[00:02:49] Intro: You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:03:02] Clay Finck: Alright, so diving right into Chapter 26, this one is titled ‘Read More History and Fewer Forecasts.’ Benjamin Graham stated that ‘If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen at the end of the stock market.’ Warren Buffet has a similar opinion. He says, ‘We believe that short-term forecasts of stock or bond prices are useless. The forecasts may tell you a great deal about the forecaster, but they tell you nothing about the future.’ And then he also says, ‘Market forecasters will fill your ear, but will never fill your wallet.’ Buffett’s partner Charlie Munger encourages investors to be a business analyst, not a market, macroeconomic, or security analyst.

[00:03:52] Clay Finck: Once when JP Morgan was asked what the market would do, he simply replied, ‘It will fluctuate every day.’ People in the media are out there making predictions day after day, and most of the time, they’re just totally wrong about their predictions. Jason Zwieg explains why this is just as nature abhors a vacuum. People hate randomness. The human compulsion to make predictions about the unpredictable originates in the dopamine centers of the reflexive brain. I call this human tendency the prediction addiction. DWG believes that people are addicted to making predictions because they get that hit of dopamine in their brain, and it gives them a chemical high that makes them feel really good.

[00:04:39] Clay Finck: Making predictions also gives us a sense of control. People would rather feel like they know what the future holds, rather than embracing the world for what it really is, which is fundamentally uncertain. Then Gautam shows this awesome chart of the S&P 500, where there are these consistent calls from major media outlets like CNBC and Morningstar, all the way from 2009 through 2017.

[00:05:05] Clay Finck: And all these headlines were saying that the top was in for the market. But over the years, the market, as we all know, just continued to head up and to the right. All of the headlines read that the easy money was made, implying that the bull run was practically over in November of 2009. The S&P 500 traded at around a thousand dollars, and at the time of this recording, the S&P 500 is around $4,100.

[00:05:36] Clay Finck: Up over four X Maid says that, try this fun exercise: check the Google results for past predictions by any market expert on any macro topic over any randomly chosen period of a few years. You’ll not take any of these people seriously ever again. Predictions just grab eyeballs and achieve nothing else.

[00:05:57] Clay Finck: This reminds me of the phrase that “stocks tend to take the stairs up and the elevator down.” Holding on the way up requires patience. Holding on the way down requires courage. Remember that stocks tend to climb a wall of worry. Peter Lynch stated that “whatever methods you use to pick stocks, your success will depend on your ability to ignore the worries of the world long enough to allow your stocks to succeed. No matter how intelligent you are, it isn’t the head but the stomach that will determine your fate.” End quote. Then Gautam writes that with rare exceptions, most of the miracles of humankind are long-term constructed events. Progress comes bit by bit. The silent miracle of humanity’s march is this: step by step, year by year, the world is improving when a trend is gradually improving over time.

[00:06:54] Clay Finck: With periodic sharp dips, people are more likely to pay attention to the dips than the overall improvement. The news media tends to focus on vivid events rather than on the daily improvements in routine goodness in the world. Fundamental improvements that are world-changing events, but too slow, rarely qualify as news.

[00:07:15] Clay Finck: The stories that circulate fastest have an element of fear or anger, and they instill a sense of helplessness. Remember, the pessimists sound smart, but it is the optimist who makes money. In Buffett’s 1994 letter, he explained that relying on negative forecasts is an expensive distraction for investors.

[00:07:35] Clay Finck: 30 years prior, had you told them that the world was going to go through a Vietnam War, wage, and price controls, two oil shocks, the resignation of a president, a one-day drop in the Dow of 508 points, and treasury yields fluctuating from 2% all the way to 17%, then he states, but surprise, none of these blockbuster events made the slightest dent in Ben Graham’s investment principles, nor did they render unsound the negotiated purchases of fine businesses at sensible prices.

[00:08:08] Clay Finck: Imagine the cost to us then if we had let a fear of the unknown cause us to defer the deployment of capital. We have usually made our best purchases when apprehensions about some macro event were at a peak, a different set of major shocks is sure to occur in the next 30 years. We will neither try to predict these nor try to profit from them.

[00:08:35] Clay Finck: End quote. Then in Buffet’s 2012 letter, he writes, American business will do just fine over time, and stocks will do well, just as certainly since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor.

[00:08:56] Clay Finck: Since the basic game is so favorable, Charlie and I believe it is a terrible mistake to try to dance in and out of it based on the predictions of experts. The risks of being out of the game are huge compared to the risks of being in it. Then there’s this almost famous chart from Jeremy Siegel’s book that shows that stocks, over the very long run, have been significantly better investments than bonds, T-Bills, gold, and the US dollar. History shows that when you zoom out over decades, stocks are very clearly the best asset class and deliver the highest long-term real returns.

[00:09:38] Clay Finck: Peter Lynch has one of my very favorite quotes that “more money has been lost, trained to anticipate and protect from corrections than actually in them.” Often when the sharp correction does occur, experts will say something to the effect of “the outlook isn’t clear,” “there’s a lot of uncertainty,” or “there’s a lot more downside to come.” When stocks drop, the experts often recommend selling or waiting until the outlook is more clear. Those who waited it out in March of 2020 missed out on what in hindsight was a bargain.

[00:10:15] Clay Finck: Prices waiting can be a very expensive mistake, as Gautam explains that superior stock returns do not accrue in a uniform manner. Rather, they can be traced to a few periods of sudden bursts of strength. Moreover, the timing and the duration of these periods cannot be predicted accurately by anyone. A significant percentage of the total gain from a bull market tends to occur during the initial market recovery phase. If an investor is out of the market at that point in time, then they’re likely to miss a substantial portion of the gains.

[00:10:53] Clay Finck: Time invested in the market matters much more than timing the market. Since timing the market is nearly impossible, we should focus on our time in the market. There have always been regular drawdowns, some being larger than others. Zooming all the way back to 1929, the S&P 500 had a drawdown of at least 20% under just about every single president. There have been five occurrences of a drawdown of 40% or more. Herbert Hoover had the first during the Great Depression as the market dropped by 86%. Franklin Roosevelt saw a 54% drawdown during his tenure during World War II.

[00:11:34] Clay Finck: The next one was Richard Nixon. In the 1970s, this was when the US was battling oil shocks, high inflation, and rising rates. The fourth occurrence was the crash of the tech bubble with George W. Bush in office, and then George Bush saw the great financial crisis as well under his tenure. Since then, the largest stock market drawdown was the Covid scare in March 2020, as stocks dropped around 24% from February to March 23rd, 2020.

[00:12:05] Clay Finck: Nowadays, all eyes are on the Federal Reserve and inflation. How will the Fed fight inflation? Will they hike 25 points or 50 basis points at the next meeting? When will they cut rates? These are all questions I see people asking. The right answer to all of these questions is that it doesn’t matter. Wall Street likes to sound smart by saying phrases such as “don’t fight the Fed,” meaning that if the Fed is going to raise rates, you shouldn’t be in stocks. If the Fed is cutting rates, you shouldn’t be short stocks, you should be long. This sounds logical, but historically, this argument really hasn’t held up. Gautam listed four times since 2001 that this strategy would have burned you: January 3rd, 2001, the Fed cut rates by 50 basis points from then until October of 2002, and the S&P 500 declined by 43% while the Fed cut rates the whole way down. A similar occurrence happened in 2007 through 2009, as the stock market declined 56% from September of 2007 through March of 2009.

[00:13:16] Clay Finck: Turning to the rate hike piece where people say “don’t fight the Fed,” this really didn’t hold up in June of 2004 and December of 2015. In 2015, for example, the Fed hiked by 25 basis points and the S&P 500 closed at 2073. It then went on to advance by 45% from that point through July of 2019, and during that period, the Fed hiked rates eight more times. This is the trouble with market predictions. Oftentimes, the experts sound really smart, and they’re really certain of their predictions, and they can make a lot of sense to people, but just because they sound smart and they sound like they make sense doesn’t mean the stock market will move in the way in which they believe it will.

[00:14:08] Clay Finck: Markets are fluid and they’re constantly changing. There are a ton of moving parts outside of the Fed’s actions that influence markets, and what happened in the past might not work as well in the future. Narratives follow what the market does; regardless of the narrative that is being pedaled by commentators, the market’s going to do what it wants when it wants.

[00:14:33] Clay Finck: Gautam encourages readers to ignore macro indicators and simply focus on businesses and their industry developments. That’s the best one can do. He also recommends being a student of history. Once Charlie Munger was asked in a USC graduate school investment class how one can make themselves a better investment professional.

[00:14:53] Clay Finck: He repeated that studying history was critically important. Studying history opens us up to possibilities we otherwise wouldn’t have considered. Harry Truman has stated that there is nothing new in the world except the history you do not know. Gautam especially recommends studying past manias and crashes to better understand the psychology of people, governments, and nations.

[00:15:16] Clay Finck: And it’s also a reminder that hardly any events in the markets are unprecedented. Different people have come and gone, but human psychology in the crowds remains the same. Human greed and the desire to get rich quickly are still ingrained in us today. People in crowds are easily impressed by images and myths, making misinformation and exaggeration contagious.

[00:15:40] Clay Finck: Jesse Livermore has said, “Nowhere does history indulge in repetition. So often as in Wall Street, when you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how the stock speculation of today differs from yesterday. The game does not change and neither does human nature” end quote.

[00:16:02] Clay Finck: Now, because human nature does not change, we will continue to see booms and busts throughout our lifetimes, so they’re worth studying. Classic examples include the Dutch tulip mania, the South Sea bubble, the Roaring twenties, and the great crash of ’29, the trons boom of the sixties, the nifty 50 in the seventies, the Japan asset bubble in the eighties, the tech bubble in the nineties, housing bubble in the two thousands.

[00:16:31] Clay Finck: And then we saw a number of bubbles around 2021, including crypto, NFTs, profitless tech, and so on. People know bubbles have happened in the past, but they believe that they’re the exception rather than the rule and see their friends getting rich, so they don’t want to miss out. Bubbles are typically fueled by the narrative of some major technological revolution, cheap liquidity, higher leverage that is oftentimes disguised and hard to see in the abandonment of the time and true methods of security valuation.

[00:17:05] Clay Finck: What brings a bubble to higher and higher levels is more leverage in margin purchases, which is ultimately the demise during its fall, and margin calls are inevitably brought to light. John Templeton famously said that the foremost dangerous role of investing this time is different. All bubbles eventually come to an end, and investors are reminded of the timeless investing wisdom of those like Benjamin Graham and Warren Buffet.

[00:17:33] Clay Finck: That valuation does matter, and we should buy securities with a margin of safety. This brings us to chapter 27, covering, updating our beliefs in light of new evidence. Alvin Toffler stated that the illiterate of the 21st century will not be those who cannot read and write, but those who cannot learn, unlearn and relearn. George Soros has stated to others, “Being wrong is a source of shame. To me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes” end quote.

[00:18:15] Clay Finck: This chapter is all about changing your opinions in your view of the world.

[00:18:21] Clay Finck: When the facts change, it’s easy to be stubborn and to think we know it all. It takes humility in setting our ego aside to understand that the world is ever changing and our opinions might be wrong. 40 years ago, no one could have imagined the companies that we have today. Uber is the world’s largest taxi company and it owns no vehicles.

[00:18:46] Clay Finck: Facebook was recently the world’s most popular social media owner, yet they create no content. Alibaba is one of the world’s largest retailers and they have no inventory. Airbnb is the world’s largest accommodation provider and they own zero real estate. We can’t even dream of some of the powerhouses that are going to emerge 40 years from now.

[00:19:10] Clay Finck: The pace at which change is happening today is faster than ever before because technology and innovation move exponentially. Marcelo Lima stated that the big picture is as software is eating the world. That is, many of the products and services developed over the past 150 years are transforming into or being disrupted by software.

[00:19:32] Clay Finck: The implications are enormous. Software is infinitely replicable, and through the internet, it can be delivered at zero marginal costs. When a major input’s a business, the distribution cost goes to zero. Entire industries get disrupted. When one can build a business model from the ground up with entirely new assumptions, one can attack incumbents in a way that is very difficult to defend.

[00:19:58] Clay Finck: The first example that comes to mind is Netflix. While Blockbuster was innovating by adding candy aisles to their stores, Netflix was creating an entirely new and better way for people to consume content such as movies and shows. Gautam rightly mentions that the five largest companies in the US are Apple, Google, Microsoft, Amazon, and Facebook.

[00:20:20] Clay Finck: These companies require virtually zero capital to grow. This book is a few years old, I believe the joys of compounding, and I believe Facebook isn’t in the top five anymore, but you get the point he’s trying to make. Software is eating the world because of these outdated business models, and companies might look cheap today when in reality they’re really just value traps.

[00:20:46] Clay Finck: We have to evolve as value investors to adapt to new ways of assessing value and in better understanding things like technology, network effects, and the role technology plays in different industries. With companies like Amazon disrupting so many industries and technology making its way into so many businesses, it requires us to be flexible in our thinking.

[00:21:10] Clay Finck: This type of mindset has enabled Warren and Charlie to do so well for so long. They continue to evolve as the world evolves. Many fund managers have a good stint for a few years, and then they fade into the distance because things change. The same thing happens with companies. TikTok took the social media space by storm in a matter of a few years, showing that even very powerful tech companies like Facebook, for example, have the potential to be disrupted very quickly.

[00:21:44] Clay Finck: And then Gautam explains that, quote, investors tend to never give up on their pet projects in their favorite stocks, even when it makes no sense to continue. And they keep averaging on the way down. In bad businesses, they follow the same approach until they go broke. One of the surest ways to go broke is to keep getting an increasing share of a shrinking market.

[00:22:10] Clay Finck: This is a slow but sure death. It’s gradual rather than sudden. Quote, Munger once stated that, “I think it’s in the nature of things for some businesses to die. It’s also in the nature of things that in some cases you shouldn’t fight it. There’s no logical answer in some cases except to ring money out and go elsewhere.”

[00:22:34] Clay Finck: Quote, Gautam explains that good investing is a peculiar balance between the conviction to follow your ideas and the flexibility to recognize when you’ve made a mistake. You need to believe in something, but at the same time, you need to recognize that you’ll be wrong a considerable number of times over the course of your investing career.

[00:22:57] Clay Finck: This fact holds true for all investors regardless of stature. The balance between confidence and humility is best learned through extensive experience and mistakes. Always respect the person on the other side of the trade and ask yourself, why does he or she want to buy or sell? What does he or she know that I don’t?

[00:23:20] Clay Finck: You must be intellectually honest with yourself at all times. We’re big fans of Ray Dalio here at TIP. When Ray’s trying to make the best possible decisions, he analyzes the facts and the information in front of him, and then he forms a hypothesis. He then shares his hypothesis with different viewpoints and perspectives, some of which he may disagree with.

[00:23:45] Clay Finck: He wants to create an environment and a culture that’s radically transparent to try and create back and forth discussions. Once he better understands the different viewpoints, he then chooses the best path forward for him. Learning from different viewpoints helps prevent us from getting tunnel vision and falling into one view of the world that might not be right or in line with reality.

[00:24:11] Clay Finck: A devil’s advocate at times can be extremely helpful as it helps prevent us from falling into an echo chamber, which is especially easy with the way social media is served to us and the way algorithms are programmed into these platforms online. Then Gautam dives into thinking probabilistically. We want to put ourselves in situations where the odds are heavily stacked in our favor.

[00:24:37] Clay Finck: For example, Buffet tends to avoid turnaround situations because they’re unlikely to play out favorably for investors. He also tends to avoid fast-changing high-tech businesses, as he stated that, “Severe change in exceptional returns usually don’t mix.” This idea is referred to as base rates.

[00:24:55] Clay Finck: This is also why many value investors tend to stay away from commodity businesses. Commodity businesses tend to have a boom and bust nature to them, and overall they have low return on invested capital in these industries. Generally, in these boom and bust industries, the odds are not stacked in your favor.

[00:25:16] Clay Finck: But Buffet over the past couple of years has actually been purchasing stakes in oil companies. So in this case, he actually does believe that the odds are in his favor. To round out this chapter, Gautam talked a bit more about his investment process and the importance of sleeping well at night. He explained that at times when a secular growth company gets too extended in terms of its valuation, then he’s willing to trim it when its valuation is at uncomfortable levels.

[00:25:50] Clay Finck: Even though he may still expect the business to fundamentally improve, he’s optimizing more for his stress levels. Walter Slosh once said that investing should be fun and challenging, not stressful and worrying. Then in an interview, Slash’s son, Edwin, said that his father’s longevity in investing philosophy was probably related.

[00:26:10] Clay Finck: “A lot of money managers today worry about quarterly comparisons and earnings. They’re biting their fingernails until five in the morning. My dad never worried about quarterly comparisons, and he slept well at night,” end quote. Gautam uses the term “stress-adjusted returns” and how that metric to him is more important than risk-adjusted returns.

[00:26:32] Clay Finck: This is why we should probably avoid things like shorting stocks, taking on personal debt to invest, or entering into long-term partnerships with management teams that make your stomach turn. We want to be flexible in our thinking. When the facts change and we see that the business fundamentals are deteriorating, we need to get out.

[00:26:54] Clay Finck: We want to own companies who continually increase their intrinsic value over time, rather than having worsening fundamentals. He writes, “be emotionally detached from the outcomes and make decisions based on a dispassionate analysis of factual data. Treat losses with equanimity and note the lessons learned.”

[00:27:12] Clay Finck: Optimism is a good thing, but self-delusion is not. Peter Lynch stated, “there’s no shame in losing money on a stock. Everybody does. What is shameful is to hold onto a stock or worse, to buy more of it when the fundamentals are deteriorating,” then Gautam continues. “Always acknowledge and embrace reality for what it really is, and don’t engage in what Munger calls thumb-sucking.”

[00:27:38] Clay Finck: If you are unsure about a stock, even after your best efforts to resolve your doubts, just exit it and get out. Otherwise, you’re gonna end up selling it in a panic at a much lower price during the next sharp market correction. You need to materially adapt when losing and remain faithful when winning. If you have the discipline to do just these two things, you will succeed as an investor.

[00:28:07] Clay Finck: It is perfectly okay to be wrong, but it is not okay to remain wrong. One of the great lessons I have learned over the course of my life in my investing career is this: “If you wanna win better than the rest, you must learn how to lose better than the rest.” I am happy to have learned Confucius’s teaching well.

[00:28:32] Clay Finck: “A man who has committed a mistake and doesn’t correct it is committing another mistake.” End quote. This brings us to chapter 28, which discusses opportunity costs. This is another lesson that Stag, our founder, shares with us here at TIP. You might have a good opportunity sitting in front of you, and some may be eager to pursue that opportunity or pursue that investment, but what they might not consider is their overall opportunity set.

[00:29:02] Clay Finck: If you can purchase a company at, say, a 10% expected return, you might think that’s great. “I’m gonna purchase that!” But if there’s another company out there that offers lower downside but more upside, say, a 15% return, then we should take the higher return. We know the second opportunity is better, so we need to look at our overall opportunity set and ensure we’re making high-quality and rational decisions.

[00:29:30] Clay Finck: Charlie Munger has stated, “If you take the best text in economics by Man Q, he says intelligent people make decisions based on opportunity costs. In other words, it’s your alternatives that matter. That’s how we make all of our decisions.” And then Gautam follows it up, “As investors, we are in the business of intelligently allocating capital with limited capital at our disposal in several alternatives.”

[00:29:57] Clay Finck: The critical concept of opportunity cost arises in opportunity. Cost is defined as the value of the second-best opportunity, which we forego when we make a choice. If you wanna be a great investor, then you should only pursue great opportunities that are presented to you. It sounds obvious, but many investors fall into the trap of needing to do something and to take action, so they chase after what Munger would call mediocre opportunities.

[00:30:27] Clay Finck: There’s that Munger quote that “It takes character to sit there with all that cash and do nothing.” “I didn’t get to where I am today by going after mediocre opportunities.” Some investors also fall for the trap of holding onto a business because they bought in at a lower price. In other words, they’re mentally anchored to the price they bought it at, which happens automatically at a subconscious level.

[00:30:56] Clay Finck: If the long-term outlook for a business is weak, then it may be best to sell the position that has appreciated significantly. Gautam does the mental exercise of liquidating his portfolio in his mind each day and asks himself a simple question. “Given all the current and updated information I now have about this business, would I buy it at the current price?” End quote.

[00:31:22] Clay Finck: It’s important that we don’t fall in love with our most loved ideas either because we’ve put a lot of time and energy towards that position. It’s fine to hang onto a high-quality business when the valuation is a bit high, but when the valuation has run up and the longer-term outlook isn’t that great, then you may be able to find better opportunities elsewhere.

[00:31:48] Clay Finck: This concept also applies to spending our time. Time spent doing one thing is time not spent doing something else. So not only should we be mindful of how we allocate capital, but also mindful of how we allocate our time. Time spent watching Netflix or doing leisure activities is time not spent with friends, family, or time spent reading?

[00:32:12] Clay Finck: It sounds so obvious again, but not many people look at their opportunity costs and really think about what is optimal for them. This is a really important chapter, like many others in this book, but this one specifically is important because our life is a result of our decisions. And to achieve great things, we need to learn how to make great decisions.

[00:32:37] Clay Finck: Gautam, for example, probably has a lot of ways he could be spending his time. He could be getting more investors, researching companies, or even spending more time relaxing, but he spent a significant amount of time and energy in writing this book, and that is going to impact many thousands of people. Just like how our money compounds, whether that be positively or negatively, our choices also compound.

[00:33:05] Clay Finck: Every single choice in every single decision we make alters the trajectory of our life, and the compound effect is in action all the time. Benjamin Franklin said that to be aware of the little expenses, a small leak will sink a great ship. Now, that’s not to say that we should not spend money on things we don’t truly need, but it’s a nice reminder that every single decision we make has an opportunity cost.

[00:33:35] Clay Finck: Identifying the best opportunities can also be helpful with recognizing patterns. This brings us to chapter 29, titled Pattern Recognition. Warren and Charlie are very good at recognizing patterns. They’re able to analyze a business and relate it back to their past experiences of studying other businesses.

[00:33:54] Clay Finck: This reminds me of Nick’s sleep and how during the early 2000s, he had studied the growth and success of Walmart over the previous decades, and this helped him lead to purchasing substantial positions in Costco and Amazon that were both very successful investments. In the case of Costco, Munger recognized that they had enormous untapped pricing power.

[00:34:17] Clay Finck: They were keeping prices low, but if they’ve raised prices even slightly, this would increase their bottom line tremendously. Although it’s great if a business can consistently increase its prices over time and they have strong pricing power, another interesting example is the case of a business that has pent-up pricing power that can be released in the future.

[00:34:41] Clay Finck: The reason this might be a good opportunity is that the market might be looking at the past earnings and essentially underappreciating the business because it’s currently underearning. This is one reason why I personally own a relatively small stake in Amazon. Because of the massive customer base and the different revenue streams they have, they can slightly tick up their prices, and it would drastically affect how much would flow through to their bottom line.

[00:35:11] Clay Finck: Earnings, Gautam mentions that. Another tool in the pattern recognition toolkit is finding businesses with strong brands that dominate the mindshare of customers. The first company that comes to mind for me is a company like Apple. Millions of people purchased Apple products, whether that be the Mac, iPhone, Apple Watch, and Apple’s ecosystem has a way of capturing the mindshare of customers.

[00:35:37] Clay Finck: Customers don’t really care too much about how much they’re paying, and it’s extremely difficult for competitors to disrupt that mindshare. One way to recognize these examples is when the company is a verb or it’s associated with the industry itself and people’s minds. This Mindshare is especially powerful if it’s difficult for you to identify the second competitor in an industry.

[00:36:02] Clay Finck: Others that come to mind are Amazon being synonymous with online retail, Google with search, Airbnb with travel, Walmart with low price retailing, or Uber with ride-sharing. Then Gautam has this section titled People Calculate Too Much and Think Too Little. The idea behind this is that with the rise of technology and computers, it’s relatively easy for them to be programmed to catch statistical mispricings in the market.

[00:36:29] Clay Finck: But what computers can’t catch as easily is the more qualitative side of the business, something that can’t be seen in the numbers. He then lists 11 different examples of opportunities he has seen based on qualitative factors that require more digging and the need to look a layer deeper than just the numbers.

[00:36:51] Clay Finck: He talks about one example of a company about to roll out a new product with a lot of promise, but investors avoided this company because of its historically high P/E. Rather than looking forward at the company’s true earnings power, they were looking at the company’s past results.

[00:37:10] Clay Finck: The second one, E lists, is receiving voluntary praise from competitors, which points to the strength of the business being so strong that competitors openly express their strength to the public. Another one E lists here is looking at the relative performance of companies within an industry. If the industry leader is lagging, while other businesses are doing well on strong reported earnings, this may mean that there is a mispricing before the leader reports their earnings. For example, if Facebook or Meta were to report strong earnings today and the stock has a strong upswing, the market should naturally bring up Alphabet’s stock price, as well as they both benefit from the tail end of the trend towards digital advertising.

[00:37:59] Clay Finck: Another example of a qualitative factor that can trip up investors is being biased towards consumer businesses because they’re more familiar with these businesses and their products. Consumer businesses are more susceptible to rapid change and unpredictability, whereas B2B businesses tend to face much slower changes in consumer preferences.

[00:38:18] Clay Finck: Sticking to the theme of patterns, when we invest in high-quality businesses, we want to see that they have secular tailwinds at their back. Newton’s first law of motion states that an object in motion tends to stay in motion, things in motion have inertia. Rather than selecting a turnaround play, select a company that has a history of consistently winning.

[00:38:43] Clay Finck: The trend is your friend. Understanding the dynamics within an industry is critically important. Adam Parker, who is a former US Equity strategist at Morgan Stanley, found that the impact of sector-specific factors on a typical stock’s annual return accounts for more than half of a stock’s performance.

[00:39:02] Clay Finck: Gautam believes that it is better to buy a good business in a great sector than a great business in a bad sector. As long-term investors, we wanna ride the long-term trends. There might be a brick and mortar business that is trading below its liquidation value, but you may be relying on the market to rerate the stock as it’s bleeding cash.

[00:39:27] Clay Finck: Two trends that I am personally riding is the move from physical stores to more shopping being done digitally. E-commerce is a trend that has exploded over the past 10 to 20 years, and it seems to have a lot more runway for growth ahead as more and more younger people are entering the workforce and they’re much more likely to do their shopping online.

[00:39:53] Clay Finck: Another trend that has been underway for years is the trend from traditional advertising, the digital advertising from newspaper and radio to the internet, and things like podcasts. Three of the biggest beneficiaries of this are currently Meta, Alphabet, and Amazon. If you want to have the opportunity to own a company with 10x or even a hundred x potential, you need to look at companies that don’t have visible ceilings on their growth.

[00:40:23] Clay Finck: This puts the likes of capitalism in the desire for the human race to continue to reach new heights on our backs, and it allows you to have a long-term call option on human ingenuity. Skipping to chapter 31 here, this chapter is titled “The Education of a Value Investor,” which is the same title as Guy Spear’s book that William Green helped write, and he starts this chapter emphasizing the importance of doing your own homework and doing research on your investments.

[00:40:56] Clay Finck: You can borrow someone else’s investment ideas, but you’ll never be able to borrow their conviction in the work they’ve done to come to understand that investment. At the end of the day, we ourselves are responsible and bear the consequences of our own decisions. If I buy a stock that someone else recommends and then the stock price just plummets or the stock’s a total dud, I have no one else to blame but myself. As Jim Roone once put it, “The day you graduate from childhood to adulthood is the day you take full responsibility for your life.”

[00:41:36] Clay Finck: Quote: Gautam explains that much of the joy in investing is seeing your hard work pay off. Anyone can go out and buy a stock that a super investor buys. The best part about the process is discovering a company for yourself and doing the bottom-up research and coming to your own conclusions. Rather than outsourcing your research and your opinions to somebody else, then he dives into the psychological side and the psychological biases.

[00:42:06] Clay Finck: Starting with anchoring, which I already mentioned earlier actually during this chapter, he tells a number of stories of somewhat rookie mistakes he made back in 2013. In that year, he bought a stock that had fallen by 50%, thinking that because it had fallen, it must be cheap without having any real understanding of the underlying value either.

[00:42:29] Clay Finck: After he bought it, the stock dropped another 50% before he exited near the bottom. He said that he was a living example of Phil Fisher’s quote that “the stock market is filled with individuals who know the price of everything but the value of nothing,” and it’s a good reminder that one of the worst ways to identify undervalued stocks is using the distance away from the 52-week high, but it’s also one of the easiest ways to actually find cheap companies.

[00:43:03] Clay Finck: Thus it’s frequently used. Remember that a stock that has fallen by 95% is simply a stock that has fallen by 90% and then fallen by yet another 50%. Another way people can anchor is by fixating on their initial purchase price. For example, if you buy a stock and you expect it to go up substantially over time, then the fact that the stock is currently trading at $1,100 shouldn’t keep you from buying more shares if your initial position was at say, a thousand dollars.

[00:43:37] Clay Finck: Psychologically, we only want to purchase more shares below the thousand dollar price because we’re anchored to that arbitrary price that we initially paid. When you have high conviction in a company, there’s a saying that this type of behavior is penny-wise and pound-foolish.

[00:43:55] Clay Finck: One of the best things some investors can do is not look for new ideas, but rather continue adding to your winners. Don’t fixate on past prices. A hundred-bagger is simply a 10-bagger. That was a 10-bagger. Yet again, if the thesis isn’t broken and the price is still compelling, continue adding more shares and ignore what the stock has historically traded at.

[00:44:21] Clay Finck: Remember that winners tend to keep on winning. Anchoring also applies to selling a stock. If a stock has fallen and investors decide they want to get out of the business, they may be fixated on their initial purchase price and wait to sell the stock when it hits that price, even though that may never happen.

[00:44:44] Clay Finck: Phil Fisher stated that more money has probably been lost by investors holding a stock they really did not want until they could at least come out even than for any other reason. And Gautam follows it up by saying, “Most investors wait to recover what’s gone, rather than retaining what’s left. They don’t realize that loss recovery does not necessarily have to be made from the same stock on which the loss was made.”

[00:45:14] Clay Finck: If the story has gone wrong, simply book your losses and move on to a better opportunity. Continuity of compounding is the key to success in this long-term game. After buying a stock, forget what you paid, or this knowledge will forever affect your judgment. Vinny has a section here discussing envy and ego.

[00:45:35] Clay Finck: Buffet stated that “it’s not greed that drives the world, but envy,” and Munger has stated, “once you get something that works fine in your life, the idea of caring terribly that somebody else is making more money is making money faster. Strikes me as insane.” We have to have the mental fortitude to avoid the temptation of FOMO in watching others getting rich while we sit on the sidelines.

[00:46:03] Clay Finck: He tells the classic story of Isaac Newton in the South Sea Bubble. Newton invested in shares of South Sea early in its euphoric rise and profited handsomely, 100% actually, before exiting his position in a few months. Meanwhile, his friends continued to ride the euphoric rise and make much bigger returns than he did.

[00:46:25] Clay Finck: So Newton decided that he would invest substantially more than what he had previously invested to avoid missing out on the gains to come. Unfortunately, for Newton, he had bought near the very top of the bubble, and he exited broke just a few months later as South Sea shares collapsed. I’m definitely not immune to envy.

[00:46:48] Clay Finck: I remember back in 2017, when I first graduated college and got more interested in investing, I had gotten caught up in the cryptocurrency craze as it seemed like all these random coins would be doubling and tripling practically overnight. Every dip was ferociously bought up as these so-called experts on Twitter and other social media platforms would try and explain why a certain coin would be the next one to increase by 10 or a hundred X as thanks rose faster.

[00:47:21] Clay Finck: My greed increased more and more until eventually it all came crashing down. Thankfully, I only invested a small amount of money, money that I was willing to part with, but it taught me many valuable lessons that I still hold today and just how easy it can be to get caught up when others around you are getting really rich.

[00:47:45] Clay Finck: Gautam writes, “Envy is the only one of the seven deadly sins that offers no upside.” Envious people are always miserable because envy has only downside risks and offers no upside reward. Do not compare yourself to others. The only person you need to be better than today is the person you were yesterday.

[00:48:07] Clay Finck: “Competing with others makes you bitter. Competing with yourself makes you better,” in quote. He touches on ensuring you take stress out of your investment decisions. It’s difficult to invest wisely and think rationally when we’re stressed, so be sure to give yourself time to relax if needed, and adhere to your checklists and processes to help ensure that you’re making the right decision and you’re making rational decisions.

[00:48:34] Clay Finck: He also talks about loss aversion and tells the story of how he mistakenly placed a stop loss order on a secular growth stock. Prior to their earnings release, the stock had risen 50% from his purchase price, and he placed the stop loss to ensure that those gains would be locked in, in case the company missed earnings and the stock would then fall.

[00:49:00] Clay Finck: Then he writes that the stop loss had actually been triggered within minutes, and he wasn’t really sure why. And then the company went on to report stellar earnings, and the stock rose by more than 100% within the next few months. What led him to making this mistake of placing a stop loss order was the psychological bias of loss aversion.

[00:49:25] Clay Finck: He didn’t want to earn all of those gains and then end up losing them. He was bullish and optimistic about the company and his prospects, but loss aversion led him to placing that stop loss order and making that mistake. Humans generally are more motivated by the thought of losing something than the thought of gaining something of equal value.

[00:49:50] Clay Finck: Our brains are wired to minimize losses rather than maximize gains. Rather than being loss averse, we should be risk averse and not be afraid to take calculated risks when the odds are in our favor. Psychologically, investors are also prone to mentally segmenting each position in our portfolio. We think about how we are up 30% on stock A, and we’re down 20% on stock B, but we should more so look at our portfolio as a whole, mentally segmenting our stocks rather than looking at the overall portfolio.

[00:50:26] Clay Finck: May lead us to the mistake of trimming our winners in adding to our losers. When you own many stocks, it’s inevitable that some of them are not going to play out how you expected. That’s just how investing goes. Even Buffett isn’t going to have a hundred percent batting average. Except that occasional losses are just a part of the game and seek to learn from them.

[00:50:53] Clay Finck: There’s almost always the possibility of being wrong, so don’t let one loss have a major effect on your portfolio by diversifying effectively. Then the final section in this chapter is on greed and fear. Before we arrive at the final chapter, which is the conclusion of the book, investing in emotions really doesn’t mix well together.

[00:51:16] Clay Finck: This might be from greed kicking in when stocks are at an all-time high, or fear is at its highest when stocks have bottomed. He tells us a lot about the early mistakes he made in his early investing career, first of which was trying to make a quick buck by taking on a loan from his broker to buy into a hot IPO with the sole objective of flipping it the next day.

[00:51:45] Clay Finck: Or doing something similar by speculating on a company’s earnings release and hoping for a surprise to the upside. Many of these that he lists here are around speculating on the company’s stock price for a variety of different reasons, and really, he had the hope of making a quick return and then getting out.

[00:52:07] Clay Finck: One form of speculation that may be more popular nowadays is following the stock recommendation of a widely followed blog or maybe even a podcast. He explained how every stock can look like a winner when it’s presented by a good storyteller. To help safeguard yourself, Gautam recommends always assuming that you aren’t being told the whole story.

[00:52:30] Clay Finck: The best investors are able to recognize when emotions are high and not be too quick to act on them. As stated, investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble.

[00:52:55] Clay Finck: In investing, we need to get used to not taking too many actions in our own portfolio and accept the fact that most of the time we should be just sitting and waiting. Munger once stated, “inactivity strikes us as intelligent behavior.” The only people who get rich when you trade excessively are the intermediaries and brokers.

[00:53:18] Clay Finck: Then, I wanted to read this last bit here. He included in the chapter, “I shared the mistakes from my investing journey because I consider them to be my greatest teachers in the lessons learned, which helped me improve significantly over the years. I have a deep appreciation for the valuable experience and wisdom that each loss has brought me.”

[00:53:42] Clay Finck: “There are no mistakes in life, only lessons. When you adopt a positive mindset, you never lose. You either win or you learn. Good judgment comes from experience, and experience comes from bad judgment.” I just love that quote. “Good judgment comes from experience, and experience comes from bad judgment.”

[00:54:02] Clay Finck: Investing isn’t a game of perfection. It’s a game of continuous improvement. Making quick money through a lucky trade early on is the worst way to win; the bad habit that it reinforces often leads us to a lifetime of losses. Beginner’s luck often turns out to be a beginner’s curse in the field of investing and early and manageable failure is a blessing. Get most of your investment mistakes out of the way while you’re young and have a significant amount of human capital but little in the way of financial capital. I do appreciate that Gautam includes so many of his mistakes in his book because these can all serve as valuable lessons for us.

[00:54:48] Clay Finck: This brings us to the final chapter of his book, which is the conclusion titled “Understanding the True Essence of Compounding.” He opens up by stating, “I have come to realize that the best things to learn from Warren Buffet have nothing to do with investing. Read, reread, and reflect on these words from him.”

[00:55:10] Clay Finck: “You only get one mind in one body, and it’s gotta last a lifetime. Now, it’s very easy to let them ride for many years, but if you don’t take care of that mind and that body, you’ll be a wreck 40 years later. It’s what you do right now that determines your mind and how your body will operate 10, 20, 30 years from now,” end quote.

[00:55:38] Clay Finck: So we need to create those habits and take those actions that support our body and develop our mind. We can make all of the money in the world, but no amount of money can replace the mind and the body that we have. We need to understand what is truly important to us because money alone won’t give us everything we desire out of life.

[00:56:04] Clay Finck: We need things like quality, relationships, and meaningful work to give us true fulfillment that we want. Then he covers the compounding of positive thoughts and shows a wonderful quote from Napoleon Hill, which I’m assuming is from his book “Think and Grow Rich,” one of my favorites. “Whatever the mind of man can conceive and believe, it can achieve.”

[00:56:28] Clay Finck: Thoughts are things and powerful things at that. When mixed with definite purpose and burning desire, they can be translated into riches. This is the type of thing I really like to see from value investors. Generally, they’re just really positive and they’re just really optimistic people who live life in a very humble way.

[00:56:50] Clay Finck: In this final chapter of the book, it is quite motivating and inspirational. Gautam writes that positive thoughts generate the consistent energy we need to reach our long-term goals. Our mind automatically generates thoughts related to the information we consume. Even if we’re adept at avoiding negativity and have trained ourselves to be relentlessly positive when it comes to sensationalism, our basic nature can’t resist.

[00:57:16] Clay Finck: Media masters understand that they know your nature in many ways better than you know it. The media has always used shocking and sensational headlines to try and draw your attention. Your mind is like an empty glass. It’ll hold anything you put into it. You put in sensational news, negative headlines, and you’re pouring dirty water into your glass.

[00:57:40] Clay Finck: If you’ve got dark, dismal, worrisome water in your glass, everything you create in your mind will be filtered through that muddy mess because that’s what you’ll be thinking about. Be cautious of your information diet. Then he ties this into gratitude writing, quote: “Gratitude is the most effective path to contentment.”

[00:58:01] Clay Finck: If you need to wake up early as a parent, you should feel grateful for having children to love. If you need to clean or repair your home, you should feel grateful for having a place to live.” And then he goes on to list a number of other examples. “Our attitude determines our altitude.” Honest mistakes are perfectly acceptable.

[00:58:25] Clay Finck: As Charlie Munger put it, “it seemed like a good idea at the time,” but failing to learn from our own mistakes is not acceptable. The difference between winners and losers is that winners take ownership of their mistakes, and as a result, learn from them and progress in life. The key to learning from mistakes is to acknowledge them without excuses and to make necessary changes to improve going forward.

[00:58:53] Clay Finck: If you can’t admit to your mistakes, you won’t grow. To really get that compounding effect going in your own life, you need to learn from your mistakes and push through your failures. Success actually lies on the same road as failure. It’s just a bit further down the road. Most people going down a particular road end up running into the same challenges and roadblocks.

[00:59:20] Clay Finck: It’s those who persist and keep going that end up getting miles ahead and expanding their limits. This is compounding in action. Perseverance and overcoming setbacks is a prerequisite to success. Munger has stated, “whenever you think that some situation or some person is ruining your life, it’s actually you who’s ruining your life.”

[00:59:41] Clay Finck: It’s such a simple idea. Feeling like a victim is a perfectly disastrous way to go through life. If you just take the attitude that however bad it is in any way, it’s always your fault and you just fix it as best you can. The so-called iron prescription, I think that really works.” End quote. Just look at Charlie Munger’s story.

[01:00:06] Clay Finck: Joshua Kenan writes in his blog about Munger’s life experience that I’ll read here from the book. In 1953, Charlie was 29 years old when he and his wife divorced. He had been married since he was 21. Charlie lost everything in his divorce. His wife kept the family home in South Pasadena. Munger moved into dreadful conditions at the University club and drove a terrible yellow Pontiac.

[01:00:33] Clay Finck: Shortly after the divorce, Charlie learned that his son Teddy had leukemia. In those days, there was no health insurance. You just paid everything out of pocket, and the death rate was near 100%. Since there was nothing the doctors could do, Rick Gurin, Charlie’s friend, said Munger would go into the hospital, hold his young son, and then walk the streets of Pasadena crying.

[01:00:59] Clay Finck: One year after the diagnosis in 1955, Teddy Munger died. Charlie was 31 years old, divorced, broke, and burying his nine-year-old son. Later in life, he faced a horrific operation that left him blind in one eye with pain. So terrible that he eventually had his eye removed. It’s a fair bet that your present troubles pale in comparison.

[01:01:23] Clay Finck: Whatever it is, get over it. Start over. He did it, and you can too. This is all such a good reminder that those who you look up to and are very successful in any field have likely been through those struggles and that pain just as much as you currently are. Gautam writes, through reflection, we learn that adversity is a natural part of life.

[01:01:49] Clay Finck: The purpose of reflecting on adversity is to understand that it’s inevitable, it’s indiscriminate in its arbitrary nature. Bad things can and do happen to good people, but we all have a hidden reserve of great strength inside that emerges when life puts us to the test. You never know how strong you are until being strong is the only choice you have.

[01:02:14] Clay Finck: In the end, we are defined by how we respond to failures and setbacks in life. Indifference towards the things outside our control is the essence of the stoic discipline, and it is one of the most liberating realizations in life. End quote. He refers to this positive attitude as the compounding of positive thoughts in action.

[01:02:37] Clay Finck: As Marco Sous stated, our life is what our thoughts make it. This is because when you change the way you look at things, the things you look at will change. Then he goes on to discuss the compounding of good habits and the importance of putting good habits in place. Once you implement good habits into your life, the positive momentum almost becomes automatic.

[01:03:03] Clay Finck: Rather than focusing extrinsically on your goals and reaching a desired destination, focus more on your habits. Good habits have a way of producing good outcomes over time because of the momentum that good habits create. One of my very favorite James Clear quotes is, “You do not rise to the level of your goals. You fall to the level of your systems.” There’s also the saying that first we make our habits, then our habits make us. There was actually research done that suggested that up to 40% of our waking hours are made up of our habits. When I look at my own life, I’m doing many of the same things at the same time each and every day.

[01:03:51] Clay Finck: So that statistic really doesn’t surprise me very much at all. Buffet has said that the chains of habit are too light to be felt until they are too heavy to be broken. Then Gautam writes, ‘We are all slaves to our habits.’ Once a habit becomes ingrained, it can last a lifetime. So, implement good habits.

[01:04:14] Clay Finck: Most bad habits creep in slowly, so be careful making small compromises. The adverse effect of such actions compounds over time. A single poor habit, which doesn’t look like much at the moment, ultimately can land you miles off the course of the direction of your goals and the life you desire.” End quote.

[01:04:36] Clay Finck: “What makes compounding so powerful is when you take those small incremental steps and small incremental improvements and apply them over a very long period of time. Compounding over periods of time is how an average person with the average intellect can far surpass an exceptional person with exceptional intellect.

[01:04:56] Clay Finck: Peter Kaufman has stated, ‘The most powerful force that could be potentially harnessed is dogged, incremental, constant progress over a very long period of time.’ Time is the great ally of compounding and gives exponential payoffs to those who think and act long term. This is because in the formula of the equation for compounding, the variable for time is in the exponent.

[01:05:21] Clay Finck: Buffet’s wealth is a factor of him having invested for over 80 years. There are investors who have achieved much higher returns than Buffet. But his trick to success is that he has compounded for such a long period of time. Had Buffett started investing at age 30 instead of when he did when he was in his teens, he would’ve only been worth 2 billion instead of 81 billion, which is what he was worth when the book was written, and that is just a staggering difference: $2 billion versus 81 billion.

[01:05:59] Clay Finck: Then there are two final sections here, the first being the compounding of knowledge. Gautam shares one of his very favorite stories of the virtues of building up one’s mental database over time. In the 1993 interview, Adam Smith asked Buffet, ‘If you were coming into the investment field today, what areas would you point yourself to?’ To which Buffett responded that if he were starting with a smaller sum of capital today, he’d do exactly what he did 40 years ago, which was learn about every company in the US that had a publicly traded security and build a bank of knowledge over time.

[01:06:41] Clay Finck: Smith then remarked that there are over 27,000 public companies, and then Buffet responded, ‘Well, start with the As,’ which is just a funny story that I got a kick out of reading. Then the final section of his book here is The Compounding of Goodwill, which is cultivated through giving with no expectation of anything in return.

[01:07:04] Clay Finck: He encourages readers to make connections online and then try and meet those people in person if possible, and make a genuine effort to create strong bonds with people who are on the same path as you. Gautam has countless quotes in his book here, but his final quote is from Gandhi, which describes compounding in all its glory, stating your beliefs become your thoughts.

[01:07:26] Clay Finck: Your thoughts become your words. Your words become your actions. Your actions become your habits. Your habits become your values, and your values become your destiny. It’s such a great quote to end this masterpiece of a book that I thoroughly enjoyed and feel very privileged to have had the opportunity to share all these lessons with you all.

[01:07:48] Clay Finck: I look forward to reading it again someday in the future as well. And then at the very end, there’s an acknowledgement section as well that I think many people would find helpful. He shares all these different people that helped shape his own thinking and you know, helped come up with a lot of this content in his book.

[01:08:03] Clay Finck: I think, for example, he said that Peter Thiel taught him the significance of monopolies, power laws, and highly innovative companies. Robert Cialdini author of the bestselling book, made him aware of the various psychological tactics used by compliance practitioners and Phil Fisher, Chuck Akre and Pat Dorsey among others, taught him how to pick a stock.

[01:08:25] Clay Finck: There are four pages of people he lists here, so it’s just amazing how he lists all these different resources for people to go out and learn more if they’d like to. If you missed any of the previous episodes covering Gautam’s book, I encourage you to go check them out. I’ve been releasing them over the past few weeks.

[01:08:40] Clay Finck: I really appreciate you tuning into my series, covering this book. If you enjoyed it, please feel free to shoot me a message on Twitter. My username is @Clay_Finck , Clay, underscore, Finck. I would love to hear from you, or if you’ve really enjoyed it, please share this episode on your preferred social media platform and be sure to tag me if it’s on Twitter.

[01:09:00] Clay Finck: With that, thank you so much for tuning in. I hope to see you again next week. 

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