[00:01:24] Clay Finck: Making money in the stock market is an incredibly difficult task. If you don’t believe me, consider that many of the world’s greatest investors have made investment decisions that have costed them billions of dollars. Even the best investors have experienced an equal part of failure for every ounce of their success.

[00:01:41] Clay Finck: Buffett and Munger knew that Walmart was a great business, but they didn’t end up buying it. And Stanley Druckenmiller had decades of incredible success as an investor, and he still got suckered into buying tech stocks near the peak of the dot com bubble. If there’s one certainty when it comes to being an active investor, it’s that eventually, we’re going to make multiple major mistakes.

[00:02:01] Clay Finck: And Batnick explains that once you think you have it all figured out, The market will humble you once more. Psychologically, dealing with these failures can be incredibly difficult, as the mistakes are oftentimes self inflicted, and it makes it difficult to deal with these mistakes in an objective manner.

[00:02:18] Clay Finck: The book Big Mistakes has 16 chapters covering the biggest mistakes from all these great investors, and I wanted to start with chapter 1, which focuses on Benjamin Graham. If anyone is going to be forever remembered in the history books of investing giants, Benjamin Graham is certainly going to be one of those people.

[00:02:35] Clay Finck: Batnick writes that Ben Graham is to investing what the Wright Brothers are to flight. And just as their names will be forever linked to the airplane, so will Graham’s to finance. Then later he writes, The most important lesson that investors should take from the person who taught us the difference between value and price is that value investing is not a panacea.

[00:02:54] Clay Finck: Cheap can get cheaper. Rich can get richer. Margins of safety can be miscalculated and value can fail to materialize, end quote. I love how Batnick also pointed out how much different today’s economy is relative to when Graham was investing. Since he was interested in these cigar butt type companies, he looked for companies with these hard assets that could be relatively easily valued.

[00:03:17] Clay Finck: You know, you look at property, plant, equipment, raw materials, inventory. But today, the world’s most valuable companies have immense amounts of intangible assets. Things that you can’t touch, see, or feel. To give an example of just how difficult investing can be nowadays, consider this example that Batnick writes about Walmart and Amazon.

[00:03:36] Clay Finck: Over a five year period, Walmart earned 75 billion in profits, and that was on 2. 4 trillion in revenue. During that same period, Amazon earned just 3. 5 billion in profits, and that was on 490 billion in revenue. And then you look at their margins. Walmart had a margin of 3. 1%, and then Amazon’s margin was 0.

[00:04:01] Clay Finck: 7%. So Walmart earned well over 10 times the amount of profits and their margins were much better. But over that time period, Walmart lost 3. 6 billion from its market cap. And then Amazon gained 350 billion in their market cap. So it’s no wonder so many people thought that Amazon was richly valued for so many years.

[00:04:24] Clay Finck: The world was just in a process. of changing drastically right before our eyes. Anyways, back to Benjamin Graham’s story that I wanted to tell here. Despite being on the Mount Rushmore of investing greats, he made major investment mistakes that went even against his own teachings. Graham started an investment partnership in 1923 and it was in the midst of the roaring 20s.

[00:04:46] Clay Finck: He performed exceptionally well until the market eventually hit its peak in 1929. And then at the end of 1929, Graham’s fund was down 20 percent and he thought that the worst of the bear market was over. He went all in and he even started to use leverage to try and juice his returns. The trouble was, many of these stocks that he owned, they looked really cheap, but they ended up getting even cheaper and the worst of the stock market crash was not over.

[00:05:11] Clay Finck: The Dow Jones collapsed and Graham had his worst year ever, losing 50%. From 1929 through 1932, Graham lost 70%. Just to get back to even his portfolio would have to rise by over three times or 230%. To give you a sense of just how cheap the markets got during that time, Graham wrote the following in 1932 in a Forbes article.

[00:05:34] Clay Finck: There are literally dozens of companies which have quoted value of less than their cash in the bank. This means that a great number of businesses are quoted at liquidating value, meaning that these businesses are worth more dead than alive. From peak to trough in the Great Depression, the Dow Jones lost 89 percent end quote.

[00:05:53] Clay Finck: So 10, 000 that was invested at the top would have dropped to just 1, 100, which is why a generation of investors would never touch stocks again after that experience that would scar them forever. This is a reminder that just because you believe a stock is incredibly cheap, it doesn’t mean that it can’t get a bit more or maybe even a lot more cheaper.

[00:06:13] Clay Finck: The market can stay irrational for much longer than you can stay solvent. What it was that made Ben Graham such a great investor Was his ability to accurately assess value and then invest based on the premise that eventually the price and the value will converge towards each other. When asked why this happens, he stated, this is one of the mysteries of our business, and it is a mystery to me as well as everybody else.

[00:06:35] Clay Finck: We know from that experience that eventually the market catches up with value, it realizes it one way or another. Batnick then writes that, It’s critically important to be aware of value, but it’s more important to not be a slave to it. Graham taught us that there are no ironclad laws in finance and that cheap can get cheaper, end quote.

[00:06:55] Clay Finck: Relative to the other chapters here in the book, Graham’s mistake really isn’t as apparent as the others. He of course suffered an immense drawdown for a few years, but so did practically every other stock investor at that time. So there really wasn’t much he could do to avoid it other than just being in cash or investing in companies that happen to do well during a depression like scenario.

[00:07:14] Clay Finck: Of course, using leverage was a really big mistake in my opinion, and the concept of avoiding leverage is something I think our audience is generally pretty familiar with. The next chapter here covers one of the more brutal stories of investing history, which was that of Jesse Livermore. People love to use these sayings or rules of thumb when it comes to investing, whether it be like buy when there’s blood in the streets or nobody went broke taking a profit.

[00:07:38] Clay Finck: There’s always a deeper level of complexity when it comes to investing, and we should never take these simple. really hard rules too seriously. Batnick writes, no investor is more emblematic of the dangers of heuristics than Jesse Livermore, who made and lost several fortunes, and each time came away with beautifully elegant analysis, end quote.

[00:08:01] Clay Finck: Livermore first got experience in the world of finance at the age of 14 as a board boy in the year 1877. By age 17, he had traded his way to 1, 200 in bankroll and he got the taste of trading success very, very early. After a few years of trading in Boston, he was practically the only person who could consistently make money.

[00:08:22] Clay Finck: So the trading firm just wouldn’t let him come back. So he is forced to move to New York and then start trading there. By age 23, he had accumulated 50, 000. And during his trading, he ended up losing it all in just a few hours because of all the leverage that he used. By age 28, he had bounced back and then he accumulated a bankroll of 100, 000.

[00:08:43] Clay Finck: And then he had this one big trade shorting Union Pacific stock, which would turn 250, 000 into 6 million rather quickly. At this point in his life, he was just addicted to trading in the market, and he was continually searching for his next big win. Because of this really big addiction, he yet again nearly lost all of his fortune, and he was just whipsawing back and forth.

[00:09:06] Clay Finck: And it’s just reminds me of sitting at a blackjack table and you’re continually putting the chips in on the table and you have no willingness to preserve your stack or walk away with big profits. In 1907, just before his 30th birthday, he had yet another big win which took his net worth to 3 million and then it was just two years later in 1909 that he got wiped out completely again.

[00:09:28] Clay Finck: When Livermore was 38, he was over 1 million in the hole and he was forced to declare bankruptcy. Then once the stock market recovered, so did Livermore once more. He was making more money than ever during the Roaring Twenties. Batnick writes, By the fall of 1929, Livermore built up his biggest short position ever.

[00:09:47] Clay Finck: It was a 450 million short position spread across 100 stocks, and he was about to receive one of the biggest paydays of his entire life. From October 25th through November 13th, the Dow Jones crashed 32%. In those 11 days, the Dow fell 5 percent seven times. Livermore then covered all of his shorts and he was worth 100 million, which is equivalent to 1.

[00:10:12] Clay Finck: 4 billion today after you adjust for inflation. He was one of the richest people in the world and this would be the height of his powers. Remember earlier how I said the Dow had fallen 89 percent in the Great Depression? Well, when it finally recovered, Livermore was short the market. Once Livermore realized this mistake, he had gone long at the top during a debt cap bounce, and that was when stocks started to fall again.

[00:10:36] Clay Finck: And already by 1933, everything he had made during that run up through 29. And then that huge amount of money he made during the crash, all that money he made was totally wiped out. So he was short when the market ripped and long when the market crashed. Apparently, much of Livermore’s early trading tactics eventually became outlawed, and he had a really difficult time trading profitably like he did earlier in his career.

[00:11:01] Clay Finck: By 1939, he had had enough, and he ended up taking his own life, and he passed away with a net worth of roughly negative 300, 000, despite being worth 100 million a decade prior. Clearly, Livermore lacked proper risk management. If you continually put yourself in a position to have a small chance of losing everything, then eventually your bad luck is going to come.

[00:11:27] Clay Finck: Always ask yourself when you’re investing, what is the downside of this investment? And what does the worst case scenario look like? No matter how small your chance of the downside, it must be considered. Now I wanted to jump to chapter four on John Merriweather, which teaches us the lesson of a genius’s limits.

[00:11:43] Clay Finck: This chapter harps on the dangers of your own intelligence. And how much of investing success not only comes from making intelligent decisions, but also being disciplined in your investing process. One of the biases we have as investors is that the vast majority of us believe that we are above average investors with above average intellect.

[00:12:03] Clay Finck: But by definition, only 50 percent of us can actually be above average. To illustrate this bias of overestimating ourselves, there was a study done that found that 94 percent of professors rated themselves as above their peer group average, and it’s likely you’d see similar results if you asked most traders and most investors.

[00:12:23] Clay Finck: One of the things that makes investing so hard is that there are so many smart people involved. Batnick guesstimated that 90% of trading volume is done by institutions which are attracting these very smart people, and they’re all competing against each other to some degree. Another issue is that when it comes to investing, it’s practically impossible to distinguish between skill and luck when we have a successful or unsuccessful investment.

[00:12:49] Clay Finck: A skilled investor may have a bad year purely due to bad luck, and an unskilled investor may have a great year purely due to luck. This is where John Merriweather comes into this story. Merriweather founded Long Term Capital Management in 1994 after two decades of investing success at Salomon Brothers.

[00:13:07] Clay Finck: Merriweather pulled together all these super smart people, and it’s the smartest people he could find from these top business schools, and they joined forces with him with the goal of outsmarting the market. It was reported that while Merriweather was doing this trading at Salomon Brothers, he had been paid 89 million dollars, while the CEO was only paid 3.

[00:13:26] Clay Finck: 5 million. In starting Long Term Capital Management, which is quite a funny name given where this story ends, he attracted some of the smartest people in finance that were clearly much smarter than what the majority of firms are pulling in for their talent. And this attracted some of the biggest investors as well, and they raked in 1.

[00:13:44] Clay Finck: 25 billion in AUM, and it became the largest hedge fund to open at that point in time. In the years that followed, they achieved it. exceptional returns. They earned 20 percent in the first 10 months, 43 percent in 1995 and 41 percent in 1996. Their success continued uninterrupted as they managed to quadruple their capital without having a single losing quarter.

[00:14:08] Clay Finck: But eventually, the good times would cease to roll on. Their arbitrage trading strategies started to become pretty well known, and once they started to put on a trade, they would see the opportunity gap start to close. Also, since they managed so much money, it was really difficult to move the needle because there were a finite number of opportunities to invest in.

[00:14:28] Clay Finck: They ended up returning 2. 7 billion to their investors to help alleviate that problem, but they didn’t take down their position sizes at that time. So they had upped their leverage essentially from 18 to one, to 28 to one. In fact, at one point they had $1.5 trillion in open positions, and they were levered 100 to one, which as Livermore taught us is a recipe for disaster.

[00:14:54] Clay Finck: Batnick writes, this leverage would lead to one of the largest disappearing acts of wealth. the world has ever seen. In May 1998, as the spreads between U. S. and international bonds widened more than their models anticipated, long term capital management lost 6. 7 percent, their worst monthly decline up until that point.

[00:15:15] Clay Finck: In June, the fund fell another 10 percent. And they were staring down the barrel of a 14 percent decline for the first half of the year. Russia was at the epicenter of long term’s downward spiral, and in August 1998, as oil fell by one third and Russian stocks were down by 75 percent for the year, short term interest rates skyrocketed.

[00:15:35] Clay Finck: And then the wheels fell off for Meriwether and his colleagues. All the brains in the world couldn’t save them from what was coming. So very quickly, the whole thing came crashing down. By the end of 1998, the fund was down 52 percent year to date. Day after day, they were losing hundreds of millions of dollars before the Federal Reserve Bank of New York would do a 3.

[00:15:57] Clay Finck: 6 billion takeover. Long term capital management was four times bigger than the next largest hedge fund, and the world hadn’t seen any collapse like it. They had 3. 6 billion of capital, of which 40 percent was theirs, and in five weeks, it was all gone. The takeaway here is that the hedge fund manager’s biggest mistake was putting too much weight on their complex models.

[00:16:21] Clay Finck: In their models, they have a view of how much they could lose in the worst case scenario, but sometimes the unthinkable can happen that your models aren’t taking into account. And that led to the downfall of long term capital management. Batnick closes this chapter with, The lesson us mere mortals can learn from this seminal blow up is obvious.

[00:16:40] Clay Finck: Intelligence combined with overconfidence is a dangerous recipe when it comes to markets. End quote. Jumping to chapter 6, this chapter teaches us a lesson of Staying within your circle of competence through the story of Michael Steinhardt. But before getting to Steinhardt, Batnick gives the great example of Buffett staying within his circle of competence.

[00:17:01] Clay Finck: During the tech bubble, while tech was going through the roof and shares of Berkshire were down 50%, Buffett stayed true to himself. He would continue purchasing companies he could understand at a price that he deemed sensible. In July of 1999, Buffett spoke at a conference filled with those in the tech industry, which were newly minted millionaires.

[00:17:21] Clay Finck: Buffett stuck to his guns of being skeptical of these valuations that didn’t make any sense to him. Meanwhile, over the previous 12 months, Berkshire had lost 12 percent of its value, while the Nasdaq rose 74%, Yahoo gained 3%. 350% in Qualcomm gained over 400%. Batnick writes, one of the keys to successfully managing your money is to accept, like Buffett did, that there will be times when your style is out of favor or when your portfolio hits a rough patch.

[00:17:50] Clay Finck: It’s when you start reaching for opportunities that you can do serious damage to your financial wellbeing. Michael Steinhart and his investors learned this lesson in 1994. Steinhardt was one of the early pioneers in the hedge fund industry. In 1967, he launched one of his own funds, and from 1967 through 1995, he earned an average return of 24.

[00:18:14] Clay Finck: 5 percent annually. One dollar invested with Steinhardt all the way through would have turned into 481. Had that dollar been invested in the S& P 500, it would be worth just 19. Of course, any investor that does this well is going to go through some rough patches as well. And that makes it incredibly difficult to stay invested through those tough periods, such as during the market crash in 1987, which Steinhardt’s fund got annihilated in.

[00:18:39] Clay Finck: But Steinhardt’s critical mistake came during the 1990s when the popularity of hedge funds exploded. Because of the spectacular investors such as Steinhardt, hedge funds started to gain a ton of attention, credibility, status, and every quote unquote sophisticated investor wanted to invest with them.

[00:18:57] Clay Finck: Easy money was available for the taking, so Steinhardt launched his 4th fund in 1993 and he had assets under management just shy of 5 billion. This was 200 times the amount of money he had started out with after adjusting for inflation, but his biggest issue was that his specialty was in small and mid cap stocks.

[00:19:16] Clay Finck: This was a field that was becoming more and more difficult to really move the needle on given that he was managing just so much capital. And given his tremendous success to date, he felt confident venturing into these other areas of the market. And he ended up seeing opportunities in emerging markets, which Batnick described as not just a few miles outside his circle of competence, but akin to traveling to the moon.

[00:19:39] Clay Finck: It was so far out of his expertise. Batnick shares a quote from Charlie Munger that if you play games where other people have the aptitudes and you don’t, you’re going to lose. And Steinhardt was playing a game that was destined for failure through these obscure trades such as swaps and directional bets on the debts in Europe, Australia, and Japan.

[00:19:59] Clay Finck: Also, he had built solid relationships with these brokers here in the US, and that gave him an edge because he was able to get in and out of positions rather quickly, but this edge was lost when he explored overseas. Batnick writes, Trouble arrived on February 4th, 1994, when the Federal Reserve raised interest rates by one quarter of one percent.

[00:20:19] Clay Finck: U. S. bonds fell, but not nearly as much as European bonds. The bond market meltdown left a hole the size of Europe in Steinhardt’s portfolio. He lost 800 million in just 4 days after the rate hikes. Putting too much money into something you don’t fully understand is a good way to lose a lot of money. But what’s more damaging than losing money is the psychological scar tissue that remains after the money vanishes.

[00:20:44] Clay Finck: His decision to exit his circle of competence sealed his fate. The episode from 1994 left Steinhardt mentally drained. Those feelings could not be shrugged off any longer. In his words, 1987 had shaken me. 1994 had been devastating. It had taken a part of me that could not be retrieved. Steinhardt and his clients, the ones who had stayed with him anyway, enjoyed a nice comeback in 1995, as they gained 26 percent and recouped much of the losses from the previous year.

[00:21:14] Clay Finck: On the back of this rebound, he decided to retire for good at 54 years old. So Steinhardt, despite having this remarkable career, was permanently scarred by this experience of getting burned badly by venturing outside of his circle of competence. He was suckered in by what looked like an opportunity, and it’s a reminder for us that there will Almost always be a sector or be a part of the market that looks really tempting to jump in on.

[00:21:39] Clay Finck: There’s almost always something that you don’t own in your portfolio, but you wish you owned it because it’s outpacing everything else. Oftentimes, when you feel tempted to hop on a trend, It’s too late to get on and you’re better off just staying with your current approach. And before you venture into something new, be sure you aren’t just doing it purely because of FOMO and that you have a solid understanding of the risks of what you’re getting into.

[00:22:02] Clay Finck: It reminds me of that saying for investors that invest internationally, that when you invest outside of your domestic country, You’re trading the known risks for the unknown risks. And it points to the fact that naturally we tend to know our domestic market a lot better than other markets. So it can feel somewhat comforting to go out and invest in other countries because it appears to be safer from an outsider’s perspective.

[00:22:24] Clay Finck: I wanted to jump in here to chapter eight. This is the chapter that covers Warren Buffett. It’s titled Beware of Overconfidence. At the beginning of this chapter, Batnick talks about the endowment effect. The endowment effect explains how when investors purchase a stock, they tend to value the holding more than when they previously owned it.

[00:22:43] Clay Finck: Psychologically, there’s something that happens when you purchase a stock where you tend to value it more, even though the company itself didn’t change at all upon you purchasing it. It’s similar to how if you placed a bet on a sports team, say it’s playing in the Super Bowl, then you feel good about the decision after you place the bet.

[00:23:00] Clay Finck: You feel much more confident just because you place a bet on a particular team. Batnick writes, when something belongs to us, Objective thinking flies out the window. This also ties directly into overconfidence, which is also a trait that is hardwired into us. For much of Buffett’s career, he really did keep his emotions in check pretty well.

[00:23:20] Clay Finck: When he’d have a really good year, he would tell his investors to not be surprised if a bad year were to come in the near future. In that exceptional results, like what he delivered, should not be expected year in and year out. But of course, not every one of Buffett’s purchases would be a big winner. His costliest mistake of his career was in 1993 with the purchase of Dexter’s shoes for 433 million.

[00:23:44] Clay Finck: The mistake was not only costly because the business would eventually go to zero, but because he was so confident in their long term prospects that he agreed to purchase this company through the issuance of shares of Berkshire Hathaway. The 25, 200 shares he paid in 1993 would be worth 13. 8 billion in 2023.

[00:24:06] Clay Finck: In 1991, Berkshire purchased a company called H. H. Brown. This was a leading North American manufacturer of work shoes and boots, so when he saw the opportunity to buy Dexter, he made sure he did not miss this opportunity. Buffett told New York Times that, quote, Dexter Shoe is exactly the type of business Berkshire Hathaway admires.

[00:24:25] Clay Finck: It has a long, profitable history, enduring franchise, and superb management. In his 1993 annual letter, Buffett wrote, It is one of the best managed companies Charlie and I have seen. seen in our business lifetimes. Now the part that Buffett missed was that us shoe companies would have lower demand over time as the demand for imported shoes would just take off.

[00:24:48] Clay Finck: And these imported shoes had much better economics, mainly due to the lower labor costs associated with creating those shoes. Essentially Buffett and Munger overestimated the moat of Dexter shoe. He saw the tremendous success of HH Brown over the past couple of years. And he got lazy in his thinking when it came to purchasing Dexter.

[00:25:05] Clay Finck: From 1994 through 1999, their shoe revenue declined by 18 percent and profits were down by 57%. And to make matters worse, in 1999, of the 1. 3 billion shoes that were purchased in the U. S. in that year, 93 percent of them came from abroad. And that’s where the low labor cost was, remember. In the year 2000, Buffett acknowledged the massive mistake of purchasing Dexter and the compounding of his mistake by paying for the company with stock instead of financing it with cash or debt.

[00:25:38] Clay Finck: Buffett’s method of dealing with overconfidence is to think of investing as if you were given a punch card with 20 holes in it, and these represent all the investments you can make in your life. And the intention with this punch card is to really think carefully about each investment you make and not take shortcuts in your thinking or your investing process.

[00:25:57] Clay Finck: Next we turn to the big mistake of Bill Ackman, which I’m sure many in the audience know what this one is going to be all about. One of the worst mistakes you can make as an investor is getting emotionally attached to an idea. Or even making an investment essentially a part of who you are. So when people hear about this company, they think about your name.

[00:26:17] Clay Finck: Charlie Munger has talked a lot about having the willingness to part ways with your best love ideas. Psychologically, once we’ve made a personal investment that we own public and we tell our friends or we announce it on a podcast, in my case, it is so, so difficult for us to part ways with it because nobody naturally likes a person who constantly changes their mind.

[00:26:37] Clay Finck: And. Essentially they just constantly flip flop on their ideas. You can think of politicians constantly flip flopping and then people just don’t really like them that much. But with investing, the world is always changing and our opinions must change with the world once we realize that an investment has turned sour.

[00:26:54] Clay Finck: So to Bill Ackman here, he started in the hedge fund world in 1993. At the age of 26, he started Gotham Partners. Batnick describes that they found success early on through the classic old school value investing approach, and that helps them grow from $3 million in a U m in 1993 to $568 million at their peak in 2000.

[00:27:16] Clay Finck: And similar to Steinhardt, he got into trouble by straying away from what he was really good at. They started making these ill timed bets, they ran a really concentrated style, and they got into these illiquid investments, and then investors had had enough. So Gotham was actually forced to shut their doors by the end of 2002.

[00:27:34] Clay Finck: Patnick then describes Ackman as one of the most competitive investors the industry has ever seen. So in January of 2004, Ackman relaunched a fund of his own called Pershing Square Capital Management, which he still manages today. All of a sudden, after he launched the fund, Ackman no longer wanted to invest the old fashioned way of buying these cheap, unloved stocks and waiting for their valuations to re rate.

[00:27:57] Clay Finck: He turned into one of the most aggressive activist investors of his era. For those not familiar, an activist investor is someone who purchases a large stake in a company and then they have the intent of enacting these changes on the company in a way that they think will be more value accretive to shareholders.

[00:28:13] Clay Finck: This could mean that the current business is being mismanaged or some unprofitable business units need to be sold off. Activist investing is of course difficult because you’re essentially telling managers how they should be running their business. But Ackman described himself as quote, the most persistent person you will ever meet.

[00:28:31] Clay Finck: Companies that Ackman had targeted included NBIA Inc. Target, Sears, Valiant, JCPenney, and the most widely known company was Herbalife. So Herbalife was a company that Ackman was very much not bullish on. He was quite a bear. He shorted the company and he made it very publicly known that he had done so.

[00:28:51] Clay Finck: Even though he had no requirement to do it, he didn’t have to file a 13 F letting everyone know he was short the company. He just was very public about it. Now, as many in the audience might know, Herbalife is a Los Angeles based company that sells weight loss products and nutritional supplements. At the time Ackman got into this ordeal, They did 5.

[00:29:10] Clay Finck: 4 billion in sales and they actually had the highest paid CEO in America. Ackman accused Herbalife of being a pyramid scheme and he gave all these presentations all about why he believed what he did about the company. He asked one crowd, has anyone ever purchased a Herbalife product? He described one of their top products as a 2 billion brand that nobody has ever heard of.

[00:29:34] Clay Finck: Ackman simply couldn’t believe that a company could sell 10 or 20 times as much product as their competition, but do so without a single store. And this company actually ended up selling through their independent partners, who then went on and sold that product for them. So they sold the product to the partners, the partners sold the product to the customers.

[00:29:54] Clay Finck: And he found that the vast majority of these distributors really weren’t making any money at all. The money was made for Herbalife, not in people actually consuming their products, but in recruiting all these different distributors who would buy the product from them. Ackman had a 3 hour presentation with 334 slides that showed how Herbalife’s product was over 60 percent more expensive than their competitors.

[00:30:18] Clay Finck: He gets into the science behind the products and every single thing you can imagine he had looked into. The presentations out there actually on YouTube, if anyone wants to watch it, it’s three hours long and that’s how you’ll know that you probably found it. In 2012 on CNBC, he stated, quote, you’ve had millions of low income people around the world who have gotten their hopes up that there’s an opportunity for them to become millionaires or some number like that.

[00:30:41] Clay Finck: And they ended up being duped. We simply want the truth to come out. If the distributors knew the probability of making 95, 000 a year was a fraction of 1%, no one would ever sign up for this. And we simply wanted to expose that fact. The company has done their best to try and keep that from the general public.

[00:31:01] Clay Finck: So from Ackman’s perspective, if most of your distributors lose money, then they’re eventually going to want to part ways with Herbalife. And he called it a pyramid scheme because according to him, if you have all these distributors leaving, then you need to continually get new distributors to come in and then fill in on the sales that had been lost from those distributors that had been left.

[00:31:22] Clay Finck: Ackman also told Bloomberg that this was the highest conviction investment he has ever made. And this whole deal with Herbalife ended up going on for years. He first got into it in 2012, and at one point his short position was valued at north of 1 billion dollars. And with the way he was so public about it, he practically stamped his entire reputation on this bet.

[00:31:43] Clay Finck: After the presentation they did, it actually sent the stock tumbling by 35 percent on the downside, and other investors apparently thought the stock was too cheap. Dan Loeb threw his hedge fund Third Point. He purchased 8. 9 million shares, which was over 8 percent of the business. Loeb said that the short seller’s report had dramatic claims about the company.

[00:32:04] Clay Finck: Then a week later, activist investor Carl Icahn purchased nearly 13 percent of the business. Part of the potential appeal was that if Herbalife stock were to rise by even a certain amount, then that could trigger Ackman to receive margin calls and turn him into a forced buyer of shares, which could, of course, send the stock higher through a short squeeze.

[00:32:24] Clay Finck: This is why it’s so dangerous to short a stock and why most investors should probably avoid ever doing so because the downside risk of shorting is unlimited. Batnick writes the key to successful investing, especially when you’re a contrarian, is to have people agree with you later, but when you’re so public about your investments, whether you’re running a hedge fund or your own brokerage account, it makes it so much harder.

[00:32:46] Clay Finck: Dealing with your own emotions is challenging enough. Dealing with the emotions and the pressure of others is even harder. When we’re verbal about our investments, we lose track of why we’re investing in the first place, which is to make money. If his investors were the only ones who knew about this Herbalife position, he could have easily said we were wrong.

[00:33:06] Clay Finck: Covered his position and moved on, end quote. Now this book by Batnick was published in 2018 and Ackman was still short the company at the time of writing, but Ackman did actually exit this position in Herbalife in early 2018. Long story short, if you’re going to make an investment public, do so knowing full well you may need to change your mind on the company next week if the facts change or if things really start to turn against you within the business.

[00:33:32] Clay Finck: Second, don’t get married to your investments and completely tie your identity to them, because if you do, it becomes psychologically incredibly difficult, if not impossible, to walk away from it. Now, when looking back at some of the best track records from these great investors, Stanley Druckenmiller is one of those investors that comes to mind as having one of the very best track records.

[00:33:53] Clay Finck: According to the book here by Batnick, Druckenmiller achieved a 30 percent average annual return over a 30 year period. Now to put this into perspective of just how impressive this is, 1 that compounds at 30 percent for 30 years would be worth over 2, 600 at the end of that time period. It just almost seems unfathomable that this is even possible.

[00:34:17] Clay Finck: Before getting to the story and the lessons from Druckenmiller, Batnick talks about Charlie Ellis book, Winning the Loser’s Game. And this book explains that in a game like, say, tennis, professional tennis players win points, whereas amateur players lose points. Professional tennis players have this laser like precision through these extended rallies, and then eventually one of their shots becomes just out of reach for the other player.

[00:34:42] Clay Finck: Whereas with the amateur tennis players, their matches aren’t really filled with rallies, but they’re filled with faults, missed shots, and mistakes. This can be directly tied to investing. Amateur investors generally buy stocks after they’ve advanced and gone up. And then they sell them after the decline.

[00:35:00] Clay Finck: Colin Roche, who’s actually a popular guest on our show here, he stated, The stock market is the only market where things go on sale and all the customers run out the store. This type of behavior leads to investors not only underperforming the market, but also underperforming their own investments.

[00:35:17] Clay Finck: Batnick writes, The spread between investment returns and investor returns is known as the behavior gap, and it is a permanent feature in any markets where human beings transact. It exists because the collective behavior of millions can overwhelm our senses. Fear and greed do not respond well when under assault, and the market is notorious for forcing unforced errors.

[00:35:41] Clay Finck: It’s interesting to think about how the market has a way of causing the most amount of pain to investors in the maximum amount of frustration. While the overall stock market tends to increase around 8 10 percent on average per year, it actually isn’t that common that stocks actually achieve these returns in any given year.

[00:35:59] Clay Finck: So 8 10 percent is what you get on average over long periods of time. Most years are either really, really good or pretty mediocre. So in the really good years is when investors, they tend to pile in, they get excited. And then when the stock market falls, investors bail out and it just feeds on itself on the upside and the downside.

[00:36:18] Clay Finck: I think back to 2021, how practically everyone was excited about the stock market and everyone wanted to get invested and find the next hot stock. I actually joined TIP in later 2021 and I still remember people texting me, you know, asking what stock I should buy. What do I think of XYZ cryptocurrency?

[00:36:36] Clay Finck: Now, the reality is that most of the money that’s made in the markets, it’s when you purchase when no one’s really excited about Stocks or when everyone was afraid of stocks in March, 2020. When people aren’t texting you about a particular investment, it’s probably a good chance to take a look at it and see what its valuation’s at when everyone’s really excited about it.

[00:36:57] Clay Finck: That’s probably the time to get out. If anything, I dive into this concept extensively when I covered Howard Marx’s book, mastering the Market Cycle back on episode 5 59. Now, turning back to Druckenmiller, he is widely known for being one of the best global macro investors of all time. Druckenmiller approaches the market from a top down perspective, and he understands the big picture and these big economic sea changes and how they’re going to impact market prices.

[00:37:24] Clay Finck: At 28 years old, Druckenmiller started Duquesne Capital Management in 1981, and right off the bat, he got off to a really strong start, and he had this really good sense of predicting how markets would move. For example, going into October 1987, Druckenmiller’s fund was 130 percent long, and that month is of course when we saw Black Monday strike, and it was the worst day in stock market history as the Dow crashed by 22.

[00:37:51] Clay Finck: 6 percent in a single day. Despite this, he was able to sidestep the market volatility and still ended up making money that month. So entering the month, he was long. 130% going into that month, and he still made money despite Black Monday happening during October. You know, that week was a really, really volatile week, so he was in and out on different trades.

[00:38:11] Clay Finck: Fast forward to 1989, he shorted the Japanese stock market, which G called the best risk reward trade he had ever seen, and here 34 years later, the NIK case stock market still trades below where it traded at at that time. And then Druckenmiller is also well known for his famous trade with George Soros of shorting the British Pound.

[00:38:30] Clay Finck: With 7 billion in AUM, he wanted to sell 5. 5 billion British Pounds short and put the money into Deutsche Marks, and he ran this idea by George Soros. Both Soros and Druckenmiller felt that it was really a sure bet, and even with the Bank of England spending 27 billion in an effort to defend the currency.

[00:38:49] Clay Finck: It wasn’t enough to keep it from just collapsing when the levy broke in the pound crashed. They both made a billion dollars in that trade and they’re both pretty famous for it. Frankly Druckenmiller like all these great investors had his fair share of losses though in 1994 He had an eight billion dollar bet against the yen and the yen ended up rising by seven percent and he lost 650 million in just two days Drunken Miller’s big mistake was during the tech bubble.

[00:39:17] Clay Finck: In 1999, he made a 200 million bet against overvalued tech stocks that ended up rising even more and the bubble hadn’t yet collapsed. This costed his fund 600 million. He had hired a couple of young traders at the time to help him get in touch with the market. And they had drunk the Kool Aid of technology bringing in an entirely new era for investors.

[00:39:39] Clay Finck: Druckenmiller was struggling to find his footing during this time. And meanwhile, these two new young traders, they were just absolutely crushing it by buying into these tech stocks. And Druckenmiller’s ego was personally hurt to have these young guys showing him up on how the game of investing was done.

[00:39:55] Clay Finck: Then prior to the bubble bursting, Druckenmiller told the Wall Street Journal, I don’t like this market. I think we should probably lighten up. I don’t want to go out like Steinhardt, but what he did was the exact opposite. He loaded up on Verisign at 50 a share. And then looking at Verisign stock chart here, it looks like this was around the fall of 1999 when it was 50 a share.

[00:40:18] Clay Finck: The next thing you know, this stock just absolutely took off. It increased by five times by early 2000 to around 240 a share. And then Druckenmiller doubled his bet. To $600 million. He thought that Verisign would be immune to any crash of this bubble, but it definitely was not. After the bubble, bursted Verisign dropped by over 98% to under $5 per share.

[00:40:43] Clay Finck: The fund dropped 21% in 2000, so it wasn’t a totally catastrophic drop. Overall in the portfolio relative to some of these other investors. Druckenmiller really knew better than to think that these tech stocks were cheap by any means. He just happened to act impulsively in light of others getting rich here.

[00:41:03] Clay Finck: Batnick writes, few people are spared from unforced errors. And the way they usually manifest themselves is because we can’t handle people making money when we aren’t. Then Drunken Miller stated, I bought 6 billion worth of tech stocks and in six weeks I had lost 3 billion in that one play. You asked me what I learned.

[00:41:21] Clay Finck: I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was an emotional basket case and I couldn’t help myself. So maybe I learned not to do it again, but I already knew that. Turning to chapter 11 here, this covers the dangers of concentrated investing as shown in the example of Sequoia.

[00:41:40] Clay Finck: Now, diversification is one of the more widely known rules of the game of investing. The last thing you want to do as a relatively new investor is jump into this game of investing, put all your money into one stock, and then watch your entire portfolio collapse because you’re too concentrated and too overconfident on that one pick.

[00:41:59] Clay Finck: On the other hand, most of the returns in a portfolio are going to come from a select few number of names. If you’re good at individual stock selection, then oftentimes your best

[00:42:16] Clay Finck: tributes. 9. Fair Traffic Potential The most powerful things on advice, all have to do with how you’re treated. It is almost impossible to own or deal with personal and job needs. Then it’s practically impossible to have a portfolio wiped out if you’re well diversified across sectors and asset classes.

[00:42:30] Clay Finck: But to get rich relatively quickly, then one of the best means of doing that is to concentrate your portfolio. par So what have you got? Tesla and SpaceX equity ownership. Jeff Bezos, he owned Amazon stock. Buffett owned Berkshire. You know, there’s so many examples of this. I’m also reminded of this incredible stat that since 1926, just 4 percent of stocks have accounted for all the gains in the stock market.

[00:42:54] Clay Finck: So if you’re going to concentrate to hit it big, you’re going to need to own part of that 4 percent of companies that have those super normal returns. In hindsight, these big winners, they look really obvious. But in real time, they aren’t so apparent. The trouble withholding the big winners is that they almost also have these big, big drawdowns.

[00:43:13] Clay Finck: And the reality with drawdowns is that when a company’s stock gets cut in half, most of them end up not recovering. So it can be really difficult emotionally, psychologically, to hang on during that volatility. And here enters Sequoia. Bill Ruane was the investor that Warren Buffett recommended people invested with once he wound down his partnership in 1969.

[00:43:33] Clay Finck: Ruane’s the one that managed the Sequoia fund. Over 47 years, the Sequoia fund outperformed the S& P 500 by 2. 6 percent annually. So Bill ran a really, really successful fund here. In 2010, Sequoia added a large position to Valiant Pharmaceuticals at 16 per share. The stock gained 70 percent that year and it quickly became the fund’s Second largest holding.

[00:43:57] Clay Finck: Then in the first three months of 2011, it gained another 76%. What Sequoia liked about Valion was that they didn’t need to invest heavily into research and development like many other pharmaceutical companies, what they would do is buy existing companies with approved products and then raise their prices of those drugs.

[00:44:15] Clay Finck: For example, when Valiant bought Medicus, they increased the price of their drug from 950 to 27, 000. Sequoia described Valiant CEO Mike Pearson as exceptionally capable and shareholder focused. Politicians, of course, see companies like Valiant as Price gougers who, you know, they have these predatory pricing practices that many would call unethical.

[00:44:38] Clay Finck: Then in October of 2015, Citron Research published a report accusing Valiant of accounting fraud and comparing them to Enron. That day shares of the company fell by 40 percent before recovering to only being down 19 percent that day. When Valiant shares would continue to fall and they were down by 50 percent accusations of fraud were just tormenting the company.

[00:44:59] Clay Finck: And Sequoia put out a letter reiterating that Valiant’s management team had done a masterful job. With their high conviction in the company, they doubled down and they increased their bet, making it 32 percent of Sequoia’s assets. Thomas Heath from the Washington Post, he described the situation as What Sequoia married itself to was an offshore drug company that borrowed heavily to buy other drug companies, cut costs and research, then raised prices on many older drugs to astronomical heights.

[00:45:30] Clay Finck: 8 months after defending the CEO in the company, Sequoia would end up exiting their entire position. I pulled up the stock chart here of this one too, and it looks to be under the ticker BCH now, and it’s just a Insane chart. You have this massive runup from 2010 through 2015, and then this thing just collapses straight down.

[00:45:52] Clay Finck: August, 2015, it was around $250 a share, and Sequoia sold their shares after a 90% drop in the high $20 range. And this looks to be around the early 2016 timeframe. We always hear about the great investors who use concentration to their advantage, but it’s also important to remember that there are going to be a lot of investors who concentrate their portfolios.

[00:46:14] Clay Finck: And it ends up working against them because their larger positions ended up being bad bets. Sequoia’s concentrated strategy worked well for a really long time, and then it eventually came to tarnish them severely as their assets under management fell by almost half from 9 billion to under 5 billion.

[00:46:32] Clay Finck: When you look at the stock chart, and you look at companies like Apple or Microsoft, Essentially, they’re just going straight up and to the right. And remember that for every Apple and every Microsoft, there are companies like Valiant and companies like Enron that just fell off a cliff almost overnight and they lost investors billions.

[00:46:50] Clay Finck: Transitioning to another chapter here, one of my very favorite stories here from the book was the story of John Maynard Keynes that was covered in chapter 12. And this chapter is titled The Most Addictive Game. The reason many of you are listening to this episode is likely because You just love the game of investing.

[00:47:07] Clay Finck: That is certainly why I’m a host here at TIP and sharing all these lessons from all these investing greats and these great books. It’s a game that I just find really fascinating. And ironically, the more I learn, the more I realize I need to learn. Paul Tudor Jones explained in the 1987 documentary titled Traitor.

[00:47:26] Clay Finck: During my second semester, senior year in college, he always said, I’ve always liked backgammon, chess, those types of games. And he said, if you think those are fun. If you really enjoy that type of stimulation, then I’ll show you a game that is the most exciting and most challenging of all. In here, of course, he’s talking about the stock market.

[00:47:44] Clay Finck: In Paul Tudor Jones, he has said that once he hits a certain mark in terms of wealth, he would eventually retire and just quit the game. But in 2023, he’s worth over 7 billion and he still manages money for a living. With 7 billion in his name, to give you a sense of just how much money this is, he could spend 100, 000 every single day, and it would still take him 191 years until he runs out of money.

[00:48:11] Clay Finck: So it’s safe to say that he isn’t investing just for the money and what the money gives him directly. Batnick writes, this is the most addictive game on the planet because it’s a game that never ends. Then Batnick talks a bit about how the odds are determined in the stock market. He uses the example of pretending you knew with complete certainty that Apple’s earnings were going to increase by 8 percent every single year for a decade.

[00:48:37] Clay Finck: And he asks you to think about whether that would give you confidence to buy the stock or not. And he argues that if you knew earnings were going to increase by 8 percent over the next decade, that shouldn’t give you confidence to buy it. Because it depends how fast the market expects Apple’s earnings to grow, and it also depends how fast the overall market is growing.

[00:48:56] Clay Finck: He’s making the point that even if you know the number one driver of stock returns with certainty, which is a company’s earnings, then that still wouldn’t tell you whether you’re making a good bet or a bad bet. And the other missing ingredient that can’t be determined with a model is investors moods and their expectations.

[00:49:13] Clay Finck: Batnick writes, With investing, the odds are determined by investors expectations, and they’re not published on any website. They’re not quantifiable because they’re subject to our manic highs and depressive lows. You can have all the information in the world. But humans set prices, and decisions are rarely made with perfect information.

[00:49:33] Clay Finck: Then he ties in John Maynard Keynes here, and all the great work he has done for us. Keynes wrote several international bestsellers, revolutionized institutional asset management, and practically built the global monetary system as we know it. And then there’s a quote from Buffett here that he has famously said, If you understand chapters 8 and 20 of the Intelligent Investor, and chapter 12 of General Theory, which was written by Keynes, you don’t need to read anything else and you can turn your TV off.

[00:50:00] Clay Finck: So clearly, Keynes is a pioneer in the investing space. He started out his investing career actually investing in currencies. He was a student of markets, and he started to earn a lot of money from book royalties and speaking engagements. So he directed his attention to where he felt like he had an edge.

[00:50:18] Clay Finck: He ended up not doing very well in currencies. So then he transitioned to commodities using a top down macro approach. And in trading commodities, he lost 80 percent of his net worth when those crashed during the 1920s. So he was still trying to figure out what approach worked best in markets. In talking about this macro approach to investing, Batnick writes, figuring out how interest rates affect currencies and how labor affects prices and how all of this affects our investments.

[00:50:47] Clay Finck: is tantamount to putting together a three dimensional puzzle where the pieces are always moving, end quote. At Keynes College, Keynes was responsible for managing the endowment fund, and he had trouble there as well, at least early on. And this is no surprise, as the Great Depression was just around the corner.

[00:51:04] Clay Finck: The fund was highly levered going into it, and it lost 30 percent in 1930, another 24 percent it lost in 1931. In his macro insights, after that crash, they weren’t really helpful either as he expected low interest rates to help fuel and boost the economy. Batnick reflects on this saying Keynes had accomplished more in 10 years than most economists would accomplish in a lifetime.

[00:51:28] Clay Finck: In brilliant as he was, His superior intellect did not provide him with superior insights into short term market movements. End quote. Initially, he thought that this frequent trading would benefit him and allow him to achieve his own destiny, but his returns through this short term approach didn’t suggest that to be true.

[00:51:48] Clay Finck: Then he did a complete 180 degree turn in his approach. Instead of making these short term speculations on currencies and commodities, He shifted his focus to being a long term investor in public equities. He put his ego to the side, and he gave up on trying to forecast interest rates, forecast currencies, and how that would affect the economy.

[00:52:09] Clay Finck: He wanted to buy businesses where he believed that the assets and the earning power of those businesses justified it trading well below its underlying value. Then Batnick has this great piece that summarizes the takeaways from this chapter as well. He writes, quote, The intellectual flexibility for a macro economist, one with a huge ego, no less, to shift from a top down to bottom up approach is truly remarkable.

[00:52:35] Clay Finck: He surrendered to the reality that forecasting investors moods is nearly impossible, and it’s mostly a waste of time. Everybody likes to think they’re long term investors, but we don’t pay enough attention to the fact that life is lived in the short term. Long term returns are all that matters to investors, but our portfolios are marked to market every day.

[00:52:57] Clay Finck: So when short term turbulence arrives, long term thinking flies out the window. Keynes referred to our tendency to get swept up by the short term thinking as animal spirits, which he described as the spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by qualitative probabilities.

[00:53:20] Clay Finck: Then from 1928 through 1931, the endowment fell by 50% relative to the 30% fall for the UK market. However, from 1932 through 1945, he grew the fund by 869%, while the UK market only grew by 23%, that’s an average annual return of 19% for Keens and just 2% for the overall market. He was able to improve his investment results because he quit trying to play the impossible game of trying to predict the animal spirits of the short term movements, and he was able to stick with the long term approach when it wasn’t working well, knowing full well that eventually gravity would take hold and give the value to businesses that they deserve to be valued at.

[00:54:05] Clay Finck: Through this approach, he’s able to just roughly assess what a business is worth rather than needing some precise figure. He’s known for saying that it’s better to be roughly right than precisely wrong. He also discovered that playing this long term equity investing game, it was much more winnable and you just had to roughly assess the value of these businesses rather than speculate on where the Japanese yen should be trading at exactly.

[00:54:31] Clay Finck: Then in the final chapter of the book here, Batnick explains how he has made many of the classic mistakes that many investors make. If you’re listening to this episode and you do implement some of these strategies that he mentions, maybe successfully, maybe unsuccessfully. This isn’t my way of saying that these are the wrong way of going about things.

[00:54:50] Clay Finck: But just that many have found, Batnick concluded that through experience, the odds really aren’t stacked in your favor in many of these investing strategies. He tried his hand at trading, investing in triple leveraged ETFs, buying options, following the investment picks of people on Twitter. And I’m sure many people in the audience, myself included can relate to at least one of these methods that, you know, it’s kind of seen as something that’s, A way to get rich quick, but you , most people end up losing a lot of money.

[00:55:18] Clay Finck: The big takeaway is that every single one of us has probably made a big mistake in investing at some point in their careers. Understand that we’ve all been there and the most important thing is to reflect on those mistakes and see what can be learned from them. Batnick ends the book with, The difference between normal people and the best investors is that the great ones learn and grow from their mistakes, while normal people are set back by them, end quote.

[00:55:44] Clay Finck: All right, so that wraps up today’s episode. This was a really fun one to put together, so I really hope you enjoyed it as well. Michael Batnick wrote a great book here, and we’ll have that linked in the show notes for anyone that’s interested in picking it up. I definitely thoroughly enjoyed the book, so if you enjoyed this episode, I think you’d like the book as well.

[00:56:01] Clay Finck: Thanks for tuning in, and I hope to see you again next week.

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