiet sanctuary away from Wall Street that protects him from being, influenced by the community, by the bigger whole.

[00:51:18] Robert Hagstrom: And that education gives you that self confidence, self reliance to make bets that are not in conformity with the market, but are probably the source of your excess return because the market’s mispriced. 

[00:51:29] Kyle Grieve: So you outline a few key attributes of the Money Mind that Warren learned from his great friend and partner, Charlie Munger.

[00:51:35] Kyle Grieve: The first was that a Money Mind seeks to build worldly wisdom. Second, the Money Mind actively studies the failures of others. Third, the Money Mind is a rational mind. And fourth, the Money Mind is pragmatic in the sense that it appreciates knowledge but always knows that there is much to learn. Now, I want to focus on the second attribute here.

[00:51:53] Kyle Grieve: What are some of the best people, businesses, events, or research that investors should study in order to avoid making the most common failures of the past? 

[00:52:02] Robert Hagstrom: Let’s put it this way. There’s just but a handful, less than on one hand, of analysts. I don’t follow market strategies or people predicting markets, but people that I actually think understand businesses.

[00:52:14] Robert Hagstrom: On Wall Street that I favor, that I think are quite good, but I’m very discriminating and they have to earn my trust and, they’ve gotta achieve certain things for me to understand that I, yeah, I think they understand how to value businesses. So set aside those select few I found, the stuff that I enjoy reading would be like trade magazines, things about industry.

[00:52:33] Robert Hagstrom: So if you’re in, you’re in the computer business or you’re in software something, the trade magazines and things like that, what’s going on in the business? It’s not what’s going on in the markets. Not what’s going on in the economies, what’s going on in the business landscape. If I own we own a business called Diageo, which is a world large spirits maker.

[00:52:50] Robert Hagstrom: I read a lot about that. We own fashion goods businesses. We own Louis Vuitton and Richemont. I love reading about fashion and fashion goods. That’s one of the hierarchy of needs that people, as they get discretionary income, the first thing they want is better taste in food. Second is they want better taste in liquor.

[00:53:06] Robert Hagstrom: Third is they want household products and beauty care products. And then fourth is fashion. They want better dress. So we know that there. Get there. And so I just like to understand what’s going on in the fashion world, what’s going on in the spirits world. We spend a lot of time in tech. We spend a lot of time in software.

[00:53:20] Robert Hagstrom: We’re spending a huge amount of time in ai, which we don’t believe is a bubble. It’ll be interesting to see how this morphs over time, but it seems to be the real deal to the degree though that I’m reading, that I’m not reading the stock market. I’m not reading an analyst who’s saying, I think the stock price is this, or who knows, right?

[00:53:37] Robert Hagstrom: I want to be the best business person I can be. If I can be the best business person in my portfolio, then I probably will be the best stock picker as a result of it. Or as Warren says, we’re business pickers, not stock pickers. If you start as a stock picker without understanding the business you’re in trouble.

[00:53:53] Robert Hagstrom: If you start with a business person’s perspective first, And the company that you own, then thinking about the stock price later becomes much easier. So trade magazines, anything other than the stock market is what you ought to be spending your time on. And books! I mean, there’s a lot, there’s great books all the time, right?

[00:54:11] Robert Hagstrom: I’m not trying to promote this book, but, book, I mean, James Besson, The New Goliaths, How Corporations Use Software to Dominate Industry. Okay, I own software companies. I’m going to read this book. This is a book that, would be very interesting to me. It’s not Wall Street research. Now, do I read Barron’s?

[00:54:27] Robert Hagstrom: Do I read the New York Times? Do I read Wall Street Journal? Yes, I do. But it usually is just for facts and information. And that’s not where wisdom is. In books and other things, it’s where wisdom comes from. You have to get the facts of the moment. You have to understand what’s going on in the world. But that’s the starting point, not the ending point.

[00:54:45] Robert Hagstrom: To get wisdom and to achieve wisdom, which gives you that ability to act independently of the market with self reliance and self confidence, you have to gather wisdom from other sources than just the market. A little bit of a long winded answer, but that’s the key. 

[00:55:00] Kyle Grieve: So one of my favorite mental models that I borrowed from you was how you view private equity in a positive light in terms of investing time horizons.

[00:55:08] Kyle Grieve: Can you outline the lessons you’ve learned from private equity that the audience can use to help them lengthen their time horizons using long horizon arbitrage? 

[00:55:16] Robert Hagstrom: Actually, when you ended it, it was actually two different things, but I thought where you were starting was just thinking about private equity into itself.

[00:55:23] Robert Hagstrom: I’m just so jealous of them, right? They’ve got it so easy. Why am I jealous of them? What do they do? They own businesses, right? Yeah. And they may be trying to fix the business or turn around the business or reorganize it with the idea that they’re going to sell it somewhere down the road. And that’s fine, there’s a lot of different ways to make money in the markets.

[00:55:40] Robert Hagstrom: But what I’m so envious of is that they own businesses that don’t have stock prices. They don’t have people dealing with myopic loss aversion and prospect theory and all this stuff. And I look at them and I go, man, this is just not fair. I mean, you guys have got it so easy, right? All you do is just tell your people what the sales were, what the earnings were.

[00:55:59] Robert Hagstrom: I said the NAV barely moves from quarter to quarter to quarter. If you look at a private equity portfolio, The NAV very rarely changes, a little upward slope over time. And then when you sell it, it goes parabolic through the roof, right? It’s one of these amazing things, right?

[00:56:14] Robert Hagstrom: And I said, you guys are getting so easy, and I’m I’m so jealous. And they all laugh and stuff like that, but that’s the truth. But when you said long horizon arbitrage, there’s a lot of good academic work is that the price, the part of the market that’s most mispriced is long horizon arbitrage.

[00:56:28] Robert Hagstrom: It’s the most difficult to figure out as well. Short horizon arbitrage is. For traders and that’s a totally different game that I’m not into. Long horizon arbitrage, though, is where the mispricing is. And Michael Mogelson said to me, there are not that many companies that actually can grow at high rates of return over a sustainable long period of time.

[00:56:45] Robert Hagstrom: The market figures them out, or competition figures them out, and creative destruction, shoemaker, all this stuff, it doesn’t last as long as it does. But if you find one that does, That can generate high returns on invested capital, that can do it over a long period of time, that can reinvest back in itself to compound over time, most likely the market’s got it mispriced.

[00:57:05] Robert Hagstrom: The mispricing for investors is out what happens 3, 4, and 5 years from now, not what happens 3, or 4, Yeah, that’s hard to arbitrage. That’s hard to figure that out. Almost impossible to figure that out. But if you’ve got a company, which you think, that will be here in 5 years, I know what they do as a business.

[00:57:24] Robert Hagstrom: I understand their economics. I understand what management’s goals and objectives are. And you look at the price and the price, the economics are above average for the market. And they’re being priced at the market. You’ve got an arbitrage, but once again it’s that long horizon, long-term investing, which is, it’s much harder than trying to figure out day to day, even though nobody can figure out day to day.

[00:57:46] Robert Hagstrom: It’s amazing how many people spend time trying to do it. 

[00:57:50] Kyle Grieve: Robert, thank you so much for joining me today. Before we say goodbye, where can the audience connect with you and learn more about you and your book? 

[00:57:58] Robert Hagstrom: Amazon’s great, and I think there’s a Robert Hackstrom Amazon, you just do Robert Hackstrom Amazon, they’ve got all the books.

[00:58:03] Robert Hagstrom: I work for a firm called Equity Compass, great little firm. We’re out of Baltimore, Maryland. I do some writings there and commentaries and stuff like that. I’m never too far afield, I just try to stay out of trouble and keep my nose down to the grindstone. 

[00:58:16] Kyle Grieve: If you enjoy reading the types of books that I discussed with Robert on this episode, I’d highly recommend checking out The Investor’s Podcast Mastermind Community.

[00:58:24] Kyle Grieve: It’s a community of dedicated value investors who are reading impactful books and discussing our high level takeaways, but this is just one of the many features of the community. We have a community forum discussing quality investing, special situations, and investing resources, among many other things.

[00:58:39] Kyle Grieve: You’ll have access to exclusive guest Q&As, where you’ll get direct access to investors like Chris Mayer, Gautam Bade, and Tobias Carlisle. If you’re interested in applying for the community, please go to theinvestorspodcast.com slash mastermind. Once again, that’s theinvestorspodcast.com slash mastermind.

[00:58:59] Kyle Grieve: Okay, folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon. 

[00:59:04] Outro: Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets.

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