So Peter Lynch 25 years later, it’s not just invest in what you know, is the title of the article. So Peter Lynch wants you to know that his ideas are being misquoted widely. And this is what Peter Lynch says, “I’ve never said if you go to a mall see a Starbucks and say it’s good coffee you should call Fidelity Brokerage and buy the stock.”

So now to the article: “Following the market still at age 71, he instead explains his philosophy this way. Use your specialized knowledge to home in on stocks you can analyze, study them and then decide if they’re worth owning. The best way to invest is to look at companies competing in the field where you work. Someone with a deep restaurant industry experience would have predicted the success of panera bread or Chipotle. He says if you’re in the steel industry, and it ever turned around, you would see it before I do. What’s wrong with the popular wisdom version of his ideology, which is usually cited as invest in what you know. It leaves out the role of serious fundamental stock research. People buying stock in something that they know nothing about is the same thing as gambling. It’s not good.”

So I think it’s a really important article to highlight before we start talking about this book, because there’s a lot of people out there who says, “Just go out and buy a company that you feel good about, or that you know, or that you frequently go to and really like the way that the business is run.” That’s not what Peter Lynch is saying. 

He’s saying that that’s a starting point and then whenever you find that company that you think might be a great business, you go and look at the fundamentals. You go look at the income statement, the balance sheet, you then look at the cash flows, you then look at how much the earnings are growing, and then you figure out what is an appropriate price to pay for owning that kind of business. That’s what Peter Lynch is saying.

Stig Brodersen  6:39  

A thing is also a question about like everything else here in the world, and especially in financial literature. It’s also a question about simplifying things. So it has really been simplified, but I do want to say that “One Up on Wall Street,” the tagline here is how to use what you already know to make money in the market. And if you read Peter Lynch’s own description of the book and it might have been for marketing purposes. He’s basically saying some of the same things as like what he was critiquing before with *inaudible. 

So for instance, in the very first chapter he talks about, “Well, a lot of people could probably have seen by going to the mall and drinking coffee at Dunkin Donuts, and he actually puts himself in the shoes of that person. With all the menu stores popping up, that might be a good stock pick.” 

So I kind of think that it’s true that you can probably say that it is not that simple. But I also think that now that we’re transitioning to the book, that that’s also one of the basic premises of the book: expertise and familiarity is definitely not the same. And we’ll be talking more about that as we go through the book.

Preston Pysh  7:48  

Alright, so the way we’re going to discuss the book today is there’s three different main sections that we’re going to cover. The first section is preparing to invest, so Stig is going to highlight a couple things here with this.

Stig Brodersen  7:59  

So one of the first things that Peter Lynch talks about in this section is that a professional needs to follow rules and an amateur doesn’t. And this is actually a big advantage for amateurs. So let’s talk about some of the constraints that professionals have. They can’t necessarily buy what they like and the thing is that most institutional investors that buy big brand names, they’re doing in part because they have so much money that they need to employ. They can only buy call it S&P 500. That’s one reason. But also because being an asset management is also about not looking bad. And it’s really, really easy to look bad, if you’re buying for instance, small cap stocks. And he’s actually talking about this saying, apparently what was going on in the 90s on Wall Street saying, “You can never get fired buying IBM.” And I just thought that was really a fun quote.

Preston Pysh  8:50  

I mean, this is true though. This is something that you see on the professional side that so many of these guys just take this safe path That, if they’re wrong, but all their buddies are wrong as well, then it doesn’t look nearly as bad. But if you go out and you do something that’s just really off the beaten path, and it fails, I mean, you’re gonna get slaughtered in this business. So that’s a really interesting highlight.

One thing that just says to cope with that, as an amateur investor, is to buy small cap stocks. And I think it’s really interesting approach that he’s having. I think it’s both correct and also think is wrong. 

Stig Brodersen  9:28  

So I think is correct in the sense that you can definitely find many small cap stocks that might be interesting. They’re not really analyzed by analysts. So like, you can find a lot of great value. But another thing is that we just talked to you too about before that the way that this book is created, is created as beginners’ book, like how do you find your first stock? I would say that the worst thing you can probably do trying to pick the first stock is probably to find a small cap business. So I kind of feel like counterintuitive

Preston Pysh  10:00  

Expound on that, Stig. Tell us why you think that that’s bad.

Stig Brodersen  10:03  

Well, there are actually multiple reasons. One reason is that small cap stocks, there are less information out there. Another thing is that smaller companies tend to be more volatile. If you haven’t tried to invest before, you don’t necessarily know what happens when your stock lose just say 5% or 10%. And you don’t know what you’re going to do if that stock drops, call it 50%. And one more thing, which is really an investor bias is that people usually invest too much in a single stock the first time that they’re investing. I can definitely testify to that. I think it will probably not be uncommon for someone to invest as much as 20% in just one stock. And that might be okay, if you’re Warren Buffett, but if you’re a new investor, this is the first stock you find is this great small cap company because you read this book and you invested 20% that, I think it can be really dangerous for you to do so.

Preston Pysh  10:57  

I want to add a comment to this as well as far as I think that something that I think a lot of people need to think about is when you get into some of these smaller companies, they don’t nearly have as much of a competitive advantage and enduring competitive advantage as some of the mid or large cap companies. That can be eroded rapidly, especially if you’re in a company that’s a tech company that’s moving pretty fast pace. Somebody could come along and just quickly erode whatever competitive advantage that the company has. And that’s something that I think a lot of new investors aren’t thinking about, and don’t necessarily understand the ramifications of how badly that could destroy the price that you paid in a really fast and rapid way.

Stig Brodersen  11:39  

Another thing, and clearly, this might also be the case for big companies, but smaller companies typically don’t have the same credit ratings, which means that they’re more vulnerable for instance, to interest rate risk. So there’s a lot of things that you might not be able to see when you just read through the financial statements. But as you get more experience and you actually get to work with a lot of stocks, a lot of these things will appear more logical to you. So definitely not start off with small cap companies.

Preston Pysh  12:04  

This is how I’d like to summarize the small cap part is, yes, there’s more opportunity in small cap because you don’t have the big players kind of necessarily operating down in them because they’ve got to move much larger sums of money. So there’s potential opportunities there and the value, but it’s kind of harder to play in that space, if you don’t know what in the world you’re doing. So that’s how I’d kind of balanced the argument is you could have some upside there, but you really have to know what you’re doing.

Stig Brodersen  12:33  

It also seems like whenever you’re reading through this, that it seems like since the institutional investors can only invest in bigger companies, that seems to be more efficient. But that’s actually not true either because the interesting thing is that the big institutional funds can actually just pick and choose among the S&P 500. They’re actually restricted in a lot of ways. So some of them might be restricted in terms of weighting in terms of the *market capitalization. 

So in other words, even though that some of the smaller, bigger companies might seem appealing, they might not be able to invest more than that. Another thing is even if they have the freedom to do so, they might not be allowed to say have more than 1% or 2% in any of the S&P 500 stocks. So even though it might seem like, “Oh, we’re heavily tilted into a small S&P 500 stock.” That’s only weighted call it point .05%. They’re still constrained in many ways. 

So basically, my point is that S&P 500 is not as it might appear a more efficient index just because they’re big and just because everyone had access to the information. Everyone, even the big players, and especially the big players are constrained a lot. So there’s a lot of inefficiency in that index as well. I know that Peter Lynch couldn’t like include everything in the first few chapters, but I think that’s something that’s extremely important for anyone starting to invest in both indexes and individual stock picks.

Preston Pysh  13:55  

So one final thing that I want to add to this section that I really like about Peter Lynch’s writing is he says that stock picking is both an art and a science. We’ve mentioned this on the show before, but I really like how he spells this out. He says that too much of either is a dangerous thing, a person infatuated with measurement, who has his head stuck in the sands of the balance sheet is not likely to succeed. If you could tell the future from a balance sheet, then the mathematicians and accountants would be the richest people in the world by now. 

What he’s really getting at here, and this is what I like about his writing style in the book, the way he writes it, he talks about this qualitative field of going out and walking through testing out these different companies that he had personal experiences with that kind of gave him a tip off. But then he does get into the math and he talks about different multiples that he finds are appropriate to pay, and at what times and cyclical stocks versus financial stocks or whatever. He gets into that and he talks about being originally tipped off through a qualitative means and then he backed it up with quantitative research. 

Alright, so now we’re into the meat of the book, we’re going to go into the second part and this is called “Picking winners,” which I’m sure everyone wants to hear about. So let’s talk about this section.

Stig Brodersen  15:11  

I thoroughly enjoyed this section that for me, this was the most interesting section, also, because he introduced the concept of a 10-bagger. And for anyone that’s not familiar with the term 10-bagger, that means that you will invest in a stock that you’ll get 10X on, basically. So he guides people in terms of how to find these companies, which is a very interesting discussion. 

One of the things that I would like to highlight here and also goes hand in hand with some of the things that Preston talked about in the introduction is that he’s basically saying here, literally, the best place to look is close to home. His thesis here is that when you are an expert, you can probably make the best qualitative analysis.  I completely agree with that. I just think that it’s very important that you don’t confuse familiarity with expertise.

I just want to come up with an example here, if people are thinking about who are the best person to value my home, who’s the best person to do that? I think a lot of them would say, that’s probably myself. Now, so there have been a lot of studies about this and it actually turns out that the worst person you can think of to value your own home is  yourself, because you have so much bias every time you look at your own home, that is very, very difficult for you to do so. 

I think this really underlines the difference between expertise, which is actually what Peter Lynch is talking about, and then familiarity. He’s basically saying here if you’re familiar with a product that you really like, then that is your cue to start your analysis. It’s not your cue to actually invest in that company. So I think that’s good point. 

In continuation on this, he comes up with this example where he’s saying that he realized the sure success of  Pampers. He was saying that, “Okay, so I saw everyone buying Pampers. It was a great product. It has a wide moat. Should you buy that stock?” Well, actually, Pampers was not really a stock because it was owned by Procter and Gamble. Even though it was a huge success, it was still less than 1% of the revenue of that company. So you probably shouldn’t go in and buy that, at least not that argument. It’s the same thing you see here with Nintendo right now. And with all those?

Preston Pysh  17:30  

Pokemon Go?

Stig Brodersen  17:33  

Yes, thank you, Preston. You clearly have young kids.

Preston Pysh  17:37  

I saw you look up and I was like, “He can’t remember the name of it.”

Stig Brodersen  17:40  

Exactly. It’s the same thing because Nintendo had like soaring stock price when Pokemon Go came out. They were like literally making no money of that product at that time, which was a lot of fun. So I just think that’s another example of if you have a really good story, it is not the same as you actually having a huge potential for monetizing it.

Preston Pysh  17:59  

So I think guess my thing I want to ask you, how many times have you seen a person that you just get in a random conversation and the person says, “Oh my, I gotta go out and buy like your example, Nintendo. This Pokemon GO thing everybody in the world is playing it.” And like that was literally their start and the end of their analysis for buying a company. That was it like there was nothing else discussed. Not only did they not look at the earnings and all the other pieces that would drive a potential price that you would pay. But they’re not talking about that second point either of like, “Okay, so that’s one product in the whole product mix of the company that might make up like your diaper example, less than 1% of the total revenues of the company.” And the person literally just purchased the stock around that one idea that had less than 1% of the overall revenue. 

I guess for me, I’ve talked to him enough people through the years to learn that most people are not big picture thinkers. I think that when you see a guy like Peter Lynch, these guys can start with this really big idea, like, “Hey, this might be a great company.” Then when they go in, they assess the company, they start with the big picture, “Okay, so how much money is this company bringing in a year? Okay, they’re making 100 million dollars. The product that I was first introduced to that kind of gave me the idea of looking at this company only makes up 10% of the revenue. So that’s $10 million of the hundred million that they’re bringing in.” 

The margin on that thing that I’m looking at is 3%. So how much am I willing to pay for like, they’re picking it apart from big picture to small picture, and then saying, “Well, how much is that worth to me to pay to own that in a per share basis?” And then they’re making a very intelligent and thoughtful decision to own it or not own it.

Stig Brodersen  19:59  

I think another argumentatio of this is that Peter Lynch in this section go through the traits of a really good stock. And like Warren Buffett, I think we probably mentioned this a few times on the podcast, he’s saying that the simpler, the better. I don’t want to brand myself as a big Nintendo. Pokemon fan. It’s not what I’m saying. But I’m just thinking something like that computer game, I guess you would need to reinvent yourself in a year or two. I don’t know how long the computer gaming cycle is, but it’s something to consider compared to say, the Dunkin Donuts example he came up with. I mean, Dunkin Donuts, it’s in a convenient location, at least according to Peter Lynch they make great coffee. I mean, they don’t need to reinvent how to make a good cup of coffee. They don’t need to reinvent a good doughnut. It’s just not how that works. And it’s something that you would do everyday. It’s something that drinking coffee had done for so many years and we continue to do for so many years. 

I’m not saying Nintendo is a bad company. I am just saying that when you come up with a new computer game, continue the success basically. And this actually also takes me to the list of the some of the traits of the perfect stock, which I found really funny and interesting. The first one was actually a boring name. I found that discussion pretty funny. I think there’s actually also been studies about that, that if you had like a really boring name, because people don’t want to tell they own boring stocks. They usually do good, the boring stocks, spin offs, that’s typically also something that’s doing well.

Preston Pysh  21:28  

So on this idea, I want to read something: “The greatest companies in lousy industry share certain characteristics. They are low cost operators and penny pinchers in executive suites. They avoid going into debt. They reject the corporate caste system. Their workers are well paid and have a stake in the company’s future. They grow fast and faster than many companies in the fashionable fast growth industries. Pompous boardrooms, overblown executive salaries, demoralized rank and file, executive indebtedness, and mediocre performance go hand in hand. This also works in reversed modest boardrooms, reasonable executive salaries, and a motivated rank and file and small debts equals superior performance most of the time.” 

And he really says a lot of the ideas that we see, the Warren Buffett’s of the world and other really successful business owners and investors, say and as almost a common thread through all these books. So I just want to throw that one in there because it totally relates to what Stig is getting out here.

Stig Brodersen  22:34  

Another interesting trait that Peter Lynch is talking about is that he’s looking at no-growth industries. I simply love this concept because every time you hear like a stock pitch or read an analysis, you would be like, “Oh, this nanotechnology is growing by 50% or 3D printers are growing by 200% a year.” Or whatever and he’s saying that that is not where he’s looking. He is looking at industries where there are no disruptors, because when there’s no disruptors, there’s very little competition, and you have fewer expenses, basically, and you have higher margins. 

I just want to come up with one example. This was actually a type of investment that will plug into months ago that didn’t pan out for one reason or the other. But the concept is still the same. I was looking at a landfill. And you might be thinking and landfill that sounds like the most boring thing I’ve ever heard about. But the thesis about this landfill out in the rural area in North America was that it has a lot of pricing power. It has a lot of monopoly power, because who is going to build a landfill right next to a landfill? It really doesn’t make any sense. 

Another thing is that if you have the chance to drive, call it 50 miles 100 miles to the landfill, is actually… Even though you can find a cheaper landfill, call 500 miles away, it’s still going to be expensive for you because you have to pay for the gas to get there.

 So you have a lot of pricing power in that area because you have monopoly power. And believe me, there are no disruptors in this industry. If you have a landfill in the middle of rural area, it’s really, really hard to compete with that company. So I’m not saying that everyone should go out and buy a landfull. That’s definitely what I’m not saying. But I’m saying that’s the way that Peter Lynch is thinking about it. I just wanted to bring up that example, so perhaps everyone could get a better grasp of what he might have meant by that.

Preston Pysh  24:36  

So if you feel like you’re ready to fall asleep, because maybe you’re talking about landfills or whatever.

Stig Brodersen  24:42  

That’s the boring name, Preston. Could you come up with an interesting name for the landfill? No, right? It’s that bad.

Preston Pysh  24:49  

If you’re ready to fall asleep talking about the pick, you’re probably starting in the right location. All right. 

At this point in the show, we’re going to take a real quick break to tell you about our show sponsor. Stig and I are really strict about only endorsing products that we personally use. For this reason we’d like to take this opportunity to tell you about the simple accounting software from freshbooks.com that has been used by more than 10 million users in more than 120 countries. 

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Stig Brodersen  25:57  

So now we’re talking about some traits of the perfect stocks. He also has some interesting trades in terms of the stocks to avoid. So one thing is that you should always dig into the financial statements and see how they make the revenue and how that’s divided into the different customers. He’s saying that he has a strict cutoff point with 25%. I mean, basically, he doesn’t want one customer to have more than 10%. But if it’s more than 25%, it’s usually a big no-no. And I think you see that with a lot of companies, especially those companies that are heavily tied into the public sector. You might think, Well, it’s public sector. It’ stable.” 

But guess what, whenever there is new legislation, and the public sector might be 80% of your revenue, like we’ve seen multiple examples of this who just had a big trouble.  I think that was a really good example that he came up with. 

Basically, I think that is very clear whenever you’re reading the book that Peter Lynch’s foundation is really into value investing, even though he talks a lot about 10-baggers, and he talks about gross stocks, he is really like, at his very core, a value investor. He also has a really interesting section about hot stocks and new issues and why you should *avoid that. So I think when you hear the term 10-bagger, it’s not necessarily how do I find the next Silicon Valley startup, that’s definitely not what he’s saying. He’s actually saying you can get 10x if you buy undervalued, great companies.

Preston Pysh  27:26  

So I want to kind of piggyback on that comment, Stig, because the thing that I find interesting about Peter Lynch is he will buy a growth company or what we would refer to as a growth company, but he will buy it at the right price that’s an appropriate premium to pay for the growth that’s occurring. 

So I want to read a short section here: “Any growth stock that sells for 40 times its earnings for the upcoming year is dangerously high priced and in most cases extravagant. As a rule of thumb, a stock should sell at or below its growth rate. That is the rate at which it increases its earnings every year. Even the fastest growing companies can rarely achieve more than a 25% growth rate, and a 40% growth rate is a rarity. At the time I was researching this company, the PE ratio of the entire S&P 500 was 23, and Coca Cola had a PE of 30.” 

So you can obviously tell this was written a long time ago. 

“If it came down to a choice between owning Coca Cola, a 15% grower selling it 30 times earnings, and the Body Shop a 30% grower selling it 40 times earning I would actually prefer the latter.” And the reason that he would prefer the latter is because there’s less of a margin between the growth rate of the Body Shop and the premium that was being paid at 40 times earnings. 

So I really like this example because he’s getting into… he’s talking about growth picks for people out there that are growth investors. Stig and I really aren’t. But for people that are and are interested in some of these ideas, I think the key point here is if you are going to pay for a premium, that thing better be growing like crazy in order to actually justify that expensive price that you’re paying. And I think that that’s a really great highlight that he puts in his book. 

Alright, so the final section we’re going to cover is called “The long term view.” And this is some other great conversations for anybody that’s just trying to get a good foundation for their investing approach. In this section, there is a really fun chapter that’s called the “12 silliest and most dangerous things people say about stock prices.” So we’re just going to throw a couple of these out here and maybe add some commentary to some of his comments. 

So one that I really liked is, “If it’s gone down this much already, it can’t go much lower.” And boy, I’ll tell you, I’ve hung on to some picks that have taught me that lesson a lot of times over. So if you ever hear that phrase or you catch yourself saying that phrase, try to remember this from Peter Lynch’s book because it’s a doozy.

Stig Brodersen  30:00  

Whether it’s high or low, it’s all about understanding why is it going high and why is it going low? And what is the price compared to the value? 

And the thing, another argument here is that if you had invested in Peter Lynch’s fund with the day he took over, as we talked about, in the very beginning of this episode, your $10,000 would have turned into $280,000. So a way to thinking about this is that well, I should probably hold on to this mutual fund for 13 years, because my initial investment was 10,000. 

Well, you can look at it like that. But remember, you also took a conscious decision to stay in that mutual fund whenever that 10,000 turned into 50,000, or whenever turned into 100,000, and so on. And the thing it’s really interesting perception to have, because it actually goes the same way as if you’re looking at a stock that can’t fall any further and you’re like, “Well, this stock used to be 10 bucks, but now it’s $1. I’m only risking $1 per stock.” But I mean, if you bank with $10,000, you buy 10,000 stocks. It’s the same thing and I know from myself that it’s very easy to get anchored on a stock price and not so much on your position.

Preston Pysh  31:08  

For how many times I’ve heard people say, “Well, you know, it’s a really cheap stock, I can buy more shares, because it’s a cheap stock.” I have heard that so many times from people to the point where I don’t even want to say anything, because I feel like I’m gonna like hurt feelings or something like that with some people. But I think as a person becomes more educated in investing, and they hear that, it really tells you how little the person really understands what they’re doing, because whether it’s stocks 50 cents or like Berkshire Hathaway $200,000 a share,there is no difference in the fundamental assets that are beneath or that represent that share of ownership in the equity. 

So I know we’re poking a little bit of fun, but it is serious. I would argue that a majority of people actually believe that and don’t understand that how wrong that statement is. And that’s one of the points that Peter Lynch has here. The quote he has is, “It’s only $3 a share. What can I lose?” Is the way he has it phrased.

Oh, I like this one, because you hear this one a lot too: “When it rebounds the $10, I’ll sell.” And, you know, like, the person’s already convinced themselves from a psychological standpoint that they’re selling when it gets to 10. There’s really no reason why they’re selling when it gets to 10, other than it got to 10, which was a nice round number. Again, they’re not digging into the fundamentals behind what represents $10 a share. Why would you sell when the market cap hits that? Is there something that’s as it hit a PE of 40 times earnings? Well, if that’s your reasoning, then maybe that makes some sense. But if there’s no analysis behind why you came up with that figure that’s kind of tied to a return a percent of a return compared to where the markets at, I would argue you’re making really bad decisions on the way that you’re buying and selling.

Stig Brodersen  33:04  

Yeah and it really comes back to the financial behavior that you have in terms of anchoring that at least, that’s what they call an anchoring. So if you bought a stock, call ait $10, you know, that is the average price or that is like, the anchor price you have in your head. And you don’t necessarily think about, as Preston said, what has really happened? Why is it not $10 anymore? So that’s why it’s so easy to say, “Okay, when it rebounds to call it $10, or whatever price I bought it for. If that’s the case, then I’ll sell.” And then we just tend to forget the opportunity costs that are involved with this, that you could probably invest in something that you might get a better return off, but it’s like we put everything into small mental boxes. And it’s really hard to say stock ABC was a really bad investment because I lost money. It’s better to say I brokeeven, even though you haven’t brokeven because it took you 10 years to break even or whatever how long it took.

Preston Pysh  33:58  

So I want to put this in context. So let’s say that in your local town, there’s a hardware store that you want to buy. And let’s say you have enough money to just buy it outright and the hardware store makes $100,000 a year after all the employees are paid. That’s how much money you would be able to keep as the owner. So a reasonable price to maybe buy would be a million bucks because you get a 10% return on your money. 

So when you say that, “A stock, I’m going to sell it when it gets to $10.” That’d be like buying this million dollar hardware store and then some random person comes into your store and says, “I’d like to buy your store for $1.1 million.” And you had told yourself in advance, if somebody comes along and offers me $1.1 million, I’m selling it. There’s no analysis behind why you’d be willing to sell at 1.1, other than you told yourself, you would sell at 1.1. 

Maybe your earnings are in $100,000 anymore, maybe your earnings are $200,000 which means you might be able to sell it for $2 million. That’s how you need to think when you’re looking at one share of stock is what’s the earnings? What did the earnings just go up to as the price went up? Maybe I can even make more money because the market is undervaluing at $10. That’s how a person needs to think they always need to look at the profit versus the price, versus the risk that’s associated with it and treat it as if it’s an entire business. One share is the same thing as an entire business. And that is so fundamental to be successful in the markets is to always look at things that way. 

All right, so that concludes our comments for the book. We really like this booka nd there’s so much more that we could cover. Peter Lynch is a fantastic writer. He keeps it qualitative and quantitative at the same time, and it’s entertaining, which is a rarity when you get into investing books. So if you’re a new investor, or you’re really trying to understand things, and you’re just starting out, I would tell you go out and get one of his books and read it. You’ll really enjoy it. There’s “Beating the Street” and then there’s also “One Up on Wall Street,” and both are really great books. So at this point in the show, we’re going to take a question from the audience and this question comes from Jordan Lee Smith.

Jordan Lee Smith  36:05  

Hi, Preston and Stig. Jordan Lee here speaking from Birmingham, United Kingdom. Warren Buffett has said many times that when he was in his early days as an investor, he would bind to companies and stocks that were fair companies at wonderful prices or cigar books as he calls them. However, today, he now establishes that this approach was bad. And he said invest in wonderful companies at fair prices. And my question is, for any investor starting today, would it still be wise to follow Buffett’s old methods of buying into smaller, less good companies selling below net asset value? 

For instance, as although Buffett has said that this was a bad method, it did seamlessly raise him a lot of capital that he uses today. Or for debt investors stick with today’s value investing methods of wonderful companies at fair, modest prices. Thank you very much, guys, for all your hard work in educating the community. I hope to hear from you soon.

Preston Pysh  36:55  

All right, Jordan Lee, fantastic question. This really kind of gets at the part of what our good friend Toby Carlisle is all about. So Toby wrote a book called “Deep Value.” And it really implements this net-net strategy where you go into the balance sheet, you find a company that has strong earnings that’s being sold at a very steep discount. But the difference between what Toby’s doing and what Toby’s recommending, and what Warren Buffett is doing is that Toby is consolidating picks across 20 to 30 companies that have been filtered down to give him those results. And his analysis in his book talks a lot about mean reversion and that these companies have been penalized so severely and been just punished, that they have such a large amount of price action to move within just a short amount of time, call it one year to a year and a half that they can recuperate to normalize price to earnings ratio, and that you can take advantage of this. If you do it in a batch, if you do this across the portfolio of companies that are all similar in the way that they’re valued, not similar in the way that they’re performing in the same sector or anything. 

So, Buffett got away from this approach, and he went into a much more qualitative approach where, as you said he’s trying to find a great company at a fair price. And he morphed away from this deep value approach and he really started placing a lot of emphasis on companies that have this enduring competitive advantage, and that don’t have a lot of tangible assets. But he’s doing it more in a manner that he’s handpicking a specific company. 

Now, the reason I think that he had the transition, and this is just my personal opinion. I think some of it had to do with his experience with Berkshire Hathaway early on. I think that drastically shaped the way that he saw things because he saw these people that in the town that were all up in arms and he was the Grim Reaper, who was going to kill the business and liquidate it and make a profit on the sale of all the assets. And as he went through that, that was a life changing event for him. 

And then Charlie Munger said, “You need to value the company as if it’s living and not that it’s getting ready to die tomorrow.” That changed him and then I think something else it has a big impact on him is the amount of capital that he has to move. He has to look for companies that are better alive than dead, if you will. I think that that’s another reason why he drifted into a different direction. 

But for the person who has a much smaller amount of money that can filter results based off of what Toby would call the enterprise value. I think that that approach is very useful. And I think that it can provide just amazing returns for people that are implementing. I’m a huge proponent and advocate of what Toby’s book talks about and what it recommends.

Stig Brodersen  39:51  

I think this is really good question too. And also think is a very complex question because it really depends onone skill set. And I want this to come off the right way, because it’s not me saying there are only so so many people that are smart enough to do this. Not everyone can do it. But I think it’s really difficult to do. And since you’re specifically talking about when you’re just starting out, I’m not necessarily sure that’s that what we call special situations is the right way to begin, even though that was how Warren Buffett began. 

I think a lot of reasons to this, as Preston also stressed, you can even as a beginner, I guess, or at least have a little experience do something like Toby because it’s all automated, and you are diversified. I think it’s really, really hard if you’re going into this special situations or net-nets, if you are picking individual stocks and perhaps putting more than 5% in one pick, because it tends to be very complex. And it has to be complex for a lot of reasons. 

One reason is that you will be looking at a lot of catalysts. Yes, very often you’ll see value being catalyst and itself. But for a lot of these companies, they’re highly undervalued or really small companies, sometimes with a lot of debt, even. It’s not always that easy, you might be waiting for that catalyst that someone will come and liquidate that company. 

Now, the thing is that as a small investor, even though you bought it at a really good price, you don’t have the authority to go in and liquidate that. You might need an active investor, an example that could be Carl Icahn, to go in and actually liquidate that company for you or to unlock some of that shareholder value. If you’re a minority shareholder, you are not in that position to do that. So you might be faced with a high opportunity cost, if you do that. So it’s definitely not something I don’t think people should look into. I think it’s very, very interesting. I just think that diversification, especially in these special situations are very important.

Preston Pysh  41:54  

All right, Jordan. Lee, thank you so much for this fantastic question for sending this in. We’re going to give you two awesome things. The first thing that we’re going to give you is a free subscription to our ETF video based course. The second thing that we’re going to give you is another free subscription to Stig’s “The Intelligent Investor” video course that we have on our website. So two free subscriptions for you. And this is on our TIP Academy website. So anybody who’s interested in learning more about these courses, go to our TIP Academy, which you’ll see in our navigation bar on our website. And that’s all at theinvestorspodcast.com. So if a person wants to record a question, just like Jordan Lee and get it played on our show and get these free subscriptions to our courses, go to asktheinvestors.com and you can record your question and potentially get it played on our show.

Stig Brodersen  42:44  

Okay, guys, that was all that we have for this week’s episode. We’ll see each other again next week.

Outro  42:49  

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