Stig Brodersen 08:17
I think it’s really interesting, Kabir, to bring that up because last week, we had James O’Shaughnessy on the podcast, which you’re probably familiar with. He was right on the same trace you were that it’s really not just about you. You might be thinking, “Hey, I’m making all these rational decisions,” but it’s really in your genes.
Kabir Sehgal 08:35
Yeah, and there’s an emerging field. It is called neuro-economics. Basically, these are brain scientists that study financial decision making. They can scan your brain and they can show you what… before you’re aware before you’re consciously aware of what stock or bond you’re going to choose because they can see what’s happening in your subconscious.
And so, these decisions manifest at the subconscious level and then they get kicked up to a conscious level. There are so many things that influence our subconscious advertising and genetics and things you’ve learned in the past. When you think you’re making financial decisions, you should really remember that money is really a biological output. It’s really the evolutionary output of a biological mechanism called the exchange. But one of the tools we have created to survive better is called money.
Stig Brodersen 09:20
Kabir, I think this was really one of the most interesting things about your book. Preston and I are currently really following the expansion of the money supply. And apparently, the concept is not new at all. It seems like the Roman emperors, Caesar, Augustus, and Nero, they were no better. could you tell us the story from “Coined” of the applied monetary policy that happened more than 2000 years ago? And what we can learn from history?
Kabir Sehgal 09:50
Yeah, good question. I think monetary expansion is it comes up almost in every society going back thousands of years. in that example, Ancient Roman time. You know the word money comes from the Romans. The Roman root of it means “warn, to warn someone.” That’s where the money comes from.
In Roman times, they would have a currency called the denarius. It was basically a silver coin. And over time as when Nero came to power, others came to power… A lot of times they had to make more money and to finance their costs. the Romans, they kept on expanding their empire. And one way to pay for this was to issue money, but there’s only a fixed amount of silver in the world. And so, they started to debase the currency, they literally punched a hole in the denarius. the quality of the coin would go down, but they would increase the number of coins circulating within the kingdom. And so over time, the currency depreciated, there was massive inflation. And a lot of the folks who have studied the end of the Roman Empire, they attribute one of the problems is to the economic malaise was to a monetary crisis in persistent Inflation.
11:01
So, the place that I found this most intriguing, to really bring this home, and I didn’t write about this in the book, but is I went to the middle of nowhere to study about this. I went to over 25 countries in researching this book, my job took me around the world. And I went to Mongolia and why did I go to Mongolia to learn about money? And that’s because the Chinese in particular, the Mongols, came in later. They invented paper money in the ninth century AD. And then what happens in the 13th century, the Mongols conquered the Chinese, and they added 60 million people to their empire.
The Mongols had this currency and it was backed by silver and silk. And Kublai Khan said we have a problem. We have 60 million people, we don’t have enough silver to back our money. he cut that link between money and metal. And he said you know what, I’m going to issue paper money. Marco Polo said the Great Khan issues money out of the barks of trees. He said essentially if you did not accept my money, I will kill you. Or if you counterfeit my money, I will kill you. And so, he ruled his entire vast kingdom, that went from Burma to Hungary, with paper money. And what happened, he started to print and print and print. They wanted to expand their kingdom, their empire. And then there was a monetary crisis, which led to an economic crisis. And eventually, that part of the Mongol Empire came to an end.
And so, money is really a fallacy in the bargain. Paper money, particularly, *inaudible bargain. And there’s always a proclivity for governments to print, print, print because it’s a silent tax. It’s an easy way to finance things, instead of directly taxing your people. It’s the last thing that comes up even today.
Preston Pysh 12:43
I’m just so glad that it has nothing to do with our current circumstances. And I say that as jokingly as possible. That is just an amazing story. And the parallels to what we’re seeing today is almost a little scary.
With that, I guess I’m going to go to my next question because I think it closely relates to what we were just talking about. when we look around the world and we see the extreme situations that central banks are facing, I think a lot of people are wondering, how does this problem get solved? Because when we look back in history, the problem basically doesn’t get solved. Everything goes up in smoke.
In your book, you talk about how money is this stored energy and I just love that reference. But whenever you said that I immediately thought of these cryptocurrencies like Bitcoin, because that’s all that is. It’s just energy sitting on a server rack, and it’s representing this new type of potential money in the world. So, when we talk about that, and we talk about cryptocurrencies, the reason that they are so excited for a lot of people is that it sets a fixed monetary baseline. do you see cryptocurrencies playing a larger role in the years to come? And specifically, that question really relates to offsetting these inflation-seeking central banks. Do you see cryptocurrencies basically being that offset, I guess is what I’m getting at?
Kabir Sehgal 14:00
I don’t see cryptocurrencies being offset to the central banks and inflation. Potential deflation we may see. I think there’s a misunderstanding of what Bitcoin really is. I mean, most people focus on Bitcoin as a currency. I don’t think Bitcoin will flourish as a currency because of governments. Governments can essentially say what is or is not money. Like in the 1930s, Franklin Roosevelt said gold is no longer money and hoarded everyone’s gold. He took everyone’s gold and he built Fort Knox. The government always can say what is or is not money. Even now, the FBI owns like 10% or I think even 15% of all the Bitcoin because it sees so many, so much Bitcoin.
But look, I think Bitcoin is going to be very, very powerful as a technology. What do I mean by that? When you boil it down, Bitcoin is a decentralized way of authenticating transactions. if I wanted to send you a PDF. If I wanted to transfer a PDF to you, I would write up and email it to you, I still retain the copy for myself. But if I wanted to transfer that PDF, I could use the Bitcoin blockchain protocol, which is just a fancy way of saying Bitcoin, to transfer the file, and I no longer have ownership of it. And that’s a very profound way of transacting.
The implication of this is that anything that can be represented digitally, like a stock or a bond, I can now transfer that without a bank, without a broker. Bitcoin is an incredible way to transfer things. And so, people often get hung up in Bitcoin is a currency. That’s not the reason that venture capitalists are so excited about Bitcoin. That’s not the reason Marc Andreessen, himself a billionaire, is so excited about Bitcoin. He’s excited because of the technology applications that wow, we could start transferring things using the Bitcoin technology. And so that’s a distinction that I think gets lost on people that Bitcoin is really about file transferring,
Stig Brodersen 16:01
I’m really happy you said that, Kabir, because Preston and I also studied Bitcoin in one of our previous episodes. And one of the things that were really interesting was how this might change our lives. Really not because of the currency, as you’re saying, but because of the technology. One thing is what will happen in the developed world, which might be limited, in my opinion. But what do you think could happen in the developing world if they started to use Bitcoin or digital currency?
Kabir Sehgal 16:30
I’m glad you asked that because that’s the most profound example of how Bitcoin could be immediately impactful. I was in Saudi Arabia last year, and there’s a big Filipino population there. Then I asked one of them, I said, “Do you send money home to the Philippines?” She said, “Yes.” I said, “How much do you pay in terms of remittance fees?” She says, “15%.” That’s a lot.
And so, using Bitcoin, she could save almost the entire thing. How does that work? Saudi Arabia, she can then use a Bitcoin inverter. And she converts from the local currency into Bitcoin. And then someone in the Philippines goes and picks it up and it converts from Bitcoin into local Philippines pesos and the transaction cost is far less. I mean, anywhere there’s like huge friction to transfer money, that’s going to be taken out by Bitcoin.
So, like in America, for example, when you go to Starbucks and you swipe your credit card. It is only about 2% that’s going to the credit card companies and the merchant acquires. But in the developing world, it’s a huge cost saving. that’s why even in like Kenya, they call it the Silicon Savannah. There’s a lot of capital going into Bitcoin investments in the emerging world. I think that is the most powerful example of Bitcoin use in the coming future.
Preston Pysh 17:51
So, Kabir, when I hear that, I immediately think, okay, well, why don’t larger banks start implementing this or even smaller banks? Why is the world not starting to conduct those transactions, those international transactions in that manner? If they can just convert it to Bitcoin transfer and then converted back and they do that in a short duration of time. You would think that the flow capital flowing through the Bitcoin community, through that protocol would then increase and maybe even drive up the price which would then I guess the point that I’m getting to is… I see it as really becoming that peg, that global peg over time, for other currencies. if these countries want to continue to manipulate, like, let’s just say the US dollar, let’s say they want to inflate the dollar in the next year. As time marches on, I see cryptocurrency, specifically Bitcoin potentially acting as that peg, just naturally because of these cheaper transaction fees as you go internationally and all the other benefits that it has. Do you see banks picking up that transaction piece of it and potentially turning it into a peg or not at all?
Kabir Sehgal 18:56
The first part? Yes, I think banks are JP Morgan is investing. Bank of America, they’re investing. They’re actually creating patents to do just that, to look at how Bitcoin can be used as a transfer protocol, to do money transfers. It’s happening. I don’t know if it’s going to become a peg in that banks have, especially big banks, they have an agreement with a government, which is essentially the Fed says, “Go out, make some loans.” And that’s how money is really introduced throughout the world. And so, I see it as a private mechanism, Bitcoin, as a way to transfer money. But in terms of money itself being a peg, I don’t know, the dollar is not going anywhere, anytime soon. And I think the dollar is going to remain the universal peg for a long time.
Preston Pysh 19:41
When I read your book, it’s got so many different levels and layers to it. What did you uncover in writing this book that was really the big nugget?
Kabir Sehgal 19:50
One of them is that talking about currency, what’s the most powerful currency in the world? It’s not Bitcoin. It’s not the yen. It’s not the dollar. I learned how powerful a gift can be, it was really debt that led to the invention of money. And actually, there’s an anthropologist who went back and studied it and they said, oh, there’s never been a society in the history of the world that’s ever existed, which is saying something, that’s relied on bartering is the principal means of exchange. Because bartering is what you do with someone you don’t know, like, okay, if I don’t see you, again, have to get a good amount of value for whatever I exchanged.
But if you know the person and they live in your community, you’re going to do an exchange. And so, I looked at 4000 years ago, actually 4000 BC, rather, there were financial loan documents. They were loaning out money to each other in ancient Mesopotamia. And it’s not until the seventh century BC that coins are invented. you have thousands of years where like, money was really debt. just as you think about a mile as a measurement of distance, think about money as a measurement of debt.
And so, as I traveled all over the world with my job, everyone looks at money in this way. It’s like a way to measure debt. And everyone has their own quirky ways of looking at gifts. I was in Japan and I gave a present to my friend and he said, “Kabir I cannot accept this.” Did I ask why not? He says, “I’ll never be able to repay you.” The word Japanese, arigato, means this difficult burden. There’s another word in Japanese called “sumimasen” which means, “I’m sorry, I cannot accept it.” So, they have all these strange cultural quirks in dealing with debt.
Even on Wall Street, JP Morgan CEO, Jamie Dimon, the billionaire himself. He keeps a list in a suit pocket. And what’s on that list are people who owe him something and people whom he owes. He’s keeping a list of his gift economy. we all do it. We all track who owes us and we all track whom we owe. And it’s this deep-seated psychology that if you want someone to do something for you, you have to give them a gift. You have to control them. when you give a gift to someone, you’re not just tying the price in wrapping paper, you’re tying the recipient to an obligation. And an obligation can be very, very powerful. I learned the power of gifts as not just a benevolent thing, but as a controlling and manipulative thing. And that gets back to the original currency, which is social debt.
Stig Brodersen 22:16
Kabir, this is so interesting. And I’m really happy that you told this story about Japan because whenever I was reading your book, I was feeling like how can the Japanese think about gifts that way? And just as you’re saying, everybody’s doing it, basically, because I know that if I receive some present from some people, perhaps people that don’t like, I feel bad about it, because then I feel like I’m indebted to them. And you might be thinking, well, because I don’t like that person. I might not care. But I just can’t wrap my head around because I still feel like I’m indebted to them. And now it’s just a very nasty feeling to have because you’re indebted to a person that you might not feel good about.
Kabir Sehgal 22:57
I think it gets back to biology because that goes back to ancient times. In caveman days, when you would go out and kill some game, you’d come back and bring it, you’d share it with your tribe because if you didn’t, and the time would come when you’d be hungry, you wouldn’t be invited to eat with everyone. And so, when you invite someone to eat with you, in ancient times, that was basically like a forged route or contract saying, “I’m going to hedge my future because ultimately, we need each other to survive.” That’s what gift-giving really highlights.
But money really introduces like an anonymous way to go about it. for example, if you go to Starbucks, and let’s say Starbucks, order a coffee, and the Starbucks barista lets you have the coffee for free. You may feel obligated to come to see her in the future, and there’s a relationship there. But if you just use money, then the relationship is over. a lot of people are happy to use money because it tapers over. You don’t owe anyone anything. Money formalizes it and it’s over. money’s an escape from the gift economy in a way.
Stig Brodersen 24:01
Kabir, it has been so great talking to you about money, you’re really a wealth of information. If you could recommend one book to our audience, or perhaps a few books that you have read to really understand money and finance, which book would that be?
Kabir Sehgal 24:17
I think one book that gets overlooked is one called “Second Nature.” It is by Haim Ofek. And it’s about the idea of exchange and how money’s really an instrument of exchange. And he goes into like, thousands of years of the caveman days, he goes into how fire was manipulated to form early currencies. it gets into the biological aspects of money. This book is a syllabus for most investors. Most investors are reading about the markets and so forth. But this is a very deep understanding of the conceptual origin of money. But I think more recently, obviously “Thinking, Fast and Slow,” Daniel Kahneman’s book. It is a great way to look at the biological cognitive biases that we deal with when it comes to money and investing. if you’ve not read that book, I would definitely recommend “Thinking, Fast and Slow.”
Preston Pysh 25:05
All right, Kabir, those are fantastic. And Stig and I, just for our audience, we just did an episode on “Thinking, Fast and Slow” And we have an executive summary of that book for anybody that’s interested.
Preston Pysh 25:15
But Kabir, thank you so much for coming on our show for our audience out there. The name of Kabir’s book is “Coined.” You go onto Amazon, you’ll see the reviews. I think he has a perfect five-star ranking, which is almost next near impossible to do on Amazon. That just tells you about the quality of the information in this book. Kabir, if the audience wants to learn more about your work, where do they go?
Kabir Sehgal 25:15
coinedbook.com. Thank you.
Preston Pysh 25:40
Yeah, absolutely. Kabir, thanks for coming on the show. We really appreciate your time.
Kabir Sehgal 25:45
My pleasure.
Preston Pysh 25:47
All right. this is the point in the show where we’re going to take a question from our audience and this one comes from Zachary Morton.
Zachary 25:53
Hey, Preston and Stig. This is Zach Morton. I am from Black Diamond, Washington. I’m a Seahawks fan. I love your show, despite your loyalty to the Steelers. But I’ve been listening to your show and going on your website and watching those videos for about a month now and learning about investing only for about a month. And it’s been my primary source of education. I have to say, it’s very helpful. And it’s well laid out, and I love it. please keep going. And please keep doing it.
And my question for you today is on Warren Buffett’s fourth rule for investing, which would be about the company being undervalued how undervalued does it need to be? So, for example, if you value the company at $40 per share, would you buy it at 39? Or does it have to be at 32? Or 30? Or 25? Or 20? Or what would you say a good rule of thumb is? Do you have any information on what Warren Buffett says about that? Or any other value investors? That’d be great. Thank you.
Preston Pysh 26:40
All right. Zachary, we just want to play the question to tell you we’re not going to answer it because you’re a Seattle Seahawks fan. that concludes our episode. I’m just joking.
So, Zachary, this is a great question. And this is the number one question I think Warren Buffett gets at all of his shareholder meetings. Everyone wants to know how do you do the intrinsic value calculation and what are the parameters of it and whatnot. the best way I can describe this and I think one of the best things that I ever heard in response to that question came from Charlie Munger, where he said, it’s all about opportunity cost. He said it’s all about opportunity cost when you’re doing intrinsic value.
And what he means by that is, there’s going to be times in the market where a lot of companies are undervalued, then there’s going to be times in the market similar to now where a lot of companies aren’t undervalued. And what he’s getting at is, it really depends on the circumstances and where you’re at any given point in time. when you look at a company and it’s undervalued, let’s say you think the value is at $40 and selling for $30. there’s a $10 discount per share. But this is the part that a lot of people miss. It’s based on a discount rate. It’s based on a certain percent yield for that price. Well, the interest values $40. And it’s trading for $30. that doesn’t mean anything to me. And the reason that doesn’t mean anything to me is that I don’t know what the yield is at that $30 price point if you think it’s worth 40.
So intrinsic value always has to have a discount rate attached to it. And when you have that discount rate, then you can compare it to other assets, like a bond, or whatever else you might be looking at, or another stock. when you understand that aspect of it, and you know that there has to be a yield associated with a subsequent price, then you can start saying, well, this one’s going to give me a 7% return, or at least that’s what I expect, based off my calculations. And this one over here is going to give me a 5% return. this one’s going to give me 2% higher of a return than the other choice. Let’s call it stock B and the other one stock A when you have that offset of 2%.
28:51
The next thing that you got to then look at is which one’s riskier and is that extra 2% worth it? If we come to the assumption or we come to the conclusion that both assets are equally risky, then we go with the one that’s going to give us 7% versus the 5%. And that’s the part that I think people need to understand is it’s this constant reevaluation of opportunity cost when you’re looking at the risk versus reward comparison. And that’s why you can’t really say, hey, it’s 5%.
Because let me give you an example, back in 2008-2009, when the market had an enormous crash, when we were looking at intrinsic values during that period, they were very high yield, like I’m saying it for stocks, well above 15%. When you look at today’s market, thinking about the market in general, as the S&P 500, you’re probably at about a 4% return. in today’s market, you’re going to be settling for a much lower yield simply because the conditions have changed. And that’s where people have to be very dynamic when they’re doing intrinsic value calculation.
Stig Brodersen 29:58
As you probably have seen on the videos we have on our site, we have provided calculators, and we have shown you how you can find the yield of these investments that Preston was just talking about. But guess what? Your calculation is nowhere better than the assumptions, the underlying assumptions. if you think that the company’s growing 6%, you come up with one result, if you think the company is growing with 8%, you come up with a different result. And since this is something that you have to estimate for the future, there is some room for error.
In theory, it’s very, very easy, but in practice, it’s really, really hard to come up with a finite intrinsic value. Now, I do want to say a few things. Obviously, the cheaper you buy the company. the better. If I can give you an example, say that you buy a company at a fair value, and that grows the intrinsic value with 10% a year. Now say that on the other hand, buy the same stock but a 50% discount to the intrinsic value, and that intrinsic value is still increased by 10%. Then you have an 18% growth in your portfolio.
As you can see from this very simple example, the cheaper you buy, obviously, you will get a higher return. The very interesting thing about investing is that if you go back and at least look at history, you will see that value is probably the best catalyst in itself. I know that you just started but Zachary as you go along and you learn more and more about investing, you will see that as long as you find that really cheap company, and perhaps a basket of dirt-cheap companies, you will see that you don’t necessarily need a catalyst. And when I say catalyst, it’s something like buybacks or regulation changes, something like that. If you are indeed buying way below the intrinsic value, you will see in a given period that the intrinsic value and the price will converge again, you will see that for almost all equities. It’s basically a matter of time.
Preston Pysh 31:55
So, I have a very important highlight to put into this mix when we’re talking about intrinsic value. And that comes from security analysis. And Ben Graham, Ben Graham says that it’s important to look at the safety of the security before you calculate the value of the company. And to not get sucked into doing it the opposite way around.
A lot of people, what they want to do is say, oh, this company is really undervalued. It’s a great pick. Now let me look at how safe it is to invest in. Ben Graham says make sure that you look at your safety barrier. First, you have to determine this is a safe asset for me to own. Then you look at whether the asset has a good return or not. And then you compare that to other safe assets. And then you see which one’s going to give you the best return. You got to do it in that order because when you don’t do it in that order, you’re going to get sucked into potentially buying something that has a lot more risk than what you were willing to do. I think that that’s extremely important for a lot of people to know as they’re conducting their intrinsic value of companies and know that that’s the method that Buffett and all of these other highly successful people. They always look at their safety first and then their return second.
That’s all we have for you guys this week. I just wanted to tell Zachary the books in the mail. Unfortunately, I’m going to have go Steelers written all over it when I mail it to you. And that is the Warren Buffett Accounting Book that we’ll be mailing out for anybody else out there, if you record a question, especially if you say that you’re a fan of anything other than Steelers. We will write go Steelers on the book, we will sign it and we will put it in the mail for you.
You can record your questions at asktheinvestors.com if you guys are curious, and you want to get your question played on the air. But we do want to thank Zachary for recording his question. That was a fantastic question. I know a lot of people out there have a very similar question and want to know more about intrinsic value. we really appreciate you recording that. That’s all we have for you guys. And we’ll see you guys next week.
Outro 35:39
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