Stig Brodersen  6:11  

Yeah, and on that note, I think that one of the common denominators was that they would keep updating themselves, they keep learning. And that I think that was why they were talking so much about their own mistakes. 

There was also something Ray Dalio was talking about that he was really learning from his mistakes and at the very beginning and over talk more about Ray Dalio–but he said that in the very beginning, he was writing down his mistakes and how he did it, but he also soon figured out that he didn’t have time enough to do all the mistakes in the world. 

That was simply to sort of approach so he had to do something different to capture all the mistakes, but he kept talking about his mistakes. I’m thinking if I’m Ray Dalio, and I’m worth like $18 billion. I’ll probably be talking more about how successful I am or why I’m successful, but he didn’t do that. And there was the same thing for all the people in the book that kept talking about the failures and how they learned from that mistake. And I just thought that was really profound.

Preston Pysh  7:10  

Well, okay, so the first point is asymmetrical trades and how they’re always trying to look for those big opportunities. The next one that we’re going to talk about is whether you’re right or you’re wrong, and that it really doesn’t matter. All that matters is whether you’re actually able to beat the market. 

And so, this idea was something that you saw a lot of gentlemen in this book talk about, and I completely agree with it because you can have the best theory in the world. You can have–let me give you an example. So Stig and I really enjoy accounting and people that have this accounting background, typically like to go in and determine what they think the value of a company is. That’s really the essence of the Warren-Buffett-approach. 

And so, we’re very quantitative people. We like to get in there. We like to see what we think the cash is going to be, then we discount those back to the present day value and we come up with this value that we think that the company’s worth. So let’s say we come to the determination that we think the company’s worth $70, at a certain discount rate, and it’s currently trading on the market for $50. We think that the company might be undervalued by $20. It doesn’t matter whether we’re right or wrong. It matters whether we hold that position long enough that it actually becomes worth $70. That’s the difference between being right and wrong and being able to make money in the market. 

And that’s what these gentlemen were all saying in the book–you can have the best philosophy in the world but if you can’t stand by it until you actually get results, you’re probably going to not last very long in being a stock investor. So, I really liked that point because it is so true and you see a lot of academics specifically and I don’t mean the bash at the academic world, but you see a lot of academics that come up with all these great theories, but you know what? If you don’t know how to apply it in the real world, so you can actually make money, the theory is worthless in an application. 

Okay, so moving on to the next thing that we had, this is one that we’ve been saying probably a lot on the show. So we’re going to probably breeze over this pretty quickly but something that we saw that was really interesting amongst all these different traders was the fact that they are using a strategy that works for them. 

When you look at each person, each person had a different approach. And each person had results to back up that their approach works, like there’s no disputing that what they’re doing is a successful way to invest. So for me, it was just a really good representation that you’re seeing in the book. You’re seeing, hey, this guy’s successful, the next guy’s successful, and they’re implementing strategies that are just so different. And you look at their personalities– the one guy they talked about his personality where he’s yelling on the phone and he smashed, I don’t know, 25 phones or something like that. So his personality’s just really rambunctious. But when you look at a guy like Warren Buffett, it’s completely different. 

Now, I’m sure Buffett’s returns are infinitely better than this other gentleman that I’m referring to but the fact of the matter is this guy was successful. He was a successful trader. Now, you might not agree with his approach in the way that he acts in the office but you can’t dispute the fact that the guy is not implementing a strategy that beats the market. And so, my whole point in saying this is his personality is completely different than another person’s personality, which is different than the next person. 

You have to kind of match your personality with your investing approach. And something that I liked about the book is you can look at these different gentlemen say, hey, I’m a lot like this guy. That’s kind of the way I see the world and maybe you can dig into his approach a little bit more. That’s probably the part that I think is good for maybe early investors. They’d be reading this.

Stig Brodersen  10:47  

I was really excited reading this book. How it happened was actually that Preston sent me an email that he would really eat this burger and soI was really excited about it. Then I saw it was like, 16 hours. I’m listening to all my books. And it’s just, oh no, 16 hours that’s a long time. 

But I think, in my opinion, it’s almost like the shortest book I ever read because it was so good, and I had to cancel appointments. This was just a fantastic book. I was just eating it up. But the funny thing is that there’s like 15 people, and I probably say I could implement strategies from one of them. One and a half, perhaps. 

Preston Pysh  11:50  

Yeah. 

Stig Brodersen  11:26  

I mean, a lot of these strategies that they were talking about, even though that’s where you’re headed, did a great job about making more symbols in detail. I do consider myself a somewhat intelligent person, but I had no clue how they did it. They were talking about how they were trading all of these options and how they’re trading volatilities and I don’t know, I don’t know. What about you, Preston, were you thinking: “Yeah, this is so obvious, why should we be doing that?” Or is it just me?

Preston Pysh  11:53  

I got the exact same impression from this book. So I’m reading it and it’s just like, I’m like, wow. Like, really? Is this really how this guy is doing it? There were times there were a few people in there, I was like, there is no way that strategy could last over the long term. And then you’d be like: and so he’s been doing this for 25 years. He’s like, what? But yeah, no, I love the book because it really kind of opened my eyes to the fact that there are people out there that can do some crazy stuff and still be successful in their approach. 

I think if you would have told me that somebody had some of these different approaches, I would have said, there is no way that will last over the long term and so I’m obviously wrong because there’s proof in their performance, but I’m right there with you Stig. There was maybe a couple, two, maybe, three people that I’d say, yeah I think that that’s probably something that I could implement into my own approach.

But don’t take that as you should avoid reading the book altogether, because what I really liked about the book was that it really challenged a lot of my own ideas, and I love that. I really like when that happens because that’s where you’re able to uncover truth in your own life and your own approach. That’s what I really liked about it.

Stig Brodersen  13:13  

Yeah, and just another find on that because I was thinking to myself, who would I invest with if I had to invest in some of those–some of these people here and I gotta say, someone like Greenblatt or a lot like his work and someone like, like Ray Dalio really impressed me. I knew them a lot beforehand, but I don’t think I would be comfortable investing with some of the other guys, even though that’s been in your *inaudible* for like 20 years because, basically, I don’t understand what they’re doing and how it works like it does. 

[It’s] like you will have someone saying, “The thing was *inaudible*.” Yeah, so whenever the market has dropped three days, I will usually go long because that’s just my experience that it will go. It will make sense to do that and I really don’t want to give that guy my money, right? I mean, it doesn’t make any sense to me. 

Preston Pysh  13:59  

Come on. Now I felt the same way man. I was like, he’s like, really? Like, are these guys–I wouldn’t be comfortable saying something like that, even if I did believe it, and I mean, it’s in the book. These guys are saying some of this stuff and I liked it though. I thoroughly enjoyed reading some of these stories because they were very surprising. I think some of them were really surprising. 

Alright, so this next point is one that I really want to talk about because I think this is very important. So one of the gentlemen, I forget which one it was–there are three different ways to beat the market. You can pick stocks better, that’s one way. That would really kind of go into, maybe the Warren-Buffett approach. 

He’s the master of picking the stocks that are better than the other ones on the market. That’s why he outperforms it. The next approach is that you can time the market better. I think if you tell somebody that you know when the market’s going to hit a top or a bottom–how much do you believe that person, Stig?

Stig Brodersen  15:04  

I don’t know. Do you think people would believe us when you say the market is overvalued?

Preston Pysh  15:08  

Well, I think there’s a difference in saying that you feel like the market’s becoming overvalued and you’re calling a top or a bottom.

Stig Brodersen  15:15  

Okay, I agree with you.

Preston Pysh  15:18  

And so, I think that if you have a person that tells you, hey, we are at the top, baby, you need to sell, I think you need to run away from that person as far as you can get. If you’re trying to pick stocks better than the other person, I think that that’s hard to do. I think it can be done, but I think it’s hard to do. If you’re trying to time the market, I think that’s almost impossible to do. 

Okay, and so then the third approach is you can adjust your exposure at a better point in time. If you’re looking at those three different options, the first two are extremely difficult to do. The third one, I think, is a lot easier to do where you are again, limiting your downside. 

When you look at all these gentlemen, the one thing that they really had in common was they were adjusting their exposure whenever they felt like they were in risky times or high overvalued times. And because they were adjusting that exposure into something that was much safer that would protect their principle, they were able to really circumnavigate all these financial storms, like 2008. 

A lot of these guys were in the green in 2008, 2009. I think a lot of that had to do with they were not in a position where they were trying to get their money out after the market had already gone down 25%. They had adjusted their exposure to equities, or whatever the big risk at the time was and they were in a position that they were going to just, basically protect their principle during those periods of time. I think that is a huge learning point that people can really take away from this book. 

The next point that we have goes hand-in-hand with that one and that these gentlemen were always preparing themselves for “The Black Swan.” I know we’ve mentioned that book a few times and to be honest with you, Stig and I have that on our list to go through an entire review of “The Black Swan” because that was one of Jeff Bezos’s favorite books. I think Michael Bloomberg also subscribes to the lessons in that book. 

But anyway, these gentlemen were always prepared for that one big event that they could not predict. And if that event did hit, they were not going to lose 50% of their net worth. They were only going to lose a very small percentage of their net worth if that black swan would come along. So I found that to be a very important point for people that really have focused portfolios, Warren Buffett talks huge about having a focused portfolio. 

But at the same time, Warren Buffett also has, what is it 70 operational subsidiaries and I don’t even know how many non-operational subsidiaries. He’s diversified. Don’t think for a second that he’s not diversified. The real point here is you got to be prepared. If let’s say, half of your portfolio is on one particular pick, we don’t see that amongst any of these people. They do not have that much focus. They have, maybe, 10%. Maybe 15% at most. When you’re doing that, you’re protecting yourself from that big catastrophic event that could wipe you out. 

The last thing that we’re going to talk about is this idea of the efficient market hypothesis. Everybody that’s a Warren Buffett fan knows how much he dislikes the efficient market hypothesis. And you know what? We found that same theme amongst every single person in this book. For anybody who’s not familiar with the efficient market hypothesis, the idea is quite simple, It’s just that, at any given point in time, the market is properly valued. 

So right now, wherever the Dow Jones or the S&P 500, whatever metric you want to use for the equity market in the United States, these people in academia is pretty much the world these people live [in]. So, all Stig’s people. I’m just kidding.

Stig Brodersen  19:04  

Thank you very much, Preston.

Preston Pysh  19:07  

I have nothing against the academia. I truly value what they do, but this is one of those things that I think a lot of people that you see a lot of conflict between the people that are in application mode, sitting on Wall Street, running these big companies that are making large amounts of money. They go toe-to-toe with all the academia that believes that the efficient market hypothesis is real and actually works. So Stig, I know you got some points on this.

Stig Brodersen  19:35  

Yeah, I gotta give a shout out to Professor because he taught everybody, including me, of course, that we had to believe in the Efficient Market Hypothesis. And every time we talked about this, he always ended his sentences with this: “Investment bankers buy and drive Ferrari, and I drive a Kia, but I just want to say that the market is efficient.” 

And I think there was a strong belief that he could observe that a lot of people in the stock market were rich and hip than he was, but he just really felt that there was nothing as well-proven as the efficient market hypothesis. So, it’s kind of contradictory. 

And I remember back when the market crashed badly in 2008, we were still told that it was because the market was efficient. And it just didn’t make sense to me. How can you cut the market in half and say it was efficient before and efficient after? That just doesn’t make sense to me. 

Preston Pysh  20:32  

I think even the academia, I mean, they tell you that, but your professor said and that’s why I drive it. So he knows that the model kind of works. And I think we talked about this in a previous episode where maybe it was Jim Rickards, or I forget…maybe we even read it in this book. 

I don’t remember where I read it, but somebody was talking about, the reason that academia uses this model is because It’s the only model that they can apply mathematics to. So he get into something that has an uneven distribution. The mathematics on everything just kind of breaks down. 

And so, how are you going to teach that as a professor when you’re trying to teach your students the different models if they can’t back it up with mathematics? Well, that doesn’t work. So, you kind of have to subscribe to this efficient market hypothesis in academia because you got to be able to do the mathematical models and grade the homework assignments, I guess.

Stig Brodersen  21:28  

Yeah, we had one of the investors in the book–he was being tested in the efficient market hypothesis back in college, and he refused to give the right answers. It was just hilarious. He was putting a note on the front page of his test and he was saying, I don’t believe in the efficient market hypothesis, and this is why. And of course, he failed the course. But I just really liked that. 

Preston Pysh  21:54  

I would have failed them.

Stig Brodersen  21:56  

*inaudible*. Yeah.

Preston Pysh  21:57  

No, I wouldn’t have. All right. So Let’s talk about where there’s a really, really good example in this book that I absolutely love that just smashes this Efficient Market Hypothesis with a hammer. This is this gentleman, Edward Thorp is his name.

Edward, for anybody who knows who Edward Thorp is, he wrote a book called “Beat the Dealer”. And we’re going to talk about this a little bit more, later on. Edward Thorp has beaten the market 227 months. He has 227 winning months out of 230 months of trading. If we were going to use a binary–let’s just say true or false kind-of-prediction:is he going to beat the market or is he not going to beat the market in this particular month, and you got 220. 

So, if we were going to turn that into like a heads or tails flip of the coin, if you were going to flip a coin 230 times and it landed on heads, 227 times, you’d either think there’s something wrong with that coin or there’s something else going on here because in order for that to happen, it’s a one times 10 to the 63rd power chance that you would actually do that. So for anybody that’s a numbers person, the probability is pretty much impossible. That is just insane odds. 

And I think that when you look at him and you look at all these other people out there that have similar numbers, like Ray Dalio. I think he’s only had what, two or three down years and like 35 years of trading or something like that? It’s totally crazy. It’s totally nuts. 

The fact that you have so many people that are doing this, I think just absolutely shatters the idea that the efficient market hypothesis is a real model that works or that represents what’s happening, in real terms. I just don’t see that to be the truth. 

Let’s keep talking about Edward Thorp. Edward Thorp was probably one of the more interesting people that they talked about in the book and the reason I felt that way, it’s just because of the way that they started off talking about them. Edward Thorp is just a mathematical genius. He is a statistics guru. He kind of got his start by really dispelling some of the ideas that you can’t beat casino odds. He took it upon himself to try to mathematically prove that certain games, Blackjack, and surprisingly Roulette–he felt that he had a formula that he could beat the casino in those two games. 

So with Blackjack, he is the guy who developed the idea of counting cards. There was a movie. What was the name of the movie that they had the MIT students go out to Vegas? Do you know the name of that, Stig?

Stig Brodersen  24:46  

Yeah, it was 21. The one with Kevin Spacey?

Preston Pysh  24:49  

Yeah, 21 with Kevin Spacey. So that method for beating Blackjack was Edward Thorp who wrote this book. The name of the book was, let me see here in my notes–it’s “Beat the Dealer.” Edward Thorp came up with that strategy. So in addition to that, Edward Thorp thought that he could beat roulette. 

And so, I’m reading this book and I said, “How in the world could you beat roulette? That is just so mathematically improbable.” I want to say the odds are something like around 47% for you to win, if you’re just playing like the blacks and the reds because of the green element on the roulette wheel for anybody that’s familiar with roulette. But Edward Thorp had a different opinion. The way he did this–and they talk about it in this book. 

It’s fascinating, the interview. He talks about the idea that if he could figure out the velocity of the ball, spinning around the wheel, if he knew how fast that ball was going, he could, maybe (and this was his theory) he could maybe determine where the ball would land on and on which number. So what he did–this is amazing. What he did is he put a device in his shoe that he could click with his foot. What he was doing is he was timing the velocity of the ball going around the roulette wheel. 

So, let’s just say he was using the green mark on the wheel, as like a point that he could mark against the ball as it was rolling in the opposite direction. So he had marked it when it passed that the first time and then when it passed it the second time, he clicked the button a second time. 

And then, I think it was maybe a secondary person (I can’t remember how it went exactly), but there was a secondary person that knew the velocity and the probability of where that ball and the number that that ball was going to land on, and then they would place their bets. And he says that in this book, he says that he was able to prove it out. He was able to implement this strategy successfully and the rest is history. 

So, this is the kind of guy that you’re dealing with and this is also the same guy that beat the market 227 months out of 230, with his strategy. And if I remember right, he was doing it through options. He was basically an options expert. And he was implementing option strategies that were just beating the pulp out of the market. So that was an amazing story in his book. I would argue that the book was worth buying just for that story alone, where he discussed Edward Thorp.

Stig Brodersen  27:19  

Yeah, and I think his humor was fantastic, because he was saying, “I can understand why the casinos are so mad at me. Yes, there might be a few that can use my system and the casino to lose a bit of money,” but he was saying, there are so many people who come to Vegas and think they can beat the house now because I told people that they can’t do that. And the casinos making much more money out of that than they’re losing to someone like me. So just like that an *inaudible* that he was having.

Preston Pysh  27:46  

This is a good story. Alright, so let’s go on to– just so you guys know, we’re in the second part of the segment where we’re talking about a few of the people that we really liked in the book. So the next one we’re going to talk about is Ray Dalio. I want to come clean because whenever we did the Tony Robbins book, this was on episode 18, where we talked about Tony Robbins new book called, Money, he talked about Ray Dalio ’til he was blue in the face. And now, I feel like I’m the person who’s talking about Ray Dalio ’til I’m blue in the face. 

And the main reason why is if you remember back to that episode Stig and I were really kind of beaten Tony Robbins up and Ray Dalio up because of the fact that he said that he would invest in gold. 

He said that at the time, what was it 7.5% of the portfolio should be in gold. Is that what he said? So, for me, I hate eating crow and going back on anything that I say but at the same time, I feel like I have a deep obligation to be honest with people here and tell you kind of the way that Stig and I have been looking at things. 

Ever since that interview, whenever Ray Dalio, this gentleman who has a net worth–personal net worth of $16 billion, he manages the biggest hedge fund in the entire planet–said that he would have 7.5% of his portfolio in gold. I did not understand that for the life of me. I was like, why in the world would this guy be saying that? 

I mean, for the last, what would it be five months? I have been researching the living daylights out of Ray Dalio and trying to read every single thing I can get my hands on with this guy to try to understand why he had that opinion, and I feel like I totally understand his opinion now. 

It really comes down to the fact that Ray Dalio got his start as a commodities-and-currency Trader. Ray Dalio understands currencies. He understands commodities very well. He started this company called Bridgewater, which we’ve talked about a lot. We’ve told people about the video that he made and his company currently has $120 billions in assets that they manage, which is just unprecedented. 

What’s even more unprecedented is his performance. Okay, so when we talk about Ray Dalio’s performance, let me give you a few stats here so you would understand the magnitude of his performance. So he has a fund, then it’s called the Alpha Fund and this fund tries to perform it 18% annually–is what this fund tries to do. 

In 2008, when the market was down 50%, his fund returned 8.7% in the green. Okay, so that’s like beating the market by like 60 to 70%, depending on which index you’re using. In 2010. Okay, just after, everything had a total meltdown, he had a 44.8% return. That’s totally insane. 

In 2011, when the market was down, a little bit that year, he was like up in the 30 or 40% range. Okay, so his returns are totally astronomical. His approach is so much different than Warren Buffett. 

Warren Buffett is a micro guy. He’s looking at the individual companies. He’s trying to find companies that are undervalued when you’re comparing it to a 10-year treasury, but Dalio, what he’s doing is he’s looking at the macro picture. He is a macro trader. And I’m going to try to explain his investing approach a lot better for people so that they understand this. 

The first thing you got to understand with Ray Dalio’s approach is that he breaks things down into four different quadrants, and he uses two different things to determine that. The first thing that he looks out is inflation for whatever particular country that he invests in. 

And just so people know, his bond is completely computer managed. He is not picking the companies like Warren Buffett is. He has a computer algorithm that is picking stocks completely hands off, and this thing is making the selections for him. 

In the interview in this book, he talks about that. He talks about How 99% of all his trades are done by a computer. I find that absolutely fascinating. But anyway, going back to his approach and how he’s doing this. So what he does is he looks across the world. He’s not just looking at the US. He’s looking at all markets across the world, and he’s distributing all of his picks and all these different markets to mitigate his risk. 

So, we were talking about probabilities earlier. This is where Ray Dalio comes in. He has just countless, thousands of different picks–now they’re nested inside of ETFs and other vehicles, so he’s distributing that across many different platforms. He’s not completely in equities. 

In fact, a lot of his money is not in equities, and I think that that’s something amazing. So back to this quadrant. The first variable that he’s looking at is inflation. Is inflation rising or is inflation decreasing? Then, the other variable that he’s looking at is the Economy GDP. Is it growing or is it slowing? Whenever you have these two variables, you’re able to break things into a four-piece quadrant. 

Let me give you an example. If he finds an economy in the world that has a rising inflation and a growing GDP that is in one of the four quadrants. So the opposite of that quadrant would be a slowing GDP and a decreasing inflation or deflation occurring that’s a different quadrant. 

Then, you could have on the opposite side those quadrants that would be an accelerating growth, but a declining inflation. So, whenever he looks at these different quadrants, he has different asset classes that he’s willing to invest in each one of these quadrants. 

So, let me give you an example. If he finds an economy that has a rising inflation and growing GDP, think China, that’s a quadrant that he would be comfortable investing in emerging equities. He’d be interested in investing in emerging bond spreads. Things like that. There’s different asset classes in that quadrant that he’s willing to buy. 

As the economy, let’s say we’re talking about China here. Let’s say that their inflation starts to slow and their growth or GDP growth starts to slow. As that magnitude decreases, he automatically starts moving into a more cash position. I’m just providing a brief example of how he’s doing this, but it’s a very dynamic approach and he’s using inflation and growth in order to determine which asset class he needs to be in. 

Now, I could go on more details, but I think over audio, and as you guys are listening to it, it’s going to be a little bit hard for people to follow and it’s probably something that you need to read and kind of absorb yourself. We’re talking about this a little bit on our forum, on thewarrenbuffettforum.com. You go in there and maybe search for some of the different results where I’ve been talking about Dalio.

I’ve also provided some links to some of the different documents where I’m learning more about Ray’s approach. But absolutely fascinating. I think one of the biggest highlights that we can talk about that occurred during this interview is Ray Dalio had the quote. He says, “diversification is the holy grail of investing.” 

And I totally agree with him because you are limiting your downside. You are distributing your risk, my personal opinion, but based on the performance that I’ve seen, the approach that he has, I think this person is probably the rising star that everyone needs to watch

Stig Brodersen  35:41  

One of the things that impressed me with Ray Dalio was that he was talking about these rules, because I think that if you read the book, you might be thinking, well, I just need a Ray Dalio’s computer program. 

If I had this program, I could also beat the market the same way as he’s doing, but what he’s talking about is that he has some rules. And as Preston said, more than 99% of his stocks, for instance, they are picked by a computer. But he keeps changing the rules, and let’s just give one example. 

Preston Pysh  36:12  

Oh, he keeps updating the rules, I think. Yeah, maybe a better way to say it. Yeah. 

Stig Brodersen  36:15  

Yeah, sorry. Yeah, keep updating rules. And let me just give an example of that. When he’s, for instance, looking at UK, and he gave an example about all prices. When he’s looking at UK that has been an oil importer for a long time, and now it’s an all export after they found a lot of all the North Sea. That means that he needs to update his rules. So this is not a static program, as what Preston was saying. This is very dynamic. 

So, it’s very dynamic because he has to account for a lot of different events. But based on those events, he is updating his rules that are basically beating the market. He’s not looking at the individual company and say I want to concentrate my portfolio on this type of securities. He’s saying that this bundle of securities is really interesting because this, this and this, and now I’m buying the diversified performance of that bundle. I found this really, really interesting. 

And really, perhaps that was probably the time when it made sense to me because also to give a shout out for the book, the Tony Robbins book that Preston has mentioned before. I think the problem was it was like a format, like you should always have 20% long term bonds. And that system just didn’t make any sense to me. But I want to say I’m a believer now. Perhaps not as much as Preston, but it makes sense to me now, why he is beating the market.

Preston Pysh  37:44  

Well, and I think that (this is no dig against Tony Robbins because I have a lot of respect for what Tony Robbins does), but I think that his book definitely comes across that way like, hey, this is what Ray Dalio said and you should always have 7.5% in gold, which is not what Ray Dalio is saying at all. I think that’s where the disconnect and I think that was one of the reasons why we didn’t like it when we read is because that’s how we read it was, hey, this is this is fixed, this is what it is. And that’s not his approach at all. 

Whenever you look at the way that Ray Dalio has everything structured is just amazing. And what he’s doing is when I’m talking about those quadrants, how he has a quadrant for rising GDP and rising inflation. So that makes up 25% of his portfolios. He is looking for economies around the world that fit that criteria. 

And at the same time, he’s looking for economies that have the negative inflation and decreasing GDP. He’s trying to put 25% of his portfolio into that quadrant. So as the world is constantly changing, and this dynamic is constantly changing, he is constantly adjusting the allocation of his assets and each one of these different quadrants, so absolutely fascinating. I’m sure Stig and I will be talking about some of this stuff through future episodes. We will definitely be more than happy to talk to people about this on our forums. If you got more questions, ask them over there. 

So the last person we’re going to talk about, and then we’ll wrap up this episode was Joel Greenblatt, which we’ve got enormous respect for Joel Greenblatt. For anybody who doesn’t know Joel Greenblatt came up with a thing called, “The Magic Formula.” Joel also wrote the book, “The Little Book that Beats the Market.” 

He also wrote the book, “You can be a Stock Market Genius”. I think that if anybody is really trying to look at his approach and how he invests, those are probably the two best places to start. I think you’ll probably get a more profound overview of how he does it in those books than you would in his interview. 

And in his interview, they really kind of talk more about his philanthropic adventures with his education. He’s trying to reform the education system. Absolutely awesome read. I really enjoyed reading about that and I’ll tell you, he’s really cracking the code on it. That’s what I took away from it, at least. And I think that it was a really valuable discussion and if you’re interested in philanthropy, I think that this is probably a fantastic thing to look at and see the impact that he’s making.

Stig Brodersen  40:11  

So, I think that Joel Greenblatt was really good, because I learned a lot from that because Joel Greenblatt is really influenced by Warren Buffett and Warren Buffett’s approach to investing. But, I also found the difference between Greenblatt and Ray Dalio really interesting because what Greenblatt is saying is that you really don’t have to update your rules. Now he’s saying that if you follow the magic formula, just really, really short he’s looking at cheap companies and high quality companies using two different metrics. 

If you are just following that formula, then you will beat the market. So it was kind of a different approach than Ray Dalio and even though that Joel Greenblatt if you really know him, he has come with a few updates and a bit of twists and tweaks. I think that was really interesting that following rules, updating or not, you can actually beat the market. I mean, at least that was his thesis. So I’ve got to ask you Preston because I thought a lot about this, do you think that you can beat the market simply by following a simple formula? Do you think that’s the way to go for a lot of investors?

Preston Pysh  41:20  

I mean, if you look at Toby’s book, Toby Carlisle, he’s in our mastermind, I would say, yes. I mean, he pretty much shows it through backtesting and I know a lot of people get a little concerned when you say the word backtesting but I mean he throws Joel Greenblatt’s magic formula up against his recommendation which is the Acquirer’s Multiple, and yes, I do think that you can. 

I think that it’s really important that if you would try to go down that route, you have to be consistent. You can’t do it for five years and then whenever you get taken to the cleaners because the market’s down, that you move into a different strategy and think that you’re going to have good results.

Stig Brodersen  42:03  

Yeah, ’cause I think it was actually in Greenblatt’s section when he was talking about the lost decade, the 2000s. And he would start saying that the average investor in the best mutual fund actually made a loss. Whereas they funded something like 80% now that I think about it, it might be actually in the book, “That Beats the Market,” I might interchange those two. But as Preston was saying, if you’re not persistent doing a formula trade, that really doesn’t make any sense. 

And all of this what Toby’s doing and Greenblatt’s doing, I think it’s perfectly fine. But you have to remember that they’re looking at really long time spans and a lot of investors that jump back and forth into the market. And if you do that, then formula investing is probably not for you. 

Preston Pysh  42:52  

Okay, so I think we’ve talked enough about the book. I think you guys got an idea of how complex and how much stuff’s in it. But what we’re going to do right now is we’re going to go a question from our audience. So our question comes from Jonathan Brasso and here’s his question.

Hey Preston and Stig of the show. This is Jonathan Brasso. And my question is, how do you stay grounded in your value investing principles when all these different macro economic factors and other outside information is constantly creeping in? Thanks.

Stig Brodersen  43:25  

Yeah, the first thing I want to say is that it’s really depends on which kind of security you’re looking at. So for instance, if you’re looking at one stock, I think it would be wrong to say something like, because the debt in Japan is sky high, then something should happen to that single security. 

Again, given that it’s not heavily exposed to Japan. That’s also why when Chris and I were talking about the stock market in general is overvalued that’s because we are speaking to a lot of people and a lot of people a lot of different stocks. I mean, if I would be speaking to two presidents specifically about my own portfolio, then we might pay more attention to that security and less attention to the macro situation. I just want to say that’s very different. 

And then, for instance, if you look at something like a bond, which is just very different than a stock, then macro might be more relevant for you, it might be more relevant to look at the interest rate. It’s extremely relevant to look at the interest rate. And since you’re talking about loan abundance, basically alone, yes, the debt situation for a country might be a genuine problem for you–a general concern for you. But clearly, when you manage your own portfolio with individual securities where I think a lot of people are doing, it doesn’t matter if the debt in France is higher or not. This is not the right way to look at it. So I would say that you need to identify which macroeconomic indicators are important to your portfolio and the way that you invest. 

And I think that’s probably also why you would see Warren Buffett pay much less attention to this than Ray Dalio. That’s not because you one is smarter than the other, that’s because it’s more relevant for Ray Dalio to look at this. And while it’s more relevant for Obama to look at the macro factors.

Preston Pysh  45:14  

Yeah and I think whenever you look at their two approaches, they’re just really different. The Warren Buffett is a hardcore equity and bond guy in the United States. That’s where he has really focused a lot of his attention, whereas Dalio is really much more of a world investor. So the approaches aren’t the same. And at the end of the day, Buffett has had, what is it? What’s his return? [It’s] like a 19.6% average return since his inception of Berkshire Hathaway. 

So at the end of the day, Buffett’s returns–they’re better than Dalio’s, so far. Buffett’s a micro guy. But the best way to ground yourself is to study, study, study. Be a learning machine. If you have a long drive to work, you should should be knocking out a book a week, and if it’s in something that you really have a vested interest [in], whether it’s investing or whatever your interest is, put that focus and put that effort into what that thing is that you’re really trying to understand. And that’s truly how you ground yourself because the truth is going to emerge the more that you study and learn it. So, that’s the best advice I can give you. 

So that’s all we have for you guys this week. We really enjoyed the question from Jonathan, thank you for submitting that. Stig and I will send you a free signed copy of our book, the Warren Buffett accounting book. 

For anybody else out there, if you’ve got a question, go to asktheinvestors.com, and you can record your question there. 

Also, head over to our forum, thewarrenbuffettforum.com, and if you have any questions, or you want to bring up any points that we discussed during this episode, you can do it there. Stig and I hang out there all the time, so we’d love to have you over there. And feel free to sign up on our mailing list, if you’d like to get our executive summary of any of our books. 

For this book that we just did The Hedge Fund Market Wizards, we typed up an executive summary. It is like four pages long, we will send that off to you guys and you can read through. And if you want to see more finer points of any of the people that we discussed, you can get that in our executive summary. We send that out for free. 

We don’t send out any spam, we hate spam. So sign up on our list at theinvestorspodcast.com and you can get our free executive summary. So we really appreciate everyone joining us and we’ll see you guys next week. 

Outro

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